FINA 4300 Review

1. Which one of the following statements is true? A. The pecking order theory suggests that only firms will outstanding profitability should consider issuing equity to obtain capital. B. The fact that debt financing is generally cheaper than equity financing is only due to the impact of tax. C. When a company is in financial distress, its shareholders may have an incentive to undertake excessively risky investments. D. A company incurs costs of financial distress only after declaring bankruptcy.

When a company is in financial distress, its shareholders may have an incentive to undertake excessively risky investments

1. The market risk premium is 6.5% and the risk-free rate is 1.5%. What is the required rate of return on common JTI's common stock if its beta is 1.4 and JTI's marginal tax rate is 25%.? A. 8.5% B. 10.6% C. 12.2% D. 7.95%

10.6%

1. The DEF Company is planning a $64 million expansion. The expansion is to be financed by selling $25.6 million in new debt and $38.4 million in new common stock. The before-tax required rate of return on debt is 9 percent and the required rate of return on equity is 14 percent. If the company is in the 35 percent tax bracket, what is the expansion's WACC? A. 8.92% B. 9.89% C. 11.50% D. 10.74%

10.74%

1. Kokapeli, Inc. has a target capital structure of 40% debt and 60% common equity, and has a 40% marginal tax rate. If the firm's yield to maturity on bonds is 7.5% and investors require a 15% return on the firm's common stock, what is the firm's weighted average cost of capital? A. 7.20% B. 10.80% C. 12.00% D. 12.25%

10.80%

1. The risk-free rate of return is 2.5% and the market risk premium is 8%. Rogue Transport has a beta of 2.2. Using the capital asset pricing model, what is Rogue Transport's cost of common stock? A. 16.4% B. 7.7% C. 19.6% D. 20.1%

20.1%

Firm A has an operating profit of $1,500,000. Its interest expense is $800,000. What is the percentage EBIT can fall before times interest earned falls below one? - 29.5% - 56.5% - 35.2% - 46.7%

46.7%

1. Blammo, Inc. has estimated its weighted average cost of capital to be 10%. Its cost of equity is 12%, and it's before-tax cost of debt is 10%. The firm has a tax rate of 25%. What is the weight of equity in the firm's capital structure? A. 44.5% B. 55.5% C. 54.00% D. 62.50%

55.5%

1. Consider a firm that borrows at 8% and then deducts its interest expense from its revenues before paying taxes at the rate of 23%. What is the actual cost of borrowing for this firm? A. 5.45% B. 7.91% C. 6.16% D. 8.14%

6.16%

KL Corporation has a projected times-interest-earned ratio of 4.0 for next year. What percentage could EBIT decline next year before JKL's times-interest-earned ratio would fall below 1.0? - 45% - 75% - 30% - Insufficient information is provided

75%

14. Wax Music expects sales of $437,500 next year. The net profit margin is 4.8 percent, and the firm has a 30 percent dividend payout ratio. What is the projected increase in retained earnings? A. $14,700 B. $17,500 C. $18,300 D. $20,600

A. $14,700

18. Westcomb, Inc. had equity of $150,000 at the beginning of the year. At the end of the year, the company had total assets of $195,000. During the year, the company sold no new equity. Net income for the year was $72,000, and dividends were $44,640. What is Westcomb's sustainable growth rate? A. 18.24 percent B. 15.32 percent C. 15.79 percent D. 17.78 percent

A. 18.24 percent

6. Which of the following statements is true? A. Due to required cash investments in current assets, fast-growing and profitable companies can literally "grow broke". B. Rapid growth spurs increases in market share and profits and thus, is always a blessing. C. The cash flows generated in a given time period are equal to the profits reported. D. Profits provide assurance that cash flow will be sufficient to maintain solvency.

