Corporate Finance Final: True/False
A company whose ROA increased with no change in Asset Turnover likely experienced an increase in Profit Margin (PM)
True
A liquid asset is one that can quickly and easily be converted into cash with little to no change in value
True
A mutual fund that focuses on value stocks instead of growth stocks would be more likely to invest in firms with low P/E ratios
True
A new long term bank loan is arranged and the funds are used to retire long-term bonds. If the interest rate on the new loan is higher than the rate on the bonds, the firm will likely decrease its TIE ratio
True
A problem with basing balance sheets on historical costs is that in a period of inflation, a company with old fixed assets will likely show a much better return on investment than a similar firm with new fixed assets
True
An IPO is an example of a primary market transaction
True
An example of a plausible negative bond covenant is that the company must avoid dividend payments in excess of its debt expense
True
Bond ratings by Moody's and Standard & Poor's provide info on the likelihood of default.
True
Bonds w/longer maturities and/or lower Coupons respond most vigorously to a change in market interest rates
True
Consider two cash flows: $1000 seven years from now, and $800 ten years from now. For all positive interest rates, in value today of the $1000 (received in 7 years) will be greater than the value of the $800 (received in 10 years)
True
Firm X and Firm Y have the same Total Asset Turnover and ROE. If X has a higher PM, then X must be using less leverage.
True
For financial planning purposes, we usually define short-term as 1 year and long-term as 2-5 years
True
For firms in growth industries, it is common for the book value of the firm to be less than the market value.
True
For profitable firms, the market value of equity will generally be greater than the book value of equity
True
If a firm remains financially healthy, it bonds will typically provide higher returns than gov.'t bonds
True
If a firm uses cash to purchase fixed assets, this will result in a decrease in its NWC
True
If a firms TIE ratio decreased from 6 to 2 without a change in interest rates or earnings, the firm likely has more leverage
True
In a large corporation, tying a manager's compensation to the performance of the stock price is one way to minimize agency costs
True
In an amortized loan (like a car loan), the fraction of each payment that goes towards reducing the loan amount increases over time
True
In general, new firms, growing firms, and firms perceived as growth firms will have a relatively high percentage of earnings retained
True
Insurance Companies are one type of investor that might find STRIPS more convenient than coupon bonds
True
Its uncommon for firms to have P/E ratios above 200
True
Many software firms capitalize (treat as an asset) the development costs associated with creating new software products. One motivation for doing this is because it increases accounting earnings
True
Many software firms capitalize the costs of developing new software products. This is because it increases accounting earnings
True
Operating cash flow does not include interest expense because it is considered a financing expense, not an operating expense
True
Prices of Zero-Coupon Bonds generally rise as maturity nears
True
Small firms tend to have larger P/E ratios than very large firms
True
Term structure of IRs is a plot of IRS for different investment/borrowing horizons at a given point in time
True
The Fisher Effect describes the relationship between the nominal interest rates, real return, and inflation. At a close approximation, the Nominal Rate of Return = Real Rate plus Expected Nate of Inflation
True
The P/E ratio is sometimes used as a measure of a firm's growth opportunities
True
The amount of retained earnings listed on the income statement will generally be lower than the amount of retained earnings on the balance sheet
True
The coupon payments from municipal bonds are exempt from federal income taxes.
True
The written, legally binding agreement between the corporate borrower and the lender detailing the terms of the bond issue is referred to as the indenture
True
US Treasury Notes and Treasury Bonds have original maturities greater than 1 year
True
When evaluating the cash flows of a new potential project, the relevant tax rate for projecting after tax cash flows is the marginal tax rate
True
If a firm issues common stock and holds the proceeds as cash, its ROA and debt to equity ratios will decrease
True.
If a firm's growth in sales is higher than its SGR, it will either need to raise money from equity or accept more debt (more risk)
True.
If a firm issues common stack and holds the proceeds as cash, its ROA and Debt-to-Equity ratio (DE) will decrease
True. Debt to Equity will decrease because equity will increase. ROA will decrease because Total Assets increases (More cash)
A company had a bad 2012 and the CEO left halfway through the year. Some employees were laid off, others are planned to be laid off in 2013. The current CEO wants to expense the severance pay for these employees in 2012. This is an example of the earnings management move called a "big bath"
True: Big bath reduces assets and net income in one year to increase it in the future. Get rid of all the bad now, and it won't weigh you down in the future.
