Managerial Finance Exam 1

True or false: If you bought 100 shares of Apple Computer stock (AAPL) today, you would be purchasing those shares directly from Apple.

False

True/False: The mix of debt and equity on the right-hand side of the balance sheet is called capital budgeting.

False

True/False: bonds are sold in increments of 10000 and have a face value of 20 years

False

True/False: For savings accounts, banks are required to post APR but not APY.

False?

If the Federal Reserve intends to raise short-term interest rates, what is the name of the specific rate that is targeted?

Federal funds rate, it is a benchmark rate which affects us in society.

T or F: The value of a bond can be approximated by summing the present value of the coupon payments (annuity) with the present value of the face amount (single sum). (See Section 6.1)

TRUE

T or F: Valuing a business is much more difficult than just appraising the hard assets and adding the value up because the business also has soft, intangible assets affecting its future for which values are very subjective (e.g. reputation, strategic or competitive advantage, loyal customers, superior location or employees, goodwill, etc.)

TRUE

T or F: Voting on a proxy is the only involvement of most stockholders in the management of "their" business.

TRUE

T or F: When Warren Buffet estimates the true price of a share of stock (intrinsic value per Buffet), he first estimates the value of the whole business by calculating the present value of its anticipated cash flows and then divides by the number of shares in the business to get the per share value.

TRUE

T or F: When a company declares bankruptcy, the bondholders and other creditors have first claim to the company assets but the stockholders, who have a residual interest, often end up with nothing.

TRUE

T or F: When state and local governments issue bonds (municipal bonds), the lenders do not have to pay federal income tax on the interest. (See Section 6.4)

TRUE

T or F: Without the use of a financial calculator/spreadsheet, finding YTM is a trial-and-error process. (See Sect. 6.1)

TRUE

True or false. The S&P500 index usually moves somewhere between the DJIA and the NASDAQ Composite (see instructor notes).

TRUE

True or false: In general, financial managers are hired to maximize the value of existing owners' stock (wealth).

TRUE

True/False: 2 reasons that a company's market value differs from book value are: book value is based on historical cost and book value does not include internally generated soft/intellectual assets.

TRUE

True/False: A bond rated BBB will offer a higher rate than a bond rated AAA

TRUE

True/False: A current ratio smaller than 1 means that there are insufficient current assets to pay for current liabilities

TRUE

True/False: A profit margin of 4% means that there are 4 cents of net income for every dollar of revenue/sales

TRUE

True/False: A typical student would be on the cash basis

TRUE

True/False: Because an investor in bonds is a creditor, bonds are considered debt securities

TRUE

True/False: If both the dividend yield on MSFT stock and capital gains yield were 5%, the total return on the stock should be 10%

TRUE

True/False: If the coupon rate is 5% and the market rate is 6% the bonds will sell for a discount

TRUE

True/False: In 2017, the corporate tax rate in the US was one of the highest in the world

TRUE

True/False: In the future value of an annuity, both interest and payment add to the growing balance over time

TRUE

True/False: Inventory would likely be more liquid than buildings and equipment

TRUE

True/False: Sears currently has liquidity and working capital problems

TRUE

True/False: The effective annual return (EAR) for savings account paying 12%, compounded semi-annually, is 12.36%

TRUE

True/False: The market maker is required to buy/sell stock when there are no brokers to trade with on the NYSE floor

TRUE

True/False: The traditional dividend growth model cannot be used to value stocks that pay zero dividends

TRUE

True/False: Valuing bonds is easier than valuing stocks because both timing and amounts of future cash flows are known in advance

TRUE

True/False: You only need to put away 100 per month over 40 years if you want to have over a million dollars, assuming 12% return

TRUE

True/False: investing in bonds is less risky than investing in stocks

TRUE

True/False: one advantage of investing in municipal bonds is that interest is not taxed by the federal government

TRUE

Using the rule of 72, if the worlds population is growing at 4% a year, the population will double in 18 years.

