Fin 310 exam 1 review

Given an interest rate of zero percent, the future value of a lump sum invested today will always: A. Remain constant, regardless of the investment time period. B. Decrease if the investment time period is shortened. C. Decrease if the investment time period is lengthened. D. Be infinite in value.

A

New Century Products is a company that was founded last year. While the outlook for the company is positive, it currently has negative earnings. If you wanted to measure the progress of this firm, which one of the following ratios would probably be best to monitor given the firm's current situation? A. Price-sales ratio B. Market-to-book ratio C. Profit margin D. ROE

A

Suppose Miller Inc. is able somehow to reduce its fixed assets without affecting the company's operations, sales, net income, or equity. This reduction will decrease which of the following ratios? A. Capital intensity ratio B. Return on assets C. Total asset turnover D. Return on equity

A

Which of the following is an advantage of the corporate form of organization? A. Corporations can easily raise capital and its ownership can be transferred easily. B. Corporations can be started easily and face little regulation. C. Owners of corporations have unlimited liability and full control. D. Corporations pay taxes on income before dividends to their owners.

A

Which of the following statements about the corporate form of ownership is FALSE? A. The shareholders are the owners of the firm and hold the top priority claim among all stakeholders. B. The shareholders elect the directors of the corporation, usually in uncontested elections. C. The directors appoint the firm's management, and yet managers usually participate in nominating new candidates for directors. D. Separation of ownership from control can cause agency problems where managers act in their own interests, rather than shareholders' interests.

A

Which of the following statements is CORRECT? A. Shareholder's equity is the residual value of a firm B. Net working capital must be a positive value C. An increase in cash reduces the liquidity of a firm D. Equipment is generally considered a highly liquid asset

A

Which of the following statements is FALSE? A. The effect of compounding is great over short time periods, but then it begins to decline as the horizon grows. B. Moving cash flows to the left on a time line is called discounting, and values are additive at any one point in time. C. Future value refers to the amount of money an investment will grow to over some period of time at some given interest rate. D. To estimate the present value of future cash flows, the discount rate should be adjusted for both the timing or maturity of that cash flow and the inherent risk of that cash flow.

A

Which of the following statements is TRUE? A. The marginal tax rate for most U.S. corporations prior to 2018 was 35% while the average tax rate actually paid across U.S. corporations had actually been closer to 25% B. A Limited Liability Company (LLC) is legally defined as a person, while a corporation with limited liability is considered a partnership of several persons C. The ability of a corporation to grow can be seriously limited by an inability to raise cash via the primary capital markets for investment. D. According to the theory of the firm, among all stakeholders, the stockholders take the least risk.

A

Which one of the following is most apt to align management's priorities with shareholders' interests? A. Compensating managers with shares of stock that must be held for 3 years before the shares can be sold B. Allowing a manager to decorate his or her own office once he or she has been in that office for a period of 3 years or more C. Increasing the number of paid holidays that long-term employees are entitled to receive D. Allowing employees to retire early with full retirement benefits

A

Which one of the following statements is true concerning the price-earnings (PE) ratio? A. A high PE ratio typically indicates that a firm is expected to grow significantly. B. A PE ratio of 16 indicates that investors are willing to pay $1 for every $16 of current earnings. C. PE ratios are unaffected by the accounting methods employed by a firm. D. The PE ratio is classified as a profitability ratio

A

Based on the information below, calculate the sustainable growth rate for Southern Lights Co. Briefly discuss whether you believe this growth rate is actually sustainable. Profit Margin = 8.4% Capital Intensity Ratio = 0.45 Leverage Ratio = Liabilities / Equity = 0.60 (described in the RWJ text as the Debt-Equity Ratio) Net Income = $95,000 Dividends = $40,000

Asset Turnover = 1 / Capital Intensity Ratio = 1 / 0.45 = 2.22 Equity Multiplier = 1 + Leverage Ratio = 1.60 ROE = Profit Margin * Asset Turnover * Equity Multiplier = (0.084)(1/0.45)(1+0.60) = 29.9% b = Plowback Ratio = (Net Income - Dividends) / Net Income = (95,000 - 40,000) / 95,000 = 0.58 or b = 1 - Payout Ratio = 1 - Dividends/Net Income = 1 - (40,000/95,000) = 0.58 Sustainable growth rate = [ROE*b] / [1 - ROE*b] = [0.299(0.58)] / [1 - 0.299(0.58)] = 20.9% Surely, 20.9% growth rate is not sustainable in the long run. The reason why that is unbelievably high is likely because the current 29.9% ROE is exceptional and not likely to continue forever.

