Fin 311 Exam 1
T/F? If a stock's market price is above its intrinsic value, then the stock can be thought of as being undervalued, and it would be a good buy.
False
T/F? It is generally less expensive to form a corporation than a proprietorship because, with a proprietorship, extensive legal documents are required.
False
T/F? Managers always attempt to maximize the long-run value of their firms' stocks, or the stocks' intrinsic values. This is exactly what stockholders desire. Thus, conflicts between stockholders and managers are not possible.
False
T/F? Other things held constant, the more debt a firm uses, the lower its operating margin will be.
False
T/F? Primary markets are large and important, while secondary markets are smaller and less important.
False
T/F? The NYSE is defined as a "primary" market because it is one of the largest and most important stock markets in the world.
False
Herring Corporation has operating income of $235,000 and a 40% tax rate. The firm has short-term debt of $115,000, long-term debt of $321,000, and common equity of $436,000. What is its return on invested capital?
16.17%
Byrd Lumber has 2 million shares of common stock outstanding that sell for $17 a share. If the company has $49 million of common equity on its balance sheet, what is the company's Market Value Added (MVA)? Answer options are provided in whole dollar.
-15,000,000
Use the Income Statement you created from the Self Assessment Quiz . What is the value of Net Income?
$72,000
Last year, Stewart-Stern Inc. reported $11,250 of sales, $4,500 of operating costs other than depreciation, and $1,250 of depreciation. The company had $3,500 of bonds outstanding that carry a 6.5% interest rate, and its federal-plus-state income tax rate was 35%. During last year, the firm had expenditures on fixed assets and net operating working capital that totaled $2,000. These expenditures were necessary for it to sustain operations and generate future sales and cash flows. This year's data are expected to remain unchanged except for one item, depreciation, which is expected to increase by $975. By how much will the depreciation change cause (1) the firm's net income and (2) its free cash flow to change? Note that the company uses the same depreciation for tax and stockholder reporting purposes. Do not round the intermediate calculations.
-$633.75; $341.25
New Business is just being formed by 10 investors, each of whom will own 10% of the business. The firm is expected to earn $500,000 before taxes each year. The corporate tax rate is 34% and the personal tax rate for the firm's investors is 35%. The firm does not need to retain any earnings, so all of its after-tax income will be paid out as dividends to its investors. The investors will have to pay personal taxes on whatever they receive. How much additional spendable income will each investor have if the business is organized as a partnership rather than as a corporation?
$11,050
Brown Fashions Inc.'s December 31, 2014 balance sheet showed total common equity of $4,050,000 and 290,000 shares of stock outstanding. During 2015, the firm had $450,000 of net income, and it paid out $100,000 as dividends. What was the book value per share at 12/31/15, assuming no common stock was either issued or retired during 2015? (Round your final answer to two decimal places.)
$15.17
Refer to Exhibit 4.1. What is the firm's EPS? Do not round your intermediate calculations.
$2.54
Helmuth Inc's latest net income was $1,410,000, and it had 225,000 shares outstanding. The company wants to pay out 45% of its income. What dividend per share should it declare? Do not round your intermediate calculations.
$2.82
X-1 Corp's total assets at the end of last year were $490,000 and its EBIT was 52,500. What was its basic earning power (BEP) ratio?
10.71%
Cielo Corp's sales last year were 3,000,000, its operating costs were $1,400,000, and its interest charges were $160,000. What was the firm's times-interest-earned (TIE) ratio? (Hint: TIE=EBIT/Interest Expense)
10x
Use the "Warm up - Fill in the Blanks #2". What is the value of Economic Value Added (EVA) in Year 1. Assume that WACC is 10% and Total Invested Capital is equal to Long-Term Debt + Common Stock + Retained Earnings. Ignore Current Portion - Long Term Debt item.
20,050
Tucson Airways had a profit margin of 8.00%, a total assets turnover of 1.5, and an equity multiplier of 1.8. What was the firm's ROE?