TRUE

true/false: Microsoft has obtained most of its financing from equity inventors rather than debt investors

TRUE

True or false: With a few exceptions, most companies on the NASDAQ are smaller than those listed on the NYSE.

TRUE, NASDAQ is mostly smaller companies with some exceptions (tech companies). Microsoft and intel

T or F: A municipal bond paying 7% is a better deal than a corporate bond paying 10%, assuming a marginal tax rate of 35% and similar terms and risks.

TRUE, the municipal bond is not subject to federal interest tax. 10% (1-.35) =6.5%

Would the agency problem occur more likely in a large corporation or in a small "mom & pop" business? Why?

it would occur at a large corporation, because at a small business you are both the owner and the manager.

Is a bear investor an optimist or a pessimist?

- Pessimistic, bulls are optimists

T or F: One way that liquidity is indicated on the balance sheet is that assets are listed in order of increasing liquidity (i.e. least liquid listed first) and liabilities are listed in order of decreasing maturity (amounts due latest are listed first).

FALSE, it should be decreasing then increasing.

True or false: When shares of Microsoft are bought/sold through a brokerage firm such as E-Trade, this transaction occurs on the primary market.

FALSE, trading with the company itself.

True/False: the dividend yield becomes more important in a bull market than a bear market

FALSE

True/False: For most young adults, waiting six years after graduating from college to start saving for retirement will have minimal effect on the final balance at retirement

FALSE?

Based on what we've covered so far in this course, rank these choices from the least risky to the most risky. (A) income stock funds (B) growth stock funds (C) short-term Treasury bond funds (D) long-term Treasury bond funds (E) corporate bond funds rated AAA

(C) short-term Treasury bond funds, (D) long-term Treasury bond funds, (E) corporate bond funds rated AAA, (A) income stock funds, and (B) growth stock funds

T or F: The typical maturity of a corporate bond is 30 years. (See Section 6.1)

TRUE

True/False: Under accrual accounting, income is only recorded when the cash is received.

FALSE

True/False: a bond rated CCC is considered an investment-grade bond

FALSE

True/False: bond interest payments are made annually

FALSE

True/False: most bonds today are bearer bonds

FALSE

True/False: simple interest includes interest on interest

FALSE

List five ways that owners can keep managers working in the owners' best interests

1. Provide performance-based compensation 2. Threaten to fire poor managers (proxy fight - proxy is how you vote) 3. Regular job evaluation 4. The threat of a hostile takeover, in which case managers lose their jobs 5. Regular Audits

List four ways that managers can protect their jobs against angry owners

1. Win the proxy fight 2. Initiate a management-led buyout 3. create costly severance package 4. Fight against hostile takeover (use greenmail, poison pills, white knights, pacman approach)

Why do we assume that corporations desire to see a constant growth rate in their dividends

A corp. who lowers a dividend investors are not happy and then the stock price can crash. It sends a very bad signal to investors.

How is a bear market technically defined?

A general definition of a bear market is when a decline of at least 20% over 3 months or more

What is a proxy?

A proxy is an agent legally authorized to act on behalf of another party or a format that allows an investor to vote without being physically present at the meeting.

L-T Solvency: total debt and times interest earned ratios

A total debt ratio above 0.5 means the company is financed mostly through debt financing. In the case of all three companies their ratios are above 0.5. Costco has enough income to pay their interest 28 times therefore they are in the best position to pay for any debts they may encounter.

Which accounting basis must be used by corporations that have their stock traded publicly? Why?

Accrual basis because of GAAP and it provides a better picture of where money has come and gone over the last period.

When owners are not involved in their business and they hire managers to manage it for them, what is the term used to describe conflicts between owners and managers? (See Ch. 1)

Agency problem

True/False: The NASDAQ market is the largest market in the US

FALSE

Why do you think MSFT first started paying dividends at that time (decades after becoming a public company)?

