NCSU BUS 420 Exam 1 Qs

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Marvin Industries is expanding its operations throughout the Southeast United States. Marvin anticipates that the expansion will increase sales by $1,500,000, and increase the costs of goods sold by $700,000. Depreciation expenses will rise by $50,000 and interest expense will increase by $150,000. The company's tax rate will remain at 40 percent. If the company's forecast is correct, how much will net income increase or decrease, as a result of the expansion?

$ 360,000 increase

Russell Securities has $100 million in total assets and its corporate tax rate is 40 percent. The company recently reported that its basic earning power (BEP) ratio was 15 percent and that its return on assets (ROA) was 9 percent. What was the company's interest expense?

Assume that a 15-year, $1,000 face value bond pays interest of $37.50 every 3 months. If you require a nominal annual rate of return of 12 percent, with quarterly compounding, how much should you be willing to pay for this bond?

$1,207.57 Inputs: N = 60; I/YR = 3; PMT = 37.50; FV = 1,000. Output: PV = -$1,207.57; VB = $1,207.57.

A $1,000 par value bond pays interest of $35 each quarter and will mature in 10 years. If your nominal annual required rate of return is 12 percent with quarterly compounding, how much should you be willing to pay for this bond?

$1115

Jackson Co. has the following balance sheet for the most recent year (as of December 31). Assets: Claims: Current assets $ 600,000 Accounts payable $ 100,000 Fixed assets 400,000 Accruals 100,000 Notes payable 100,000 Total current liabilities $ 300,000 Long-term debt 300,000 Total equity 400,000 Total assets $1,000,000 Total claims $1,000,000 During the most recent year, the company reported sales of $5 million, net income of $100,000, and dividends of $60,000. The company anticipates its sales will increase 20 percent in the next year and its dividend payout will remain at 60 percent. Assume the company is at full capacity, so its assets and spontaneous liabilities will increase proportionately with an increase in sales. Assume the company uses the AFN formula and all additional funds needed (AFN) will come from issuing new long-term debt. Given its forecast, how much long-term debt will the company have to issue in the next year?

$112,000

You intend to purchase a 10-year, $1,000 face value bond that pays interest of $60 every 6 months.If your nominal annual required rate of return is 10 percent with semiannual compounding, how much should you be willing to pay for this bond?

$1124.62

A share of Lash Inc.'s common stock just paid a dividend of $1.00. If the expected long-run growth rate for this stock is 5.4%, and if investors' required rate of return is 11.4%, what is the stock price?

$17.57

A stock is expected to pay a dividend of $0.75 at the end of the year. The required rate of return is rs = 10.5%, and the expected constant growth rate is g = 6.4%. What is the stock's current price?

$18.29

The Jameson Company just paid a dividend of $0.75 per share, and that dividend is expected to grow at a constant rate of 5.50% per year in the future. The company's beta is 1.15, the market risk premium is 5.00%, and the risk-free rate is 4.00%. What is Jameson's current stock price, P0?

$18.62

The projected cash flow for the next year for Minesuah Inc. is $100,000, and FCF is expected to grow at a constant rate of 6%. If the company's weighted average cost of capital is 11%, what is the current value of its operations?

$2,000,000

New Mexico Lumber recently reported that its earnings per share were $3.00. The company has 400,000 shares of stock outstanding. The company's interest expense was $500,000. The corporate tax rate is 40 percent. What was the company's operating income (EBIT)?

$2,500,000

Based on the corporate valuation model, Dabney Inc.'s value of operations is $425 million. Its balance sheet shows: $175 million of short-term investments that are unrelated to operations $100 million of accounts payable $125 million of notes payable $175 million of long-term debt $40 million of common stock (par plus paid-in-capital) $160 million of retained earnings. What is the best estimate for the firm's value of equity, in millions? Assume that the book value of debt is close to its market value

$300

Based on the corporate valuation model, Carton Inc.'s value of operations is $500 million. Its balance sheet shows: $75 million of short-term investments that are unrelated to operations $100 million of accounts payable $150 million of notes payable $100 million of long-term debt $40 million of common stock (par plus paid-in-capital) $160 million of retained earnings. What is the best estimate for the firm's value of equity, in millions? Assume that the book value of debt is close to its market value

$325

A company forecasts the free cash flows (in millions) shown below. The weighted average cost of capital is 13%, and the FCFs are expected to continue growing at a 5% rate after Year 3. Assuming that the ROIC is expected to remain constant in Year 3 and beyond, what is the Year 0 value of operations, in millions? FCF: 1 -15 ; 2 10; 3 40 a. $315 b. $331 c. $348 d. $367 e. $386

$386

Given the following information, calculate the market price per share of WAM Inc.

$4.00

Strother Inc. has the following information for the previous year: Net income = $400 Net operating profit after taxes (NOPAT) = $600 Total assets = $2,000 Total net operating capital = $1,800. The information for the current year is: Net income = $900 Net operating profit after taxes (NOPAT) = $800 Total assets = $2,300 Total net operating capital = $2,200. What is the free cash flow for the current year?

$400

Perry Technologies Inc. had the following financial information for the past year:

$430,000

Reynolds Construction's value of operations is $750 million based on the free cash flow valuation model. Its balance sheet shows: $50 million of short-term investments that are unrelated to operations $100 million of accounts payable $100 million of notes payable $200 million of long-term debt $40 million of common stock (par plus paid-in-capital) $160 million of retained earnings. What is the best estimate for the firm's value of equity, in millions?

$500

Due to a number of lawsuits related to toxic wastes, a major chemical manufacturer has recently experienced a market reevaluation. The firm has a bond issue outstanding with 15 years to maturity and a coupon rate of 8 percent, with interest paid semiannually. The required nominal rate on this debt has now risen to 16 percent. What is the current value of this bond?

$550

The Charleston Company is a relatively small, privately owned firm. Last year the company had after-tax income of $15,000, and 10,000 shares were outstanding. The owners were trying to determine the equilibrium market value for the stock, prior to taking the company public. A similar firm which is publicly traded had a price/earnings ratio of 5.0. Using only the information given, estimate the market value of one share of Charlestons stock.

$7.50

Heritage Parts is undergoing a restructuring, and its free cash flows are expected to be unstable during the next few years. However, FCF is expected to be $40 million in Year 5, i.e., FCF at t = 5 equals $40 million, and the FCF growth rate is expected to be constant at 6% beyond that point. If the weighted average cost of capital is 12%, what is the horizon value (in millions) at t = 6?

$749

Hayes Corporation has $300 million worth of common equity on its balance sheet, and 6 million shares of stock outstanding. The companys Market Value Added (MVA) is $162 million. What is the companys stock price?

$77

A company forecasts the following FCF. If the overall cost of capital is 13% and the FCF are expected to continue growing at the same rate of growth as that exhibited between years 2 and 3, what is the current value of operation? FCF: Year 1 $-25 Year 2 $30 Year 3 $33

$862.83

Akyol Corporation is undergoing a restructuring, and its free cash flows are expected to be unstable during the next few years. However, FCF is expected to be $50 million in Year 5, i.e., FCF at t = 5 equals $50 million, and the FCF growth rate is expected to be constant at 6% beyond that point. If the weighted average cost of capital is 12%, what is the horizon value (in millions) at t = 5?

$883

What economic conditions affect the cost of money?

-Federal Reserve policies -Budget deficits/surpluses -Level of business activity (recession or boom) -International trade deficits/surpluses

What factors affect the weighted average cost of capital?

1. Capital structure (the firm's relative amounts of debt and equity) 2. Interest rates 3. Risk of the firm 4. Stock market investors' overall attitude toward risk

You hold a diversified portfolio consisting of a $5,000 investment in each of 20 different common stocks. The portfolio beta is equal to 1.15. You have decided to sell one of your stocks, a lead mining stock whose b is equal to 1.0, for $5,000 net and to use the proceeds to buy $5,000 of stock in a steel company whose b is equal to 2.0. What will be the new beta of the portfolio?

1.20 Before: 1.15 = 0.95(bR) + 0.05(1.0) 0.95(bR) = 1.10 bR = 1.158. After: bP = 0.95(bR) + 0.05(2.0) = 1.10 + 0.10 = 1.20.

Assume that the risk-free rate is 5 percent, and that the market risk premium is 7 percent. If a stock has a required rate of return of 13.75 percent, what is its beta

1.25 13.75% = 5% + (7%)b 8.75% = 7%b b = 1.25

A firm has total interest charges of $10,000 per year, sales of $1 million, a tax rate of 40 percent, and a net profit margin of 6 percent. What is the firm's times-interest-earned ratio?

Bouchard Company's stock sells for $20 per share, its last dividend (D0) was $1.00, and its growth rate is a constant 6 percent. What is its cost of common stock, rs?

11.3%

You own a portfolio that is invested 38 percent in stock A, 43 percent in stock B, and the remainder in stock C. The expected returns on these stocks are 10.7 percent, 15.4 percent, and 9.1 percent, respectively. What is the expected return on the portfolio?

12.42%

A firm has a profit margin of 15 percent on sales of $20,000,000. If the firm has debt of $7,500,000, total assets of $22,500,000, and an after-tax interest cost on total debt of 5 percent, what is the firm's ROA?