2.T76. (6 points) Caldweiler & Co. owes a total of $21,684 in taxes for this year. The taxable income is $72,000. If the firm earns $100 more in income, it will owe an additional $36 in taxes. a) What will its average tax rate be on income of $72,100? b) What is its marginal tax rate? Briefly compare these tax rates.

Average tax rate = ($21,684 + $36) / $72,100 = 30.12% b) What is its marginal tax rate? Briefly compare these tax rates. Marginal tax rate = $36 / $100 = 36% The marginal tax rate is the tax on the next increment of income and is larger than the average tax rate.

Hon just bought 800 shares of TYUJ stock, which has been trading for some time on the NYSE. In which market did Hon's purchase occur? A. Dealer market B. Secondary market C. Derivative market D. Primary market

B

Operating cash flow is defined as: A. a firm's net profit over a specified period of time. B. the cash that a firm generates from its normal business activities using its existing assets. C. the change in the net working capital over a stated period of time. D. the cash that is generated and added to retained earnings.

B

Which of the following statements is FALSE? A. A bond's yield represents the annualized return that an investor would earn by holding it to maturity, if it does not default. B. Over time as a bond's maturity grows closer, if it does not default and if market yields do not change, then the price on a discount bond will decrease. C. When interest rates increase, then bond prices fall, and moreso the longer their maturity and the smaller their coupons. D. If a bond is held to maturity and it does not default, then the reinvestment rate risk will offset the price risk.

B

Which of the following statements is FALSE? A. An easy way to compute the value of an annuity due (such as a lease) is to compute the value of a regular annuity, and then compound the result forward one period. B. The annual percentage rate (APR) is the best way to compare two investments with different compounding periods. C. Lenders and investors prefer daily compounding to annual compounding. D. The process of paying off a loan by making regular principal reductions is called amortizing.

B

Which of the following statements is FALSE? A. Financial Managers make three basic types of decisions: Capital Budgeting, Capital Structure, and Working Capital Management. B. Capital budgeting is the process of planning and managing a firm's short-term investments. C. The primary goal for corporate managers should be to make good decisions to maximize the market value of the owner's equity. D. Agency conflicts, which sometimes arise when CEOs are overly motivated to seek job security, can be reduced by adjusting managerial compensation.

B

Which of the following statements is FALSE? A. Market capitalization is the number of shares outstanding times the market price. B. A company with a .05x interest coverage ratio would be at less risk of missing payments on interest than a company with a 4.9x interest coverage ratio. C. The DuPont Identity is an expression that breaks the return on equity into three parts that measure operating efficiency, asset use efficiency, and financial leverage. D. Sometimes book equity can become negative, and when that happens, positive ROE is not a good sign.

B

Which of the following statements is FALSE? A. The APR should not be used to compare two investments with different compounding periods. B. Lenders prefer less frequent compounding. C. Treasury Bills are pure discount loans with no coupon payments. D. Typical bullet bonds are interest-only loans where the principal is not amortized.

B

Which of the following statements is FALSE? A. The current ratio provides a measure of the short-term solvency of the firm. B. Price-earnings ratio reflects the book value per share per dollar of accounting earnings for a firm. C. Total asset turnover measures how much in sales is generated by each dollar of firm assets. D. Times interest earned, also known as the interest coverage ratio, provides a relative measure of how well the firm's operating earnings can cover current interest obligations.

B

Which of the following statements is FALSE? A. While the book value of equity can be negative, the market value of equity cannot be negative. B. On the income statement, financial analysts often focus on a company's EBIT, and items above this line depend on the company's long-term financing choices among debt and equity. C. The average tax rate is always less than or equal to, and often considerably less than, the marginal tax rate. D. Managers should use the marginal tax rate when making decisions regarding new investments and financing choices.