Approx. in 2003 they started paying dividends. Investors did not ask for dividends and they did not need to pay out. They started paying dividends because of the turn of the century changed the way investors looked at their stock. As it went down stockholders wanted some kind of payment.

Why are proxies used?

Because it is not worth it for all stockholders to go to the meeting, its expensive. So many just attend digitally to vote.

What are two reasons why long-term rates are usually higher than short-term rates? In other words, what are the two reasons that a bond yield curve usually slopes up to the right?

Because of interest rate risk premium and inflation risk (locked into a rate).

True/False: The two cash flows with bonds are dividends and face value of 1000

FALSE

If a corporation is directly involved with investors only in the primary market, why does a corporation care about having a robust and liquid secondary market?

Because the secondary market provides a place to sell shares and it provides pricing information. Without the secondary market we wouldn't know what the shares are worth. Liquidity and pricing are important components for a corporation.

Why does the value of stock eventually depend on dividends or similar cash distributions to owners?

Because there is no point to investing if the company never gives out any reward for the use of your money.

Why do you think investors like to invest in municipal bonds?

Because there is no tax on the interest for municipal bonds and this is attractive to those who are in a high tax bracket.

Why are the future cash flows for bond investors considered less risky than those for stock investors?

Bond is less risky because the amount and time is known in advance. Stock investors do not have any idea what the cash returns will be.

What does callable mean?

Callable means the company can take the bonds back and send them out at a lower interest rate.

What was the term used in Ch. 1 to refer to the mix of debt and equity on the right side of the balance sheet?

Capital Structure

Define three primary areas that concern a financial manager

Capital structure, Capital Budget, and working capital

A series of cash flows of the same amount occurring at the same time each period is called an annuity. Give two examples of an annuity that might occur in common American life.

Car payment, house payment, or saving for retirement

Which is more Investment in common stock of a public company or investment in a private business partnership?

Common stock in a public company is more liquid can sell much faster than a private business partnership.

How does corporate democracy differ from political democracy when it comes to voting?

Corporate is one vote per share and political it is one vote per person.

Turnover: inventory turnover

Costco has the best inventory turnover because they sell all of their inventory about 11 times each year while Target and Walmart only sell theirs 5 and 9 times a year respectively. Costco also has a better days' sale in inventory at only 32 days. Target and Walmart both are higher meaning their inventory remains in their store longer and waits to be sold. Overall Costco manages inventory, receivables, and total assets better.

Debt vs. equity: You bought a General Motors corporate bond.

Debt

Debt vs. equity: You opened a saving account at the Umpqua Bank down the street.

Debt

What are the two types of future cash flows that stock investors may (or may not) receive?

Dividends and the gain on the sale of the stock.

Why do you suppose that most investors in preferred stock are corporate investors?

Dividends are tax free.

Debt vs. Equity: You opened a saving account at Blue Mtn. Credit Union by buying shares (members own the credit union)

Equity

Debt vs. equity: You became a partner in a small local business by buying a 50% stake

Equity

Debt vs. equity: You purchased one share of General Motors common stock.

Equity

T or F: A bond rated AAA will offer a higher interest rate than a bond rated BBB. (See Section 6.3)

FALSE

T or F: A zero coupon bond pays interest in regular intervals during the life of the bond. (See Section 6.4)

FALSE

T or F: Although the NYSE has more companies listed than the Nasdaq, all the companies traded on the Nasdaq are very big companies while the NYSE includes mostly smaller companies.

FALSE

T or F: An annuity payment occurring at the end of each period is called an annuity due, but an annuity payment occurring at the beginning of each period is called an ordinary annuity.

