F200 Final
Pacer Sports would like to set up a lock box collection system that would reduce it collection float by 4 days. The company receives an average of $3,000 in payments per day. If the opportunity cost is 10%, how much should the company be willing to pay per year for the lock box system?
$1,200 A Lockbox would save 4 days of collection float, which equals $12,000 (4 days x $3000) , that could be invested at 10% per annum. Additional interest income of $1,200 ($12,000 x 10%) could be earned and so that is maximum per year it should be willing to pay.
You are the CFO of the Final Four Sneaker Co. and you are looking to buy a competitor company. You are using the capital asset pricing model (CAPM) to determine your required return on the investment. Your team has provided the following data: the risk-free rate is 4.0% and market risk premium is 7.0%. They have also estimated the beta of the target competitor company is 1.5. The competitor's expected return based on its forecasted dividend and its current stock price is 16%. What is your required return under the CAPM, and should you buy the competitor if it can be purchased at the current stock price per share?
14.5% and yes, buy the competitor Required return per CAPM = 4.0% + (1.5*7.0%) = 14.5% Your required return is less than the current expected return of 16% and therefore as CFO you should buy the competitor (assuming you can buy it for the current market price).
The common stock of Company A has a beta coefficient of 2.0, and the common stock of Company B has a beta coefficient of 1.0. The risk free rate of return is 3.00% currently. The expected rate of return on the S&P 500 (a proxy for the average market expected return) Is 6.0%. By how much - what percentage - does Company A's required return exceed the required return of Company B's stock? You will need to calculate the required return for both Company A and Company B using the CAPM.
3.00%
Huppe Furniture Company management has forecasted 2022 Sales of $5,000,000 and EBIT or Net Operating Income (NOI) of $1,000,000. The company will incur $375,000 of interest expense on its total outstanding debt. The finance division has calculated the Degree of Operating Leverage (DOL) as 2.5. Dividends of $275,000 will be paid to the common shareholders. The companies marginal tax rate is 35%. What is Huppe's degree of total leverage (DTL)? Hint: you must first calculate DFL or the degree of financial leverage.
4.00 EBIT = $1,000,000 Interest = $375,000 Common dividends = $275,000 Marginal tax rate = 35% DFL = EBIT / EBT = $1,000,000/ ($1,000,000-375,000) = 1.60 DTL - DOL x DFL = 2.5 x 1.6 = 4.0
Utilizing the information in question 1 above for the Level One-up Company in 2021, calculate the number of days in receivable ... (round to closest whole number of days)?
46 days Receivables Period = 365 / Receivables Turnover • Average Receivables = (Beg Rec + End Rec) / 2 = 4,900 • Receivables Turnover = Credit Sales / Average Receivables= = 39,200/4,900 = 8.0 times • Receivables Period = 365/8= 45.6 or 46 days rounded to nearest whole number
What is the expected return of the following $100,000 portfolio of stock vestments? Stock Amount Return PEPPER $ 30,000 10.0% SALT 25,000 12.0% TARAGON 45,000 7.0% $100,000
9.15%
Which of the following types of organizations are considered financial intermediaries?
A. Commercial banks B. Life insurance companies C. Pension funds D. Credit unions Correct! All of the above
Which of the following statements are true?
A. Leverage, which is the presence of fixed costs (both operating and possibly financing costs), magnifies the effects of changes in sales revenue on operating and net income. B. It is important for financial management to consider and evaluate the effects of leverage on the company's creation of value for its stockholders, and to establish a target optimal capital structure. C. The greater a company's business risk inherent in its operations (measured by operating leverage), the lower the amount of debt that is optimal in its capital structure. D. A firm's optimal capital structure is the combination of debt and equity that maximizes the value of its stock price. Correct Answer F. All of the above are true statements.
Company A and Company B both have a Return on Assets ratio of 10% in 2020. Company A's Return on Equity (ROE) is 20% and Company B's ROE is 15%. Therefore we can conclude ... (hint: Refer to the Dupont Identity)
Company A has a higher debt to equity ratio than Company B
What are the Net Present Value [NPV] and IRR [IRR] percentage of the project? Please round your answers to whole numbers - for example $10,000 and 10%.
Correct. the Project Cash Flows are: YEAR0123456INITIAL OUTLAY -$269,400 OCF$73,050$82,230$72,285$66,930$66,165$62,340TERMINAL CASH FLOW $37,500PROJECT CASH FLOW-$269,400$73,050$82,230$72,285$66,930$66,165$99,840
Based on the calculations and analysis above, management should REJECT the proposal.
False
The debt and equity Capital Markets are the financial markets that companies access to finance short-term investments like Inventory and Accounts Receivable, while the Money Markets are used to finance long-term assets like a new new manufacturing facility or a new distribution center.