13.3%

A firm has notes payable of $1,546,000, long-term debt of $13,000,000, and total interest expense of $1,300,000. If the firm pays 8 percent interest on its long-term debt, what rate of interest does it pay on its notes payable?

16.8%

Spencer Inc. has the following information for the current year: Net income = $600 Net operating profit after taxes (NOPAT) = $500 Total assets = $4,000 Short-term investments = $500 Stockholders equity = $2,000 Debt = $1,000 Total net operating capital = $2,500. What is the Return on invested capital (ROIC) for the current year?

20.0%

Carter Corporation has some money to invest, and its treasurer is choosing between City of Chicago municipal bonds and Microsoft corporate bonds. Both have the same maturity, and they are equally risky and liquid. If Microsoft bonds yield 6 percent, and Carters marginal income tax rate is 40 percent, what yield on the Chicago municipal bonds would make Carters treasurer indifferent between the two?

3.60%

Manufacturer's Inc. estimates that its interest charges for this year will be $700 and that its net income will be $3,000. Assuming its average tax rate is 30 percent, what is the company's estimated times-interest-earned ratio?

7.12

If D1 = $1.25, g (which is constant) = 5.5%, and P0 = $44, what is the stock's expected total return for the coming year?

8.34%

Which of the following is an example of a moral hazard?

A CEO orders the headquarters moved just so he can have a nicer office.

Limited Liability Company (LLC)

A business structure that offers the limited personal liability associated with a corporation, but the company's income is taxed like a partnership

Business Ethics

A company's attitude and conduct toward its stakeholders- employees, customers, stockholders, and so forth; ethical behavior requires fair and honest treatment of all parties

S Corporation

A corporation with no more than 100 stockholders that elects to be taxed the same as proprietorships and partnerships so that business income is taxed only once

Corporate Charter

A document filed with the secretary of the state in which a business is incorporated that provides information about the company, including its name, address, directors, and amount of capital stock

10.8%

A fire has destroyed a large percentage of the financial records of the Carter Company. You have the task of piecing together information in order to release a financial report. You have found the return on equity to be 18 percent. If sales were $4 million, the debt ratio was 0.40, and total liabilities were $2 million, what was the return on assets (ROA)?

13.3%

1.7%

A firm has total assets of $1,000,000 and a debt ratio of 30 percent. Currently, it has sales of $2,500,000, total fixed costs of $1,000,000, and EBIT of $50,000. If the firm's before-tax cost of debt is 10 percent and the firm's tax rate is 40 percent, what is the firm's ROE?

11 times

A firm has total interest charges of $10,000 per year, sales of $1 million, a tax rate of 40 percent, and a net profit margin of 6 percent. What is the firm's times-interest-earned ratio?

False

A firm whose days sales outstanding is much higher than the industry's average is likely to either be too "tight" in its credit policy or too "loose" in its collection policy.

Which of the following statements is most correct?

A firm with financial leverage has a larger equity multiplier than an otherwise identical firm with no debt in its capital structure

The firm's liquidity position probably has improved

A firm's current ratio has steadily increased over the past 5 years, from 1.9 five years ago to 3.8 today. What would a financial analyst be most justified in concluding?

Which of the following statements is most correct?

A firm's fundamental value is the present value of its future free cash flows

accounting profits

A firm's net income as reported on its income statement.

What determines a firm's value?

A firm's value is the sum of all the future expected free cash flows when converted into today's dollars:

dupont equation

A formula that gives the rate of return on assets by multiplying the profit margin by the total assets turnover.

Corporation

A legal entity created by a state, separate and distinct from its owners and managers, having unlimited life, easy transferability or ownership, and limited liability

Why might you want to make your financial statements look artificially good?

A manager might inflate a firm's reported earnings or make its debt appear to be lower if he or she wanted the firm to look good temporarily.

Which of the following actions are likely to reduce the agency problem between stockholders and managers?

A manager receives a lower salary but receives additional shares of the company's stock. The board of directors has become more vigilant in its oversight of the company's management. Increasing the threat of corporate takeover.

Which of the following statements is most correct?

A market is transparent when accurate information is available to all market participants.

free cash flow

A measure of the cash flow that the firm is free to pay to investors after considering cash investments that are needed to continue operations.

Agency Problem

A potential conflict of interest between outside shareholders (owners) and managers who make decisions about how to operate the firm

quick (acid test) ratio

A ratio calculated by deducting inventories from current assets and dividing the remainder by current liabilities.

inventory turnover ratio

A ratio calculated by dividing cost of goods sold by inventories.

current ratio

A ratio calculated by dividing current assets by current liabilities. It indicates the extent to which current liabilities are covered by assets expected to be converted to cash in the near future.

times interest earned (TIE) ratio

A ratio calculated by dividing earnings before interest and taxes (EBIT) by interest charges; measures the ability of the firm to meet its annual interest payments.

return on equity (ROE)

A ratio calculated by dividing income available to stockholders by common equity; measures the rate of return on common stockholders' investments.

price/earnings (P/E) ratio

A ratio calculated by dividing market price per share by earning per share; measures how much investors are willing to pay per dollar of current profits.

net profit margin

A ratio calculated by dividing net income by sales; measures net income per dollar of sales.

return on assets (ROA)

A ratio calculated by dividing net income by total assets; provides an idea of the overall return on investment earned by the firm.

debt ratio

A ratio calculated by dividing total debt by total assets; indicates the percentage of total funds provided by creditors.

annual report

A report in the forms of 10-K issued by a corporation to its stockholders that contains basic financial statements as well as the opinions of management about the past year's operations and the firm's future prospects.

Bylaws

A set of rules drawn up by the founders of the corporation that indicate how the company is to be governed; includes procedures for electing directors, the rights of the stockholders, and how to change the bylaws when necessary

statement of retained earnings

A statement reporting the change in the firm's retained earnings as a result of the income generated and retained during the year. The balance sheet figure for retained earnings is the sum of the earnings retained for each year that the firm has been in business.

income statement

A statement summarizing the firm's revenues and expenses over an accounting period, generally a quarter or a year.

statement of cash flows

A statement that reports the effects of a firm's operating, investing, and financing activities on cash flows over an accounting period.

balance sheet

A statement that shows the firm's financial position—assets, and liabilities and equity—at a specific point in time.

True

A stock dividend and a stock split should, at least conceptually, have the same effect on shareholders' wealth.

Common stock account Paid-in capital account Retained earnings account

A stock dividend will, in and of itself, affect the amounts in which of the following accounts? (Assume the stock has a par value.)

None of the above (Cash, Common stock, Paid-in capital, Retained earnings)

A stock split will cause a change in the total dollar amounts shown in which of the following balance sheet accounts?

Progressive Tax

A tax that requires a higher percentage payment on higher incomes. The personal income tax in the United States is progressive.

Performance Shares

A type of incentive plan in which managers are awarded shares of stock on the basis of the firm's performance over given intervals with respect to earnings per share or other measures

Executive Stock Option

A type of incentive plan that allows managers to purchase stock at some future time at a given price

Other things held constant, which of the following will not affect the quick ratio? (Assume that current assets equal current liabilities.)

Accounts receivable are collected

economic value added (EVA)

After-tax operating earnings adjusted for the costs associated with the firm's financing—shows how much a firm's economic value increased during a particular period.

Which of the following is a reason why companies move into international operations?

All of the above

Which of the following statements is most correct? Select one: a. All else equal, long-term bonds have more interest rate risk than short term bonds. b. All else equal, higher coupon bonds have more reinvestment risk than low coupon bonds. c. All else equal, short-term bonds have more reinvestment risk than do long-term bonds. d. Statements a and c are correct. e. All of the statements above are correct.

All of the above

Depreciation

All of the following represent cash outflows to the firm except

What three aspects of cash flows affect an investment's value?

Amount of expected cash flows Timing of the cash flow stream Risk of the cash flows

True

An agency problem exists between stockholders and managers. A second agency problem arises between stockholders and creditors

What is an agency relationship?

An agency relationship arises whenever one or more individuals, called principals, (1) hires another individual or organization, called an agent, to perform some service and (2) then delegates decision-making authority to that agent.

A moral hazard problem arises when:

An agent takes unobserved actions on his own behalf

False

An increase in an asset account is a source of cash, whereas an increase in a liability account is a use of cash.

Proprietorship

An unincorporated business owned by one individual

Partnership

An unincorporated business owned by two or more persons

What kind of compensation program might you use to minimize agency problems?

Annual salary Cash (or stock) bonus Stock Options EVA Implications

Current Debt ratio TIE ratio 1.5 1.5 0.50

As a short-term creditor concerned with a company's ability to meet its financial obligation to you, which one of the following combinations of ratios would you most likely prefer?

42%

Assume Meyer Corporation is 100 percent equity financed. Calculate the return on equity, given the following information: (1) Earnings before taxes = $1,500 (2) Sales = $5,000 (3) Dividend payout ratio = 60% (4) Total assets turnover = 2.0 (5) Applicable tax rate = 30%

Which bond would have the largest price increase if the YTM on all Treasuries were to decline?

Bonds with the smallest coupon and longest maturity will be most sensitive to changes. ex. 15 yr zero coupon Treasury bond

Which of the following scenarios implies a capital loss?

