Finance: Practice Exam

28. Gupta Corporation is undergoing a restructuring, and its free cash flows are expected to vary considerably during the next few years. However, the FCF is expected to be $85.00 million in Year 5, and the FCF growth rate is expected to be a constant 6.5% beyond that point. The weighted average cost of capital is 12.0%. What is the horizon (or continuing) value (in millions) at t = 5? a. $1,646 b. $1,662 c. $1,234 d. $1,432 e. $2,041

a. $1,646 Correct. FCF5: $85.00 g: 6.5% WACC: 12.0% FCF6 = FCF5(1 + g) = $90.5250 HV5 = FCF6/(WACC - g) = $1,646

10. Tuttle Enterprises is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that if a project's projected NPV is negative, it should be rejected. WACC: 11.50% Year 0 1 2 3 4 Cash flows -$1,000 $350 . $350 . $350 . $350 a. 074.36 b. 082.54 c. 059.49 d. 084.03 e. 064.70

a. 074.36 Correct. WACC: 11.50% Year: 0 1 2 3 4 Cash flows: -$1,000 . $350 . $350 . $350 . $350 NPV = 074.36

1. 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. Without more information, we cannot tell if HD or LD would have a higher or lower net income. c. HD would have the higher operating margin. d. HD would have the lower equity multiplier for use in the DuPont equation. e. HD would have to pay more in income taxes.

a. HD would have the lower net income as shown on the income statement.

11. The cash flows associated with common stock are more difficult to estimate than those related to bonds because stock has a residual claim against the company versus a contractual obligation for a bond. a. True b. False

a. True

12. Profitability ratios show the combined effects of liquidity, asset management, and debt management on a firm's operating results. a. True b. False

a. True

23. Ratio analysis involves analyzing financial statements to help appraise a firm's financial position and strength. a. True b. False

a. True

24. Suppose a U.S. treasury bond will pay $1,700 five years from now. If the going interest rate on 5-year treasury bonds is 4.25%, how much is the bond worth today? a. $1,711.95 b. $1,380.60 c. $1,698.14 d. $1,090.68 e. $1,035.45

b. $1,380.60 Correct. N: 5 I/YR: 4.25% PMT: $0 FV: $1,700.00 PV: $1,380.60

19. Based on the corporate valuation model, Morgan Inc.'s total corporate value is $200 million. The balance sheet shows $90 million of notes payable, $30 million of long-term debt, $40 million of preferred stock, and $100 million of common equity. The company has 10 million shares of stock outstanding. What is the best estimate of the stock's price per share? a. $3.36 b. $4.00 c. $3.88 d. $3.80 e. $4.12

b. $4.00 Correct. Assuming that the book value of debt is close to its market value, the total market value of the firm's equity is: Total corporate value $200 Notes payable . -$90 Long-term debt . -$30 Preferred stock . -$40 ___________ MV equity $40 Shares outstanding /10 . = 4.00 Stock price = Value of equity/Shares outstanding = $4.00 The book value of equity figures are irrelevant for this problem.

6. Jose now has $500. How much would he have after 6 years if he leaves it invested at 6.7% with annual compounding? a. $568.13 b. $737.83 c. $855.88 d. $752.59 e. $885.40

b. $737.83 Correct. N: 6 I/YR: 5.1% PV: $500 PMT: $0 FV: $737.83

27. You want to buy a new sports car 3 years from now, and you plan to save $2,700 per year, beginning one year from today. You will deposit your savings in an account that pays 5.2% interest. How much will you have just after you make the 3rd deposit, 3 years from now? a. $9,807.78 b. $8,528.50 c. $8,357.93 d. $9,296.07 e. $7,846.22

b. $8,528.50 Correct. N: 3 I/YR: 5.2% PV: $0.00 PMT: $2,700 FV: $8,528.50

21. Simms Corp. is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's projected IRR can be less than the WACC or negative, in both cases it will be rejected.Year0 1 2 3 Cash flows-$1,025$425$425$425 a. 10.82% b. 11.76% c. 12.58% d. 11.29% e. 9.64%

b. 11.76% Correct. Year: 0 1 2 3 Cash flows: -$1,025 . $425 . $425 . $425 IRR = 11.76%

