Fin 300 Exam 1
True/False: High current and quick ratios always indicate that the firm is managing its liquidity position well.
False
HD Corp and LD Corp have identical assets, sales, interest rates paid on their debt, tax rates, and EBIT. Both firms finance using only debt and common equity and total assets equal total invested capital. However, HD uses more debt than LD. Which of the following statements is CORRECT? a. HD would have the lower net income as shown on the income statement. b. HD would have to pay more in income taxes. c. HD would have the higher operating margin. d. HD would have the lower equity multiplier for use in the DuPont equation. e. Without more information, we cannot tell if HD or LD would have a higher or lower net income.
A
Which of the following investments would have the lowest present value? Assume that the effective annual rate for all investments is the same and is greater than zero. a. Investment D pays $2,500 at the end of 10 years (just one payment). b. Investment A pays $250 at the end of every year for the next 10 years (a total of 10 payments). c. Investment C pays $125 at the beginning of every 6-month period for the next 10 years (a total of 20 payments). d. Investment E pays $250 at the beginning of every year for the next 10 years (a total of 10 payments). e. Investment B pays $125 at the end of every 6-month period for the next 10 years (a total of 20 payments).
A
West Corporation has $50,000 that it plans to invest in marketable securities. The corporation is choosing between the following three equally risky securities: Alachua County tax-free municipal bonds yielding 8.5%; Exxon Mobil bonds yielding 10.5%; and GM preferred stock with a dividend yield of 9.25%. West's corporate tax rate is 37.00%. What is the after-tax return on the best investment alternative? Assume a 70% dividend exclusion for tax on dividends. (Assume the company chooses on the basis of after-tax returns. Round your final answer to 3 decimal places.) a. 8.500% b. 6.885% c. 7.480% d. 6.545% e. 6.630%
B
Which of the following would, generally, indicate an improvement in a company's financial position, holding other things constant? a. The total assets turnover decreases. b. The quick ratio increases. c. The current ratio declines. d. The DSO increases. e. The TIE declines.
B
The CFO of Daves Industries plans to have the company issue $300 million of new common stock and use the proceeds to pay off some of its outstanding bonds that carry a 7% interest rate. Assume that the company, which does not pay any dividends, takes this action, and that total assets, operating income (EBIT), and its tax rate all remain constant. Which of the following would occur? a. The company's taxable income would fall. b. The company's interest expense would remain constant. c. The company's net income would increase. d. The company would have to pay less taxes. e. The company would have less common equity than before.
C
Which of the following mechanisms would be most likely to help motivate managers to act in the best interests of shareholders? a. Elect a board of directors that allows managers greater freedom of action. b. Decrease the use of restrictive covenants in bond agreements. c. Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries. d. Eliminate a requirement that members of the board of directors have a substantial investment in the firm's stock. e. Take actions that reduce the possibility of a hostile takeover.
C
Companies HD and LD have the same tax rate, sales, total assets, and basic earning power. Both companies have positive net incomes. Both firms finance using only debt and common equity and total assets equal total invested capital. Company HD has a higher total debt to total capital ratio and, therefore, a higher interest expense. Which of the following statements is CORRECT? a. Company HD has a lower equity multiplier. b. Company HD has a lower ROE. c. Company HD has more net income. d. Company HD pays more in taxes. e. Company HD has a lower times-interest-earned (TIE) ratio.
E
Which of the following items is NOT normally considered to be a current asset? a. Accounts receivable. b. Inventory. c. Short-term, highly-liquid, marketable securities. d. Cash. e. Bonds.
E
Which of the following statements is most correct? a. Individuals are allowed to exclude 70% of their dividend income from their taxes. b. Corporations are allowed to exclude 70% of their interest income from corporate taxes. c. Individuals are allowed to exclude 70% of their interest income from their taxes. d. Individuals pay taxes on only 30% of the income realized from municipal bonds. e. Corporations are allowed to exclude 70% of their dividend income from corporate taxes.