21.60%
Assume that the corporate tax rate is 34% and the personal tax rate is 30%. The founders of a newly formed business are debating between setting up the firm as a partnership versus a corporation. The firm will not need to retain any earnings, so all of its after-tax income will be paid out to its investors, who will have to pay personal taxes on whatever they receive. What is the difference in the percentage of the firm's pre-tax income that investors actually receive and can spend under the corporate and partnership forms of organization?
23.80%
Houston Pumps recently reported $207,500 of sales, $140,500 of operating costs other than depreciation, and $9,250 of depreciation. The company had $35,250 of outstanding bonds that carry a 6.75% interest rate, and its federal-plus-state income tax rate was 35%. In order to sustain its operations and thus generate future sales and cash flows, the firm was required to spend $15,250 to buy new fixed assets and to invest $6,850 in net operating working capital. What was the firm's free cash flow?
24,688
Use the Balance Sheet you created from the Self Assessment Quiz . What is the value of Net Property, Plant and Equipment?
300,000
Last year Rennie Industries had sales of $395,000, assets of $175,000 (which equals total invested capital), a profit margin of 5.3%, and an equity multiplier of 1.2. The CFO believes that the company could reduce its assets by $51,000 without affecting either sales or costs. The firm finances using only debt and common equity. Had it reduced its assets by this amount, and had the debt/total invested capital ratio, sales, and costs remained constant, how much would the ROE have changed? Do not round your intermediate calculations.
5.90%
Charleston Corporation (CC) now operates as a "regular" corporation, but it is considering a switch to S Corporation status. CC is owned by 100 stockholders who each hold 1% of the stock, and each faces a personal tax rate of 35%. The firm earns $2,800,000 per year before taxes, and since it has no need for retained earnings, it pays out all of its earnings as dividends. Assume that the corporate tax rate is 34% and the personal tax rate is 35%. How much more (or less) spendable income would each stockholder have if the firm elected S Corporation status?
6,188
Last year Kruse Corp had $410,000 of assets (which is equal to its total invested capital), $403,000 of sales, $28,250 of net income, and a debt-to-total-capital ratio of 39%. The new CFO believes the firm has excessive fixed assets and inventory that could be sold, enabling it to reduce its total assets and total invested capital to $252,500. The firm finances using only debt and common equity. Sales, costs, and net income would not be affected, and the firm would maintain the same capital structure (but with less total debt). By how much would the reduction in assets improve the ROE? Do not round your intermediate calculations.
7.05%
Use the Income Statement you created from the Self Assessment Quiz . With the passage of the Tax Cuts and Jobs Act (TCJA), many tax brackets, thresholds, and rates changed in 2018. Accordingly, the corporate tax rate will decline from 40% to 21%. What is the value of Net Income if tax rate is 21% ?
94,800
Which of the following statements is CORRECT?
A corporation is a legal entity created by a state, and it has a life and existence that is separate from the lives and existence of its owners and managers.
With which of the following statements would most people in business agree?
Although people's moral characters are probably developed before they are admitted to a business school, it is still useful for business schools to cover ethics, if only to give students an idea about the adverse consequences of unethical behavior to themselves, their firms, and the nation.
Considered alone, which of the following would increase a company's current ratio? (hint: Current Ratio= Current Assets / Current Liabilities)
An increase in accounts receivable.
Which of the following statements is CORRECT?
As they are generally defined, money market transactions involve debt securities with maturities of less than one year.
Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and managers? A) Pay managers large cash salaries and give them no stock options. B) Change the corporation's formal documents to make it easier for outside investors to acquire a controlling interest in the firm through a hostile takeover. C) Beef up the restrictive covenants in the firm's debt agreements. D) Eliminate a requirement that members of the board of directors must hold a high percentage of their personal wealth in the firm's stock. E) For a firm that compensates managers with stock options, reduce the time before options are vested, i.e., the time before options can be exercised and the shares that are received can be sold.
B) Change the corporation's formal documents to make it easier for outside investors to acquire a controlling interest in the firm through a hostile takeover.
Which of the following statements is CORRECT?