3. If D1 = $1.25, g (which is constant) = 4.7%, and P0 = $22.00, what is the stock's expected dividend yield for the coming year? a. 6.25% b. 5.68% c. 4.26% d. 5.40% e. 6.08%

b. 5.68% Correct. D1: $1.25 g: 4.7% P0: $22.00 Dividend yield = D1/P0 = 5.68%

26. You plan to invest in securities that pay 7.0%, compounded annually. If you invest $5,000 today, how many years will it take for your investment to grow to $9,140.20? a. 9.01 b. 8.92 c. 9.63 d. 6.78 e. 10.79

b. 8.92 Correct. I/YR: 7.0% PV: $5,000.00 PMT: $0 FV: $9,140.20 N: 8.92 years

13. A basic rule in capital budgeting is that if a project's NPV exceeds its IRR, then the project should be accepted. a. True b. False

b. False

7. High current and quick ratios always indicate that the firm is managing its liquidity position well. a. True b. False

b. False

18. Which of the following statements is CORRECT? a. The basic earning power ratio (BEP) reflects the earning power of a firm's assets after giving consideration to financial leverage and tax effects. b. The "apparent," but not necessarily the "true," financial position of a company whose sales are seasonal can change dramatically during a given year, depending on the time of year when the financial statements are constructed. c. In general, if investors regard a company as being relatively risky and/or having relatively poor growth prospects, then it will have relatively high P/E and M/B ratios. d. The market/book (M/B) ratio tells us how much investors are willing to pay for a dollar of accounting book value. In general, investors regard companies with higher M/B ratios as being more risky and/or less likely to enjoy higher future growth. e. It is appropriate to use the fixed assets turnover ratio to appraise firms' effectiveness in managing their fixed assets if and only if all the firms being compared have the same proportion of fixed assets to total assets.

b. The "apparent," but not necessarily the "true," financial position of a company whose sales are seasonal can change dramatically during a given year, depending on the time of year when the financial statements are constructed.

17. You are considering two equally risky annuities, each of which pays $5,000 per year for 10 years. Investment ORD is an ordinary (or deferred) annuity, while Investment DUE is an annuity due. Which of the following statements is CORRECT? a. The present value of ORD must exceed the present value of DUE, but the future value of ORD may be less than the future value of DUE. b. The present value of DUE exceeds the present value of ORD, and the future value of DUE also exceeds the future value of ORD. c. If the going rate of interest decreases from 10% to 0%, the difference between the present value of ORD and the present value of DUE would remain constant. d. The present value of DUE exceeds the present value of ORD, while the future value of DUE is less than the future value of ORD. e. The present value of ORD exceeds the present value of DUE, and the future value of ORD also exceeds the future value of DUE.

b. The present value of DUE exceeds the present value of ORD, and the future value of DUE also exceeds the future value of ORD.

29. Stock X has the following data. Assuming the stock market is efficient and the stock is in equilibrium, which of the following statements is CORRECT? Expected dividend, D1: $3.00 Current Price, P0: $50 Expected constant growth rate, g: 6.0% a. The stock's required return is 10%. b. The stock's expected dividend yield and growth rate are equal. c. The stock's expected price 10 years from now is $100.00. d. The stock's expected capital gains yield is 5%. e. The stock's expected dividend yield is 5%.

b. The stock's expected dividend yield and growth rate are equal. Correct. D1/P0: 6.0%

8. Ryan Enterprises forecasts the free cash flows (in millions) shown below. The weighted average cost of capital is 13.0%, and the FCFs are expected to continue growing at a 5.0% rate after Year 3. What is the firm's total corporate value, in millions?Year123FCF-$15.0$10.0$25.0 a. $196.22 b. $217.75 c. $239.29 d. $272.79 e. $268.01

c. $239.29 Correct. g: 5% WACC: 13% Year: 1 2 3 4 FCF: -$15.00 . $10.00 . $25.00 $26.25 Horizon value FCF3(1 + g)/(WACC - g) $328.13 Annual FCF: -$15.00 . $10.00 . $353.13 PVs at 13%: -$13.27 . $7.83 . $244.73 Total corporate value = Sum =$239.29

25. If D0 = $2.25, g (which is constant) = 3.5%, and P0 = $54, what is the stock's expected dividend yield for the coming year? a. 3.45% b. 3.75% c. 4.31% d. 5.05% e. 4.23%

c. 4.31% Correct. D0: $2.25 g: 3.5% P0: $54.00 D1 = D0(1 + g) =$2.329 Dividend yield = D1/P0 =4.31%

20. Dyl Inc.'s bonds currently sell for $870 and have a par value of $1,000. They pay a $65 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,100. What is their yield to maturity (YTM)? a. 6.66% b. 7.38% c. 8.02% d. 9.71% e. 8.66%

c. 8.02% Correct. N: 15 I/YR: 8.02% = YTM PV: $870 PMT: $65 FV: $1,000

5. For a portfolio of 40 randomly selected stocks, which of the following is most likely to be true? a. The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation. b. The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation. c. The beta of the portfolio is equal to the weighted average of the betas of the individual stocks. d. The beta of the portfolio is larger than the weighted average of the betas of the individual stocks. e. The beta of the portfolio is less than the weighted average of the betas of the individual stocks.

c. The beta of the portfolio is equal to the weighted average of the betas of the individual stocks.