False
Tiger Golf Co. sells its custom golf shoes on credit terms because its competitors, NIKE and Foot Joy are also trying to increase market share. Tiger must have a credit policy that covers which of the following:
How customers qualify for credit. You Answered The maximum credit that a customer can be allowed. The specific terms of the credit arrangement between the company and the customer. Specific steps and actions that will be taken if the customer does not pay part or all of the amounts due on a timely basis. Correct Answer All of the above.
Financial Managers in a company are focused on value creation and a key element is operating cash flow generated by the business. Which of the following would likely increase value for the owners of the business?
Increasing the annual cash flow of the business Reducing the operating or financing risk of the business Accelerating the timing of cash flows to an earlier period Correct! All of the above
If you have $10,000 to invest for 5 years and can chose either an investment in alternative A that pays interest at a rate of 7.0% compounding semi-annually (every 6 months), or investment B that has an interest rate of 7.0% compounding every day, which investment should you chose?
Investment Alternative B Investment B is compounding daily whereas Investment A is compounding semi-annually. therefore Investment B has a higher EAR (higher return on investment) and is better for the investor because the interest it earns is compounding more frequently.
Which of the following choices are advantages of the corporate form of business organization?
Limited personal liability of the owners for debts of the corporation and Ability to attract new investors and other funding sources.
Generally financial managers in a company are focused on what primary goal in their decision making process?
Maximizing the value of shareholders' equity (Owners' investment in the business)
The Grant Company is considering two options for credit terms for its customers. The first option (1) is net 45 days and would generate $75,000 in annual sales and the finance team estimates the average collection period (DSO) would approximate 50 days. The second option (2) is Net 30 which would generate $70,000 in annual sales and a DSO of 35 days. The operating expenses are estimated to be 65% of sales and the cost of funds is assumed to be 14%. The finance team has run a number of scenarios and they have concluded the net present value of option 1 is higher than option 2. Which option should the finance team recommend to senior management?
Option 1 because it has the higher NPV
Google management is evaluating whether they should get into the ride sharing business. Uber is currently the market leader in this business segment. The company generally uses NPV analysis to evaluate these decisions. The CFO of Google has asked you to evaluate the Market risk of the project and advise her on the appropriate discount rate (required rate of return) to be applied to the project's forecasted cash flows. You advise her to use ...
The required rate of return (discount rate) using Uber's beta coefficient in the CAPM.
The process of evaluating a capital budgeting opportunity uses the same concepts used in valuing and evaluating a financial asset, like a stock or bond: 1) determine/estimate the future positive cash flows the project is expected to generate over its useful life; 2) Estimate the required return on investment based on the risks of the project 3) Compute the present value (PV) of the estimated future cash flows using the data from steps 1) and 2) and then 4) Compare the computed PV of the positive future cash flows to the project's total cost (may need to compute the PV of such costs if they occur over a long period of time).
True
The total risk of any investment, (i.e., a stock, a bond or any other investment asset) can be divided into two risk components: "diversifiable risk" and "nondiversifiable risk". Diversifiable risk or firm-specific risk is not of concern to informed investors as the investor can reduce or even eliminate this risk by investing in a diversified portfolio of investments, for example investing in a mutual fund or ETF (exchange traded fund) with exposure to the companies included in the S&P 500 index (rather than investing in just one company, for example Amazon).
True
When performing financial statement ratio analysis, it may be difficult to compare some of the ratios of two companies in the same industry if their accounting policies are different in key areas, for example different inventory and cost of goods sold policies.
True
Which of the following are components of financial statement ratio analysis?
a. Calculation of each firm's basic financial ratios, including profitability, liquidity, asset management and debt management ratios. b. Comparison of each firm's ratios over several time periods - trend analysis. c. Comparison of ratios among firms in the same industry - competitor analysis. d. Research the reasons why the company's ratios are better or worse than prior periods, or its competitors Correct Answer e. All of the above
The Chief Financial Officer's (CFO) key subordinates are the Treasurer and the Controller. Which of the following are generally the responsibility of the Treasurer?
a. Direct responsibility for managing the firm's cash and marketable securities b. Planning how and when the firm is financed with debt and equity funding. c. Assisting management with capital budgeting decisions related to material fixed asset purchases. d. Assisting the credit management team on extending financing terms to customers (i.e., Accounts Receivable) All of the above
Which of the following are possible mechanisms applicable to large corporations that motivate managers to act in the best interests of the shareholders?
a. Managerial compensation (incentives) b. Shareholder intervention c. Threat of a takeover by an outside entity Correct! d. All of the above
Which of the following are a disadvantage of the proprietorship form of business organization?
a. Unlimited personal liability for business debts b. Limited to life of the individual who created the proprietorship c. Potential for ownership transfer issues d. Difficulty raising large sums of capital Correct! All of the above
Tesla's management is evaluating a capital (budgeting) project that would involve building a factory in North Carolina that makes electric pickup trucks. The current factory in this area makes electric cars. This type of capital project could be characterized by management as a/an _____ .
expansion decision Correct, Capital budgeting projects can be characterized as Replacement or Expansion projects. Additionally our analysis needs to consider any constraints or limits to the analysis resulting in the characterization that the projects are either Independent or Mutually Exclusive. In this case the company is expanding it production capacity into a new market - electric pickup trucks.