The capital structure decision can also be thought of as determining how much financial leverage to have
True: Capital Structure = getting the money
If operating cash flow is negative, then cash flows from assets may still be positive
True: Cash Flows from Assets = Operating cash flows - net capital spending - change in net working capital. So if Net Capital Spending or change in NWC is negative, than cash flows from assets can be positive.
If a firm only has current assets and no fixed assets, its times interest earned ratio will equal its cash coverage ratio
True: Cash coverage is Times Interest earned, but Depreciation is added to the numerator.
If you multiply a bond's Current Yield by its price, you get the coupon payment
True: Current Yield = (Coupon Payment/Market Price). Coupon = interest payments
If a firms TIE ratio increased from 2 to 6, and the firms earnings and interest rates haven't changed, it would likely suggest the firm has less leverage.
True: EBIT would increase if there was less debt, given that IRs are the same and earnings are too.
A firm's IGR is 8% and its SGR is 12%. If the firm grows at 10% it can finance its asset needs by raising external debt (and using internal financing), and its leverage will decline compared to last year.
True: If its within the SGR, than you can raise new debt without going increasing the leverage.
A company has a promising new product, but accelerating development will depress earnings for the next few quarters. If the managers choose to forego this opportunity, it could be the example of an indirect agency cost
True: Indirect agency costs are when opportunities are missed because of disagreements.
If a firm sells part of its inventory at a loss, its current ratio will decrease
True: Inventory is part of current liabilities
Capital Budgeting involves the process of planning and managing the firm's long-term investments
True: Investments cost $$$
Facebook likely has a higher P/E ratio than facebook
True: It likely has a lot more growth potential
A shipping company will likely have higher leverage ratios than a computer software company
True: Lots of debt needed to finance the equipment for a shipping company
You have a choice between $750,000 today or an annuity payment of $50,000 at the end of each of the next 20 years. You are indifferent when the IR is 2.91 percent. At interest rates below this level you would choose the annuity
True: Lower interest rate = lower discount rate, so the amount of money you can earn through other investments is less
Facebook likely has a higher market-to-book ratio than Home Depot
True: Market value is that special something, which Facebook has a lot more of
Manufacturing firms will likely have larger differences between their TIE and Cash Coverage ratios than consulting firms
True: More equipment = more depreciation.
New common stock is issued and the proceeds are used for capital expenditures. This would decrease the leverage of the firm.
True: More equity = less leverage
Home Depot finished a new renovation of one of its stores including new cash registers and shelves. This change is likely to decrease their Fixed Asset Turnover Ratio, but may increase their Inventory Turnover Ratio this year
True: New Shelves = higher inventory turnover. New cash registers = new equipment = more fixed assets = lower FATR.
For a Premium Bond, YTM < CR
True: Premium Bond = YTM < CR Discount Bond = YTM > CR
All else equal, an increase in the dividend payout ratio will decrease the sustainable growth rate
True: SGR = ROE x (1 - dividend-payout ratio)
The market price for a 20yr bond is currently equal to par value. If 5 years go by and IRs remain the same, the bond will still sell at par value
True: Since interest rates = coupon rate, the bond sells at par. Thus, only a change in IR would change the bond's market price
If a firm has no debt of any kind, its sustainable growth rate will be the same as its internal growth rate
True: Sustainable growth rate is the maximum amount a firm can grow without having to increase its leverage or debt ratios. The internal growth rate is the amount a firm can grow without external financing. Since taking on any debt would change growth rates for a firm without debt, SGR = IGR
A firm has a current ratio of 2.5. If it pays off an accounts payable with cash, its current ratio will increase (Special Question)
True: There will be a slight increase.
If a firm has a better than expected quarter, the managers may have an incentive to artificially inflate expenses this quarter to facilitate smooth, steady growth in income in future quarters
True: This is earnings management
Consider two callable bonds. All else equal, the one with the longer call protection period will have a lower Yield-to-maturity
True: YTM = Required Rate of Return. Longer call protection = lower required return. YTM is the discount rate that equates the market value (price) of a bond and the present value of the future. Interest: Payments and redemption of principal.
A public company is one that sells directly to the public, as opposed to wholesalers
False
For a profitable firm, the market value of equity will generally be greater than the book value of equity, which generally shows up on the balance sheet as goodwill
False
For highly leveraged firms, return on assets describes how well the firm uses the owner's money to generate profits.