22. Which of the following statements is CORRECT? a. To implement the corporate valuation model, we discount net operating profit after taxes (NOPAT) at the weighted average cost of capital. b. To implement the corporate valuation model, we discount projected free cash flows at the cost of equity capital. c. To implement the corporate valuation model, we discount projected free cash flows at the weighted average cost of capital. d. To implement the corporate valuation model, we discount projected net income at the weighted average cost of capital. e. The corporate valuation model requires the assumption of a constant growth rate in all years.

c. To implement the corporate valuation model, we discount projected free cash flows at the weighted average cost of capital.

4. You have a chance to buy an annuity that pays $1,400 at the beginning of each year for 3 years. You could earn 5.5% on your money in other investments with equal risk. What is the most you should pay for the annuity? a. $3,745.76 b. $3,945.00 c. $4,223.94 d. $3,984.85 e. $4,781.82

d. $3,984.85 Correct. BEGIN Mode N: 3 I/YR: 5.5% PMT: $1,400 FV: $0.00 PV: $3,984.85

9. Sam was injured in an accident, and the insurance company has offered him the choice of $46,000 per year for 15 years, with the first payment being made today, or a lump sum. If a fair return is 7.5%, how large must the lump sum be to leave him as well off financially as with the annuity? a. $536,896.32 b. $541,261.33 c. $453,961.11 d. $436,501.07 e. $475,786.17

d. $436,501.07 Correct. BEGIN Mode N: 15 I/YR: 7.5% PMT: $46,000 FV: $0.00 PV: $436,501.07

14. You must estimate the intrinsic value of Noe Technologies' stock. The end-of-year free cash flow (FCF1) is expected to be $24.50 million, and it is expected to grow at a constant rate of 7.0% a year thereafter. The company's WACC is 10.0%, it has $125.0 million of long-term debt plus preferred stock outstanding, and there are 15.0 million shares of common stock outstanding. What is the firm's estimated intrinsic value per share of common stock? a. $47.96 b. $40.12 c. $38.27 d. $46.11 e. $34.58

d. $46.11 Correct. FCF1: $24.50 Constant growth rate: 7.0% WACC: 10.0% Debt & preferred stock: $125 Shares outstanding: 15 Total firm value = FCF1/(WACC - g) =$816.67 Less: Value of debt & preferred: -$125.00 Value of equity: $691.67 Number of shares: 15 Value per share = Equity value/Shares =$46.11

16. You want to quit your job and go back to school for a law degree 4 years from now, and you plan to save $2,400 per year, beginning immediately. You will make 4 deposits in an account that pays 5.7% interest. Under these assumptions, how much will you have 4 years from today? a. $11,711.12 b. $9,390.99 c. $11,490.15 d. $9,501.47 e. $11,048.22

e. $11,048.22 Correct. BEGIN Mode N: 4 I/YR: 5.7% PV: $0.00 PMT: $2,400 FV: $11,048.22

2. Nachman Industries just paid a dividend of D0 = $3.75. Analysts expect the company's dividend to grow by 30% this year, by 10% in Year 2, and at a constant rate of 5% in Year 3 and thereafter. The required return on this low-risk stock is 9.00%. What is the best estimate of the stock's current market value? a. $135.11 b. $151.68 c. $130.01 d. $144.04 e. $127.47

e. $127.47 Correct. rS =9.0% Year 0 1 2 3 Growth rates: 1=30.0% . 2=10.0% . 3=5.0% Dividend: 0=$3.75 . 1=$4.875 . 2=$5.363 . 3=$5.631 Horizon value: D3/(rs - g3)= 140.766 Total CFs: 1=$4.875 . $146.128 PV of CFs $4.472 + $122.993 Stock price = $127.47

30. A stock just paid a dividend of D0 = $1.50. The required rate of return is rs = 14.1%, and the constant growth rate is g = 4.0%. What is the current stock price? a. $18.84 b. $19.15 c. $12.97 d. $12.82 e. $15.45

e. $15.45 Correct. D0: $1.50 rS: 14.1% g: 4.0% D1 = D0(1 + g) = $1.56 P0 = D1/(rS - g) = $15.45

15. How much would $1, growing at 12.1% per year, be worth after 75 years? a. $4,465.19 b. $6,041.14 c. $6,408.86 d. $5,095.57 e. $5,253.16

e. $5,253.16 Correct. N: 75 I/YR: 12.1% PV: $1.00 PMT: $0.00 FV: $5,253.16

32. Song Corp's stock price at the end of last year was $16.75 and its earnings per share for the year were $1.30. What was its P/E ratio? a. 11.98 b. 14.82 c. 15.72 d. 9.79 e. 12.88

e. 12.88 Correct.Stock price: $16.75 EPS: $1.30 P/E = Stock price / EPS = 12.88

31. River Corp's total assets at the end of last year were $480,000 and its net income was $32,750. What was its return on total assets? a. 5.73% b. 6.48% c. 6.28% d. 7.71% e. 6.82%

e. 6.82% Correct. Total assets: $480,000 Net income: $32,750 ROA = NI/Assets = 6.82%