FALSE

T or F: Bond prices and interest rates move in the same direction (e.g. if interest rates increase, so would the price of the bonds.) (See Section 6.1)

FALSE

T or F: Bonds whose ownership is registered with the corporation are called bearer bonds. (See Section 6.2)

FALSE

T or F: In practice, bonds issued in the U.S. usually make coupon payments for interest only once a year. (See Ex. 6.1)

FALSE

T or F: Most corporate bonds today are bearer bonds. (See Section 6.2)

FALSE

T or F: The balance over time decreases in a future-value-of-annuity problem and increases in a present-value-of-annuity problem.

FALSE

T or F: Unlike the cash flows for bonds, the cash flows for stocks are very easy to predict because their timing and amounts are specified and guaranteed in advance.

FALSE

True or false: Initial public offerings, such as Lyft's (LYFT) occur in the secondary market

FALSE

True/False: A company should try to keep its market-to-book ration less than one

FALSE

True/False: A company with a debt ratio of 0.6 has used more equity financing than debt financing to acquire its assets

FALSE

True/False: A low P/E ratio usually indicates investor confidence in the company's future

FALSE

True/False: Although Warren Buffet is lauded as one of the most successful investors ever, he has not been able to consistently beat the returns of the S&P500

FALSE

True/False: Because corporations can deduct dividends on their tax returns, stock financing is generally preferred over bond financing

FALSE

True/False: Days' sales in inventory of 90 days would be an excellent figure for a retailer such as Walmart

FALSE

True/False: For a common-sized income statement Net income should be set at 100%

FALSE

True/False: From a management perspective, a smaller inventory turnover is better.

FALSE

True/False: Generally, companies should try to keep their market-to-book ratio less than one

FALSE

True/False: Having positive cash flows from investing activities is normally considered a positive sign

FALSE

True/False: Many states require straight voting for common stock owners, because cumulative voting can freeze out minority shareholders from electing anyone on the board of directors

FALSE

True/False: Preferred stockholders vote before common stockholders

FALSE

True/False: Suppose a company has a goal of collecting its receivable within 30 days. If the inventory turnover is 5, it appears the company is meeting its goal

FALSE

Is Ford Motor Company (ticker F) traded on the NYSE or the NASDAQ? How can you tell?

Ford is traded on the NYSE. You can tell where a stock is traded by looking at the tickers (letters), three or less means it is probably NYSE and four or more is generally traded on the NASDAQ.

What is liquidity?

How quickly you can turn stuff into cash. "Liquidity describes the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset's price" (Investopedia).

Why do you think it is selling at a discount or premium?

If a bond's coupon rate is less than its YTM, then the bond is selling at a discount. "The bond discount is the difference by which a bond's market price is lower than its face value" (Investopedia). Therefore, the it is selling at a discount because the bond is lower than market value.

Do higher inflation rates harm savers (with fixed-rate investments) or borrowers (with fixed-rate loans)?

Inflation rates are very influential on the saver, higher inflation rates can harm a savers detrimentally. Borrows love inflation because it helps them pay back their debt.

Why is the S&P500 preferred by academics over the DJIA (see instructor notes)?

Is doesn't have any of the weaknesses of the DOW. There are 500, includes every industry, and the way they calculator the index is much more superior.

Liquidity: current ratio.

It depends on the store because sometimes a current ratio less than one can mean that the store has a quick inventory turnover. It seems like Costco has a better current ratio because it is above one, but again it depends on the items being sold at the store and the way in which inventory items are sold.

What main physical property does a liquid have that a solid does not? (Hint: Why does grandpa have to liquidate the farm in order to divide the assets among all the heirs?)

Liquid can be easily divisible and solid must have some sort of tool to break it part. Liquidity means easily divisible.

T or F: The entity selling bonds is borrowing money and the entity buying bonds is lending money.

TRUE

What is the name of the largest dealer market? Where is this market physically located (trick question)?

NASDAQ which is a virtual market and is not located physically anywhere

What is the name of the most prominent auction market in the U.S.? What is its nickname (see instructor notes)?

NYSE is the most prominent and nickname is "the big board".

Can the DGM be used to value stock of a company that doesn't pay dividends?