False
Many software firms capitalize (treat as an asset) the development costs associated with creating new software products. One motivation for doing this is to lower their tax burden
False
One of the benefits of organizing as a sole proprietorship is that the interest paid on debt is tax deductable
False
The price of a BB bond will always be more sensitive to changes in interest rates than AA bond
False
The sale of used equipment at book value for cash will increase earnings per share
False
When a company conducts a stock buy-back and repurchases its own equity shares in the open market this is a primary market transaction
False
When a retailing company purchases inventory, the book value per share of the company increases
False
While stocks and bonds are issued first in the primary market, firms actually receive most of their financing through the sale of securities in the secondary market
False
You would buy stock for a company at the primary market
False
If a firm sells part of its inventory at a loss, its quick ratio will decrease
False, selling inventory increases the quick ratio, the loss, or gain, does not effect it.
Earnings that are paid out as dividends show up on the balance sheet as additional paid-in capital
False.
A bond with a face value of $1,000 has annual coupon payments of $100 and was issued 7 years ago. Today, YTM = 10% and has 8 years left until maturity. Today, the Current Yield on this bond will be < 10%.
False. CY = 10%
You need money for tuition so you decide to sell some bonds from your portfolio. You have two types of bonds. The two types are identical except X bonds have a longer maturity than Y bonds. If you expect that interest rates will fall soon after you sell your bonds and stay there indefinitely, you would sell some X Bonds
False. Longer Maturity = bigger response to IR changes. Falling IR = Bigger returns.
Normally an analyst would believe that a Manu. firm with a current ratio of 3:1 was in serious liquidity trouble
False: >1 is good.
If a firm has a P/E ratio of 30, the way to interpret this is that for every dollar investors are willing to pay (per share), the firm earns $30 (per share)
False: A P/E of 30 means that investors are willing to pay $30 for for $1 of current earnings.
Interest payments to bondholders are subject to double taxation as a result of corporate and personal taxes
False: Bonds are not subject to double taxation, only dividend payments are.
Common size financial statements are obtained by dividing numbers on the income and balance sheet by sales
False: Common size balance sheet is found by dividing things by total assets and total liabilities and equity
If a firm profitably sells some of its inventory, its current ratio will remain unchanged
False: Current Assets will decrease, but Current Liabilities will stay the same
If a firm sells one of its fixed assets on credit (an accounts receivable is created), its current ratio will increase but its quick ratio will decrease
False: Current and Quick Ratio will increase
Joel (the owner of Dave's Cosmic Subs) decides to get a gold-plated toaster. This is an example of a direct agency cost
False: Dave is the sole owner, there are no agency costs whatsoever
Double taxation refers to the fact that investors are taxed both on the dividends they receive and on any capital gains
False: Double taxation refers to the fact that Corporations are taxed before they pay out dividends, and then stockholder's are taxed on the dividends they receive.
The Du Pont Identity decomposes ROE into components related to operating efficiency, growth potential, and financial leverage
False: Du Pont Identity decomposes ROE into components related to: Operating Efficiency (Profit Margin, net income/sales); Asset Use Efficiency (Total Asset Turnover, sales/total assets); Financial Leverage (Equity Multiplier, total assets/total equity)
An annuity due receives payments at the beginning of the period. This makes the FV of an Annuity Due = the FV of an Original Annuity + the FV of an extra payment
False: FVAD = FVOA + PV of an extra payment
A firm wants to boost sales and reduce inventory so they lower the price of their product. All else equal, this will likely lower their profit margin and decrease total asset turnover
False: Firm will have a lower profit margin, but its total asset turnover will likely increase.
Bonds are referred to as floating rate bonds when their par values vary with inflation
False: Floating rate bonds COUPON RATE fluctuates with inflation.
For bonds selling at a premium, the "Yield to Maturity" is greater than the "Current Yield"
False: For premium bonds, YTM is < COUPON RATE
If a firm has no debt of any kind, It's ROA will be lower than ROE
False: If a firm has no debt, ROA will be equal to ROE.
The income statement represents a snapshot of a firm's financial position at a given point in time.
False: Income statement is over a period, Balance Sheet is a snapshot.
The amount of RE listed on the income statement should equal the amount of RE on the balance sheet
False: Income statement will be lower because balance sheet is Cumulative RE.
