Finance 3110 Final Exam
Micron Inc. is considering two new silicon wafer milling machines. Both will produce the same number of integrated circuits each year with similar quality levels. The TechPress costs $240,00, has a 3-year life, and has annual pretax operating costs of $63,000. The CircuitCutter has a price tag of $420,000, a 5-year life, and annual operating costs of $35,000. For both milling machines, assume straight-line depreciation to zero over the project's life. If Micron's tax rate is 25% and it requires a 10% discount rate, which machine should it select?
CircuitCutter
When trying estimate the price of common stock, why don't we generally use the annuity or perpetuity formulas used in the valuation of bonds and preferred stock?
Common stock dividends are normally expected to grow over time, rather than being constant as are payments on most bonds and most preferred stock. - Since the dividends typically grow over time, we can't use a pattern of cash flows that requires equal cash flows each period.
Interstellar Touring wishes to replace its luxury space bus in 8 years by accumulating funds in a special account. The new bus is expected to cost $1,500,000. How much must Stellar put into the fund in equal, end-of-year amounts if the account pays 10% interest compounded annually?
$131,166.03
Victory Village Victuals, a company selling foodstuffs to local restaurants has the following sales forecast. Typically 75% of each month's sales are on a cash basis. Additionally, the average collection period is 1 month. What is the total expected cash inflows for the month of May as would be shown on a cash budget? January February March April May Total Sales $90,000 $100,000 $120,000 $132,000 $144,000
$141,000 - In May, sales would be 75% x $144,000 = $108,000. Credit collections in May will be the amount sold on credit in April, i.e., 1 month earlier. Credit Sales in April = 25% x $132,000 = $33,000. Total cash receipts in May will be $108,000 + $33,000 = $141,000
What is the cost of sales for a firm with a gross profit margin of 32 percent, a net profit margin of 8 percent, and earnings after taxes of $40,000?
$340,000 - 1) Use net income and net profit margin to find sales: NPM = EAT/Sales --> Sales = NPM/EAT = 40,000/0.08 = 500,000 - 2) Use gross profit margin and sales to find cost of sales: GPM = (Sales - Cost of Sales)/Sales --> Sales x GPM = Sales - Cost of Sales --> Cost of Sales = Sales x (1-GPM) = 500,000 x (1-0.32) = 340,000
Central Rolling Mills will purchase a new grain mill that replace an older mill that is less efficient. The new mill costs $450,000 and shipping costs are $20,000. Upgrading the power lines for the new mill will cost an additional $5,000. The old mill has a book value of $28,000 and can be sold for $38,000. The installation of the new mill will cause net working capital to increase $18,000. If Central Rolling Mills has a marginal tax rate of 25%, what is the NINV for the new mill?
$457,500
Manchester Plastics, Inc., has total owner's equity of $18,800. The firm has current assets of $23,100, current liabilities of $12,200, and total assets of $36,400. What is the value of the long-term debt?
$5,400 - Total Assets = Total Liabilities + Equity = Current Liabilities + LTD Debt +Equity LTD = Total Assets - Current Liabilities - Equity = 36,400 - 12,200 - 18,800 = 5,400
You are planning a trip to the U.K. and plan on spending £3,600. How many dollars will this trip cost you if the exchange rate is £0.6112/$?
$5890.05 - 3,600/0.6112 = 5,890.05
A project requires $562,000 of equipment that is classified as five-year MACRS property. What is the depreciation expense in year 4?
$64,742.40 - the depreciation rate for year 4 for a 5-year MACRS class asset is 11.52%. Multiplying that by the original basis of $562,000 gives a depreciation expense of $64,742.40.
During the past 8 years, PET Company common stock dividends have grown from $1.39 to $2.33 per share (currently). Determine the value of PET common stock to an investor who requires a 10.5% rate of return, assuming that dividends continue growing for the foreseeable future at the same rate as over the past 8 years.
$64.88
The Lane Corp. purchased a new inventory sorting system to replace an older less automated system. The old system is 10 years old and fully depreciated. The new system will be depreciated as a 7-year asset for MACRS purposes. The more efficient machine, which costs $280,000 installed, will reduce operating costs by $72,000 per year. Compute the net cash flows in year 2 for the new system, assuming a 25% tax rate.
$71,143
You have just signed on with Holloway Financial Advisors, whose investment account offers an 8.0% interest rate (compounded annually). If you deposit $19,000 at the end of year 1, $10,000 at the end of year 2, $13,000 at the end of year 3, and $20,000 at the end of year 4, how much will you have accumulated in your account by the end of year 5?