Bond covenants are designed to protect bondholders and to reduce potential conflicts between stockholders and bondholders.
Which of the following statements is CORRECT?
Both NASDAQ dealers and "specialists" on the NYSE hold inventories of stocks.
Use the Balance Sheet you created from the Self Assessment Quiz . What is the value of Net Working Capital (NWC) and Net Operating Working Capital (NOWC)?
C - NWC = 93,500 NOWC= 93,500
Which of the following statements is CORRECT?
Capital market instruments include both long-term debt and common stocks.
Companies HD and LD have the same tax rate, sales, total assets, and basic earning power. Both companies have positive net incomes. Both firms finance using only debt and common equity and total assets equal total invested capital. Company HD has a higher total debt to total capital ratio and, therefore, a higher interest expense. Which of the following statements is CORRECT?
Company HD has a lower times-interest-earned (TIE) ratio.
Which of the following statements is CORRECT?
Conflicts can exist between stockholders and managers, but potential conflicts are reduced by the possibility of hostile takeovers.
Which of the following could explain why a business might choose to operate as a corporation rather than as a proprietorship or a partnership?
Corporations generally find it easier to raise large amounts of capital.
Which of the following items cannot be found on a firm's balance sheet under current liabilities?
Cost of goods sold.
Which of the following statements is CORRECT?
Due to legal considerations related to ownership transfers and limited liability, which affect the ability to attract capital, most business (measured by dollar sales) is conducted by corporations in spite of large corporations' less favorable tax treatment.
Which of the following statements is CORRECT? A) Corporations face few regulations and more favorable tax treatment than do proprietorships and partnerships. B) Managers who face the threat of hostile takeovers are less likely to pursue policies that maximize shareholder value compared to managers who do not face the threat of hostile takeovers. C) Bond covenants are an effective way to resolve conflicts between shareholders and managers. D) Because of their simplified organization, it is easier for proprietors and partnerships to raise large amounts of outside capital than it is for corporations. E) One advantage to forming a corporation is that the owners of the firm have limited liability.
E) One advantage to forming a corporation is that the owners of the firm have limited liability.
Which of the following is a primary market transaction?
Facebook issues 12,000,000 shares of new stock and sells them to the public through an investment banker (such as Goldman Sachs).
T/F? A decline in a firm's inventory turnover ratio suggests that it is improving both its inventory management and its liquidity position, i.e., that it is becoming more liquid.
False
T/F? A disadvantage of the corporate form of organization is that corporate stockholders are more exposed to personal liabilities in the event of bankruptcy than are investors in a typical partnership.
False
T/F? An advantage of the corporate form of organization is that corporations are generally less highly regulated than proprietorships and partnerships.
False
T/F? Both interest and dividends paid by a corporation are deductible operating expenses, hence they decrease the firm's taxes.
False
T/F? Even though Firm A's current ratio exceeds that of Firm B, Firm B's quick ratio might exceed that of A. However, if A's quick ratio exceeds B's, then we can be certain that A's current ratio is also larger than B's.
False
T/F? For a stock to be in equilibrium as the book defines it, its market price should exceed its intrinsic value.
False
T/F? High current and quick ratios always indicate that the firm is managing its liquidity position well.
False
T/F? If a firm is reporting its income in accordance with generally accepted accounting principles, then its net income as reported on the income statement should be equal to its free cash flow.
False
T/F? If management operates in a manner designed to maximize the firm's expected profits for the current year, this will also maximize the stockholders' wealth as of the current year.
False
T/F? It is appropriate to use the fixed assets turnover ratio to appraise firms' effectiveness in managing their fixed assets if and only if all the firms being compared have the same proportion of fixed assets to total assets.
False
T/F? The NYSE is defined as a "spot" market purely and simply because it has a physical location. The NASDAQ, on the other hand, is not a spot market because it has no one central location.
False
T/F? The basic earning power ratio (BEP) reflects the earning power of a firm's assets after giving consideration to financial leverage and tax effects.