B

Which of the following statements is TRUE? A. Companies are required by law to have their bonds rated by agencies such as Moody's or S&P. B. The Fisher effect is the relationship between nominal returns, real returns, and inflation. C. Investors require higher yields on secured bonds than on unsecured bonds. D. A callable bond can be swapped for a fixed number of shares of stock before maturity at the holder's option.

B

Which of the following statements is TRUE? A. When yields increase, bonds with shorter maturities tend to decrease in value more than bonds with longer maturities. B. Over time, if yields do not change, the values of premium bonds decrease toward par smoothly. C. A "call provision" allows the bond holder the option to determine when they want the company to buy back the bond. D. Treasury Bonds are pure discount loans sold by the US government as a means to borrow money for less than one year.

B

Lisa has $1,000 in cash today. Which one of the following investment options will come closest to doubling her money? A. 12 percent interest for 5 years B. 7 percent interest for 9 years C. 8 percent interest for 9 years D. 6 percent interest for 10 years

C

Managers should act in shareholders' interests because shareholders have ___________ priority in receiving their claims. A. Top B. Somewhere in the middle C. Bottom D. Equal (to those of all other stakeholders)

C

Which of the following is NOT an advantage to the corporate form of organization? A. Ability to raise large sums of equity capital B. Ease of ownership transfer C. Profits taxed at the corporate level D. Limited liability for all owners

C

Which of the following statements is FALSE? A. The book value of equity rarely equals the market value of equity except when the market-to-book ratio is 1.0. B. The book value of equity is the residual difference between assets and liabilities. C. The book value of equity increases when a company pays dividends. D. The ultimate goal of financial managers is to maximize the current market value of the company's existing equity.

C

Which of the following statements is FALSE? A. The yield to maturity is a bond's rate of return that is required by the market place. B. When a bond's yield to maturity is less than a bond's coupon rate, the bond is selling at a premium. C. A convertible bond initially sells at a deep discount and pays no interest payments. D. The invoice amount that an investor actually pays to purchase an outstanding bond is not its 'clean' quoted price.

C

Which of the following statements is FALSE? A. While the book value of equity can be negative, the market value of equity cannot be negative. B. Market values are the prices at which assets, liabilities, and equities can be bought or sold for now. C. EBIT is the 'bottom line.' D. Average Tax Rates are less useful for making financial decisions than Marginal Tax Rates.

C

Which of the following statements is FALSE? A. With simple interest, the interest is not reinvested, so interest is earned each period only on the original principal. B. Both lenders and investors prefer more compounding. C. Amortizing a loan allows for a portion of principal to be paid with the interest each period principal so that the actual payments to interest will increase with each payment. D. Treasury Bills are pure discount loans sold by the US government that repay a fixed amount as one lump sum at some time in the future.

C

Which of the following statements is TRUE? A. All secondary markets are dealer markets. B. All secondary markets are broker markets. C. All stock trades between existing shareholders are secondary market transactions. D. All stock transactions are secondary market transactions.

C

Which of the following statements is TRUE? A. Bank loans, private placements to funds and insurance companies, and investment bank transactions are all activities in the secondary markets. B. Like general partners, the owners of a corporation have unlimited liability for business debts. C. While maximizing stockholder wealth is the relevant goal of the corporation, sometimes management goals are pursued at the expense of the stockholders. D. The Sarbanes-Oxley Act of 2002 dramatically streamlined American corporate regulations resulting in billions of dollars in overall savings.

C

Which of the following statements is TRUE? A. In a sole proprietorship, the owner has limited liability and full control. B. In a partnership, ownership can be transferred quickly, and capital can be raised easily. C. Corporations face double taxation, meaning the corporation pays taxes on income before dividends, while the owners pay personal taxes on dividends and capital gains. D. Intended to improve public disclosures, the Sarbanes-Oxley Act has likely increased the number of small companies going public in the USA.

C

Which one of the following represents additional compensation provided to bondholders to offset the possibility that the bond issuer might not pay the interest and/or principal payments as expected? A. Interest rate risk premium B. Taxability premium C. Default risk premium D. Liquidity premium

C

Which one of the following situations is most apt to create an agency conflict? A. Giving all employees a bonus if a certain level of efficiency is maintained B. Hiring an independent consultant to study the operating efficiency of the firm C. Rejecting a profitable project to protect employee jobs D. Selling an under producing segment of the firm

C

A call provision in a bond... A. Limits the actions of the borrower. B. Protects the borrower from unscrupulous practices by the lender. C. Allows the issuer to repurchase the bonds on the open market prior to maturity. D. Grants the issuer the option to repurchase the bonds prior to maturity at a pre-specified price.