$75,209.61
New Philadelphia Partners, Inc., just issued a $1,000 face-value bond with a coupon rate of 6.0 percent and 10 years to maturity. If this bond pays interest semiannually, what is the value of this bond to an investor who requires a 7 percent rate of return?
$928.94 - If the bond has a coupon rate of 6%, the total coupons paid each year will be 6% x 1000 = $60. However if there are two payments each year, each payment will be $30. - The semiannual yield will be half of the 7% annual yield to maturity. Also, there will be 20 payments in 10 years.
Johnson & Johnson Inc. recently issued a 10-year $1,000 face-value bond at a price of $1102.60. The coupon rate is 10% and the bond pays interest semiannually. The bond is callable in 5 years with a call price of $1,075.00. What is the yield to maturity for the Johnson & Johnson, Inc. bond?
0.0846
What is the yield to call for the Johnson & Johnson, Inc. bond?
0.0866
What is the standard deviation of Mr. James' portfolio?
0.0914
What is the Net Profit Margin for Oliver King Productions?
0.1012 Net Profit Margin = Earnings After Taxes/Sales 164000/1620000 = 0.1012
Parker James is considering investing in the common stock of Benton Place Partners and Pikeway, Inc. The following data is available for these securities -Benton Place: expected return of 0.11, standard deviation of returns of 0.07, beta of 0.78 -Pikeway: expected return of 0.24, standard deviation of returns of 0.20, beta of 1.29 He is planning to invest 70% of his portfolio in Benton Place and the rest in Pikeway. The correlation between these securities is 0.40. What is the expected return for Mr. James' portfolio?
0.149 0.70(0.11) + 0.30(0.24) = 0.149 or 14.9%
Stock A has a beta of 1.24 while stock B has a beta of 1.06 and a required return of 15.92 percent. What is the required return on stock A if the risk-free rate is 3.2 percent and both stocks plot on the security market line?
0.1808
What is Powell's average tax rate for 2020?
0.2094 or 20.94% Average tax rate = taxes/taxable income = 18,850/90,000 = 0.2094
What is Powell's marginal tax rate for 2020?
0.34 or 34% Marginal Tax Rate = Taxes on next dollar of income = 34%
The Dollar Store, Inc., has inventory of $318,000, equity of $421,800, total assets of $647,700, and sales of $687,400. What is the common size percentage for the inventory account?
0.4910 or 49.10% - Common-size inventory = 318,000/647,700 = 0.4910 or 49.10%.
Using the financial statements for Oliver King Productions, calculate the Return on Equity using the Du Pont identity.
0.5091
What is the beta of the following portfolio? Stock Value Beta A $17,100 0.94 B $22,500 1.12 C $11,400 1.03 D $24,000 0.79
0.96
The Green Goat Farm is currently considering a project that will produce cash inflows of $19,000 a year for three years followed by $7,000 in year four. The cost of the project is $45,000. What is the profitability index if the discount rate is 9 percent?
1.18
The common stock of Moon Microcomputer system is currently selling for $50.60. The firm's most recent dividend (D0) was $1.52 per share. If the required return on investments for this level of risk is 13.5%, what is the implied future growth rate for dividends?
10.19%
Given the following information, what is the standard deviation of the returns on this stock? State of Economy Probability Rate of Return Boom 0.20 0.20 Normal 0.50 0.08 Recession 0.30 -0.10
10.82%
FARMA is a multi-divisional utility company. FARMA has the following divisions with the following betas and proportions of the firm's total assets: Division Beta % of assets Electric and gas 0.80 60 Bus transportation 1.00 10 Real estate 1.40 20 Recreation 1.15 10 The risk-free rate is 2 percent and the market risk premium is 8 percent. If FARMA is considering developing a new children's board game, what should use as its cost of equity in evaluating this project?
11.2%
Anna has $1,000 she is depositing into a bank account today. Which one of the following investment options will result in an ending account balance closest to double her initial balance?
12 percent interest for 6 years - the rule of 72 says that if the product of the interest rate and the number of periods is 72, your money will double over that time period
Black Sun Enterprise will pay an annual dividend of $1.15 next year. The dividend growth rate is expected to be 5.0 percent for the foreseeable future. What is the investor's required rate of return for the BSE common stock if the current price is $14.52?
12.92%
2021 Accounts Payable
120,000
2021 Earnings After Taxes
145,500
Mr. Johnson is 28 years old today and is beginning to plan for his retirement. He wants to set aside an equal amount at the end of each of the next 37 years so that he can retire at the age 65. He wants to be able to withdraw $230,000 per year from the account on his 66th through 85th birthdays. The account is expected to earn 7 percent per annum for the entire period of time. Determine the size of the annual deposits that must be made by Mr. Johnson.