No not really, there are substitutes for dividends in other models.

How much more purchasing power would you get from the increase in your account if inflation was also 10%/yr.

Nothing

Why do you think certain corporations pay higher dividend yields than the others?

One of the only ways to attract people to your company is by dividends of your company is not making a profit.

Indicate the operating, investing, and financing positive or negative: Going strong & ensuring strength for tomorrow by investing in the future with funds from operations and external financiers (normal cash flow, particularly in early stages)

Operating Activities +200 Investing Activities - 400 Financing Activities +200

Indicate the operating, investing, and financing positive or negative: Going strong, investing in the future, and rewarding external financiers (normal cash flow, particularly in later maturity stages)

Operating Activities +200 Investing Activities -100 Financing Activities -100

Indicate the operating, investing, and financing positive or negative: Hoarding cash for an unknown reason (selling assets and borrowing cash, possibly to have enough for a takeover or expansion)

Operating Activities +300 Investing Activities +100 Financing Activities +200

Indicate the operating, investing, and financing positive or negative: Satisfying cash-hungry financiers by selling investments & distributing cash (typical in late maturity stage)

Operating Activities +300 Investing Activities +200 Financing Activities -500

Indicate the operating, investing, and financing positive or negative: Moving ahead in faith; despite the odds, somebody believes in you enough to provide external financing so that you can make L/T investments and hopefully turn things around (cash flow typical in start-up stages)

Operating Activities -100 Investing Activities -200 Financing Activities +300

Indicate the operating, investing, and financing positive or negative: Poor health and getting ready to die (liquidation: selling off investments and paying off debts; reaching for the coffin lid)

Operating Activities -200 Investing Activities +400 Financing Activities -100

T or F: The market interest rate is also called the yield-to-maturity (YTM) or just "yield." (See Section 6.1)

TRUE

What are the two types of future cash flows that bond investors expect to receive?

Regular interest payments called coupons and (2) the face value to be paid at the end

What is the difference between simple and compound interest?

Simple interest: interest on the original principal only this is a linear equation Compound interest: This is interest on interest and this is an exponential equation

What are three reasons that the Dow Jones Industrial Average (DJIA) does not reflect the overall market very well (see instructor notes)?

Small sample size (only 30) This only represents industrials (small part of the economy) Doesn't represent smaller companies at all (only 30 largest)

T or F: The process of finding the present value of a future cash flow is also called discounting.

TRUE

T or F: The right-hand side of the balance sheet tells us who (creditors vs. owners) has claim to the assets

TRUE

T or F: The typical face value or par value of a corporate bond is $1,000 each. (See Section 6.1)

TRUE

What are the key differences between T-Bills, T-Notes, and T-Bonds?

T-bill - short term (1 year or less) T-notes - mid-term( greater then 1-10 years) T-bond long term (greater then 10 years)

Which type of marketable treasury security has been used the most for borrowing?

T-notes are used the most for borrowing

T or F: A perpetuity is an annuity that continues forever.

TRUE

T or F: A sinking fund is an arrangement made to pay-off a portion of the bonds each year so that the borrower isn't faced with a huge balloon payment at maturity which it can't pay. (See Section 6.2)

TRUE

T or F: An indenture is the formal bond contract, a debenture is an unsecured bond, and a denture is false teeth. (See Sect.6.2)

TRUE

T or F: An investor buying a bond gets a discount when the fixed coupon interest rate offered by the bond is inferior to the rate the investor could get elsewhere for a similar bond. (See Section 6.1)

TRUE

T or F: An investor is willing to pay a premium for a bond when the bond offers superior fixed interest payments compared to other bonds of similar risk. (See Section 6.1)

TRUE

T or F: Because future cash flows from stocks are so unpredictable, their values may, to some degree, depend on the investor's perspective (e.g. "beauty is in the eyes of the beholder").