D

Fill in the blanks: An annuity is worth _______ than a perpetuity, and a constant annuity is worth _______ than a growing annuity. (assuming the normal circumstance where the discount rate exceeds the growth rate and where the growth is positive) A. more, more B. more, less C. less, more D. less, less

D

Firms that compile financial statements according to GAAP: A. record income and expenses at the time they affect the firm's cash flows B. have no discretion of recording either revenue or expense items C. must record all expenses when incurred D. can still manipulate their earnings to some degree

D

If any, which of the following statements is FALSE? A. Capital Budgeting is the process of planning and managing a firm's long-term investments where managers identify investments that are worth more than they cost to acquire. B. Capital Structure is the mix of debt and equity maintained by a firm to finance operations, where the firm decides how much to borrow and what the cheapest sources of funds are. C. Working Capital Management is the day-to-day management of finances that determines how much cash and inventory should be kept on hand, whether to sell on credit to customers, and how to obtain short-term financing. D. None of the above statements is false.

D

Other things equal, investors will require higher yields on, and be willing to pay lower prices for, bonds with the following characteristics, except those which: A. Are unsecured B. Have less protective covenants C. Have lower credit quality D. Are convertible into common shares

D

Today, Courtney wants to invest an amount less than $5,000 with the goal of receiving $5,000 back some time in the future. Which one of the following statements is correct? A. The period of time she has to wait until she reaches her goal is not affected by the compounding of interest. B. The lower the rate of interest she earns, the shorter the time she will have to wait to reach her goal. C. The length of time she has to wait to reach her goal is directly related to the interest rate she earns. D. The period of time she has to wait decreases as the amount she invests today increases.

D

Which of the following choices is NOT a CORRECT way to complete this sentence: Other things equal, a set of cash flows is more valuable ... A. The longer they last B. The more frequently they are paid C. The faster they grow D. The larger the time value that investors require compensation for trading a dollar today for dollars tomorrow

D

Which of the following is NOT an effective means of aligning management goals with shareholder interests? A. Employee stock options B. Threat of a takeover C. Management bonuses tied to performance goals D. Compensating managers with salaries significantly higher than their peers

D

Which of the following statements is FALSE? A. Across a longer time period, a single cash flow grows to a larger future value B. For a higher interest rate, a single cash flow has a smaller present value C. If its payments last longer, an annuity has a larger present value D. For a higher interest rate, an annuity has a smaller future value

D

Which of the following statements is FALSE? A. Financial ratios help compare over time companies of different sizes and industries, and since not all sources calculate them the same way, managers should understand how they are derived. B. Asset utilization ratios describe how efficiently, or intensively, a firm uses its assets to generate sales. C. To a firm's creditors, particularly short-term creditors such as suppliers, the higher the current ratio is, the better. D. Higher margin, turnover, leverage, and dividends all generally allow a firm to grow faster over the long run.

D

Which of the following statements is FALSE? A. Liquidity measures the speed and ease with which assets can be converted to cash without significant loss of value, and 'fortress' balance sheets are especially liquid. B. Even though depreciation is not a cash expense, it affects taxes, and corporations prefer to depreciate assets using accelerated over straight line methods for tax purposes. C. The marginal tax rate is the tax rate payable on the next dollar earned and is always higher than the average tax rate. D. Operating Cash Flow is generated from utilizing existing assets after deducting interest expense

D

Which of the following statements is FALSE? A. The average tax rate is the total tax expense divided by the total taxable income. B. The marginal tax rate is the tax rate that applies to the next dollar of taxable income that a firm earns. C. The average tax rate is always less than or equal to, and often considerably less than, the marginal tax rate. D. Managers should use the average tax rate when making decisions regarding new investments and financing choices.