Buy a security for $100, sell it for $99

False

By maximizing the earnings of the firm we will ensure that the price per share of common stock is maximized, hence shareholders' wealth also will be maximized

The coefficient of variation (CV) is calculated as:

CV = Standard deviation / expected return

All of the following are external factors that influence the stock prices of the firm except

Capital structure

A firm has several classes of securities outstanding. Which of the following is the MOST risky from an investors point of view? a. Debenture b. Mortgage bond c. Common stock d. Preferred stock e. The risk is the same if issued by the same company

Common Stock

Company J and Company K each recently reported the same earnings per share (EPS). Company J's stock, however, trades at a higher price. Which of the following statements is most correct?

Company J must have a higher P/E ratio

Why is corporate finance important to all managers?

Corporate finance provides the skills managers need to: Identify and select the corporate strategies and individual projects that add value to their firm. Forecast the funding requirements of their company, and devise strategies for acquiring those funds.

Which of the following would be most likely to lead to higher interest rates on all debt securities in the economy?

Corporations step up their expansion plans and thus increase their demand for capital.

Which of the following statements is most correct? A) Free cash flows are called free because the cost of capital for these cash flows is zero. B) Stock is valuable only because it generates cash flows for the investor. C) Managers can affect firm value by changing the riskiness of its cash flows. D) (a) and (b) are correct. E) (b) and (c) are correct.

Correct Answer: D

What do we call the price, or cost, of equity capital?

Cost of equity = Required return = dividend yield + capital gain

What international conditions affect the cost of money?

Country Risk Exchange Rate Risk

What actions might make a loan feasible?

Creditors can protect themselves by (1) having the loan secured and (2) placing restrictive covenants in debt agreements. They can also charge a higher than normal interest rate to compensate for risk.

$50.00

Culver Inc. has earnings after interest but before taxes of $300. The company's before-tax times-interest-earned ratio is 7.00. Calculate the company's interest charges.

Favor capital gains because the tax does not have to be paid until the stock is sold

Current tax laws have which of the following effects?

If D1 = $1.25, g (which is constant) = 4.7%, and P0 = $26.00, what is the stock's expected dividend yield for the coming year?

D1: $1.25 g: 4.7% P0: $26.00 Dividend yield = D1/P0 = 4.81%

The ratio of total liabilities to total assets is called the:

Debt Ratio

False

Depreciation, as shown on the income statement, is regarded as a use of cash because it is an expense.

Other things held constant, (1) if the expected inflation rate decreases, and (2) investors become more risk averse, the Security Market Line would shift

Down and have steeper slope.

False

During a period of lowering prices, the FIFO accounting method will produce a higher balance sheet inventory but a lower cost of goods sold than the LIFO accounting method.

Which of the following statements is most correct?

EVA is a measure of the firm's true profitability

Which of the following actions is consistent with social responsibility but is necessarily inconsistent with stockholder wealth maximization?

Each of the above actions is consistent with social responsibility and none are necessarily inconsistent with stockholder wealth maximization

Is maximizing stock price good for society, employees, and customers?

Employment growth is higher in firms that try to maximize stock price. Consumer welfare implications Should firms behave ethically? YES!

A 20-year original maturity bond with 1 year left to maturity has more interest rate risk than a 10-year original maturity bond with 1 year left to maturity. (Assume that the bonds have equal default risk and equal coupon rates.) (T/F)

False

A hostile takeover involves an attempt by one group of stockholders to solicit votes from other stockholders in order to put a new management team into place and is usually motivated by low stock prices

False

A hostile takeover is a method of seizing control of a company and involves an action taken against the opposition of incumbent management. However, this action is typically motivated by a desire to control the firm's assets and is rarely motivated by a low share price.

False

According to the basic FCF stock valuation model, the value an investor should assign to a share of stock is dependent on the length of time he or she plans to hold the stock.

False

According to the basic FCF stock valuation model, the value an investor should assign to a share of stock is dependent on the length of time he or she plans to hold the stock. (T/F)

False

An agency relationship exists when one or more persons hire another person to perform some service but withhold decision-making authority from that person.

False

Because present value refers to the value of cash flows that occur at different points in time, present values cannot be added to determine the value of a capital budgeting project. (T/F)

False

Executive stock options are shares of stock awarded to managers on the basis of corporate performance.

False

If a firm has high current and quick ratios, this is always a good indication that a firm is managing its liquidity position well. (T/F)

False

If a firm raises capital by selling new bonds, the buyer is called the "issuing firm," and the coupon rate is generally set equal to the required rate. (T/F)

False

Pro forma financial statements, as discussed in the text, are used primarily to assess a firm's historical performance. T/F

False

Pro forma financial statements, as discussed in the text, are used primarily to assess a firm's historical performance. (T/F)

False

Retained earnings refer to the portion of a corporation's profits that are paid out to shareholders.

False

The corporate valuation model cannot be used unless a company doesn't pay dividends. T/F

False

The proper goal of the financial manager should be to maximize the firm's expected profit because this will add the most wealth to each of the individual shareholders of the firm

False

The slope of the SML is determined by the value of beta. (T/F)

False

When a firm makes bad managerial judgements or has unforeseen negative events happen to it that affect its returns, these random events are unpredictable and therefore cannot be diversified away by the investor. (T/F)

False

True

Four of the disadvantages of a partnership are (1) unlimited liability, (2) limited life of the organization, (3) difficulty of transferring ownership, and (4) difficulty in attracting large amount of capital

Which of the following best describes free cash flow?

Free cash flow is the amount of cash flow available for distribution to all investors after all necessary investments in operating capital have been made.

Which of the following mechanisms is NOT used by shareholders to get managers to act in a shareholder's best interests?

Golden Parachute

Taxable Income

Gross income minus exemptions and allowable deductions as set forth in the Tax Code

__________ is also called terminal value, or continuing value.

Horizon value

False

If a firm has a single owner, we can say that the proper goal of a financial manger would be to maximize the firm's earnings per share

False

If a firm has high current and quick ratios, this always is a good indication that a firm is managing its liquidity position well.

False

If a firm's stock price falls during the year, this indicates that the firm's managers are NOT acting in the shareholders' best interest

Which of the following statements is CORRECT?

If expected inflation increases, interest rates are likely to increase.

Which of the following statements concerning a firm's quest to maximize wealth is correct?

If government did not mandate socially responsible corporate actions, such as those relating to product safety and fair hiring practices, most firms in competitive markets probably would not pursue such policies voluntarily

False

In accounting, emphasis is placed on determining net income. In finance, the primary emphasis also is on net income because that is what investors use to value the firm. However, a secondary consideration is cash flow because that's what is used to run the business.

False

In order to avoid double taxation and to escape the frequently higher tax rate applied to capital gains, stockholders generally prefer to have corporations pay dividends rather than to retain their earnings and reinvest the money in the business. Thus, earnings should be retained only if the firm needs capital very badly and would have difficulty raising it from external sources

Which of the following statement is correct?

In part due to limited inability and ease of ownership transfer, corporations ave less trouble raising money in financial markets than other organizational forms.

Which of the following work to reduce agency conflicts between stockholders and bondholders?

Including restrictive covenants in the company's bond contract

Which of the following work to reduce agency conflicts between stockholders and bondholders?

Including restrictive covenants in the company's bond contract.

Would expansion increase or decrease potential agency problems?

Increase. If you expanded to additional locations you could not physically be at all locations at the same time. Consequently, you would have to delegate decision-making authority to others.

Which of the following does NOT always increase a company's market value?

Increasing the expected growth rate of sales

Which of the following actions are likely to reduce agency conflicts between stockholders and managers?

Increasing the threat of corporate takeover

When evaluating projects, if the cash flows of one are unaffected by the acceptance of the other, it is considered:

Independent

Profitability index is the present value of future cash flows divided by the:

Initial Cost

False

Interest and dividends paid by a corporation are considered to be deductible operating expenses, hence they decrease the firm's tax liability

Capital components are sources of funding that come from

Investors

If a bond's YTM increases:

Its price will fall

S corporation, to enjoy tax advantages and gain limited liability.

Jane Doe, who has substantial personal wealth and income, is considering the possibility of opening a new business in the chemical wasted management field. She will be the sole owner. The business will have a relatively high degree of risk, and it is expected that the firm will incur losses for the first few years. However, the prospects for growth and positive future income look good, and Jane expects to realize substantial cash flows from dividends the firm will eventually pay out. Which of the legal forms of business organization would probably best suit her needs?

Which of the following statements is incorrect?

Large European firms generally have many more individual owners than large U.S. firms

$33,200

Lone Star Plastics has the following data: Assets: $100,000 Profit margin: 6.0% Tax rate: 40% Debt ratio: 40.0% Interest rate: 8.0% Total asset turnover: 3.0 What is Lone Star's EBIT?

The best proxy for the risk free rate to evaluate a 3 year investment is the yield on a :

Long term Treasury Bond T-Bill used to evaluate short term investments (< 1 year) T-Bonds used to evaluate long term investments (> 1 year)`

The types of long-term capital that firms use are:

Long term debt Preferred stock Common Equity (all of the above)

Tax Loss Carryback (Carryover)

Losses that can be carried backward (forward) in time to offset taxable income in a given year

True

Market value ratios provide management with a current assessment of how investors in the market view the firm's past performance and future prospects.