One reason a firm might consider using bonds (debt) to finance a new long-term investment opportunity is ...
financing with bonds (debt) is generally cheaper than financing with equity capital
There are three major forms of business organization in the United States. They are the corporation, proprietorship, and Partnership .
partnership
Pete's Tavern in New York City is a well known restaurant and bar. The company's balance sheet at the end of 2020 reported total assets of $1.7 million and total liabilities of $700,000. Pete's Return on Equity (ROE) for the year was equal to 10.5%. What was the net income for Pete's Tavern in 2020?
$105,000
Lebron Shoe Design Company is evaluating expanding with 5 new stores and estimates it will cost $200,000 to make tenant improvements in the five stores before opening and then the five stores will generate in total cash flow net of expenses of $75,000 per year over the 7 year life of the store leases. Assuming the company uses a 10.0% required return based on the CAPM to evaluate such projects, what is the estimated net present value of the capital expansion proposal?
$165,131
The Excel spread sheet included in the instructions to this quiz details a capital budgeting proposal for a new piece of equipment for your company that will replace an existing piece of equipment (replacement project). You are the financial manager that will explain the proposal to the senior management. What is the (tax) depreciable basis of the new equipment proposed?
$255,000
The initial cash outlay of the proposal includes: the cost of equipment, installation costs, any increase or decrease (change) in working capital, and the proceeds on selling (salvage value) the old equipment that is being replaced, net of any tax on the gain or loss on the sale of the old equipment. The initial cash outlay of this proposal is ...
$269,400 New Equipment = ($225,000) Installation cost = ($30,000) Proceeds of sale of old equipment, net of taxes = $5,600 Increase in Working capital = ($20,000) (positive increase in cash flow at time of installation) Net outflow at inception of Project = $269,400
You are the CFO of a company that plans to invest an amount of money in a three (3) year certificate of deposit (CD) at a local bank. The stated interest rate applied to the CD is ten percent (10%), and is compounded annually and paid out at the end of the third (3rd) year. At the maturity of the CD the funds are to be invested in a new headquarters. How much must the company invest in the CD today, if your staff has determined the balance in the CD account must be $4,000,000 at the end of year three (3) to cover the purchase price of the headquarters? (HINT: First ask are you solving for a present (or current value) or a future value?)$3,005,259
$3,005,259
Last year, in 2021, the Joaquin Agave Tequila Company retained $325,000 of its net income of $650,000. This year the company expects sales to stay the same but marketing expenses will be higher due to greater competition. Management is forecasting 2022 net income of approximately $600,000. The company follows a constant payout ratio dividend policy. Based on this year's net income forecast, how much is Joaquin budgeting for dividends to its stockholders in 2022?
$300,000
The future value (FV) of an investment of $25,000 today that earns a 7.5% annual return and pays out all cash five years from today is what dollar amount? (pick the closest whole dollar amounts)
$35,890 25,000 * (1+.075)^5 = 25,000 * 1.4356 = $35,890 Financial calculator inputs: N= 5 (periods), PV = 25,000, r= 7.5%, PMT = 0, solve for Future Value (FV) = ?
The Rocket Growth Company has a common stock outstanding that pays a current dividend of $2 per share. Investors expect the dividend to increase 15% by the end of the year and thereafter to grow at a rate of 4% annually. The same investors would like to earn a return of 10.00% on securities with that particular risk. You own some of these Rocket common shares and would like to sell them to one of these investors - what is the approximate price per share that you expect to receive from an investor? (Hint: Use the Dividend growth model/formula.)