E
True/False : A decline in a firm's inventory turnover ratio suggests that it is improving both its inventory management and its liquidity position, i.e., that it is becoming more liquid.
False
True/False: 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
True/False: A time line is not meaningful unless all cash flows occur annually.
False
True/False: Because the U.S. tax system is a progressive tax system, a taxpayer's marginal and average tax rates are the same.
False
True/False: For a stock to be in equilibrium as the book defines it, its market price should exceed its intrinsic value.
False
True/False: The return on common equity (ROE) is generally regarded as being less significant, from a stockholder's viewpoint, than the return on total assets (ROA).
False
True/False : Partnerships and proprietorship generally have a tax advantage over corporations.
True
True/False: The current and quick ratios help us measure a firm's liquidity. The current ratio measures the relationship of the firm's current assets to its current liabilities, while the quick ratio measures the firm's ability to pay off short-term obligations without relying on the sale of inventories.
True
True/False: Disregarding risk, if money has time value, it is impossible for the present value of a given sum to exceed its future value.
True
True/False: The NYSE is defined as a "primary" market because it is one of the largest and most important stock markets in the world.
False
True/False: The balance sheet measures the flow of funds into and out of various accounts over time, while the income statement measures the firm's financial position at a point in time.
False
Which of the following statements is CORRECT? a. EVA stands for economic value added, and it is defined as follows: EVA = NOPAT - (Total invested capital)(AT cost of capital %) b. The primary difference between EVA and accounting net income is that when net income is calculated, a deduction is made to account for the cost of common equity, whereas EVA represents net income before deducting the cost of the equity capital the firm uses. c. EVA gives us an idea about how much value a firm's management has added over the firm's life. d. MVA gives us an idea about how much value a firm's management has added during the last year. e. MVA stands for market value added, and it is defined as follows: MVA = (Shares outstanding)(Stock price) + Book value of common equity.
A
Which of the following statements is CORRECT? a. The NYSE operates as an auction market, whereas NASDAQ is an example of a dealer market. b. While the distinctions are becoming blurred, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties. c. Money markets are markets for long-term debt and common stocks. d. A liquid security is a security whose value is derived from the price of some other "underlying" asset. e. Money market mutual funds usually invest their money in a well-diversified portfolio of liquid common stocks.
A
Which of the following statements is CORRECT? a. Interest paid to an individual is counted as income for federal tax purposes and taxed at the individual's regular tax rate, which in 2015 could go up to 39.6%, but qualified dividends received were taxed at a maximum rate of 15% for individuals earning less than $411,500 and married taxpayers filing jointly earning less than $464,850. b. Corporations obtain capital for use in their operations by borrowing and by raising equity capital, either by selling new common stock or by retaining earnings. The cost of debt capital is the interest paid on the debt, and the cost of the equity is the dividends paid on the stock. Both of these costs are deductible from income when calculating income for tax purposes. c. The maximum federal tax rate on personal income in 2015 was 50%. d. Since companies can deduct dividends paid but not interest paid, our tax system favors the use of equity financing over debt financing, and this causes companies' debt ratios to be lower than they would be if interest and dividends were both deductible. e. The maximum federal tax rate on corporate income in 2015 was 50%
A
Which of the following statements regarding a 15-year (180-month) $125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.) a. Because it is a fixed-rate mortgage, the monthly loan payments (which include both interest and principal payments) are constant. b. The proportion of the monthly payment that goes towards repayment of principal will be lower 10 years from now than it will be the first year. c. The outstanding balance declines at a slower rate in the later years of the loan's life. d. Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant. e. The remaining balance after three years will be $125,000 less one third of the interest paid during the first three years.
A
Which of the following statements is CORRECT? a. If an investor sells shares of stock through a broker, then it would be a primary market transaction. b. The New York Stock Exchange is an auction market, and it has a physical location. c. While the distinctions are blurring, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties. d. Home mortgage loans are traded in the money market. e. Capital markets deal only with common stocks and other equity securities.