Profit Maximization

Maximization of the firm's net income each year

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

Maximize the stock price per share

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

Maximize the stock price per share.

The primary goal of a financial manager should be to __

Maximize the value of the firm's stock

Which of the following factors would be most likely to lead to an increase in interest rates in the economy?

Most businesses decide to modernize and expand their manufacturing capacity, and to install new equipment to reduce labor costs

True

Multinational managerial finance requires that financial analyses consider the effects of changing currency values

The internal rate of return of a capital investment

Must exceed the cost of capital in order for the firm to accept the investment. Is similar to the yield to maturity on a bond.

True

Net fixed assets reflect the historical costs for property, plant, and equipment less accumulated depreciation.

Earnings Per Share (EPS)

Net income divided by the number of shares of common stock outstanding

Which of the following statements is most correct?

Newly-privatized firms generally hire more employees

Which of the following is an example of an area of business where use of "questionable" ethics is considered a necessity?

None of the above

Which of the following statements is most correct about Economic Value Added (EVA)?

None of the statements above is correct.

False

On the balance sheet, total assets must always equal total liabilities. The amount remaining is what is used to finance the firm and includes equity and long-term debt.

Which of the following statements is most correct?

One advantage to forming a corporation is that the owners of the corporations have limited liability.

Industrial Groups

Organizations that consist of companies in different industries with common ownership interests, which include firms necessary to manufacture and sell products- a network of manufacturers, suppliers, marketing organizations, distributors, retailers, and creditors

Total asset turnover Return on equity

Other things held constant, if a firm holds cash balances in excess of their optimal level in a non-interest bearing account, this will tend to lower the firm's

Accounts receivable are collected

Other things held constant, which of the following will not affect the quick ratio? (Assume that current assets equal current liabilities.)

Only Pepsi Corporation's current ratio will be increased

Pepsi Corporation's current ratio is 0.5, while Coke Company's current ratio is 1.5. Both firms want to "window dress" their coming end-of-year financial statements. As part of their window dressing strategy, each firm will double its current liabilities by adding short-term debt and placing the funds obtained in the cash account. Which of the statements below best describes the actual results of these transactions?

Suppose the U.S. Treasury announces plans to issue $50 billion of new bonds. Assuming the announcement was not expected, what effect, other things held constant, would that have on bond prices and interest rates?

Prices would decline and interest rates would rise

What four factors affect the cost of money?

Production opportunities Time preferences for consumption Risk Expected inflation

In the United States, the most common form of business is the ____, and the form of business that generates most of the sales and profits is the ____.

Propitership, corporation

Purchasing additional inventory on credit (accounts payable).

Recently the M&M Company has been having problems. As a result, its financial situation has deteriorated. M&M approached the First National Bank for a badly needed loan, but the loan officer insisted that the current ratio (now 0.5) be improved to at least 0.8 before the bank would even consider granting the credit. Which of the following actions would do the most to improve the ratio in the short run?

Which of the following actions will increase a company's quick ratio?

Reduce inventories and use the proceeds to reduce current liabilities

Which of the following statements is most correct?

Sarbanes-Oxley prohibits auditors from providing consulting services to the companies they audit.

Which of the following statements is most correct

Sarbanes-Oxley requires the CEO sign and certify the company's financial statements.

3.3%

Selzer Inc. sells all its merchandise on credit. It has a profit margin of 4 percent, days sales outstanding equal to 60 days, receivables of $150,000, total assets of $3 million, and a debt ratio of 0.64. What is the firm's return on equity (ROE)?

False

Since ROA measures the firm's effective utilization of assets (without considering how these assets are financed), two firms with the same EBIT must have the same ROA.

Which of the following statements is most correct?

Statements a and b are correct. (Restrictions are included in credit agreements to protect bondholders from the agency problem that exists between bondholders and stockholders; The threat of a takeover can reduce the agency problem between bondholders and stockholders.)

Which of the following actions are likely to reduce the agency problem between stockholders and managers?

Statements b and c are correct

Which of the following statements is most correct?

Statements b and c are correct (The threat of takeover is one way in which the agency problem between stockholders and managers can be alleviated; Managerial compensation can be structured to reduce agency problems between stockholders and managers.)

Which of the following statements is most correct?

Stock can be valuable because it generates cash flows for the investor. Managers can affect firm value by changing the riskiness of its cash flows. A firm's fundamental value is the present value of its future free cash flows. The threat of takeover is one way in which the agency problem between stockholders and managers can be alleviated Managerial compensation can be structured to reduce agency problems between stockholders and managers.

Are similar to stock splits in that they do not change the fundamental position of current shareholders

Stock dividends...

Restricted Stock Grants

Stock is granted to employees based on the firm's performance, but the stock is restricted in the sense that an employee is not vested- that is, does not have the right to ownership of the stock- until some period in the future

An outlay that has already occurred and is not affected by a decision under consideration is called a ____________.

Sunk Cost

Average Tax Rate

Taxes paid divided by taxable income

"window dressing" techniques

Techniques employed by firms to make their financial statements look better than they actually are.

Corporate Governance

The "set of rules" that a firm follows when conducting business; these rules identify who is accountable for major financial decisions

16.99%

The Amer Company has the following characteristics: Sales: $1,000 Total Assets: $1,000 Total Debt/Total Assets: 35% EBIT: $200 Tax rate: 40% Interest rate on total debt: 4.57% What is Amer's ROE?

$7.50

The Charleston Company is a relatively small, privately owned firm. Last year the company had after-tax income of $15,000, and 10,000 shares were outstanding. The owners were trying to determine the market value for the stock, prior to taking the company public. A similar firm which is publicly traded had a price/earnings ratio of 5.0. Using only the information given, estimate the market value of one share of Charleston's stock.

Which of the following statements is most correct?

The agency conflicts between bondholders and stockholders can be reduced with the use of bond covenants.

net working capital

The amount of current assets that is financed with long-term sources of funds —equals current assets minus current liabilities.

Stockholder Wealth Maximization

The appropriate goal for management decisions; considers the risk and timing associated with expected cash flows to maximize the price of the firm's common stock

False

The balance sheet is a financial statement measuring the flow of funds into and out of various accounts over time while the income statement measures the progress of the firm at a point in time.

False

The balance sheet lists ant their fair market value as of midnight on the annual fiscal end date for the firm.

False

The book value of an asset is the market value less any accumulated depreciation.

The CFO of Mulroney Brothers has suggested that the company should issue $300 million worth of common stock and use the proceeds to reduce some of the company's outstanding debt. Assume that the company adopts this policy, and that total assets and operating income (EBIT) remain the same. The company's tax rate will also remain the same. Which of the following will occur:

The company's net income will increase.

The 11 "titles" in the Sarbanes-Oxley Act of 2002 establish standards for accountability and responsibility of financial reporting information for major corporations. Which of the following activities does the act not provide rules that a corporation must abide by?

The corporation must maximize social welfare though funding of environmentally friendly activities.

False

The fact that a percentage of the interest income received by one corporation is excluded from taxable income has encouraged firms to use more debt financing relative to equity financing

True

The fact that a proprietorship, as a business, pays no corporate income tax and that it is easily and inexpensively formed are often cited as key advantages to that form of business

False

The four basic financial statements included in the annual report are the balance sheet, the income statement, the statement of cash flows, and the statement of reported earnings.

common stockholders' equity (net worth)

The funds provided by common stockholders— common stock, paid-in capital, and retained earnings. It equals total assets minus total liabilities.

False

The goal of maximizing stock price is a detriment to society in that few of the actions that result in maximization of stock price also benefit society

What do we call the price, or cost, of debt capital?

The interest rate

True

The inventory turnover and current ratios are related. The combination of a high current ratio and a low inventory turnover ratio relative to the industry norm might indicate that the firm is maintaining too high an inventory level or that part of the inventory is obsolete or damaged.

False

The inventory turnover ratio and days sales outstanding (DSO) are two ratios that can be used to assess how effectively the firm is managing its assets in consideration of current and projected operating levels.

Depreciation

The life over which assets can be depreciated for tax purposes and the methods of depreciation that can be used

False

The major advantage of a regular partnership or a corporation as a form of business is the fact that both offer their owners limited liability, whereas proprietorships do not

Compared to corporations, what is the primary disadvantage of partnerships as forms of business organizations?

The owners of a partnership - that is, the partners- have unlimited liability when it comes to business obligations whereas the owners of a corporation have limited liability.

Marginal Tax Rate

The percent tax applicable to the last unit (dollar) or income

retained earnings

The portion of the firm's earnings that has been reinvested in the firm rather than paid out as dividends.

Value

The present, or current, value of the cash flows an asset is expected to generate in the future

What should be management's primary objective?

The primary objective should be shareholder wealth maximization, which translates to maximizing stock price.

False

The proper goal of the financial manager should be to maximize the firm's expected profit, because this will add the most wealth to each of the individual shareholders (owners) of the firm

market/book (M/B) ratio

The ratio of a stock's market price to its book value.

Which of the following mechanisms is used to motivate managers to act in the interests of shareholders?

The threat of a takeover & Executive stock options (B & C)

Which of the following mechanisms is used to motivate managers to act in the interests of shareholders?