D

Which of the following statements is FALSE? A. The future value of a single cash flow grows across a longer time period B. The present value of a single cash flow falls with a higher interest rate C. The present value of an annuity grows if the annuity lasts longer D. The future value of an annuity falls with a higher interest rate

D

Which of the following statements is FALSE? A. The market value of any asset is what an item is actually worth if sold and must always be a positive value. B. Even though depreciation is not a cash expense, it affects taxes, and corporations prefer to depreciate assets using accelerated over straight line methods for tax purposes. C. The marginal tax rate is the tax rate payable on the next dollar earned and, due to deductions and credits, the marginal tax rate is always higher than the average tax rate. D. Priority measures the speed and ease with which assets can be converted to cash without significant loss of value.

D

Which of the following statements is FALSE? A. When market yields rise, the price of discount bonds fall further below par or face value. B. When market yields rise, the price of long-term bonds fall by a greater percent than short-term bonds. C. When market yields rise, the price of bonds with small coupons fall by a greater percent than those with large coupons. D. When market yields rise, investors redeem or 'call' the callable bonds they own, forcing the issuer of the bond to pay at least the face value.

D

Which of the following statements is TRUE? A. The APR is equal to the EAR for a loan that charges interest monthly. B. The EAR is always strictly greater than the APR. C. The APR on a monthly loan is equal to (1 + monthly interest rate)12 - 1. D. The EAR is the best measure of the actual rate you are paying on a loan.

D

Which of the following statements is TRUE? A. The coupon rate on a previously issued bond represents the rate of return required by today's participants in the market place. B. When a bond's yield to maturity is less than its coupon rate, the bond is selling at a discount. C. The market prices of bonds with higher coupons are more sensitive to changes in market interest rates. D. The market prices of bonds with longer maturities are more sensitive to changes in market interest rates.

D

Which of the following will increase the sustainable rate of growth for a firm? A. Decreasing the profit margin B. Increasing the dividend payout ratio C. Decreasing the asset turnover D. Increasing the target debt-equity ratio

D

Which one of the following has the highest effective annual rate? A. 6 percent compounded annually B. 6 percent compounded semi-annually C. 6 percent compounded quarterly D. 6 percent compounded monthly

D

The firm's operating cash flow from existing assets generated $66m, and combined with its $8m recovered investment in assets for future operations, its Free Cash Flows, available to be paid to investors, amounted to $74m.

FCF = OCF - (CapEx + ΔNWA) = 66 - (-8) = +74 Of that amount, $6m was paid in interest on debt and $2m was paid in dividends to equity holders. The remainder $66m reduced the debt balance and/or the common & paid-in equity: The debt balance actually decreased by $54m and the equity balance decreased by $12m. Not only did this firm pay interest to debt holders and dividends to equity holders, this firm paid down its debt balance a lot and even (depending on accounting conventions) bought back some shares.

Q2.P8. (8 points) Hammett, Inc., has sales of $19,570, costs of goods sold of $9,460, depreciation expense of $2,130, and interest expense of $1,620. If the tax rate is 35%, what is its net income? What is its operating cash flow? Does that represent cash flowing into or flowing out of the company?

First calculate EBIT = Sales - COGS - SGA - Depreciation = $19,570 - 9,460 - 2,130 = $7,980 Taxable Income subtracts interest expense: $7,980 - 1,620 = $6,360 Taxes at 35% of Taxable Income are 35% * 6,360 = $2,226 Net Income = Taxable Income - Taxes = $6,360 - 2, 226 = $4,134 OCF = EBIT + Depreciation - Taxes = $7,980 + 2,130 - 2,226 = $7,884 This positive Operating Cash Flow represents cash flowing into the company from current operations.

Ch2.KP8. (8 points) Last year, Drumor, Inc. earned $20.4m. This year it has sales of $81.3m, costs of goods sold of $60.7m, depreciation expense of $18.5m, and interest expense of $4.1m. If the tax rate is 35%, what is its net income? What is its operating cash flow? Does that represent cash flowing into or flowing out of the company?