B
Which of the following statements is CORRECT? a. Managers who face the threat of hostile takeovers are less likely to pursue policies that maximize shareholder value compared to managers who do not face the threat of hostile takeovers. b. One advantage to forming a corporation is that the owners of the firm have limited liability. c. Because of their simplified organization, it is easier for proprietors and partnerships to raise large amounts of outside capital than it is for corporations. d. Bond covenants are an effective way to resolve conflicts between shareholders and managers. e. Corporations face few regulations and more favorable tax treatment than do proprietorships and partnerships.
B
True/False: The basic earning power ratio (BEP) reflects the earning power of a firm's assets after giving consideration to financial leverage and tax effects.
False
Amram Company's current ratio is 2.0. Considered alone, which of the following actions would lower the current ratio? a. Borrow using short-term notes payable and use the proceeds to reduce accruals. b. Use cash to reduce accruals. c. Borrow using short-term notes payable and use the proceeds to reduce long-term debt. d. Use cash to reduce accounts payable. e. Use cash to reduce short-term notes payable.
C
Casey Communications recently issued new common stock and used the proceeds to pay off some of its short-term notes payable. This action had no effect on the company's total assets or operating income. Which of the following effects would occur as a result of this action? a. The company's total debt to total capital ratio increased. b. The company's times interest earned ratio decreased. c. The company's current ratio increased. d. The company's equity multiplier increased. e. The company's basic earning power ratio increased.
C
Which of the following statements is CORRECT? a. Assets other than cash are expected to produce cash over time, and the amount of cash they eventually produce must be the same as the amounts at which the assets are carried on the books. b. Assume that two firms are both following generally accepted accounting principles. Both firms commenced operations two years ago with $1 million of identical fixed assets, and neither firm either sold any of those assets or purchased any new fixed assets. The two firms would be required to report the same amount of net fixed assets on their balance sheets as those statements are presented to investors. c. The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firm's future earnings and dividends, and the riskiness of those cash flows. d. EPS stands for earnings per share, while DPS stands for dividends per share. We would normally expect to see DPS exceed EPS. e. The income statement shows the difference between a firm's income and its costs--i.e., its profits--during a specified period of time. However, all reported income comes in the form of cash, and reported costs likewise are consistent with cash outlays. Therefore, there will not be a substantial difference between a firm's reported profits and its actual cash flow for the same period.
C
Which of the following statements is CORRECT? a. Because bankruptcy requires that corporate bondholders be paid in full before stockholders receive anything, bondholders generally prefer to see corporate managers invest in high risk/high return projects rather than low risk/low return projects. b. Potential conflicts between stockholders and bondholders are increased if a firm's bonds are convertible into its common stock. c. Since bondholders receive fixed payments, they do not share in the gains if risky projects turn out to be highly successful. However, they do share in the losses if risky projects fail and drive the firm into bankruptcy. Therefore, bondholders generally prefer to see corporate managers invest in low risk/low return projects rather than high risk/high return projects. d. One advantage of operating a business as a corporation is that stockholders can deduct their pro rata share of the taxes the firm pays, thereby eliminating the double taxation investors would face in a partnership. e. One drawback of forming a corporation is that you lose the limited liability that you would otherwise receive as a proprietor.
C
Which of the following statements is CORRECT? a. Proprietorships are subject to more regulations than corporations. b. In any partnership, every partner has the same rights, privileges, and liability exposure as every other partner. c. Proprietorships and partnerships generally have a tax advantage over corporations. d. Corporations of all types are subject to the corporate income tax. e. One of the disadvantages of incorporating your business is that you could become subject to the firm's liabilities in the event of bankruptcy.