The threat of a takeover. Executive stock options.

False

The time dimension is important in financial statement analysis. While the balance sheet and income statements represent the firm's financial position at a point in time, the statement of cash flows reports changes that were made to the firm's accounts over a period of time.

True

The times-interest-earned ratio is one indication of a firm's ability to meet both long-term and short-term obligations.

Which of the following is not something that corporations can do with their profits?

They can do all of these

operating cash flows

Those cash flows that arise from normal operations; the difference between cash collections and cash expenses associated with the manufacture and sale of inventory.

Stakeholders

Those who are associated with a business; stakeholders include managers, employees, customers, suppliers, creditors, stockholders, and other parties with an interest in the firm

What are the potential consequences of inflating earnings or hiding debt?

Trading Issues Lending Issues

According to the nonconstant growth model discussed in the textbook, the discount rate used to find the present value of the expected cash flows during the initial growth period is the same as the discount rate used to find the PVs of cash flows during the subsequent constant growth period. T/F

True

An increase in the firm's inventory balance will normally require additional financing unless the increase is matched by an equally large decrease in some other asset account. T/F

True

Capital gains are taxed and capital losses are not.

True

Conflicts between two mutually exclusive projects, where the NPV method chooses one project but the IRR method chooses the other, should generally be resolved in favor of the project with the higher NPV.

True

Founders' shares are a type of classified stock where the shares are owned by the firm's founders, and they generally have more votes per share than the other classes of common stock

True

Free cash flows should be discounted at the firm's weighted average cost of capital to find the value of its operations. (T/F)

True

If a firm's managers want to maximize stock price it is in their best interests to operate efficient, low-cost plants, develop new and safe products that consumers want, and maintain good relationships with customers, suppliers, creditors, and the communities in which they operate

True

If any firm with a positive net worth is operating its fixed assets at full capacity, if its dividend payout ratio is 100 percent, and if it wants to hold all financial ratios constant, then for any positive growth rate in sales, the firm will require external financing. (T/F)

True

In a competitive marketplace, if managers deviate too far from making decisions that are consistent with stockholder wealth maximization, they risk being disciplined by the market. Part of this discipline involves the threat of being taken over by groups who are more aligned with stockholder interests.

True

In general, the role of the financial manager is to plan for the acquisition and use of funds so as to maximize the value of the firm

True

NOPAT is the amount of profit a company would have from its operations if it had no interest income or income expense. (T/F)

True

Net operating profit after taxes (NOPAT) is the amount of profit a company would have from its operations if it had no interest income or interest expense.

True

The key importance of annual report information is that it is used by investors when they form their expectations about the firm's future earnings and dividends and the riskiness of those cash flows. (T/F)

True

The riskiness inherent in a firm's earnings per share (EPS) depends on both the types of projects the firm takes on and the manner in which the projects are financed

True

The term multinational corporation is used to describe a firm that operates in two or more countries

True

Two firms with the same capital intensity ratios were generating the same sales. However, one firm was operating below capacity. If the two firms expect the same growth in sales in the next period, it is more likely that the firm operating at full capacity will need additional funds, other things held constant. T/F

True

We will generally find that the beta of a diversified portfolio is more stable over time than the beta of a single security. (T/F)

True

Two key limitations of the proprietorship form of business involve potential difficulty in raising needed capital and the presence of unlimited personal liability for business debts

True

Under our current tax laws, when investors pay taxes on their corporate dividend income, they are being subjected to a form of double taxation

Proxy Votes

Voting power that is assigned to another party, such as another stockholder or institution

WACC

WACC = (E/V) x RE + (D/V) x RD(1-TC) WACC = wERE + wDRD(1-TC)

WACC (Preferred Stock)

WACC = (E/V) x RE + (P/V) x Rp +(D/V) x RD(1-TC) WACC = wERE + wpRp + wDRD(1-TC)

Total assets

We can be sure that, in and of itself, a stock dividend will not affect which of the following financial aspects of the firm? (Assume the stock has a par value.)

True

When a firm pays off a loan using cash, the source of funds is the decrease in the asset account, cash, while the use of funds involves a decrease in a liability account, debt.

Each of the above actions is consistent with social responsibility and none is necessarily inconsistent with stockholder wealth maximization

Which of the following actions is consistent with social responsibility but is necessarily inconsistent with stockholder wealth maximization?

All of the above must be considered (projected earnings, financial market conditions, timing of the earnings flow, riskiness of the firm)

Which of the following does NOT need to be considered when assessing the impact of financial decisions?

Elimination of double taxation

Which of the following is NOT one of the things that causes a corporation to have significant advantage over a partnership or a proprietorship?

All of the above A. To take advantage of lower production costs in regions of inexpensive labor B. To develop new markets for their finished products C. To better serve their primary customers D. Because important raw materials are located abroad

Which of the following is a reason why companies move into international operations?

Performance shares

Which of the following mechanisms is NOT used by shareholders to get managers to act in shareholders' best interests?

A good example of an agency relationship is the one between stockholders and managers

Which of the following statements is correct?

All of the above statements are true A. For the most part, our federal tax rates are progressive, because higher incomes are taxed at a higher average rates B. Bonds issued by a municipality such as the city of Miami would carry a lower interest rate than bonds with the same risk and maturity issued by a private corporations such as Florida Power & Light C. Our federal tax laws tend to encourage corporations to finance with debt rather than with equity securities D. Our federal tax laws encourage the managers of corporations with surplus cash to invest it in stocks rather than in bonds. However, other factors may offset tax considerations

Which of the following statements is correct?

Both answers b and d are correct B. Bond covenants, or restrictions on debt, are an important device to reduce agency conflicts between stockholders and bondholders D. Compensation packages are designed, in part, to reduce agency conflicts between shareholders and managers

Which of the following statements is correct?

If two firms pay the same interest rate on their debt and have the same rate of return on assets, and if that ROA is positive, the firm with the higher debt ratio will also have a higher rate of return on common equity

Which of the following statements is correct?

In part due to limited liability and ease of ownership transfer, corporations have less trouble raising money in financial markets than other organizational forms.

Which of the following statements is correct?

Maximizing the income statement item "net income" is not the best goal for a corporation whose managers are interested in maximizing the economic welfare of the firm's stockholders.

Which of the following statements is correct?

Partnerships have difficulties attracting capital in part because of the other disadvantages of the partnership form of business, including impermanence of the organization.

Which of the following statements is correct?

The key importance of annual report information is that it is used by investors when they form their expectations about the firm's future earnings and dividends and the riskiness of those cash flows

Which of the following statements is correct?

There are more partnerships and sole proprietorships than corporations in the U.S., but corporations produce more goods and services than do other forms of business.

Which of the following statements is correct?

An increase in a firm's debt ratio, with no changes in its sales and operating costs, could be expected to lower its profit margin on sales

Which of the following statements is most correct?

High inflation can seriously distort firms' balance sheets, and since inflation also affects depreciation and inventory costs, profits can also be affected

Which of the following statements is most correct?

$88,400

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?

a. $ 0 Correct BEP = EBIT/TA 0.15 = EBIT/$100,000,000 EBIT = $15,000,000. ROA = NI/TA 0.09 = NI/$100,000,000 NI = $9,000,000. EBT = NI/(1 - T) EBT = $9,000,000/0.6 EBT = $15,000,000. Therefore interest expense = $0.

Simonyan Inc. forecasts a free cash flow of $40 million in Year 3, i.e., at t = 3, and it expects FCF to grow at a constant rate of 5% thereafter. If the weighted average cost of capital is 10% and the cost of equity is 15%, what is the horizon value, in millions at t = 3?

a. $ 840 FCF3: $40 g: 5% WACC: 10% HV3 = FCF4/(WACC - g) = FCF3(1 + g)/(WACC - g) = $40(1 + 0.05)/(0.10 - 0.05) = $42/0.05 = $840

The Cooper Company is a relatively small, privately owned firm. Last year the company had after-tax income of $15,000, and 10,000 shares were outstanding. The owners were trying to determine the equilibrium market value for the stock, prior to taking the company public. A similar firm which is publicly traded had a price/earnings ratio of 6.0. Using only the information given, estimate the market value of one share of Cooper's stock. a. $ 9.00 b. $ 8.50 c. $ 7.00 d. $ 6.50 e. $ 2.50

a. $ 9.00 Correct EPS = $15,000/10,000 = $1.50. P/E = 6.0 = P/$1.50. P = $9.00.

Oliver Incorporated has a current ratio = 1.6, and a quick ratio equal to 1.2. The company has $2 million in sales and its current liabilities are $1 million. What is the company's inventory turnover ratio? Select one: a. 5.0 b. 5.2 c. 5.5 d. 6.0 e. 6.3

a. 5.0 Correct Quick Ratio = (Current assets - Inventory)/Current liabilities 1.2 = (CA - I)/$1,000,000 CA - I = $1,200,000. Current Ratio = (Current assets - Inventory + Inventory)/Current liabilities =Quick Ratio + Inventory (added back)/Current liabilities 1.6 = ($1,200,000 + Inventory)/$1,000,000 $1,600,000 = $1,200,000 + Inventory Inventory = $400,000. Inventory turnover = Sales/Inventory = $2,000,000/$400,000 = 5´.

