Finance Final Module 1,2,6,7,8
Langston Labs has an overall (composite) WACC of 10%, which reflects the cost of capital for its average asset. Its assets vary widely in risk, and Langston evaluates low-risk projects with a WACC of 8%, average projects at 10%, and high-risk projects at 12%. The company is considering the following independent projects with normal cash flows. Project Risk Expected Return A High 15% B Average 12 C High 11 D Low 9 E Low 6 Which set of projects would maximize shareholder wealth?
A, B, and D
Which of the following is NOT one of Modigliani and Miller's set of conditions referred to as perfect capital markets?
All investors hold the efficient portfolio of assets
Lincoln Industries' current ratio is 0.5. Considered alone, which of the following actions would increase the company's current ratio
Borrow using short-term notes payable and use the cash to increase inventories
Lincoln Industries' current ratio is 1.5. Considered alone, which of the following actions would decrease the company's current ratio?
Borrow using short-term notes payable and use the cash to increase inventories
The major components of common stockholders' equity are
Common stock, paid-in surplus, and retained earnings
Companies Heidee and Leaudy are both profitable, and they have the same total and fixed assets (TA), Sales (S), return on assets (ROA), and net profit margin (PM). However, Company Heidee has the higher debt ratio. Which of the following statements is CORRECT
Company Heidee has a higher ROE than Company Leaudy,
Is NOT one of the steps taken in the financial planning process
Consult with key competitors about the optimal set of prices to charge, i.e., the prices that will maximize profits for our firm and its competitors
All else equal, an increase in the corporate tax rate would tend to encourage a company to increase its debt ratio
Correct
Increasing a company's debt ratio will typically increase the marginal cost of both debt and equity financing. However, this action still may lower the company's WACC.
Correct
When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are deductible by the paying corporation.
Correct
Based on the information below for Benson Corporation, what is the optimal capital structure?
Debt = 60%; Equity = 40%; EPS = $3.18; Stock price = $31.20
If a firm is planning an expansion or changes in how it manages its inventory, long te rm financial planning can help determine the impact on the firm's _______
Debt Financing Capital investment and Free Cash Flow
Anyone who purchases the stock on or after the ________ date will not receive the dividend
Ex-Dividend
Building a model for long-term forecasting reveals points in the future where the firm will have ______.
Excess cash that can be used for dividends, debt repayment, or stock repurchases. Cash needs that must be funded with external financing. A need for expanding property, plant and equipment to meet increases in capacity
If Firm A and Firm B are in the same industry and use the same production method, and Firm A's asset turnover is higher than that of Firm B, then all else equal we can conclude:
Firm A is more efficient in using their assets than Firm B.
Below are portions of the balance sheet and income statement for two companies in 2008. Based upon this information, which of the following statements is most likely to be true?
Fixed asset turnover ratios indicate that firm A is generating fewer sales for the assets they employ than firm B
The term "additional funds needed (AFN)" is generally defined as follows
Funds that a firm must raise externally from non-spontaneous sources, i.e., by borrowing or by selling new stock to support operations
Suppose Tapley Corporation uses a WACC of 8% for below-average risk projects, 10% for averagerisk projects, and 12% for above-average risk projects. Which of the following independent projects should Tapley accept, assuming that the company uses the NPV method when choosing projects
Project B, which has below-average risk and an IRR = 8.5%
A delivery company is creating a balance sheet. Which of the following would most likely be considered a short-term liability on this balance sheet?
Revenue received for the delivery of items that have not yet been delivered
If the above balance sheet is for a retail company, how has the company's leverage changed between 2007 and 2008
The company has experienced a significant increase in its leverage
If the above balance sheet is for a retail company, what indications about this company would best be drawn from the changes in the balance sheet between 2007 and 2008?
The company is having difficulties selling its product
If the above balance sheet is for a retail company, what indications about this company would best be drawn from the changes in stockholders' equity between 2007 and 2008?
The company's net income in 2008 was negative
what is a firm's gross profit?
The difference between sales revenues and the costs associated with those sales
what is the firms new income?
The difference between the sales and other income generated by the firm, and all costs, taxes, and expenses incurred by the firm in a given period The last or "bottom" line of the income statement A measure of the firm's profitability over a given period
Which of the following is NOT associated with (or does not contribute to) business risk? Recall that business risk is affected by a firm's operations.
The extent to which interest rates on the firm's debt fluctuate.