A. Due to required cash investments in current assets, fast-growing and profitable companies can literally "grow broke".

Which one of the following will increase the sustainable rate of growth a corporation can achieve? A. decrease in the dividend payout ratio B. avoidance of external equity financing C. increase in corporate tax rates D. reduction in the retention ratio

A. decrease in the dividend payout ratio

According to the pecking order theory of capital structure, why do firms avoid issuing equity? - Because equity issuance signals that managers believe their stock is overvalued, which causes the price of the stock to fall - Because fees associated with issuing new equity are so high - Because they want to avoid dilution of earnings per share - All of above

All of above

12. Gujarat Corporation doubled its shareholders' equity during the year 2017. Gujarat did not issue any new equity, repurchase any equity, or pay out any dividends during the year. What is Gujarat's sustainable growth rate for 2017? A. 50% B. 100% C. 150% D. 200%

B. 100%

9. You constructed a pro forma balance sheet for next year and found that external financing required was negative (i.e., the company projected a financing surplus). Which of the following options, all else equal, would NOT correct the projected imbalance? A. A stock repurchase B. An increase in the retention ratio C. A decrease in accounts payable D. An increase in cash and marketable securities

B. An increase in the retention ratio

5. The retention ratio is A. equal to net income divided by the change in total equity. B. the percentage of net income available to the firm to fund future growth. C. equal to one minus the asset turnover ratio. D. the change in retained earnings divided by the dividends paid.

B. the percentage of net income available to the firm to fund future growth.

20. What is the difference between Boss's sustainable growth rate and its actual growth rate for 2017?

B. −3.04%

16. Komatsu has a 4.5 percent profit margin and a 15 percent dividend payout ratio. The asset turnover ratio is 1.6, and the assets-to-equity ratio (using beginning-of-period equity) is 1.77. What is Komatsu's sustainable rate of growth? A. 1.91% B. 6.12% C. 10.83% D. 11.26%

C. 10.83%

13. Hayesville Corporation had net income of $5 million this year on net sales of $125 million per year. At the beginning of this year, its debt-to-equity ratio was 1.5 and it held $75 million in total liabilities. It paid out $2 million in dividends for the year. What is Hayesville Corporation's sustainable growth rate? A. 4% B. 5% C. 6% D. 7%

C. 6%

19. What is the sustainable growth rate for 2016? A. −17.6% B. 8.27% C. 9.97% D. 12.23%

C. 9.97%

15. Milano Corporation has experienced growth of 20% for each of the last 5 years. Over this 5-year period, Milano's return on equity has never exceeded 15%, its profit margin has held steady at 5%, and its total asset turnover has not changed. Over the 5-year period, Milano paid no dividends and issued no new equity. Based on this information, which of the following can you most likely infer about Milano's performance over the past 5 years? A. Milano's leverage has decreased. B. Milano's leverage has remained constant. C. Milano's leverage has increased. D. None of the options are correct.

C. Milano's leverage has increased.

2. All of the followings are true except for A. A company experiencing balanced growth does not generate cash surpluses or cash deficits. B. In recent years, U.S. companies as a whole have repurchased more equity than they have issued. C. Share repurchases usually decrease earnings per share. D. One way to manage an actual growth rate below the sustainable growth rate is to buyback shares.

C. Share repurchases usually decrease earnings per share.

17. A firm has a retention ratio of 40 percent and a sustainable growth rate of 6.2 percent. Its asset turnover ratio is 0.85, and its assets-to-equity ratio (using beginning-of-period equity) is 1.80. What is its profit margin? A. 3.79% B. 5.69% C. 6.75% D. 10.13%

D. 10.13%

10. Which of the following can affect a firm's sustainable rate of growth? I. Asset turnover ratio II. Profit margin III. Dividend policy IV. Financial leverage A. I and III only B. II, III, and IV only C. I, II, and IV only D. I, II, III, and IV

D. I, II, III, and IV

4. Which of these ratios are the determinants of a firm's sustainable growth rate? I. Assets-to-equity ratio II. Profit margin III. Retention ratio IV. Asset turnover ratio A. I and III only B. II and III only C. I, II, and III only D. I, II, III, and IV

D. I, II, III, and IV

7. Which of the following questions are appropriate to address upon conducting sustainable growth analysis and the financial planning process? I. Should the firm merge with a competitor? II. Should additional equity be sold? III. Should a particular division be sold? IV. Should a new product be introduced? A. I, II, and III only B. I, II, and IV only C. I, III, and IV only D. I, II, III, and IV