Which of the following statements is most correct? Select one: a. If a companys ROA is 7 percent, then its ROE must be greater than or equal to 7 percent. b. The BEP and ROA will be the same for a company with no debt in its capital structure. c. A company with a low debt ratio will have a high equity multiplier. d. Both statements a and c are correct. e. None of the statements above is correct.

a. If a companys ROA is 7 percent, then its ROE must be greater than or equal to 7 percent. Statement a is correct. The other statements are false. EBIT and net income will still differ by taxes paid. Thus, ROA and BEP will not be equal. In addition, a company with a low debt ratio will have a low equity multiplier.

Which of the following alternatives could potentially result in a net increase in a company's free cash flow for the current year? Select one: a. Reducing the days-sales-outstanding ratio. b. Increasing the number of years over which fixed assets are depreciated. c. Decreasing the accounts payable balance. d. All of the answers above are correct. e. Answers a and b are correct.

a. Reducing the days-sales-outstanding ratio. Statement a is correct. The other statements are false. Increasing the years over which fixed assets are depreciated results in smaller amounts being depreciated each year. Given that depreciation is a non-cash expense and is used to reduce taxable income, the change would result in less depreciation expense and higher taxes for the year. Since taxes are paid with cash, the companys free cash flow would decrease. In addition, decreasing accounts payable results in a use of cash.

The three (3) key components in creating a financial plan are:

a. The sales forecast, proforma financial statement and external financing plan

The three (3) key components in creating a financial plan are: Select one: a. The sales forecast, proforma financial statement and external financing plan b. Strategic plan, corporate purpose and corporate scope c. Cash, short term investments and accounts receivable d. Free cash flow, Economic Value Added, sales forecast e. None of the above

a. The sales forecast, proforma financial statement and external financing plan

days sales outstanding (DSO)

also called the average collection period (ACP), A ratio calculated by dividing accounts receivable by average sales per day, which indicates the average length of time it takes the firm to collect for credit sales.

Leak Inc. forecasts the free cash flows (in millions) shown below. If the weighted average cost of capital is 11% and FCF is expected to grow at a rate of 5% after Year 2, what is the Year 0 value of operations, in millions? Assume that the ROIC is expected to remain constant in Year 2 and beyond (and do not make any half-year adjustments). FCF 1 = -50 FCF 2 = 100 a. $1,456 b. $1,529 c. $1,606 d. $1,686 e. $1,770

answer: $1,456

If D1 = $1.25, g (which is constant) = 4.7%, and P0 = $26.00, what is the stock's expected dividend yield for the coming year? a. 4.12% b. 4.34% c. 4.57% d. 4.81% e. 5.05%

answer: 4.81%

Burke Tires just paid a dividend of D0 = $1.32. 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. $41.59 b. $42.65 c. $43.75 d. $44.87 e. $45.99

answer: 44.87

Franklin Corporation is expected to pay a dividend of $1.25 per share at the end of the year (D1 = $1.25). The stock sells for $32.50 per share, and its required rate of return is 10.5%. The dividend is expected to grow at some constant rate, g, forever. What is the equilibrium expected growth rate? a. 6.01% b. 6.17% c. 6.33% d. 6.49% e. 6.65%

answer: 6.65%

answer: a. $424.78

Merrell Enterprises' stock has an expected return of 14%. The stock's dividend is expected to grow at a constant rate of 8%, and it currently sells for $50 a share. Which of the following statements is CORRECT? a. The stock's dividend yield is 8%. b. The current dividend per share is $4.00. c. The stock price is expected to be $54 a share one year from now. d. The stock price is expected to be $57 a share one year from now. e. The stock's dividend yield is 7%.

answer: c

Corporate assets consist of: a. Operating assets b. Nonoperating assets c. Corporate debt d. a & b e. None of the above

answer: d

Assets-in-Place include tangible assets such as: a. Building b. Inventory c. Land d. Machines e. All of the above

answer: e

A company has the following balance sheet. What is it's net operating working capital?

Non-operating assets include:

b & c (marketable securities & Non-controlling interests in the stock of other companies)

Which of the following statements is most correct?

b and c are correct (Stock can be valuable because it generates cash flows for the investor; Managers can affect firm value by changing the riskiness of its cash flows)

Kellner Motor Co.'s stock has a required rate of return of 11.50%, and it sells for $25.00 per share. Kellner's dividend is expected to grow at a constant rate of 7.00%. What was the last dividend, D0?

b. $1.05

A company has the following income statement. What is its net operating profit after taxes (NOPAT)? Sales $1,000 Costs 700 Depreciation 100 EBIT $ 200 Interest expense 50 EBT $ 150 Taxes (40%) 60 Net income $ 90 Select one: a. $ 90 b. $120 c. $150 d. $180 e. $200

b. $120 CorrectNOPAT = EBIT(1 - T) = $200(1 - 0.4) = $120.

Kinkead Inc. forecasts that its free cash flow in the coming year, i.e., at t = 1, will be −$10 million, but its FCF at t = 2 will be $20 million. After Year 2, FCF is expected to grow at a constant rate of 4% forever. If the weighted average cost of capital is 14%, what is the firm's value of operations, in millions? a. $158 b. $167 c. $175 d. $184 e. $193

b. $167

Judd Corporation has a weighted average cost of capital of 10.25%, and its value of operations is $57.50 million. Free cash flow is expected to grow at a constant rate of 6.00% per year. What is the expected year-end free cash flow, FCF1 in millions?

b. $2.44

Based on the corporate valuation model, Carton Inc.'s value of operations is $500 million. Its balance sheet shows $75 million of short-term investments that are unrelated to operations, $100 million of accounts payable, $150 million of notes payable, $100 million of long-term debt, $40 million of common stock (par plus paid-in-capital), and $160 million of retained earnings. What is the best estimate for the firm's value of equity, in millions?

b. $325 Value of operations: $500 Short-term investments: $ 75 Notes payable: $150 Long-term debt: $100 Assuming that the book value of debt is close to its market value, the total market value of the company is: Total market value = Value of operations + Value of non-operating assets $575 = $500 + $75 Value of Equity = Total MV - Long- and Short-term debt = 575-150-100 = $325. The book value of equity figures are irrelevant for this problem. Also, the accounts payable are not relevant because they were netted out when the FCF was calculated. The correct answer is: $325

Teri's Photography has total assets of $50,800, fixed assets of $47,400, long-term debt of $36,300, and total debt of $42,900. If inventory is $1,200, what is the current ratio? a. .33 b. .52 c. .84 d. 1.18 e. 1.94

b. .52 Current Assets: 50,800 (Total assets) - 47,400 (fixed assets)=$3,400 Current Liabilities: 42,900 (total debt) - 36,300 (Long term debt) = $6,600 Ratio CA/CL=.52 The correct answer is: .52

You are considering adding a new product to your firm's existing product line. It should cause a 15 percent increase in your profit margin (i.e., new PM = old PM x 1.15), but it will also require a 50 percent increase in total assets (i.e., new TA = old TA/1.5). You expect to finance this asset growth entirely by debt. If the following ratios were computed before the change, what will be the new ROE if the new product is added and sales remain constant? Ratios before new product Profit margin = 0.10 Total assets turnover = 2.00 Equity multiplier = 2.00 Select one: a. 11% b. 46% c. 40% d. 20% e. 53%

b. 46% New profit margin: (0.10)(1.15) = 0.115. New total asset turnover: 2.0/1.5 = 1.33. New ROA: (0.115)(1.33) = 0.153. New equity multiplier: 2.0(1.5) = 3.0. ROE: (0.153)(3.0) = 0.46 = 46%. The correct answer is: 46%

The current ratio is calculated by dividing: Select one: a. Current liabilities by current assets b. Current assets by current liabilities c. Current assets by inventories d. Current liabilities by inventories e. Current assets by common equity

b. Current assets by current liabilities

1. AFN is best defined as: a. Funds that are obtained automatically from routine business transactions b. Funds that a firm must raise externally through borrowing or by selling new common or preferred stock c. The amount of assets required per dollar of sales d. The amount of cash generated in a given year minus the amount of cash needed to finance the additional capital expenditures e. A forecasting approach in which the forecasted percentage of sales for each item is held constant.

b. Funds that a firm must raise externally through borrowing or by selling new common or preferred stock

__________ is also called terminal value, or continuing value.

b. Horizon value

A company is forecasting an increase in sales and is using the AFN model to forecast the additional capital that they need to raise. Which of the following factors are likely to increase the additional funds needed? a. The company has a lot of excess capacity b. The company has a high dividend payout ratio c. The company has a lot of spontaneous liabilities that increase as sales increase d. The company has a high profit margin e. All of the above

b. The company has a high dividend payout ratio

Which of the following statements is most correct? a. One of the key steps in the development of pro forma financial statements is to identify those assets and liabilities which increase spontaneously with net income. b. The first, and most critical, step in constructing a set of pro forma financial statements is establishing the sales forecast. c. Pro forma financial statements as discussed in the text are used primarily to assess a firms historical performance. d. The capital intensity ratio reflects how rapidly a firm turns over its assets and is the reciprocal of the fixed assets turnover ratio. e. The percentage of sales method produces accurate results when fixed assets are lumpy and when economies of scale are present.

b. The first, and most critical, step in constructing a set of pro forma financial statements is establishing the sales forecast.

