FINA 4200 Final

You are holding a stock which has a beta of 2.0 & is currently in equilibrium. The required return on the stock is 15% & the return on average stock is 10%. What would be the percentage change in return on the stock, if the return on an average stock increased by 30% while the risk-free rate remained unchanged.

+40% (See Midterm 1 for solution)

When the market's required rate of return for a particular bond is much less than its coupon rate, the bond is selling at

A premium

Jefferson City Computers has developed a forecasting model to determine the additional funds it needs in the upcoming year. All else being equal

-A sharp increase in its forecasted dales and the company's fixed assets are at full capacity. -The company reduces its reliance on trade credit that sharply reduces its accounts payable.

Last year Quayle Energy had sales of $200 million and its inventor turnover ratio was 5.0. The company's current assets totaled $100 million and its current rain was 1.2. What was the company's quick ratio?

.72 (Midterm 1)

Elephant books sells paperbacks books for $7 each The variable cost per book is $5. At current annual sales of 200,000 books the publisher is just breaking even. It si estimated that if the authors royalties are reduced the variable cost per book will drop by $1. Assume authors' royalties are reduced an sales remain constant; how much more money can the publisher put into advertising (a fixed cost) and still break even

200,000

Stock A: SD: .15 Beta: .79 Stock B: SD: .25 Beta: .61 Stock C: SD: .20 Beta: 1.29 If you are a risk minimizer, you should choose Stock ____ if it is to be held in isolation and Stock ____ if it is to be held as part of a well-diversified portfolio.

A ( lowest SD) ; B ( lowest Beta)

Which of the following events is likely to encourage a company to raise its target debt ratio

A) An increase in the corporate tax rate

Which of the following statements is most correct?

A) Inherent in the AFN formula is the assumption that each asset item must increase in direct proportion to sales increases & the spontaneous liability accounts also grow at the same rate as sales.

Which of the following is not considered a capital component for the purpose of calculating the weighted average cost of capital as it applies to capital budgeting?

A) Long term debt B) Common Stock *C) Accounts Payable* D) Preferred Stock E) All of the above are considered capital component for the purpose of calculating the weighted average cost of capital as it applies to capital budgeting?

Which of the following statements is correct?

A) Since debt financing raises financial risk, raising a company's debt ratio will always increase the company's WACC B) Since debt financing is cheaper than equity financing; raising a company's debt ratio will always reduce the company's WACC. C) Increasing a company's debt ratio will typically reduce the marginal cost of both debt and equity financing; however, it still may raise the company's WACC. D) Statements a & c are correct *E) None of the above is correct*

You have been scouring the Wall Street Journal looking for stocks that are "good values" and have calculated the expected returns for 5 stocks. Assume the risk free rate is 7% & the market risk premium is 2%. Which security would be the best investment

B) 7.06% (expected return) 0.00 (Beta)

A company's balance sheets show a total of $30 million long term debt with a coupon rate of 10%. the yield to maturity on this debt is 12% and the debt has a total current market value of $20 million. The balance sheets also show that the company has 10 million shares of stock; the total of common stock and retained earning is $40 million. The current stock price is $15 per share. The current return required by stock holders, re, is 15%. The company has a target capital structure of 40% debt and 60 % equity. the tax rate is 40%. What weighted average cost of capital should you use to evaluate potential projects?

C) 11.88% .4 x 12% (1-1.4) + .6 x 15%

The projected cash flow for the next year of Mine-X Inc. is $100,000 and FCF is expected to grow at a a constant rate of 6%. If the company's WACC is 11% what is the value of its operations

D) 2,000,000 Vop = 100,000/(.11-.06)

Adam Smith is considering automating his pin factory with the purchase of a $475,000 machine. Shipping and installation would cost $5000. Smith has calculated that automation would result in savings of $45,000 a year due to reduced scrap and $65,000 a year due to reduced labor costs. The machine has a useful life of 4 years and falls in the 3- year property class for MACRS depreciation purposes. The estimated final salvage value of the machine is $120,000. The firm's marginal tax rate is 34%. the incremental cash outflow at time period 0 is closest to...

D) 480,000 -Cash outlay at t=0 is : 475K + 5K = 480k

The cost of capital for a firm ---- when we allow for taxes, bankruptcy, and agency costs --

First declines and then ultimately rises with increasing levels of financial leverage

What is the value of the tax shield if the of the firm is $5 million, its value if unlettered would be $4.78 million and the present value of bankruptcy and agency costs is $360,000?