$38
Smith & Rock Entertainment Inc.'s CFO has determined the optimal capital structure is 30 percent debt and 70 percent equity. The company's WACC is 12% assuming the amount of earnings that can be retained and reinvested is adequate to fund the total equity portion (70%) of the current year's proposed capital budget. However if the capital budget requires the company raise new equity by issuing new common shares then the WACC will increase to 15%. The CFO estimates net income will be $400,000 this year and it pays dividends in accordance with the residual policy. It has two large independent capital projects being proposed: Project A is a $500,000 project (cost) with an IRR estimate 17.0% and Project B is a $450,000 project with an estimated IRR of 14%. The company follows a residual dividend policy. What is the expected dividend payout for this budget year? (hint: see assigned problem 13-18)
$50,000 The company's optimal capital structure is 30% debt and 70% equity. It has two proposed capital projects totaling $950,000. Net income is estimated at $400,000 and if it all of it was retained for capital projects then that amount plus new debt could fund projects totaling about $571,000 ($400,000 / 70%). Therefore the company would have to raise new equity funding in order to do both projects and if that is required the cost of capital (WACC) increases to 15% as stated. Project B has an IRR estimate of 14% and therefore does not meet the new higher WACC hurdle of 15%. Only Project A should be approved - the estimated cost of $500,000 would require retention of $350,000 of the forecasted net income of $400,000 ($400,000 x 70%= $350,000). The remaining funding for this project would be new debt of $150,000. If the company retains $350,000 of earnings for project A, then under Residual dividend policy it can pay dividends to shareholders of $50,000 ($400,000-$350,000).
J&J Medical Supplies expect to sell 12,000 medical imaging machines this year. Each machine costs J&J $2,000 to purchase from China. Inventory carrying costs are 45% of the purchase price, and the cost of placing an order is $120. If the EOQ or Economic Order Quantity is 70 units. What is the total inventory cost (carrying and ordering costs) at that EOQ level?
$52,071 T = 12,000 PP = $2,000 C = 45% O = $120 Q = 70 Total inventory cost at EOQ that is 70: [120 (12,000/70)] + 2000 (.45) (70/2) = $20,571 + $31,500= $52,071
Bumble Company is planning an IPO and management is meeting with their investment bankers to discuss the pricing strategy for this first time offering of the company's shares to the public. Bumble's CFO has spent a lot of time researching the price to earnings per share ratios (P/E Ratios) of several competitor companies, including Match which currently trades between $100 and $125 per share. The P/E ratios of the various publicly traded competitor companies range from 20-25x the next year's forecasted earnings per share. Bumble's Chief Financial Officer is forecasting Bumble's next year's earnings per share will be $2.80. She expects the Investment Bank to discuss a price range for the Bumble IPO of ...?
$56-$70 per share
General Motors (GM) issued a 10-year bond 2 years ago with an interest coupon of 4.0% that is paid annually. At maturity in 8 years, a single GM bond will pay out $1,000. If investors currently require a return of 5.0% on bonds with GM's risk profile, what should be the market price the buyer should expect to pay on the bond? (round to nearest $ amount) (Hint: The bonds are paying a rate lower than the expected return of the investors.)
$935
America Airlines decides it needs to raise $90 million of cash liquidity to last through the cycle of the pandemic downturn. If the company issues new common shares to raise the funds, the flotation costs will be 6% to the underwriter and there are an estimated $1 million of out-of-pocket expenses for lawyers, accountants, printing, etc. The underwriter is confident the shares can be sold for $50 per share. How many shares must American issue in order to have $90 million of proceeds after all of its expenses and floatation costs (round up your solution to whole number of shares)?
1,936,171 shares
Your are considering an investment in a company that paid dividends of $2 per share at the end of last year and expects its dividends to grow by 2% per year for the foreseeable future. The company's stock is currently selling for $25.50. What is the expected rate of return?
10.0%
24x7 Hamburgers Inc. currently has a capital structure of 20 percent debt, 30 percent preferred stock and the remainder is equity common stock and retained earnings. The finance department estimates that new capital in the form of debt would have an after tax cost of 4.0%, the cost of the preferred would be 8.0% and the cost of equity (estimated cost of a blend of new equity and the current year's retained earnings after dividends) would be 14.0%. Assuming all capital projects have the same risk profile as the company currently, what is the company's estimated weighted average cost of capital (WACC) for this year's capital budgeting plan?
10.2% Debt 20% x 4.0% = .80% Preferred Stock. 30% x 8.0% = 2.40% Common Stock/Retained Earnings. 50% x 14.0% = 7.0% WACC= 10.2%
Compute the traditional payback period for an expansion project that costs $700,000 and that is expected to generate incremental net cash flows of $200,000 per year. If the management team cannot recommend any projects that have a payback period longer than 3 years should they go ahead and recommend this project to the company's board of directors? Calculate the payback period and decide whether management should approve and recommend the expansion.
3.5, no, do not approve the project
Utilizing the information in question 1 for Level One-up Company, what was the full cash conversion cycle for the company in 2021? Hint: You will first need to calculate the Days Payables Outstanding - again round to closest whole number of days.