Which of the following statements is most correct? Select one: a. One of the key steps in the development of pro forma financial statements is to identify those assets and liabilities which increase spontaneously with net income. b. The first, and most critical, step in constructing a set of pro forma financial statements is establishing the sales forecast. c. Pro forma financial statements as discussed in the text are used primarily to assess a firms historical performance. d. The capital intensity ratio reflects how rapidly a firm turns over its assets and is the reciprocal of the fixed assets turnover ratio. e. The percentage of sales method produces accurate results when fixed assets are lumpy and when economies of scale are present.

b. The first, and most critical, step in constructing a set of pro forma financial statements is establishing the sales forecast.

After analyzing a stock, you find that its expected return exceeds its required return. This suggests that you think a. the stock should be sold. b. the stock is a good buy. c. management is probably not trying to maximize the price per share. d. dividends are not likely to be declared. e. the stock is experiencing supernormal growth.

b. the stock is a good buy.

When a bond sells at a premium

bond value > par value

Garfield Industries is expanding its operations throughout the Southeast United States. Garfield anticipates that the expansion will increase sales by $1,000,000, and increase the costs of goods sold by $700,000. Depreciation expenses will rise by $50,000 and interest expense will increase by $150,000. The company's tax rate will remain at 40 percent. If the companys forecast is correct, how much will net income increase or decrease, as a result of the expansion? a. No change. b. $ 40,000 increase. c. $ 60,000 increase. d. $100,000 increase. e. $180,000 increase.

c. $ 60,000 increase. Set up an income statement: Sales $1,000,000 COGS (700,000) Depreciation (50,000) EBIT $ 250,000 Interest (150,000) EBT $ 100,000 Taxes (40,000) Taxes = 0.4($100,000) = $40,000 Net Income $ 60,000

A company has the following income statement. What is its net operating profit after taxes (NOPAT)? Sales $1,000 Costs 600 Depreciation 250 EBIT $ 150 Interest expense 50 EBT $ 100 Taxes (40%) 40 Net income $ 60 a. $ 60 b. $ 80 c. $ 90 d. $100 e. $120

c. $ 90 CorrectNOPAT = EBIT(1 - T) = $150(1 - 0.4) = $90.

Karney Corporation reported the following income statement for the most recent year (numbers are in millions of dollars): Sales $7,000 Total operating costs 3,000 EBIT $4,000 Interest 200 Earnings before tax (EBT) $3,800 Taxes (40%) 1,520 Net income available to common shareholders $2,280 The company forecasts that its sales will increase by 10 percent in the next year and its operating costs will increase in proportion to sales. The company's interest expense is expected to remain at $200 million, and the tax rate will remain at 40 percent. The company plans to pay out 40 percent of its net income as dividends, the other 60 percent will be additions to retained earnings. What is the forecasted addition to retained earnings for the next year? Select one: a. $1,008 b. $1,240 c. $1,512 d. $1,690 e. $1,910

c. $1,512

Based on the corporate valuation model: The value of a company's operations is $900 million. The company's balance sheet shows: $70 million in accounts receivable $50 million in inventory $30 million in short-term investments that are unrelated to operations. $20 million in accounts payable $110 million in notes payable $90 million in long-term debt $20 million in preferred stock $280 million in total common equity $140 million in retained earnings If the company has 25 million shares of stock outstanding, what is the best estimate of the stock's price per share? Assume that the book value of debt is close to its market value. a. $23.00 b. $25.56 c. $28.40 d. $31.24 e. $34.36

c. $28.40

Bailey Computer Products' sales are expected to increase by 20% from $5 million to $6 million in 2012.Its assets totaled $3 million at the end of 2011.Bailey is at full capacity, so its assets must grow at the same rate as projected sales. At the end of 2011, current liabilities were $1 million, consisting of $250,000 of accounts payable, $500,000 of notes payable, and $250,000 of accruals.The after-tax profit margin is forecasted to be 5%, and the forecasted payout ratio is 60%.Use the AFN formula to forecast Bailey's additional funds needed for the coming year.

c. $380,000

Bailey Computer Products' sales are expected to increase by 20% from $5 million to $6 million next year. Its assets totaled $3 million at the end of this year. Bailey is at full capacity, so its assets must grow at the same rate as projected sales. Current liabilities are $1 million, consisting of $250,000 of accounts payable, $500,000 of notes payable, and $250,000 of accruals. The after-tax profit margin is forecasted to be 5%, and the forecasted payout ratio is 60%. Use the AFN formula to forecast Bailey's additional funds needed for the coming year. Select one: a. $250,000 b. $320,000 c. $380,000 d. $410,000 e. $500,000

c. $380,000

Byrd Lumber has 2 million shares of stock outstanding. On the balance sheet the company has $40 million worth of common equity. The company's stock price is $15 a share. What is the company's Market Value Added (MVA)?

c. ($10 million) MVA = (Shares outstanding)(Stock Price) - Total common equity. MVA = (2,000,000)($15) - $40,000,000 MVA = -$10,000,000.

1. Forecasting the future sales growth rate typically begins with reviewing sales during the past: a. 1-5 years b. 2-7 years c. 5-10 years d. 8-10 years e. 10-20 years

c. 5-10 years

Considering each action independently and holding other things constant, which of the following actions would reduce a firm's need for additional capital? Select one: a. An increase in the dividend payout ratio. b. A decrease in the profit margin. c. A decrease in the days sales outstanding. d. An increase in expected sales growth. e. A decrease in the accrual accounts (accrued wages and taxes).

c. A decrease in the days sales outstanding.

Stock A has a beta of 1.2 and a standard deviation of 20 percent. Stock B has a beta of 0.8 and a standard deviation of 25 percent. Portfolio P is a $200,000 portfolio consisting of $100,000 invested in Stock A and $100,000 invested in Stock B. Which of the following statements is most correct? (Assume that the required return is determined by the Security Market Line.) a. Stock B has a higher required rate of return than stock A. b. Portfolio P has a standard deviation of 22.5 percent. c. Portfolio P has a beta equal to 1.0. d. Statements a and b are correct. e. Statements a and c are correct.

c. Portfolio P has a beta equal to 1.0. Statement c is correct; the others are false. Stock A will have a higher required rate of return than B because A has the higher beta. The standard deviation of a portfolio is not the average of the standard deviations of the component stocks. The portfolio beta is a weighted average of the component stocks betas; therefore, bP = 1.0.

Which of the following is likely to increase the additional funds needed in a given year? Select one: a. The company reduces its dividend payout ratio b. The company's profit margin is projected to increase c. The company decided to reduce its reliance on accounts payable as a form of financing d. The company is operating well below full capacity e. All of the statements are correct.

c. The company decided to reduce its reliance on accounts payable as a form of financing

Which of the following is likely to increase the additional funds needed in a given year? a. The company reduces its dividend payout ratio b. The company's profit margin is projected to increase c. The company decided to reduce its reliance on accounts payable as a form of financing d. The company is operating well below full capacity e. All of the statements are correct.

c. The company decided to reduce its reliance on accounts payable as a form of financing

Which of the following are likely to occur if Congress passes legislation which forces manufacturing companies to depreciate their equipment over a longer time period: a. The company's physical stock of assets would increase. b. The company's reported net income would decline. c. The company's cash position would decline. d. All of the answers above are correct. e. Answers b and c are correct.

c. The company's cash position would decline. Statement c is correct. In the statement of cash flows, depreciation is a source of cash. Therefore, a decrease in depreciation means that cash will decrease. The other statements are false. The physical stock of assets would not change. In the income statement, the depreciable amount is deducted from sales; therefore, a decrease in the depreciable amount means that net income will increase and cause more taxes to be paid.

The quick ratio, or acid test ratio is calculated by deducting inventories from current assets and then dividing the remainder by:

current liabilities

Orange & Sons recently reported sales of $100 million, and net income equal to $5 million. The company has $70 million in total assets. Over the next year, the company is forecasting a 20 percent increase in sales. Since the company is at full capacity, its assets must increase in proportion to sales. The company also estimates that if sales increase 20 percent, spontaneous liabilities will increase by $2 million. If the companys sales increase, its profit margin will remain at its current level. The companys dividend payout ratio is 50 percent. Based on the AFN formula, how much additional capital must the company raise in order to support the 20 percent increase in sales?

d. $ 9.0 million AFN = Required asset increase - Spontaneous liability increase - Increase in retained earnings = $70/$100($20) - $2 - (0.05)($120)(1 - 0.50) = $14 - $2 - $3 = $9 million.

A 20-year bond with a par value of $1,000 has a 9 percent annual coupon. The bond currently sells for $925. If the bond's yield to maturity remains at its current rate, what will be the price of the bond 5 years from now?

d. $ 933.09 Step 1 Find the YTM. N = 20; PV = -925; PMT = 90; FV = 1000; and solve for I = YTM. I = 9.8733%. Step 2 Solve for P5. In 5 years, there will be 15 years left until maturity, so the price at t = 5 is: N = 15; I/YR = 9.8733; PMT = 90; FV = 1000; and solve for PV. PV = $933.09.