C
Which of the following statements is CORRECT? a. A decline in a firm's inventory turnover ratio suggests that it is improving both its inventory management and its liquidity position, i.e., that it is becoming more liquid. b. If a firm's fixed assets turnover ratio is significantly lower than its industry average, this could indicate that it uses its fixed assets very efficiently or is operating at over capacity and should probably add fixed assets. c. The days sales outstanding ratio tells us how long it takes, on average, to collect after a sale is made. The DSO can be compared with the firm's credit terms to get an idea of whether customers are paying on time. d. The more conservative a firm's management is, the higher its total debt to total capital ratio is likely to be. e. In general, it's better to have a low inventory turnover ratio than a high one, as a low one indicates that the firm has an adequate stock of inventory relative to sales and thus will not lose sales as a result of running out of stock.
C
Which of the following statements is CORRECT? a. One of the ways in which firms can mitigate or reduce potential conflicts between bondholders and stockholders is by increasing the amount of debt in the firm's capital structure. b. The creation of the Securities and Exchange Commission (SEC) has eliminated conflicts between managers and stockholders. c. The threat of takeovers tends to reduce potential conflicts between stockholders and managers. d. The threat of takeover generally increases potential conflicts between stockholders and managers. e. Managerial compensation plans cannot be used to reduce potential conflicts between stockholders and managers.
C
A firm wants to strengthen its financial position. Which of the following actions would increase its quick ratio? a. Issue new common stock and use the proceeds to increase inventories. b. Issue new common stock and use the proceeds to acquire additional fixed assets. c. Speed up the collection of receivables and use the cash generated to increase inventories. d. Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2) lead to an increase in accounts receivable. e. Use some of its cash to purchase additional inventories.
D
True/False: It is generally less expensive to form a corporation than a proprietorship because, with a proprietorship, extensive legal documents are required.
False
The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to a. Minimize the chances of losses. b. Maximize its expected total corporate income. c. Maximize the stock price on a specific target date. d. Maximize the stock price per share over the long run, which is the stock's intrinsic value. e. Maximize its expected EPS.
D
Which of the following actions would be likely to encourage a firm's managers to make decisions that are in the best interests of shareholders? a. The firm's founder, who is also president and chairman of the board, sells 90% of her shares. b. The state legislature passes a law that makes it more difficult to successfully complete a hostile takeover. c. The percentage of executive compensation that comes in the form of cash is increased and the percentage coming from long-term stock options is reduced. d. The percentage of the firm's stock that is held by institutional investors such as mutual funds, pension funds, and hedge funds rather than by small individual investors rises from 10% to 80%. e. The firm's board of directors gives the firm's managers greater freedom to take whatever actions they think best without obtaining board approval.
D
Which of the following statements is CORRECT? a. If Firm X's P/E ratio exceeds that of Firm Y, then Y is likely to be less risky and/or be expected to grow at a faster rate. b. If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their market-to-book ratios must also be the same. c. If Firms X and Y have the same P/E ratios, then their market-to-book ratios must also be equal. d. If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their P/E ratios must also be the same. e. If Firms X and Y have the same earnings per share and market-to-book ratio, they must have the same price/earnings ratio.
D
Which of the following statements is CORRECT? a. Using restrictive covenants in debt agreements is an effective way to reduce conflicts between stockholders and managers. b. Most business in U.S. is conducted by corporations, and corporations' popularity results primarily from their favorable tax treatment. c. One disadvantage of organizing a business as a corporation rather than a partnership is that the equity investors in a corporation are exposed to unlimited liability. d. The managers of established, stable companies sometimes attempt to get their state legislatures to impose rules that make it more difficult for raiders to succeed with hostile takeovers. e. Managers generally welcome hostile takeovers since the "raider" generally offers a price for the stock that is higher than the price before the takeover action started.
D
Which of the following statements is CORRECT? a. Other things held constant, the higher a firm's total debt to total capital ratio, the higher its TIE ratio will be. b. Other things held constant, the more debt a firm uses, the higher its operating margin will be. c. Other things held constant, the more debt a firm uses, the higher its profit margin will be. d. Debt management ratios show the extent to which a firm's managers are attempting to reduce risk through the use of financial leverage. The higher the total debt to total capital ratio, the lower the risk. e. Debt management ratios show the extent to which a firm's managers are attempting to magnify returns on owners' capital through the use of financial leverage.