34 days The cash conversion cycle calculates the time it takes to convert inventory into cash. It is composed of three categories: the days sales outstanding, plus the days inventory outstanding less the days payable outstanding . Days sales outstanding is the amount of time a company takes, on average, to collect accounts receivable. Days inventory outstanding is the amount of time, on average, a firm takes to convert inventory to sales. Days payable outstanding or the payables deferral period is a firm's average period of time the company takes to pay its vendors . • Cash Conversion Cycle = Receivables Collection Period + Inventory Conversion Period - Payables Deferral Period 1) First calculate the Payables Deferral Period • Payables Period = 365 / Payables Turnover • Average Payables = (Beg Pay + End Pay) / 2 = 4,320 Payables Turnover = COGS / Average Payables = 21,600/4,320 = 5.0 • Payables Period (# of days) = 365/5 • Payables Deferral Period = 73 days 2) Then calculate the Cash Conversion Cycle = 61 + 46 - 73 = 34 DAYS
Auto Pilot Car Company had earnings per share of $4 per share last year and it paid a $2 per share in dividends. Total retained earnings increased by $10 million during the year. Auto Pilot has no preferred stock, and no new common stock was issued during the year. The company has how many common shares outstanding during the year?
5 million
The US Federal Reserve is forecasting the rate of inflation for the years 2022, 2023 and 2024 will be 4.5%, 3.0% and 2.5%, respectively, and then 2.0% every year thereafter. If you assume the real risk free rate for bonds that mature in 5 years is 3.0% (and it already reflects a maturity risk premium of .15%), what is the nominal risk-free rate for bonds maturing at the end of the same 5 years?
5.80%
Today you sold your 100 shares of Apple Inc. for $75 per share. You had purchased the shares exactly one year ago today for $50 per share. Apple Inc. had also declared and paid dividends equal to $1 per share each quarter (every 3 months) during the one year period of your ownership. What is the total return (yield - percentage) on your investment that you earned during the one-year time that you owned the shares?
58% Similar to assigned text book problem 7-3 Capital gain yield: ($75-$50) / $50 = 50% Dividend yield: 4x $1 = $4 annual dividend $4/$50 = 8% Total return or yield = 58%
Level One-up Company The Balance Sheet and Income Statement of the Company as of and for the twelve months ending December 31, 2021 shows the following information (in thousands): Opening (i.e., beginning of the year) and Ending balances Accounts Receivable: Opening $4,500, Ending $5,300 Accounts Payable: Opening $4,100 Ending $4.540 Inventory: Opening $3,000, Ending $4,200 Sales on Credit (12months) $39,200 Cost of Goods Sold (COGS) (12 months) $21,600 QUESTION: Using this information, how many days are in the Inventory Conversion Period for the year (ROUND TO THE NEAREST WHOLE DAY IF NECESSARY)?
61 days Inventory Period = 365/Inventory Turnover • Inventory Turnover = COGS / Average Inventory • Average Inventory = (Beg Inv + End Inv) /2 = $3,600 Inventory Turnover = COGS/AVE INV = 21,600/$3,600 = 6.00 times • Inventory CONVERSION Period = 365 / 6.0 = = 60.8 = 61 days rounded IT TAKES ABOUT 61 DAYS FOR INVENTORY TO TURNOVER
The Lebron's Sporting Goods store in downtown Los Angeles reported net income after taxes equal to $150,000 in 2020. Revenues were $2.1 million, Cost of Good Sold were $735,000 and Depreciation Expense equaled $60,000 in 2020. What was Lebron's gross profit margin percentage in 2020 (round your answer to one decimal point - i.e., 50.1%) ?
65% Gross Profit $ = Sales (revenues) - Cost of goods Sold: $2,100,000 - $735,000 = $1,365,000 Gross Profit Margin = Gross Profit $/Sales (Revenues) $1,365,000/ $2,100,000 = 65.0%
Brentwood Co.'s management would like to estimate investors' required rate of return on Brentwood's common stock using the CAPM. The current risk free rate is 2.0%, the overall market required return is 6.0%, and management estimates the beta coefficient appropriate for the company is 1.5. What is the estimate of investors' required rate of return on the company's stock using CAPM? HINT: YOU MUST CALCULATE THE MARKET RISK PREMIUM.
8.00%
In January 2022 Eli Lilly (Company) issued $500 million of corporate bonds at their par and maturity value of $1,000 per bond. The bonds have a stated coupon rate of 6% at issuance. Which of the following statements would be true?
A. In February 2022, the market interest rate required by investors equals the coupon rate of the Company's recently issued bond, and therefore the market value of each bond is its par value. B. In February 2022, the market interest rate required by investors is higher than the coupon rate of the Company's recently issued bond, and therefore the market value of each bond is lower than its par value (the value of each bond has decreased and is trading at a discount to its par value). C. In February 2022, the market interest rate required by investors is lower than the coupon rate of the Company's recently issued bond, and therefore the market value of each bond is higher than its par value (the value of each bond has increased and is trading at a premium to its par value). Correct Answer D. All of the above statements are true.
