Fundamental Concepts Practice Exam 1-5

Which of the following statements is NOT CORRECT?

"Going public" establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares.

Emery Mining Inc. recently reported $150,000 of sales, $75,500 of operating costs other than depreciation, and $10,200 of depreciation. The company had $16,500 of outstanding bonds that carry a 7.25% interest rate, and its federal-plus-state income tax rate was 35%. How much was the firm's net income? The firm uses the same depreciation expense for tax and stockholder reporting purposes.

$41,017.44 _________________________ $ 16,500 Interest rate 7.25% Tax rate 35% Sales $ 150,000 Operating costs excluding depreciation 75,500 Depreciation 10,200 Operating income (EBIT) $64,300.00 Interest charges −1,196.25 Taxable income $63,103.75 Taxes −22,086.31 Net income $41,017.44

Hartzell Inc. had the following data for 2012, in millions: Net income = $600; after-tax operating income [EBIT(1 − T)] = $700; and Total assets = $2,000. Information for 2013 is as follows: Net income = $825; after-tax operating income [EBIT(1 − T)] = $925; and Total assets = $2,500. How much free cash flow did the firm generate during 2013?

$425 (925-500=425)

During 2012, Bascom Bakery paid out $33,525 of common dividends. It ended the year with $197,500 of retained earnings versus the prior year's retained earnings of $159,600. How much net income did the firm earn during the year? $71,425 $78,746 $86,818 $82,683 $74,996

$71,425 ____________________ 197,500- 159,600 = 37,900 37,900 + 33,525 = 71,425

Your corporation has the following cash flows: Operating income $250,000 Interest received 10,000 Interest paid 45,000 Dividends received 20,000 Dividends paid 50,000 If the applicable income tax rate is 40 percent, and if 70 percent of dividends received are exempt from taxes, what is the corporation's tax liability?

$88,400 ______________________ (250000+10000-45000+20000x.3)x.4= 88400

Last year Almazan Software reported $10.50 million of sales, $6.25 million of operating costs other than depreciation, and $1.30 million of depreciation. The company had $5.00 million of bonds that carry a 6.5% interest rate, and its federal-plus-state income tax rate was 35%. This year's data are expected to remain unchanged except for one item, depreciation, which is expected to increase by $0.70 million. By how much will net income change as a result of the change in depreciation? The company uses the same depreciation calculations for tax and stockholder reporting purposes

-$0.455 Change in depreciation $0.700 Tax rate 0.350 Reduction in net income $0.455

Last year Blease Inc had a total assets turnover of 1.33 and an equity multiplier of 1.75. Its sales were $295,000 and its net income was $10,600. The CFO believes that the company could have operated more efficiently, lowered its costs, and increased its net income by $10,250 without changing its sales, assets, or capital structure. Had it cut costs and increased its net income by this amount, how much would the ROE have changed?

1) Asset turnover ratio = Sales / Total assets 1.33 = $295,000 / Total assets Total assets = $221,804.51 2) Equity multiplier = Total assets / Equity. 1.75 = $221,804.51 / Equity Equity = $126,745.44 3) ROE Before = Net income / equity = $10,600 / $126,745.44 = 8.36% 4) ROE After = Net income / equity = [$10,600 + $10,250] / $126,745.44 = 16.45% By increasing the net income by $10,250 the ROE change by = 8.36% to 16.45% = 8.09%

Your child's orthodontist offers you two alternative payment plans. The first plan requires a $4,000 up-front payment. The second plan requires you to make monthly payments of $137.41, payable at the end of each month for 3 years. What nominal annual interest rate is built into the payment? Please show breakdown with your solution. Thanks!

14.36% annual interest rate is 1.1967% monthly interest rate. For 3 years, you have 36 months, so: P = A (P/A,i,N) = 137.41 (P/A,i=1.1967%,N=36) = 137.41 (29.1096) = 3999.95 = 4,000

Your Aunt Ruth has $450,000 invested at 6.5%, and she plans to retire. She wants to withdraw $40,000 at the beginning of each year, starting immediately. How many years will it take to exhaust her funds, i.e., run the account down to zero?

18 years (Picture saved on desktop) rate- 6.5% pmt- 40000 PV- -45000 FV- 0 Type- 1 = 18.425

What's the present value of $1,100 discounted back 5 years if the appropriate interest rate is 6%, compounded monthly?

815.51

Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and managers?

Change the corporation's formal documents to make it easier for outside investors to acquire a controlling interest in the firm through a hostile takeover.

Which of the following statements is CORRECT?

As they are generally defined, money market transactions involve debt securities with maturities of less than one year.

Which of the following statements is CORRECT?

Both NASDAQ dealers and "specialists" on the NYSE hold

A loss incurred by a corporation

Can be carried back 2 years, then carried forward up to 20 years following the loss.

Which of the following statements is CORRECT?

Capital market instruments include both long-term debt and common stocks.

T/F Suppose all firms follow similar financing policies, face similar risks, have equal access to capital, and operate in competitive product and capital markets. However, firms face different operating conditions because, for example, the grocery store industry is different from the airline industry. Under these conditions, firms with high profit margins will tend to have high asset turnover ratios, and firms with low profit margins will tend to have low turnover ratios.

False

T/F Suppose you are analyzing two firms in the same industry. Firm A has a profit margin of 10% versus a margin of 8% for Firm B. Firm A's debt ratio is 70% versus 20% for Firm B. Based only on these two facts, you cannot reach a conclusion as to which firm is better managed, because the difference in debt, not better management, could be the cause of Firm A's higher profit margin.