First calculate EBIT = Sales - COGS - SGA - Depreciation = $81.3 - 60.7 -18.5 = $2.1m Taxable Income subtracts interest expense: $2.1 - 4.1 = -$2.0m Taxes at 35% of Taxable Income are 35% * -2.0 = -$0.7m, which is a refund and fully recoverable immediately because Drumor earned a substantial profit last year. Net Income = Taxable Income - Taxes = -$2.0 - -$0.7 = -$1.3m OCF = EBIT + Depreciation - Taxes = 2.1 + 18.5 - -0.7 = +$21.3m This positive Operating Cash Flow represents cash flowing into the company from current operations. Even though net income is negative, depreciation is non-cash and taxes in this case provided a refund.

A U.S. bank quotes 4.2% per year compounded monthly on deposits. a) If you invest $20,000, how much will your investment be worth in 5 years? r = 4.2% per year, or 4.2/12 = 0.35% per month Time 0 5 years, or 5*12 = 60 months $10,000 FV What is the APR? What is the EAR?

For r =0.35% per period and t =60 periods: FV = PV * (1+r)t = $20,000 * (1 + .0035)60 = $24,665 For r = 4.2% per year, t = 5 years, and m = 12 periods per year FV = PV * (1+r/m)mt = $20,000 * (1 + .042/12)12*5 = $24,665 The Annual Percentage Rate is the rate required to be quoted by law, which is 4.2% per year. The Effective Annual Rate is the rate which would be earned if it were compounded once a year. EAR = [1 + (APR / m)]m - 1 = [1 + (.042 / 12)]12 - 1 = 4.28% per year.

Q2.P10. (5 points) The December 31, 2009 balance sheet of Anna's Tennis Shop, Inc., showed current assets of $1,015 and current liabilities of $870. The December 31, 2010 balance sheet showed current assets of $1,230 and current liabilities of $905. What was the company's 2010 change in net working capital? Does that represent cash flowing into or flowing out of the company?

Net Working Capital is current assets less current liabilities NWC = CA - CL = $1,015 - 870 = $145 at the end of 2009 NWC = CA - CL = $1,230 - 905 = $325 at the end of 2010 The change in net working capital is the end of period net working capital minus the beginning of period net working capital: ΔNWC = $325 - 145 = $180 in 2010 This positive change in net working capital represents cash flowing out of the company to invest in current operating assets.

Q2.P9. (5 points) Rotweiler Obedience School's December 31, 2009 balance sheet showed net fixed assets of $1,725,000 and the December 31, 2010 balance sheet showed net fixed asset of $2,040,000. The company's 2010 income statement showed a depreciation expense of $321,000. What was Rotweiler's net capital spending for 2010? Does that represent cash flowing into or flowing out of the company?

Net capital spending is the increase in fixed assets, plus depreciation. CapEx = ΔNFA + Depreciation = $2,040,000 - 1,725,000 + 321,000 = $636,000 This positive capital expenditure represents cash flowing out of the company to invest for future operations.

Ch2.KP9. (5 points) Drumor's current balance sheet showed net fixed assets of $160.4m and its balance sheet last year showed net fixed asset of $174.3m. The company's income statement this year showed a depreciation expense of $18.5m . What was Drumor's net capital spending for the current year? Does that represent cash flowing into or flowing out of the company?

Net capital spending is the increase in fixed assets, plus depreciation. CapEx = ΔNFA + Depreciation = ($160.4m - $174.3) + $18.5m = +$4.6m Net fixed assets fell but by a smaller amount than caused by noncash depreciation. This positive capital expenditure represents cash flowing out of the company to invest for future operations.

Ch2.Hwk4b. (12 points) Roscoe's purchased new machinery three years ago for $1.8 million. The machinery can be sold to Stewart's today for $1.2 million. Roscoe's current balance sheet shows net fixed assets of $840,000, current liabilities of $348,000, and net working capital of $144,000. If all the current assets were liquidated today, the company would receive $476,000 cash. What is the book value of the firm's assets today? What is the market value? If these values are not the same, briefly discuss why they differ.

The purchase price of the machinery has been depreciated to $840,000 on the current balance sheet Since NWC = CA - CL, CA = NWC + CL = $144,000 + $348,000 = $492,000 Book value = $840,000 + $492,000 = $1,332,000 Market value = $1,200,000 + $476,000 = $1,676,000 The market value of assets is their current liquidation or sale value, which must always be positive. Market values can be higher or lower than book values, which generally reflect their historical costs.