The relevant cash flows that are included in the evaluation of any capital budgeting project are only those incremental cash flows affected by the decision to proceed with the project. If a cash flow does not change as a result of the decision to proceed with the project (invest in it), it is not relevant to the analysis and decision (NPV and IRR analysis). Which of the following incremental cash flows should be included in our evaluation of the projects NPV?
A. Initial investment outlay (e.g., purchase price of the equipment) B. Any installation costs associated with the project with C. Sunk costs (e.g. the cash already paid to a consultant to evaluate the environmental impact of the project. D. Opportunity costs (e.g., the value of land that company already owns but that would be used for the project if approved) E. Supplemental operating cash flows including any incremental working capital required by the project. F. Answers A, B and E. Correct Answer G. Answers A, B, D and E.
Sales Force borrowed $150 million for 360 days from Chase bank. The interest on the loan is 10 percent. Sales Force has no cash balances in its accounts with Chase at the time of this loan. Calculate the APR and rEAR assuming the loan is a simple interest loan and has a 20% compensating balance requirement.
APR = 12.5% and rEAR = 12.5% 150 million x 10% (360/360) = $15,000,000 APR = 15,000,000 / ($150,000,000 - 30,000,000) = 15,000,000 / $120,000,000 = .125 or 12.5% rEAR =[ (1.125) ^ 12/12] - 1 = 12.5%
The Treasurer of the company asks you to calculate the present value (PV) of a series of cash flows: $10,000 received at the end of each year for the next 10 (ten) years using a discount rate of five percent (5.0%). You calculate the amount, using those assumptions. However, before you can communicate your results, the CFO informs you that new information indicates the project has greater risk and a higher return threshold. She asks that you revise your calculation on an eight percent (8.0%) discount rate. Based on this new information, the PV amount calculated in the second calculation would be higher or lower than the first calculation?
As the discount rate applied to the calculate the PV of the series of cash flows is higher (more risk), the PV of the cash flows will be lower.
North Star Breweries' net income for 2021 was $1.2 million. The company's marginal tax rate is 40 percent and its interest expense on its debt for the year was $1.5 million. There is $15 million of invested capital in the business and the company's average cost of funds was 18 percent over the past year. What is North Star's economic value added (EVA) for 2021?
B. ($600,000) or - 0.6 million
The new equipment will increase cash flow by reducing annual expenses by $7,500.
False
A stock split and a stock dividend both require shareholders to invest new cash in the company.
False Both a stock split and a stock dividend result in an increase in the number of shares of outstanding stock but do not require stockholders to invest any additional funds.
In a corporate (form of organization) business entity the "agency problem" is described as the potential for conflict between two parties -- the principals (outside shareholders) and the company's customers.
False The Corporate form of organization has a potential for conflict between two parties -- the principals/owners (outside shareholders) and the management as agents on certain issues (for example budgeting financial performance for the upcoming year, including incentive compensation for the managers).
The CAPM includes several elements including the risk free rate, the market risk premium (which is the current required rate of return on an average portfolio of stocks less the risk free rate), and a beta coefficient, which measures the relative risk of a stock to the overall systematic or market risk of an average portfolio of stocks. If the ABC Company stock has a beta coefficient of 2.0 and the XYZ Company has a beta coefficient of 1.0, then we can conclude that investors in the ABC Company would require an investment return that is double the required return for investors in XYZ Company. (Hint: Look carefully at the CAPM equation before answering).
False - The Beta Coefficient is only applied to the Market Risk Premium in the CAPM equation. The risk free rate element of the CAPM is not impacted by the Beta Coefficient. See Problem 8-2 in CFIN7.
Financial statements contain important information on the company's operations, assets and financing, and are utilized by which of the following interested parties?
Financial Managers Creditors Shareholders (owners) Potential lenders to, or investors in, the company Correct!
ABC Company and CBS Company are rated "A" and "BBB", respectively, by the credit rating agency Standard & Poor's. If the ABC Company bonds were going to be sold with a yield of 6.00%, an investor considering buying the bonds of both companies, would likely require a higher rate of return on the CBS Company bonds to compensate them for the higher risk of the CBS bonds Vs. the ABC bonds.
Higher A BBB credit rating implies more risk to an investor than a single A rating and if CBS Company's bonds have higher risk, then investors would expect to receive a higher return on their investment for taking that risk.
The driving service VIA's financial team has estimated and calculated the cash flows and Modified IRR's of two independent projects (i.e., they could do both projects). Based on the estimated cash flows Project A has a Modified IRR of 15%, while Project B has Modified IRR of 16%. Management's minimum required investment return for the projects like these is 20% based on the capital asset pricing model (CAPM). Management should ...