15,196.85
2021 Notes Payable
150,000
Powell's Safe Hands Inc., a maker of distinctive hand sanitizers, has taxable income of $90,000 in 2020. What is its total taxes in 2020?
18,850 With taxable income, the total taxes = 13,750 +34%(15,000) = 18,850
2021 Sales:
2,400,000
What is the equity multiplier for Oliver King Productions?
2.236 Equity Multiplier = Total Assets/Total Equity 720000/322000 = 2.236
What is the total asset turnover for Oliver King Productions Inc.?
2.25 Total Asset Turnover = Total Sales/Total Assets 1620000/720000 = 2.25
The Condor Blue Cooking School is considering the issuance of additional long-term debt to finance expansion. Right now, the company has $500,000 of 9% bonds outstanding. It's after-tax net income net income is $210,000 and the company's income tax rate is 30%. The company is required by the bondholders to maintain its Times Interest Earned Ratio at 5.0 or greater. Determine the maximum additional debt the firm can issue if the interest rate on the new debt is 12%.
200,000
2021 Earnings Before Interest and Taxes
240,000
2021 Accumulated Retained Earnings
265,500
The dividends of Soggy Futures Weather Forecasting Company are expected to grow at an annual rate of 8% over the next 3 years and then slow to a constant rate of 5% per year. Soggy currently pays a dividend of $2.08 per share. What is the value of Soggy's stock to an investor who requires a 12% rate of return?
33.78
2021 Long-Term Debt
384,500
At the next annual meeting for Peace Tree Restaurants, four directors will be elected. The company has 1,200,000 shares of stock outstanding. What is the minimum number of shares of stock that you must own to guarantee that you and your business associate are both elected to the board of directors if the firm uses cumulative voting?
480,001
Your bank has agreed to lend you $32,242 today, but you must repay $43,936 in 5 years. What rate is the bank charging you?
6.38%
PAC-Ten Co. has 4.8 percent, semiannual coupon bonds on the market with four years left to maturity. If the bond currently sells for $908.60, what is the YTM?
7.49%
Milne Fruit Products, Inc., has an issue of preferred stock outstanding that pays a $4.30 dividend. If the price of this preferred stock is $49.60 per share right now, what is the required return?
8.67%
What is the additional financing needed?
84,500
2021 Accounts Receivable
96,000
2021 Total Assets
960,000
You and your spouse have decided to buy a home and are now looking at options for a mortgage. You have collected the following information about the rates offered by banks and other lending institutions in your area: Bank A: 9.65% APR compounded quarterly Bank B: 9.70% APR compounded semiannually Bank C: 9.60% APR compounded monthly Bank D: 10.00%APR compounded annually Which bank should you borrow from if you want to minimize the true interest rate that you pay?
Bank B
Which of the following is not a characteristic of long-term debt?
Bondholders have voting rights to elect at least one director -bondholders typically do not have any voting rights. Most preferred shares also do not have any voting rights
An example of of an operating activity on the Statement of Cash Flows is:
Buying extra inventory
Mary owns 100 shares of stock. Each share entitles her to one vote per open seat on the board of directors. Assume there are 3 open seats in the current election and Mary casts all 300 of her votes for a single candidate. What is the term used to describe this type of voting?
Cumulative - Only cumulative voting allows a shareholder to cast all of their votes for a single candidate instead of having to cast votes for different candidates for each position on the board being elected.
What is an example of systemic risk?
Expected increase in tax rates - of the choices, only the change in tax rates will affect the entire economy. All of the other choices affect a single company or a small group of companies without affecting the entire economy.
Salt Lake City Flatware currently produces silverware and serving utensils. The company is considering expanding its product offerings to include plastic forks, knives, and spoons. Which of the following are cash flows relevant to the new product? I. Molds needed to form the plastic utensils II. Projected decrease in silverware sales if the plastic items are produced III. a portion of the production manager's current annual salary of $75,000
I and II only - since the current salary is something that the firm will still have to pay if the plasticware project is not accepted, it is a sunk cost and should not be included in the relevant cash flows. However, if the manager were to get a raise, the amount of the raise would be an incremental cash flow.
Holding all else constant, an increase in which of the following will increase net income?
Revenue
A general partner:
Is personally responsible for all the partnership debts. - general partners have "joint and several" liability, which means that they can held responsible for all of the partnership's debts, not just a fractional share.
Which one of the following is is the vertical (y-axis) intercept of the security market line?
Risk-free rate -the security market line will cross the y-axis when the beta (as measured on the x-axis) is zero. If a security has no systemic risk, it should have an expected return equal to the risk-free rate.