False
T/F? The first major section of a typical statement of cash flows is "Operating Activities," and the first entry in this section is "Net Income." Then, also in the first section, we show some items that represent increases or decreases to cash, and the last entry is called "Net Cash Provided by Operating Activities." This number can be either positive or negative, but if it is negative, the firm is almost certain to soon go bankrupt.
False
T/F? The term IPO stands for "individual purchase order," as when an individual (as opposed to an institution) places an order to buy a stock.
False
T/F? There are many types of unethical business behavior. One example is where executives provide information that they know is incorrect to banks and to stockholders. It is illegal to provide such information to banks, but it is not illegal to provide it to stockholders because they are the owners of the firm, not outsiders.
False
T/F? Trades on the NYSE are generally completed by having a brokerage firm acting as a "dealer" buy securities and adding them to its inventory or selling from its inventory. The NASDAQ, on the other hand, operates as an auction market, where buyers offer to buy, and sellers to sell, and the price is negotiated on the floor of the exchange.
False
Which of the following statements is CORRECT?
Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light regulation is that only "sophisticated" investors (i.e., those with high net worths and high incomes) are permitted to invest in these funds, and these investors supposedly can do any necessary "due diligence" on their own rather than have it done by the SEC or some other regulator.
Which of the following statements is CORRECT?
If a company pays more in dividends than it generates in net income, its retained earnings as reported on the balance sheet will decline from the previous year's balance.
Which of the following statements is CORRECT?
If someone deliberately understates costs and thereby causes reported profits to increase, this can cause the stock price to rise above its intrinsic value. The stock will probably fall in the future. Both those who participated in the fraud and the firm itself can be prosecuted.
Which of the following statements is CORRECT?
In a "Dutch auction," investors who want to buy shares in an IPO submit bids indicating how many shares they want to buy and the price they are willing to pay. The company determines how many shares it wants to sell. The highest price that enables the company to sell the desired number of shares is the price that all buyers must pay.
A firm's new president wants to strengthen the company's financial position. Which of the following actions would make it financially stronger?
Increase EBIT while holding sales and assets constant.
Which of the following mechanisms would be most likely to help motivate managers to act in the best interests of shareholders?
Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries.
The Nantell Corporation just purchased an expensive piece of equipment. Assume that the firm planned to depreciate the equipment over 5 years on a straight-line basis, but Congress then passed a provision that requires the company to depreciate the equipment on a straight-line basis over 7 years. Other things held constant, which of the following will occur as a result of this Congressional action? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes.
Nantell's operating income (EBIT) will increase.
Which of the following statements is CORRECT?
One drawback of forming a corporation is that it generally subjects the firm to additional regulations.
Which of the following statements is CORRECT?
One of the disadvantages of a proprietorship is that the proprietor is exposed to unlimited liability.
Which of the following statements is CORRECT?
Operating income is derived from the firm's regular core business. Operating income is calculated as Revenues less Operating costs. Operating costs do not include interest or taxes.
If a bank loan officer were considering a company's loan request, which of the following statements would you consider to be CORRECT?
Other things held constant, the lower the total debt to total capital ratio, the lower the interest rate the bank would charge.
Which of the following statements is CORRECT?
Partnerships have more difficulty attracting large amounts of capital than corporations because of such factors as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and selling) of partnership interests.
Which of the following is an example of a capital market instrument?
Preferred stock Corporate bonds
Which of the following statements is CORRECT?
Proprietorships and partnerships generally have a tax advantage over corporations.
Money markets are markets for
Short-term debt securities such as Treasury bills and commercial paper.
T/F? A hostile takeover is said to occur when another corporation or group of investors gains voting control over a firm and replaces the old managers. If the old managers were managing the firm inefficiently, then hostile takeovers can improve the economy. However, hostile takeovers are controversial, and legislative actions have been taken to make them more difficult to undertake.
True
Which of the following statements is CORRECT?
Stockholders should generally be happier than bondholders to have managers invest in risky projects with high potential returns as opposed to safe projects with lower expected returns.
Which of the following statements is CORRECT?