Neither one should be pursued
Given the following information about the risk free rate, the market risk premium and the beta coefficient of Budget Company's common stock, if the stock currently pays an annual dividend of $2.00 per share and the expectation is that dividend will grow 2% each year into the future, would you buy this stock if it was currently possible to purchase it for $20 per share on the NYSE?
No it would not make sense to buy the stock at $20 as the required return is greater than the expected return.
You are a finance team member at Rolls Royce and you have been asked to justify the monthly staffing effort that is put into managing the working capital of the business. You believe it is important to identify the various strategies currently utilized to manage working capital in the business. Which of the following would you include in your list?
Preparing a monthly cash budget forecast so funds can be invested or borrowed on a timely basis. C. Establish and implement a short-term marketable securities investment policy. D. Collect cash on accounts receivable in an efficient manner based on an established credit policy. E. Use an economic ordering quantity model or an EOQ to determine the optimal amount of inventory to be carried at any point in time. Correct Answer F. Answers B, C, D and E.
Investors find financial ratio analysis of large, multidivisional firms tends to be more challenging than analyzing simpler companies competing in only one industry sector.
True
A company's annual financial statements include a Balance Sheet and an Income Statement and a Statement of Cash Flows. The Balance Sheet is as of a certain date - for example December 31, 2020 and is a "snap shot" of the firm's resources (assets) and how they were funded or paid for (liabilities and equity) by the company. The Income Statement covers a certain period (e.g., 12 months) - and is more like a "movie" - providing detail on the company's revenues earned and expenses incurred. The Statement of Cash Flows shows how the firm generated cash (inflows) and how the firm used cash (outflows) during a particular accounting period. If the firm uses more cash than it generates through normal operations, it is sometimes referred to as deficit spending. Deficit spending must be financed with external financing from either stock or debt investors/lenders.
True
A corporation that plans to raise funds will usually work with an investment bank to structure the transaction. If the investment bank agrees to underwrite the securities to be issued, then the investment bank is taking the risk that the securities will be sold.
True
Generally, if management of a company is able to consistently make investments and operating decisions that result in returns on the assets (investment) greater than the cost of the debt and equity capital funding the business, then management is creating value for the owners (shareholders).
True
If the normal shape of US Treasury securities yield curve is upward (positive) sloping and short-term interest rates are lower than long-term interest rates, one explanation for a downward sloping yield curve would be that investors expect inflation to decline in the future (See Figure 5.5 in your textbook - Illustrative Yield Curves for Treasury Securities).
True
In addition to the operating cash flow (OCF) for year 6, the final year of the proposal's cash flows also includes the salvage value of the new equipment, net of any taxes on the gain or loss, and reverses the positive or negative cash flow impact associated with the working capital requirement of the project.
True
In the process of evaluating capital budgeting projects, we must consider stand-alone risk, market risk and corporate risk. Stand-alone risk is generally evaluated using sensitivity and scenario analysis on the various cash flow inputs (e.g., the expected increase in sales volume). Market risk can be assessed and adjusted using the Capital Asset Pricing Model. Although each of these three risk areas should be considered independently, generally we should be aware that if the risk associated with a capital budgeting project differs substantially from the average risk of the firm's existing assets (businesses) then some adjustment (up or down) to the firm's average required rate of return should be considered when evaluating the project (NPV and IRR analysis).
True
Management is trying to optimize its capital structure to reduce its WACC and maximize the equity value for its stockholders. Adding more debt as a percentage of total capital may be attractive due to the debt investors lower return expectations, and the fact that debt interest is a tax expense that lowers taxable income (whereas dividends to shareholders are not tax deductible in the United States). Too much debt leverage however increases the risk of financial distress in recessions or unanticipated events like the Covid virus related shutdowns - therefore management must use their best judgement in determining how much is too much debt in their quest to lower the company's WACC and maximize shareholder value.
True
Maximizing value for shareholders' is the primary goal of corporate finance. The Time Value of Money (TVM) concept has broad application in corporate finance. The term Discounted Cash Flow Analysis is used to describe the application of TVM to business cash flow opportunities. It can be mathematically represented as: Value = Cash Flows ( 1 / (1+r) ^n)), where Cash Flow represents the Magnitude or dollar amount, n represents the Timing, and r represents the Risk of the cash flows. Finance managers analyze opportunities to improve these three inputs - magnitude, timing and risk - to increase value for the shareholders.
True
Open market stock repurchases, wherein the company systematically is a buyer of its own common shares in the public financial markets, have become a popular strategy of large public companies to add value to shareholders. This strategy has the benefit of not locking the company into paying a higher dividend - therefore it provides more flexibility. The stock buy-back strategy also: 1) reduces the number of shares outstanding, and therefore contributes to an increase in the Earnings Per Share (EPS) of the company, 2) should benefit the shareholders by increasing the market price per share of the stock, and 3) does not create a taxable event for the shareholders.