E
Which of the following statements is CORRECT? a. If a firm sold some inventory on credit, its current ratio would probably not change much, but its quick ratio would decline. b. If a firm has high current and quick ratios, this always indicate that the firm is managing its liquidity position well. c. If a firm sold some inventory on credit as opposed to cash, there is no reason to think that either its current or quick ratio would change. d. If a firm sold some inventory for cash and left the funds in its bank account, its current ratio would probably not change much, but its quick ratio would decline. e. The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess how effectively a firm is managing its current assets.
E
Which of the following statements is CORRECT? a. Using some of the firm's cash to reduce long-term debt is an example of "window dressing." b. Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase fixed assets is an example of "window dressing." c. "Window dressing" is any action that does not improve a firm's fundamental long-run position and thus increases its intrinsic value. d. Borrowing by using short-term notes payable and then using the proceeds to retire long-term debt is an example of "window dressing." Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is another example of "window dressing." e. Borrowing on a long-term basis and using the proceeds to retire short-term debt would improve the current ratio and thus could be considered to be an example of "window dressing."
E
True/False: If a bank compounds savings accounts quarterly, the nominal rate will exceed the effective annual rate.
False
True/False: If a firm sold some inventory on credit as opposed to cash, there is no reason to think that either its current or quick ratio would change.
False
True/False: The greater 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
True/False: Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.
False
True/False: Financial institutions are more diversified today than they were in the past, when federal laws kept investment banks, commercial banks, insurance companies, and similar organizations quite separate. Today the larger financial services corporations offer a variety of services, ranging from checking accounts, to insurance, to underwriting securities, to stock brokerage.
True
True/False: Free cash flow (FCF) is, essentially, the cash flow that is available for interest and dividends after the company has made the investments in current and fixed assets that are necessary to sustain ongoing operations.
True
True/False: If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by multiplying the periodic rate by the number of periods per year.
True
True/False: In order to maximize its shareholders' value, a firm's management must attempt to maximize the stock price in the long run, or the stock's "intrinsic value."
True
True/False: Interest paid by a corporation is a tax deduction for the paying corporation, but dividends paid are not deductible. This treatment, other things held constant, tends to encourage the use of debt financing by corporations.
True
True/False: One danger of starting a proprietorship is that you may be exposed to personal liability if the business goes bankrupt. This problem would be avoided if you formed a corporation to operate the business.
True
True/False: Suppose Firms A and B have the same amount of assets, total assets are equal to total invested capital, pay the same interest rate on their debt, have the same basic earning power (BEP), finance with only debt and common equity, and have the same tax rate. However, Firm A has a higher debt to capital ratio. If BEP is greater than the interest rate on debt, Firm A will have a higher ROE as a result of its higher debt ratio.
True
True/False: The annual rate of return on any given stock can be found as the stock's dividend for the year plus the change in the stock's price during the year, divided by its beginning-of-year price.
True
True/False: The annual report contains four basic financial statements: the income statement, the balance sheet, the cash flow statement, and statement of stockholders' equity.
True
True/False: The payment made each period on an amortized loan is constant, and it consists of some interest and some principal. The closer we are to the end of the loan's life, the greater the percentage of the payment that will be a repayment of principal.
True
True/False: The present value of a future sum decreases as either the discount rate or the number of periods per year increases, other things held constant.
True
True/False: The term "marginal investor" means an investor who is active in the market and would tend to buy a stock if its price fell and sell it if it rose, barring any new information coming out about the stock. It is the "marginal investor" who determines the actual stock price.
True
True/False: The times-interest-earned ratio measures the extent to which operating income can decline before the firm is unable to meet its annual interest costs.
True
True/False: Time lines can be constructed in situations where some of the cash flows occur annually but others occur quarterly.
True
True/False: When a corporation's shares are owned by a few individuals who are associated with the firm's management, we say that the stock is closely held.
True