D)580,000 Vl = Vu = TAXSHIELD - PV of bankruptcy + Agency costs 5 million = 4.78 million + TS - 360K. TS = 580K

If the company's expected return on invested capital is less than it cost of equity then the company must also have a negative MVA

FALSE

A call provision gives bondholders the right to demand or "call for" repayment of a bond. Typically, calls are exercised if interest rates rise, because when rates rise the bondholder can get the principal amount back & reinvest it elsewhere at higher rates.

False

You are considering two bonds. Both are rated double A (AA), both mature in 20 years both have a 10% coupon and both are offered to you at their $1,000 par value. However Bond X has a sinking fund while Bond Y does not. This is probably not an equilibrium situation, as Bond X, which has the sinking fund, would generally be expected to have a higher yield than Bond Y.

False

Don't Know Inc.'s FCF is expected to be $10 million in year 6 and the FCF growth rate is expected t be constant at 4% beyond that point. if the weighted average cost of capital is 10% what is the horizon value (in millions) at t = 6?

HV = 10 (1+0.04)/ (.10 - .04) = 173.33 million

Each of the calling statements is correct?

If the IRR of a project is greater than the discount rate k its PI will be less than 1 and its NPV will be greater than 0.

Which of the following does not always increase a company's MVA?

Increasing the expected growth rate of sales

A firm's degree of operation leverage (DOL) depends primarily upon its

Level of fixed operating costs

All of the following influence capital budgeting cash flows *except*:

Method of project financing used

Plaid Pants, Inc. common stock has a beta of .9, while Acme Dynamite Company common stock has a beta of 1.80. The expected return on the market is 10%, and the risk free rate is 6%. According to the CAPM model and making use of the info above, the required return of Plaid Pants' common stock should be ______, and the required return on acme's common stock should be_____.

Plaid Pants: r = 6% + 0.9 (10% - 6%) = 9.6% Acme Dynamite: r = 6% + 1.8 (10% - 6%) = 13.2%

Felton Farm Supplies Inc. has an 8% return on total assets of $300,000 and a net profit margin of 5%. What are sales?

TAT = NI/A = NI/300,000 = 8% *Net PM = NI/Sales = 5%* NI = 8% of 300,000 = 24000 Then use this NI in equation 2.

To compute the required rate of return for equity in a company using the CAPM, it is necessary to know all of the following EXCEPT:

The earnings for the next time period.

Which of the following statements in general is correct?

The lower the total debt-to-equity ration, the lower the financial risk for a firm.

If the intrinsic value of a stock is greater than its market value, which of the following is a reasonable conclusion

The market is undervaluing the stock

A profitability index of .85 for a project means that:

The project returned 85 cents in present value for each current dollar invested.

You have just noticed in the financial pages of the local newspaper that you can buy a $1,000 par value bond for $800. If the coupon rate is 10% with annual interest payments and there are 10 years to maturity you should make the purchase if your required return on investments of this is 12%

True.

If miller & modigliani has considered the cost of bankruptcy it is unlikely that they would have concluded that 100 percent debt financing is optimal for the firm

True

There is an inverse relationship between bond rating & the required return on a bond. The required return is lowest for AAA -rated bonds, & required returns increase as the ratings get lower

True

This type of risk is avoidable through proper diversification

Unsystematic risk

A firm's value of operations is $480 million. The balance sheet shows $20 million of short-term investments that are unrelated to operations, $50 million of accounts payable, $100 million of notes payable, $50 million of long-term debt, $50 million of preferred stock, and $100 million of common equity. The firm has 10 million shares outstanding. What is the best estimate of the stocks price per share?

V = Vop + S - T Investments (480 + 20 = $500 mil) E = V - Debt - Preferred Stock (500 - [100+50] - 50 = $300 mil) P = $300/ 10 = $30

Which of the following statements is most correct

a) Market participants are able to eliminate virtually all market risk if they hold a large diversified portfolio of stocks. b) Market participants are able to eliminate virtually all company - specific risk if they hold a large diversified portfolio of stocks. c) It is possible to have a situation where the market risk of a single stock is less than that of a well-diversified portfolio d) Answers A & C are correct *e) Answers B & C are correct*

The trade off theory tells us that the capital structure decision involves a tradeoff btw the costs of debt financing and the benefits of debt financing

true