The only way a company can grow at a rate above its current SGR is to by issuing new stock
False: It can also take on new debt
The Return on Equity ratio describes the relationship between the market value of a firm and its earnings
False: It describes the relationship between Earnings and the amount of money stockholder's put into the firm. It should be called return on book equity. For every dollar in equity, the firm generated ROE cents in profits.
An increase in the number of shares of common stock outstanding will decrease a company's P/E ratio if the market price per share does not change
False: It has no effect
The sale of used equipment at book value for cash will decrease earnings per share
False: It has no effect on earnings per share
Buying a new piece of equipment is a source of cash
False: It is an output of cash or an expense.
When market value is below book value, this indicates that the investors view the company has having strong future potential
False: It means that the firm has low future potential
A grocery store will likely have a higher days' sales in inventory than a car dealer
False: It will be much lower. Much higher inventory turnover rate
If a firm uses accounts payable to purchase a new fixed asset, this will make the current ratio move away from 1
False: It will decrease
If a firm buys fixed assets using short-term credit, this will result in an increase in NWC
False: It will decrease NWC (CA-CL) by increasing CL, without changing CA.
A bond's maturity value will generally be greater than its par value
False: It will generally be less than.
If a firm is not operating at full capacity, assuming assets grow with sales will likely understate the firms funding needs
False: It will overstate the firms funding needs, because it will suggest that the firm must fund more equipment/assets, but it could really just use existing ones.
If a new (long term) bank loan is arranged and the funds are used to retire outstanding bonds, this will increase the financial leverage of the firm
False: Leverage will either stay the same, or decrease
If a firm uses accounts payable to buy a new fixed asset, this would have no effect on net working capital
False: NWC would decrease because current liabilities increases, but current assets do not
Information on the balance sheet is all that is necessary to determine the receivables turnover ratio
False: Need sales from income statement
A retail firm will have a smaller difference between its current ratio and its quick ratio than a service industry firm will have.
False: Quick ratio does not have inventory.
A company that has an increase in ROA, but no noticeable change in Asset Turnover, has most likely experienced an increase in financial leverage.
False: ROA = (net income/total assets). Asset Turnover = (sales/total assets). If ROA increases, but Asset turnover does not change, then the firm has likely decreased its financial leverage (less money has to go to creditors).
ROE describes the relationship between the market value of a firm and its earnings
False: ROE measures the book value of a firm against it's earnings.
Treasury securities are considered riskless because investors can always sell the bonds back to the gov.'t at face value
False: Riskless because no risk of default
A utility firm will likely have a small difference between its times interest earned and cash coverage ratios
False: Since Utility firms are all equipment, they have a lot of depreciation, thus their CC Ratio will be much higher than their TIE Ratio.
A company issues new debt and proceeds to buy back common stock (assume no effect on revenues or operating expenses). This would likely raise the amount of taxes paid by the firm.
False: Taxes would decrease because interest expense would increase, thus decreasing earnings
The P/E ratio expresses the relationship between the selling prices of a company's products and the related earnings
False: That's more similar to profit margin
Equity financing has a tax advantage since dividends paid out to shareholders reduce a firms taxable income
False: The firm is taxed before dividends are paid
If a firm that had positive profits, paid 1/3 out in dividends, and raised no new debt or equity, its ROE would increase relative to the previous year.
False: The increase in net income would not
For highly levered firms, ROA describes how well the firm uses the owner's money to generate profits
False: The more leverage, the higher ROE will be. Still the definition of ROE
The replacement of an old, fully depreciated equipment with new equipment would result in an increase in the fixed asset turnover ratio
False: The new asset would increase net fixed assets, so the ratio would decrease
All else equal, if a firm raises funds by selling new stock, it will increase its degree of financial leverage
False: This will decrease its degree of financial leverage.
This week Publix finished a quick renovation of one of its stores including a new fridge and new shelves. This will likely decrease their fixed asset turnover ratio and inventory turnover ratio
False: This will increase their inventory turnover ratio
Total Asset Turnover measures the amount of assets used for each dollar of sales
False: Total Asset Turnover = The amount of sales generated for each dollar in assets.
Total Asset Turnover measures the amount of assets used for each dollar of sales.
False: it measures the amount of sales generated per $ of assets
According to GAAP, assets are shown on financial statements at their market value
False: they are shown at book value