True
The CFO of SalesForce has just received two new proposals that are considered mutually exclusive capital projects. Therefore, she must rank the projects based on the firm's preference for IRR criteria, but she knows that she may not end up with a clear ranking of the two projects. Using the Net Present Value (NPV) method instead of IRR as the second measure should generally provide a consistent and clear ranking of the projects and therefore resolve her issue.
True
The equity capital markets are described as having three categories of activity. The first two occur in the Primary market and are 1) the Initial Public Offering (IPO) by a company, and 2) any additional offerings of shares for sale by the same company. The 3rd is the trading (buying/selling) of the company's shares between third parties (investors) which is said to occur in the Secondary market. Primary market transactions are capital raising transactions for the company as the proceeds of sale, net of various expenses, go to the company to finance some aspect of the business.
True
The financial ratios Net Profit Margin, Return on Assets and the Equity Multiplier are all elements of what financial professional know as the Dupont Identity, which is used to analyze the financial ratio Return on Equity (ROE).
True
The managers of a public company that has net income during the period must make a decision as to how much of the net income will be paid out as dividends and how much of net income should be invested back into the business as Retained Earnings (balance sheet).
True
We have learned as financial manager's that the company's goal is to maximize shareholder value. We have also learned that management should approve capital budgeting projects that meet or exceed the firm's WACC. Therefore companies that have many acceptable capital budgeting projects may pay little or no dividends because earnings from operations are retained and re-invested in the firm (source of financing capital projects). This growth oriented strategy is often attractive to investors.
True
The new equipment is expected to increase cash flow by facilitating incremental sales of $90,000 each year.
True Revenues are forecasted to increase from $310,000 to $400,000.
Tres Amigos Tequila Co. currently has $5 million in total liabilities and $5 million of common equity and retained earnings in its capital structure. There is no preferred stock on the balance sheet. The CFO has prepared a schedule for the Board of Directors that shows the impact of changing the capital structure by adding more debt. Based on the current capital structure, the company's current earning forecast for 2022 is Earnings Per Share (EPS) of $2.50 and the stock is trading for $10.0 per share. The CFO's schedule shows that if the company increases the amount of debt in its capital structure by $2 million to fund all 2022 capital projects, the firm's WACC will decrease. The CFO estimates the EPS under this capital structure will be $2.30 per share in 2022; however, the stock would be expected to increase in value to $12.0 - $13.0 per share. The CFO has hired an investment bank that confirmed the conclusions summarized in the schedule. Should the Board of Directors approve the recommended $2 million increase in the amount of debt in the capital structure?
Yes, the Board should approve the recommendation. Although EPS is lower, the goal is maximize shareholder value and lowering the WACC for future capital projects is consistent with the objective of maximizing value as indicated by the stock price which is expected to increase from $10 per share to a $12-$13 range.
Management is considering a number of expansion and diversification opportunities in the current budget cycle. Each option requires significant upfront investments before generating positive cash flow over different time frames. Management has estimated the firm's required return on each opportunity based on an assessment of the risks. Generally, which of the following strategies is likely to create wealth for the owners (shareholders) over the long run?
d. Consistently making investments in those capital projects with a positive Net Present Value based on the company's estimated required return on the investments. Correct. Management teams that apply a consistent policy and practice of estimating the positive and negative (investment) cash flows of a project and calculating the net present value based on the company's required return and accepting only those that deliver a positive NPV are most likely to create wealth for their shareholders over time.
The CFO of Eli Lilly is considering building more manufacturing capacity. It has identified two locations. One is in Indiana and the other is in the state of Kentucky. When management is considering independent capital projects, which of the following capital project finance concepts would be important to calculate and consider for each alternative?
the Net Present Value (NPV) of each potential location. the project locations' Modified Internal Rate of Return (MIRR). the expected Discounted Payback Period for each location. Correct! All of the above methods as each provides different perspectives. Correct. Financial Managers generally will calculate and evaluate all of these methods (NPV, Modified IRR, and Payback or Discounted Payback Period) when assessing a capital budgeting project.
Tesla must carry inventory to meet demand from its customers. If the item is not in inventory the production process is interrupted and costs go up significantly. However, Tesla's finance managers are concerned about carrying too much material inventory as they borrow money to finance the inventory on hand which can prove to be expensive. Management therefore spends a considerable amount of time evaluating ______?
the demand for its products over the next period. the costs associated with holding a sufficient amount of inventory - both financing, storage, transportation and other costs the costs associated with not having enough inventory to satisfy customer demand. the EOQ model or economic ordering quality model to determine the optimal amount of inventory to maintain. Correct! all of the above.