Besides being considered inefficient, there are three levels of market efficiency. All of the following statements are correct EXCEPT: - The semi-strong form of efficiency states that no investor can earn excess returns based on an investment strategy using public information. - Market efficiency is a hard and fast rule that has been verified in real-world situations. - The strong form of efficiency states that no investor can consistently earn excess returns since all public and private information is reflected in stock prices. - The weak form efficiency states that no investor can earn excess returns based on historical price information. - ALL of the other statements are correct.
Market efficiency is a hard and fast rule that has been verified in real-world situations.
Which of the following best states the primary goal of financial management?
Maximize the current market price per share - the goal of the financial manager should be to maximize shareholder wealth. We measure shareholder value as the total market capitalization, i.e., number of shares outstanding multiplied by the current stock price.
Assuming that interest rates do not change, do you expect the Johnson & Johnson, Inc. bond to be called in 5 years?
NO Since the decision about whether to call is made by the company, which is looking to maximize shareholder wealth, not bondholder wealth. Comparing the two yields indicates that there is a higher cost to borrowing if the bonds are called after 10 years (8.66%) instead of remaining outstanding until maturity (8.46%). SO we would expect that the bonds will not be called.
In the percent-of-sales forecasting method, all of the following balance sheet and income statement items are assumed to increase proportionately with sales EXCEPT: - property, plant, and equipment - cost of goods sold - accounts payable - notes payable - inventory
Notes payable
Which of the following is a primary market transaction?
Sale of a new share of stock by issuing company to an individual investor - the primary market deals with the issuance of new securities (either stock or bonds). The company is one party to the transaction (the seller). Transactions involving two investors, neither of which are the company, would be conducted in the secondary market. The original issuer may also participate in secondary market transactions, such as when it repurchases stock (which is then listed on the company's balance sheet as treasury stock) or resells those shares later on. Unless it is a newly issued security it is not taking place in the primary market.
Which of the following questions is a working capital management decision?
The amount of resources needed to allow customers to purchase new products on a credit basis. - The working capital decision, one of the three major decisions made by financial managers, is concerned with the day-to-day operating accounts, which include cash, accounts receivable (i.e., allowing customers to buy on credit), inventory, accounts payable, and accrued expenses.
Which one of the following is true if the managers of a firm only accept projects that have a profitability index greater than 1.25?
The value of the firm is not growing as much as it could be. - Any project with a profitability index greater than 1.0 will have a positive NPV. If a company doesn't accept projects that have a PI greater than 2.0 but less than or equal to 1.25, it will not see the increase in value that it would if it accepted these projects.
You are working as a financial analyst for Fergus Furniture Outlet and have been asked to build pro forma financial statements for 2021 using the percentage of sales technique. You are told that the sales are forecast to grow by 20% in 2021. Additionally, the interest expense is expected to increase to $46,000, the firm's tax rate will be 25%, and the company expects to keep dividends at $90,000 this upcoming year. Should the firm need to raise any external capital, it will issue additional long-term debt.
Use for numbers 54-63
According to the efficient market hypothesis, financial markets fluctuate daily because they:
are continually reacting to new information.
Agency problems are most associated with:
corporations. - only corporations have a separation of ownership and control where the managers are effectively "playing" with someone else's money. For all of the other forms, the owners themselves are the ones making the day-to-day decisions.
Sensitivity Analysis:
helps identify the variable within a project that presents the greatest forecasting risk. -Sensitivity analysis changes only one input factor to see how it affects the end result. Comparison of sensitivity results for more than one factor allows the analyst to see which factors are the most influential, i.e., which ones need to have the best estimate to ensure that the projections are reasonably accurate.
Junk bonds are
issued by firms with a high debt ratio
When a firm sells an asset for an amount ____, it realizes a capital gain and must pay capital gains taxes on it as well as ordinary income taxes on any ordinary gain.
more than its original cost - When an asset is sold for an amount up to (or equal) to the original cost, any difference between the selling price and the book value can be handled with depreciation recapture. However, if the asset is sold for more than its original cost, there is no way for depreciation to increase the book value to equal the selling price. Thus, any portion of the selling price that exceeds the original cost is treated as a separate type of gain, e.g., a capital gain, and may be taxed at a different rate than ordinary gains
If the present value and the future value of a given cash flow are equal, then
the discount rate must be zero - The formula for a lump sum is: FV1 = PV0 x (1+i)^t - If FV = PV, then i, the interest rate, must be zero
The risk-adjusted discount rate approach is preferable to the weighted cost of capital approach when:
the projects under consideration have different risk characteristics - if all projects have the same risk characteristics, they should be the same as the weighted average. However, if the projects have different risk characteristics, then the average required return may be too high or too low for individual projects.