The NYSE operates as an auction market, whereas NASDAQ is an example of a dealer market.
Which of the following statements is CORRECT?
The New York Stock Exchange is an auction market, and it has a physical location.
Which of the following statements is CORRECT?
The assets section of a typical company's balance sheet begins with cash, then lists the assets in the order in which they will probably be converted to cash, with the longest lived assets listed last.
Which of the following statements is CORRECT?
The board of directors is the highest ranking body in a corporation, and the chairman of the board is the highest ranking individual. The CEO generally works under the board and its chairman, and the board generally has the authority to remove the CEO under certain conditions. The CEO, however, cannot remove the board, but he or she can endeavor to have the board voted out and a new board voted in should a conflict arise. It is possible for a person to simultaneously serve as CEO and chairman of the board, though many corporate control experts believe it is bad to vest both offices in the same person.
Last year Besset Company's operations provided a negative cash flow, yet the cash shown on its balance sheet increased. Which of the following statements could explain the increase in cash, assuming the company's financial statements were prepared under generally accepted accounting principles (GAAP)?
The company sold some of its fixed assets.
Austin Financial recently announced that its net income increased sharply from the previous year, yet its net cash provided from operations declined. Which of the following could explain this performance?
The company's depreciation expense declined.
The firm has never paid a dividend on its common stock, and it issued $2,400,000 of 10-year, non-callable, long-term debt in 2014. As of the end of 2015, none of the principal on this debt had been repaid. Assume that the company's sales in 2014 and 2015 were the same. Which of the following statements must be CORRECT?
The firm issued new common stock in 2015.
Which of the following statements is CORRECT?
The income statement for a given year is designed to give us an idea of how much the firm earned during that year.
Which of the following statements is CORRECT?
The managers of established, stable companies sometimes attempt to get their state legislatures to impose rules that make it more difficult for raiders to succeed with hostile takeovers.
Which of the following actions would be likely to encourage a firm's managers to make decisions that are in the best interests of shareholders?
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 80%
Which of the following statements is CORRECT?
The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firm's future earnings and dividends, and the riskiness of those cash flows.
Which of the following would, generally, indicate an improvement in a company's financial position, holding other things constant?
The quick ratio increases.
Which of the following statements is CORRECT?
The threat of takeovers tends to reduce potential conflicts between stockholders and managers.
Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and bondholders?
The use of covenants in bond agreements that limit the firm's use of additional debt and constrain managers' actions.
Jason recently sold 1,000 shares of Apple stock to his sister at a family reunion. At the reunion his sister gave him a check for the stock and Jason gave his sister the stock certificates. Which of the following best describes this transaction?
This is an example of a direct transfer of capital.
You recently sold 100 shares of Microsoft stock to your brother at a family reunion. At the reunion your brother gave you a check for the stock and you gave your brother the stock certificates. Which of the following best describes this transaction?
This is an example of a direct transfer of capital.
T/F? A publicly owned corporation is a company whose shares are held by the investing public, which may include other corporations as well as institutional investors.
True
T/F? Each stock's rate of return in a given year consists of a dividend yield (which might be zero) plus a capital gains yield (which could be positive, negative, or zero). Such returns are calculated for all the stocks in the S&P 500. A weighted average of those returns, using each stock's total market value, is then calculated, and that average return is often used as an indicator of the "return on the market."
True
Use the Balance Sheet you created from the Self Assessment Quiz . What is the value of Total Assets? End-of- year (EOY) Retained Earnings?
Total Assets = 417,000; Retained Earnings = $152,000
T/F? Financial institutions are more diversified today than they were in the past, when federal laws kept investment banks, commercial banks, insurance companies, and similar organizations quite separate. Today the larger financial services corporations offer a variety of services, ranging from checking accounts, to insurance, to underwriting securities, to stock brokerage.
True
T/F? Hedge funds are somewhat similar to mutual funds. The primary differences are that hedge funds are less highly regulated, have more flexibility regarding what they can buy, and restrict their investors to wealthy, sophisticated individuals and institutions.