D. I, II, III, and IV

1. All of the followings are false except for A. If a company seeks to maximize firm value, it should never grow at a rate above its sustainable growth rate. B. The only way a company can grow at a rate above its current sustainable growth rate is by increasing leverage. C. One way to manage an actual growth rate above the sustainable growth rate is to decrease prices. D. The sustainable growth rate is the only growth rate in sales that is consistent with stable values of the profit margin, retention rate, asset turnover, and leverage

D. The sustainable growth rate is the only growth rate in sales that is consistent with stable values of the profit margin, retention rate, asset turnover, and leverage

8. The sustainable growth rate of a firm is best described as the A. minimum growth rate achievable, assuming a 100 percent retention ratio. B. minimum growth rate achievable if the firm maintains a constant equity multiplier. C. maximum growth rate achievable, excluding external financing of any kind. D. maximum growth rate achievable, excluding any external equity financing while maintaining a constant debt-equity ratio

D. maximum growth rate achievable, excluding any external equity financing while maintaining a constant debt-equity ratio.

11. Which of the following is NOT a reason for why U.S. corporations haven't issued more equity in recent years? A. Managers usually believe that their stock is overvalued. B. Managers try to avoid bad signals to the market C. Equity is relatively expensive to issue. D. Managers try to avoid dilution of earnings per share. E. None of above

E. None of above

1. Which one of the following statements is false? A. Cost of capital is true is the ultimate cost of raising funding to run or expand a business B. Cost of capital determines the required return necessary to make a project worthwhile. C. For bonds, cost of capital is always lower than the yield to maturity of the bond. D. For equity, cost of equity is always higher than the required rate of return on common stock.

For equity, cost of equity is always higher than the required rate of return on common stock.

According to the pecking order theory, which of the following are correct? I For financing needs, firms prefer to first tap internal sources, such as retained earnings II. Firms prefer to issue private debt over public debt. III. Firms prefer to issue new equity rather than source external debt. IV. Firms should aim to reach a target debt-ratio in the long-run. II and IV I and III I and II I, II, and IV

I and II

Which of the following factors favor the issuance of debt in the financing decision? I. Market signaling II. Distress costs III. Tax benefits IV. Financial flexibility I, II, and IV I and III II and IV III and IV

I and III

The term "financial distress costs" includes which of the following? I. Bankruptcy cost II. Indirect cost III. Conflicts of Interest IV. Flotation costs I, II, and III I and II II and III I and IV

I, II, and III

Which of the following factors favor the issuance of equity in the financing decision? I. Market signaling II. Distress costs III. Bankruptcy costs I V. Financial flexibility I only II and III II, III, and IV I and IV

II, III, and IV

Increase in financial leverage I. increases expected ROE but does not affect its variability. II. increases expected return and risk to owners. III. decreases the interest earned. IV. reduces sustainable growth rate II only I and III III and IV II, and III

II, and III

1. Which one of the following statements is true? A. If the operating return on assets is greater than the interest rate on a debt, then a higher debt-to-equity ratio increases return on equity. B. Usually, debt financing in associated with higher cost of capital relative to equity financing. C. Retained earnings is the best source of capital because it has no cost. D. Empirical evidence indicates that, on average, a company's stock price increases when it announces a new issue of equity.

If the operating return on assets is greater than the interest rate on a debt, then a higher debt-to-equity ratio increases return on equity.

1. Which one of the following statements is false? A. Increased debt lowers the initial investment required by shareholders. B. Increased debt amplifies the expected return. C. Increased debt amplifies coverage ratios D. Increased debt amplifies the risk faced by shareholders.

Increased debt amplifies coverage ratios

Which of the following statements is MOST correct? - No matter if a firm pays a dividend or not, the cost of common stock is normally bigger than the cost of debt. - Because the cost of debt is lower than the cost of equity, value-maximizing firms maintain debt ratios of close to 100%. - Corporations that are 100% equity financed will have a much lower weighted average cost of capital because the lack of debt lowers their risk of bankruptcy. - The cost of capital on any source of capital, is always equal to the required rate of return on that source.

No matter if a firm pays a dividend or not, the cost of common stock is normally bigger than the cost of debt.