False

The fewer the number of compounding periods within a year, then (1) the greater the future value of a lump sum investment at Time 0 and (2) the greater the present value of a given lump sum to be received at some future date.

False

Which of the following statements is CORRECT?

Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light regulation is that only "sophisticated" investors (i.e., those with high net worths and high incomes) are permitted to invest in these funds, and these investors supposedly can do any necessary "due diligence" on their own rather than have it done by the SEC or some other regulator.

Which of the following statements is CORRECT?

In a "Dutch auction," investors who want to buy shares in an IPO submit bids indicating how many shares they want to buy and the price they are willing to pay. The company determines how many shares it wants to sell. The highest price that enables the company to sell the desired number of shares is the price that all buyers must pay.

Which of the following investments will have the HIGHEST FUTURE VALUE at the end of 10 years? Assume that the effective annual rate for all investments is the same.

Investment D pays $2,500 at the end of 10 years (a total of one payment).

The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to

Maximize the firm's EPS (earnings per share), which must also maximize the firm's price per share. Maximize the stock price per share over the long run, which is the stock's intrinsic value.

The primary goal of a publicly-owned firm interested in serving its stockholders should be to

Maximize the market value of the stock.

A new firm is developing its business plan. It will require $565,000 of assets, and it projects $452,800 of sales and $354,300 of operating costs for the first year. Management is quite sure of these numbers because of contracts with its customers and suppliers. It can borrow at a rate of 7.5%, but the bank requires it to have a TIE of at least 4.0, and if the TIE falls below this level the bank will call in the loan and the firm will go bankrupt. What is the maximum debt-to-assets ratio the firm can use? (Hint: Find the maximum dollars of interest, then the debt that produces that interest, and then the related debt ratio.)

Maximum debt to assets ratio = Debt / assets = ($24625 / 7.5% ) / $565000 = 328333 / 565000 = 58.11% Note:- Earning before interest and tax = sales- operating cost = $452800 - $354300 =$98500 TIE(times interest earned) = Earning before interest and tax / interest 4.0 = $98500 / interest interest = $24625

Charter Bank pays a 5.20% nominal rate on deposits, with monthly compounding. What effective annual rate (EFF%) does the bank pay?

Monthly Rate=5.20/12 0.4333 Effective Annual Rate=(1.004333^12-1)*100 5.325 or 5.33%

Helmuth Inc's latest net income was $1,250,000, and it had 225,000 shares outstanding. The company wants to pay out 45% of its income. What dividend per share should it declare? a. $2.14 b. $2.26 c. $2.38 d. $2.50 e. $2.63

Net income $1,250,000 Shares outstanding 225,000 Payout ratio 45% EPS = NI/shares outstanding = $5.56 DPS = EPS × Payout % = $2.50

You plan to borrow $45,000 at a 7.5% annual interest rate. The terms require you to amortize the loan with 7 equal end-of-year payments. How much interest would you be paying in Year 2?

PV 45,000, R 7.5%, N 7. Computes to Annual Annuity Payment of 8,496. In Yr 1, interest = 45,000 x 7.5%, or 3,375 of the total payment of 8,496. So principal paid was 5,121. In Yr 2, Beginning balance was 39,879 x 7.5% = 2,990.93 interest in yr 2.

Your bank offers to lend you $230,000 at an 8.5% annual interest rate to start your new business. The terms require you to amortize the loan with 10 equal end-of-year payments. How much interest would you be paying in Year 2?

Present value (PV) = PMT [1/I) - 1/I(1+I)^N] N 10 I 8.5% PV $230,000 PMT $20313.6 Amortization schedule (first 2 years) Year Beg. Balance Payment Interest Principal End. Balan 1 230,000 20314 19550 764 229236 2 229236 20314 19485 829 228407 so the ANSWER is $19485

You have won a lottery which will pay you 10 annual checks of $3 million each. Your checks will begin arriving starting a year from now. Calculate the present value annuity in millions of dollars of these cash flows assuming a discount rate of 5%.

Present value of annuity = P×[1-(1÷(1+r)^n)]÷r r is interest rate per period P is payment per period n is number of payments = $3×[1-(1÷(1+5%)^10)]÷5% = $23.16 million

Which of the following statements is CORRECT?

Sole Proprietorships and partnerships generally have a tax advantage over corporations.

Which of the following statements is CORRECT?

The NYSE operates as an auction market, whereas NASDAQ is an example of a dealer market. inventories of stocks.

Which of the following statements is CORRECT?

The New York Stock Exchange is an auction market, and it has a physical location.

Which of the following actions would be likely to reduce potential conflicts of interest between stockholders and managers?

The composition of the board of directors is changed from all inside directors to all outside directors, and the directors are compensated with stock rather than cash

T/F In finance, we are generally more interested in cash flows than in accounting profits. Free cash flow (FCF) is calculated as after-tax operating income plus depreciation less the sum of capital expenditures and changes in net working capital.

True

T/F The advantage of the basic earning power ratio (BEP) over the return on total assets for judging a company's operating efficiency is that the BEP does not reflect the effects of debt and taxes.

True

n/a

n/a

What is the future value of $4,900 invested for 8 years at 7 percent compounded semiannually?

n= 8 *2 = (semi-annual) FV= $4900 * (1 +0.07)^16 FV = $4900 * 2.9521 FV = 14,465.29

Your father is about to retire, and he wants to buy an annuity that will provide him with $50,000 of income per year for 20 years, beginning a year from today. The going rate on such annuities is 6%. How much would it cost him to buy such an annuity today

present value of annuity = 50000/1.06 + 50000/1.06^2 .........50000/1.06^20 =$5,73,496.06