Schalheim Sisters Inc. has always paid out all of its earnings as dividends, and hence has no retained earnings. This same situation is expected to persist in the future. The company uses the CAPM to calculate its cost of equity. The firm is financed with common stock and debt. Which of the following events would reduce the WACC
The market risk premium declines
What does the firm's equity multiplier measure?
The value of assets held per dollar of shareholder equity
Which of the following best describes why firms produce financial statements
To provide interested parties, both inside and outside the company, with an overview of the short and long term financial condition of a business
The firm's overall cost of capital that is a blend of the costs of the different sources of capital is known as the firm's
Weighted average cost of capital
Which of the following is the best statement of the efficient markets hypothesis?
With competition, the price that an investor would pay for a stock (or a bond) equals the PV of cash flows he expects to receive from owning the asset
Poff Industries' stock currently sells for $120 a share. You own 100 shares of the stock. The company is contemplating a 2-for-1 stock split. Which of the following best describes what your position will be after such a split takes place?
You will have 200 shares of stock, and the stock will trade at or near $60 a share.
Suppose Novak Company experienced a reduction in its ROE over the last year. This fall could be attributed to:
a decrease in asset turnover
A company that produces drugs is preparing a balance sheet. Which of the following would be most likely to be considered a long-term asset on this balance sheet?
a patent for a drug held by the company
F. Marston, Inc. has developed a forecasting model to estimate its AFN for the upcoming year. All else being equal, which of the following factors is most likely to lead to an increase of the additional funds needed (AFN)?
a sharp increase in its forecasted sales
Which of the following assumptions is embodied in the AFN equation
accounts payable and accruals are tied directly to sales
in the real world, dividends
are usually more stable than earnings
WorldCom classified $3.85 billion in operating expenses as long-term investments. How would this make WorldCom's financial statements more attractive to investors?
by raising it reported earnings
The relative proportion of debt, equity, and other securities that a firm has outstanding constitute its
capital structure
A negative AFN indicates that retained earnings and spontaneous liabilities are far more than sufficient to finance the additional assets needed
correct
If a company has an established clientele of investors who prefer a high dividend payout, and if management wants to keep stockholders happy, it should not follow the strict residual dividend policy
correct
If a company's tax rate increases but the YTM of its bonds remains the same, the after -tax cost of its debt will fall
correct
If a firm follows the residual dividend policy, then a sudden increase in the number of profitable projects is likely to reduce the firm's dividend payout
correct
If two firms differ only in their use of debt, i.e., they have identical assets, sales, operating costs, interest rates on their debt, and tax rates, but one firm has a higher debt ratio, the firm that uses more debt will have a lower profit margin on sales.
correct
Other things held constant, the lower the debt ratio, the lower the interest rate the bank would charge the firm
correct
Stock repurchases can be used by a firm that wants to increase its debt ratio.
correct
Stock repurchases make the most sense at times when a company believes its stock is undervalued
correct
Suppose a firm's total assets turnover ratio falls from 1.0 to 0.9, but at the same time its profit margin rises from 9% to 10% and its debt increases from 40% of total assets to 60%. Under these conditions, the ROE will increase
correct
The firm mails dividend checks to the registered shareholders on the
distribution date
Which of the following industries is likely to have the lowest costs of financial distress?
electric utilities
Building a model for long-term forecasting reveals points in the future where the firm will need ______ when retained earnings are not enough to fund planned future investments
external financing
If Alex Corporation takes out a bank loan to replace a machine used in production and everything else stays the same, its equity multiplier will ________, and its ROE will ________.
increase;increase
This does NOT always increase a company's stock price
increasing the expected growth rate of sales
Which of the following is not an operating expense
interest expense
direct cost of bankruptcy
investment banking costs cost of accounting experts legal costs and fees
The after-tax cost of debt ________ the before-tax cost of debt for a firm that has a positive marginal tax rate.
is always less than
If Moon Corporation's gross margin declined, which of the following is TRUE?
its cost of goods sold as a percent of sales increased
While the assets and accounts payable of a firm may reasonably be expected to grow with sales, _______ will not naturally grow with sales
long term bedt
indirect cost of bankruptcy
loss of supplies loss of employees loss of customers
If a firm adheres strictly to the residual dividend policy, then if its optimal capital budget requires the use of all earnings for a given year (along with new debt according to the optimal debt/total assets ratio), then the firm should pay
no dividends to common stock
If a firm adheres strictly to the residual dividend policy, the issuance of new common stock would suggest that
no dividends were paid during the year
A(n) ________ is the most common way that firms repurchase shares.