True
T/F? If a corporation elects to be taxed as an S corporation, then it can avoid the corporate tax. However, its stockholders will have to pay personal taxes on the firm's net income.
True
T/F? If a firm's board of directors wants to maximize value for its stockholders in general (as opposed to some specific stockholders), it should design an executive compensation system whose focus is on the firm's long-term value.
True
T/F? If someone deliberately understates costs and thereby increases profits, this can cause the stock price to rise above its intrinsic value. The stock price will probably fall in the future. Also, those who participated in the fraud can be prosecuted, and the firm itself can be penalized.
True
T/F? If we were describing the income statement and the balance sheet, it would be correct to say that the income statement is more like a video while the balance sheet is more like a snapshot.
True
T/F? In most corporations, the CFO ranks under the CEO.
True
T/F? In order to maximize its shareholders' value, a firm's management must attempt to maximize the stock price on a specific target date.
True
T/F? Interest paid by a corporation is a tax deduction for the paying corporation, but dividends paid are not deductible. This treatment, other things held constant, tends to encourage the use of debt financing by corporations.
True
T/F? It is generally harder to transfer one's ownership interest in a partnership than in a corporation.
True
T/F? Klein Cosmetics has a profit margin of 5.0%, a total assets turnover ratio of 1.5 times, no debt and therefore an equity multiplier of 1.0, and an ROE of 7.5%. The CFO recommends that the firm borrow money, use the funds to buy back stock, and raise the equity multiplier to 2.0. The size of the firm (assets) would not change. She thinks that operations would not be affected, but interest on the new debt would lower the profit margin to 4.5%. This would probably be a good move, as it would increase the ROE from 7.5% to 13.5%.
True
T/F? One danger of starting a proprietorship is that you may be exposed to personal liability if the business goes bankrupt. This problem would be avoided if you formed a corporation to operate the business.
True
T/F? Partnerships and proprietorships generally have a tax advantage over corporations.
True
T/F? Suppose Firms A and B have the same amount of assets, total assets are equal to total invested capital, pay the same interest rate on their debt, have the same basic earning power (BEP), finance with only debt and common equity, and have the same tax rate. However, Firm A has a higher debt to capital ratio. If BEP is greater than the interest rate on debt, Firm A will have a higher ROE as a result of its higher debt ratio.
True
T/F? The alternative minimum tax (AMT) was created by Congress to make it more difficult for wealthy individuals to avoid paying taxes through the use of various deductions.
True
T/F? The annual rate of return on any given stock can be found as the stock's dividend for the year plus the change in the stock's price during the year, divided by its beginning-of-year price.
True
T/F? The board of directors is the highest ranking body in a corporation, and the chairman of the board is the highest ranking individual. The CEO generally works under the board and its chairman, and the board generally has the authority to remove the CEO under certain conditions. The CEO, however, cannot remove the board, but he or she can endeavor to have the board voted out and a new board voted in should a conflict arise. It is possible for a person to simultaneously serve as CEO and chairman of the board, though many corporate control experts believe it is bad to vest both offices in the same person.
True
T/F? The inventory turnover and current ratio are related. The combination of a high current ratio and a low inventory turnover ratio, relative to industry norms, suggests that the firm has an above-average inventory level and/or that part of the inventory is obsolete or damaged.
True
T/F? The price/earnings (P/E) ratio tells us how much investors are willing to pay for a dollar of current earnings. In general, investors regard companies with higher P/E ratios as being less risky and/or more likely to enjoy higher growth in the future.
True
T/F? The term "marginal investor" means an investor who is active in the market and would tend to buy a stock if its price fell and sell it if it rose, barring any new information coming out about the stock. It is the "marginal investor" who determines the actual stock price.
True
T/F? When a corporation's shares are owned by a few individuals who are associated with the firm's management, we say that the stock is closely held.
True
The primary operating goal of a publicly-owned firm trying to best serve its stockholders should be to
Use a well-structured managerial compensation package to reduce conflicts that may exist between stockholders and managers.