TRUE

T or F: Because interest on municipal bonds is not subject to federal income tax, the federal government subsidizes the cost of borrowing for state and local governments.

TRUE

T or F: Historically, an inverted yield curve has preceded every economic recession in U.S. history.

TRUE

T or F: In a zero-coupon bond, interest is paid all at the end, when the bond matures, but no interest payments occur during the life of the bond. (deep discount bonds)

TRUE

T or F: In essence, a call provision allows the corporation to refinance bonds at a lower interest rate.

TRUE

T or F: In order to trade stock on the floor of the NYSE, you must acquire a license (formerly called a seat).

TRUE

T or F: In terms of dollar volume, the largest stock market is the world in the NYSE

TRUE

T or F: In the event of default, senior bondholders get paid before junior bondholders. (See Section 6.2)

TRUE

T or F: Junk bonds are non-investment-grade bonds. (See Section 6.3)

TRUE

T or F: Most bonds are traded over-the-counter, which means there is no physical place of trading but that trades are processed by a group of dealers around the world who are connected electronically.

TRUE

T or F: Most corporate bonds, with the exception of railroads & utilities, are debentures. (See Section 6.2)

TRUE

T or F: On a typical day, the dollar volume of bonds traded is larger than the dollar volume of stocks traded.

TRUE

T or F: Preferred stockholders have preference over common stockholders when it comes to dividends (they get dividends first) and to claims for residual assets in a bankruptcy --- but in so doing, they forfeit their right to vote.

TRUE

T or F: Regarding common stock voting procedures, many states require cumulative voting because straight voting can freeze out minority shareholders.

TRUE

T or F: Stock investors usually face significantly more risk than bond investors do because stock investors can only guess what their future cash flows might be, whereas bond investments know the timing and amount of future cash flows, which are guaranteed by the investee.

TRUE

Profitability: profit margin and return on equity ratios

Target appears to be more profitable because for every dollar of revenue how much did we take home with us in net income (3.9 pennies at Target). Walmart is not as profitable as they have been in previous years. Target also has a higher return on equity at 0.26.

Market Value: price/earnings and market-to-book (also called price/book) ratios

Target compared to other stocks in S&P 500 is slightly underpriced while Walmart seems to be overpriced. Costco has a very good market value at almost 8 times what the accountants say it is worth.

Why is an ask price higher than a bid price?

The bid price represents the maximum price that a buyer is willing to pay for a security. The ask price represents the minimum price that a seller is willing to receive. The difference between the two is the spread and the smaller the spread the more liquid the asset.

If the value of an investment today is the present value of the future cash flows, which do you think is easier to value correctly: a bond or in a stock?

The bond because you know what the future value is the cash is.

Would you suspect that interest rates on 30-year corporate bonds would be higher or lower than 30-year Treasuries? Why?

The government has power to print money and can create more therefore the interest rates on the corporate bonds will have higher rates.

What is the Rule of 72?

The rule of 72 is taking how long it take something to double and multiple it by your rate. Rate*# of periods= 72.

Why do you think many public corporations don't pay dividends?

This is because they are often to new and they do not have enough money to pay out money to their investors. Also many are not considered about the dividends when they know the stock price is going up. They would rather the company keep the money and invest it in the company.

Suppose you own one share in Microsoft. List at least three rights you have as part-owner of MSFT.

To vote Share of dividends Percentage of ownership Right to any leftovers

Do you think an upward or downward-sloping term structure is more normal in a growing economy?

Upward

What is meant by the term "the agency problem"?

When a conflict arises between stockholders (principles) and mangers (agents).

List two key differences between dealer and auction markets.

• Dealer markets are virtual: NASDAQ o You are trading with the dealer and from their own inventory • Auction markets are physical: NYSE o Match buyers/sellers. Not dealing with dealers, instead you are using a broker to find another broker who wants to trade.

Identify the four basic areas of finance

• Investments • Financial institutions • International finance • Corporate finance