open market share repurchases
The idea that managers who perceive the firm's equity is underpriced will have a preference to fund investment using retained earnings, or debt, rather than equity is known as the
pecking order hypothesis
The ________ method assumes that as sales grow, many income statement and balance sheet items will grow, remaining the same percent of sales
percent of sales
The firm will pay the dividend to all shareholders who are registered owners on a specific date, set by the board, called the:
record date
The amount of dividends a company pays will affect the _______ it has to finance future growth.
retained earnings
Which of the following industries likely to have the highest costs of financial distress?
semiconductors
A firm's dividend policy is unaffected by the firm's ability to accelerate or delay investment projects
statement is not correct
Which of the following statements best describes the optimal capital structure? The optimal capital structure is the mix of debt, equity, and preferred stock that maximizes the company's ____.
stock price
A firm can repurchase shares through a(n) ________ in which it offers to buy shares at a pre-specified price during a short time period—generally within 20 days
tender offer
Which of the following statements regarding the balance sheet is INCORRECT
the balance sheet reports liabilities on the left-hand side
Other things held constant, which of the following events is most likely to encourage a firm to increase the amount of debt in its capital structure?
the corporate tax rate increases
If you want to value a firm but do not want to explicitly forecast its dividends, what is the simplest model for you to use?
the discounted free cash flow model
Which of the following is the LEAST likely explanation for a firm's high ROE
the firm is growing
As Modigliani and Miller made clear in their original work, capital structure matters in perfect capital markets. Thus, if capital structure does not matter, then it must stem from a market imperfection.
this statement is false
Because of the increasing popularity of repurchases, firms cut dividends much more frequently than they increase them
this statement is false
Calculating the precise present value of financial distress costs is a straightforward process.
this statement is false
Equity holders expect to receive dividends and the firm is legally obligated to pay them
this statement is false
Firms whose value and cash flows are very volatile (for example, semiconductor firms) must have much higher levels of debt to avoid a significant risk of default.
this statement is false
Firms with high R&D costs and future growth opportunities typically maintain high debt levels.
this statement is false
Free cash flow measures the cash generated by the firm after payments to debt or equity holders are considered
this statement is false
Given a 35% corporate tax rate, for every $1 in new permanent debt that the firm issues, the value of the firm increases by $0.65.
this statement is false
In perfect markets, WACC decreases with leverage because the firm can take on cheaper debt.
this statement is false
Indirect costs are typically much smaller than the direct costs of bankruptcy
this statement is false
Taxes are not an important market imperfection that influence a firm's decision to pay dividends or repurchase shares.
this statement is false
The presence of financial distress costs can explain why firms choose debt levels that are too high to fully exploit the interest tax shield
this statement is false
The tradeoff theory weighs the costs of debt that result from shielding cash flows from taxes against the benefits from the effects of financial distress associated with leverage
this statement is false
U.S. firms can file for two forms of bankruptcy protection: Chapter 11 or Chapter 13.
this statement is false
When using the discounted free cash flow model we should always use the firm's equity cost of capital.
this statement is false
Whether default occurs depends on the cash flows, not on the relative values of the firm's assets and liabilities
this statement is false
With perfect capital markets, a firm's WACC is dependent of its capital structure and is equal to its equity cost of capital only the firm it is unlevered
this statement is false
With tax-deductible interest, the effective after-tax borrowing rate is r(TC) where TC is the marginal tax rate
this statement is false
A firm's additional funds needed (AFN) must come from external sources. Typical sources include short-term bank loans, long-term bonds, and common stock.
true
Forecasting a balance sheet with percent of sales method requires at least two passes - a first pass to determine financing needs and a second pass that shows the sources and amounts o f financing.
true
If a firm's projects differ in risk, then different projects should be evaluated using risk-adjusted discount rates
true
The goal of the financial manager is to maximize the value of the shareholder's stake in the firm
true
The trade-off theory states that the capital structure decision involves a tradeoff between the costs and benefits of debt financing
true
Apple computers has raised all its capital via equity rather than debt. Such a firm is also referred to as an ________ firm
unlevered
Apple computers has raised all its capital via equity rather than debt. Such a firm is also referred to as an ________ firm.
unlevered