Using the AFN formula approach, calculate the total assets of Harmon Photo Company given the following information: Sales this year = $3,000 Increase in sales projected for next year = 20 percent Net income this year = $250 Dividend payout ratio = 40 percent Projected excess funds available next year = $100 Accounts payable = $600 Notes payable = $100 Accrued wages and taxes = $200. Except for the accounts noted, there were no other current liabilities. Assume that the firm's profit margin remains constant and that the company is operating at full capacity. Select one: a. $3,000 b. $2,200 c. $2,000 d. $1,200 e. $1,000

d. $1,200

d. $17.57

d. $2,500,000 EPS = NI/Shares NI = EPS ´ Shares = $3.00 ´ 400,000 = $1,200,000. EBT = NI/(1 - T) = $1,200,000/(1 - 0.4) = $2,000,000. EBIT = EBT + Interest expense = $2,000,000 + $500,000 = $2,500,000.

Based on the corporate valuation model, Bernile Inc.'s value of operations is $750 million. Its balance sheet shows: $50 million of short-term investments that are unrelated to operations $100 million of accounts payable $100 million of notes payable $200 million of long-term debt $40 million of common stock (par plus paid-in-capital) $160 million of retained earnings. What is the best estimate for the firm's value of equity, in millions? (Assume that the book value of debt is close to its market value) a. $429 b. $451 c. $475 d. $500 e. $525

d. $500

d. 13.3% Net income = 0.15($20,000,000) = $3,000,000. ROA = $3,000,000/$22,500,000 = 13.3%. The correct answer is: 13.3%

d. 42% Profit margin = ($1,500(1 - 0.3))/$5,000 = 21%. Equity multiplier = 1.0 since firm is 100% equity financed. ROE = (Profit margin)(Assets turnover)(Equity multiplier) = (21%)(2.0)(1.0) = 42%. The correct answer is: 42%

Apex Roofing Inc. has the following balance sheet (in millions of dollars): Current assets $3.0 Accounts payable $1.2 Net fixed assets 4.0 Notes payable 0.8 Accrued wages and taxes 0.3 Total current liabilities $2.3 Long-term debt 1.2 Common equity 1.5 Retained earnings 2.0 Total assets $7.0 Total liabilities & equity $7.0 Last years sales were $10 million, and Apex estimates it will need to raise $2 million in new debt and equity next year. You have identified the following facts: (1) it pays out 30 percent of earnings as dividends; (2) a profit margin of 4 percent is projected; (3) fixed assets were used to full capacity; and (4) assets and spontaneous liabilities as shown on last years balance sheet are expected to grow proportionally with sales. If the above assumptions hold, what sales growth rate is the firm anticipating? (Hint: You can use the AFN equation to help answer this problem.) Select one: a. 187% b. 51% c. 97% d. 44% e. 26%

d. 44%

Company X has a beta of 1.6, while Company Y's beta is 0.7. The risk-free rate is 7 percent, and the required rate of return on an average stock is 12 percent. Now the expected rate of inflation built into rRF rises by 1 percentage point, the real risk-free rate remains constant, the required return on the market rises to 14 percent, and betas remain constant. After all of these changes have been reflected in the data, by how much will the required return on Stock X exceed that on Stock Y?

d. 5.40% bX = 1.6; bY = 0.7; rRF = 7%; rM = 12%. Inflation increases by 1%, but r* remains constant. rRF increases by 1%; rM rises to 14%. Before inflation change: rX = 7% + 5%(1.6) = 15%. rY = 7% + 5%(0.7) = 10.5%. After inflation change: rX = 8% + (14% - 8%)1.6 = 17.6%. rY = 8% + (14% - 8%)0.7 = 12.2%. rX - rY = 17.6% - 12.2% = 5.4%.

A seven-year municipal bond yields 4.8 percent. Your marginal tax rate (including state and federal taxes) is 28 percent. What interest rate on a seven-year corporate bond of equal risk would provide you with the same after-tax return? a. 3.46% b. 4.80% c. 6.14% d. 6.68% e. 17.14%

d. 6.67% Equivalent pre-tax yield on corporate bond = 4.8%/(1-0.28)=6.67%. Equivalent Pre-Tax Yield = Municipal Bonds Yield / (1 - Marginal Tax Rate)

Other things held constant, which of the following will not affect the quick ratio? (Assume that current assets equal current liabilities.) Select one: a. Fixed assets are sold for cash. b. Cash is used to purchase inventories. c. Cash is used to pay off accounts payable. d. Accounts receivable are collected. e. Long-term debt is issued to pay off a short-term bank loan.

d. Accounts receivable are collected. CorrectThe quick ratio is calculated as follows: (Current Assets-Inventories)/Current Liabilities The only action that doesn't affect the quick ratio is statement d. While this action decreases receivables (a current asset), it increases cash (also a current asset). The net effect is no change in the quick ratio.

The percentage of sales method produces accurate results unless which of the following conditions is (are) present? a. Fixed assets are "lumpy." b. Strong economies of scale are present. c. Excess capacity exists because of a temporary recession. d. Answers a, b, and c all make the percentage of sales method inaccurate. e. Answers a and c make the percentage of sales method inaccurate, but, as the text explains, the assumption of increasing economies of scale is built into the percentage of sales method.

d. Answers a, b, and c all make the percentage of sales method inaccurate.

Which of the following statements is most correct? Select one: a. If a company increases its current liabilities by $1,000 and simultaneously increases its inventories by $1,000, its current ratio must rise. b. If a company increases its current liabilities by $1,000 and simultaneously increases its inventories by $1,000, its quick ratio must fall. c. A companys quick ratio may never exceed its current ratio. d. Answers b and c are correct. e. None of the answers above is correct.

d. Answers b and c are correct.

Harmeling Enterprises experienced a decline in net operating profit after taxes (NOPAT). Which of the following definitely cannot help explain this decline? a. Sales revenues decreased. b. Costs of goods sold increased. c. Depreciation increased. d. Interest expense increased. e. Taxes increased.

d. Interest expense increased. NOPAT does not take into account interest income or expense.

A firm is considering actions which will raise its debt ratio. It is anticipated that these actions will have no effect on sales, operating income, or on the firm's total assets. If the firm does increase its debt ratio, which of the following will occur? Select one: a. Return on assets will increase. b. Basic earning power will decrease. c. Times interest earned will increase. d. Profit margin will decrease. e. Total assets turnover will increase.

d. Profit margin will decrease.

If a company's free cash flows are expected to grow at a constant rate of 5% a year, which of the following statements is CORRECT? The stock is in equilibrium. a. The company's stock's dividend yield is 5%. b. The value of operations is expected to decline in the future. c. The company's WACC must be equal to or less than 5%. d. The company's value of operations one year from now is expected to be 5% above the current price. e. The expected return on the company's stock is 5% a year.

d. The company's value of operations one year from now is expected to be 5% above the current price.

e. $112,000

e. $883 FCF5: $50 g: 6% WACC: 12% HV5 = FCF6/(WACC - g) = FCF5(1 + g)/(WACC - g) = $50(1 + 0.06)/(0.12 - 0.06) = $53/0.06 = $883

Walter Jasper currently manages a $500,000 portfolio. He is expecting to receive an additional $250,000 from a new client. The existing portfolio has a required return of 10.75 percent. The risk-free rate is 4 percent and the return on the market is 9 percent. If Walter wants the required return on the new portfolio to be 11.5 percent, what should be the average beta for the new stocks added to the portfolio?

e. 1.80 Find the beta of the original portfolio (bOld) as 10.75% = 4% + (9% - 4%)bOld or bOld = 1.35. To achieve an expected return of 11.5%, the new portfolio must have a beta (bNew) of 11.5% = 4% + (9% - 4%)bNew or bNew = 1.5. To construct a portfolio with a bNew = 1.5, the added stocks must have an average beta (bAvg) such that: 1.5 = ($250,000/$750,000)bAvg + ($500,000/$750,000)1.35 1.5 = 0.333bAvg + 0.90 0.6 = 0.333bAvg bAvg = 1.8.

A firm has notes payable of $1,699,000, long-term debt of $13,000,000, and total interest expense of $1,300,000. If the firm pays 8 percent interest on its long-term debt, what rate of interest does it pay on its notes payable? Select one: a. 8.2% b. 13.1% c. 16.8% d. 18.0% e. 15.3%

e. 15.3% Long-term interest = ($13,000,000)(0.08) = $1,040,000. Short-term interest = $1,300,000 - $1,040,000 = $260,000. Short-term interest rate = $260,000/$1,699,000 = 15.3%. Total INT - LT INT = ST INT ST INT / NP = Notes Payable Interest Rate

Your company has the following balance sheet (in millions of dollars): Current assets $4.0 Accounts payable $0.8 Net fixed assets 4.0 Notes payable 1.0 Accrued wages and taxes 0.2 Total current liabilities $2.0 Long-term debt 1.5 Common equity 1.5 Retained earnings 3.0 Total assets $8.0 Total liabilities & equity $8.0 You have determined the following facts: (1) last years sales were $10 million; (2) the company will pay out 40 percent of earnings as dividends; (3) a profit margin of 3 percent is projected; (4) fixed assets were used to full capacity; and (5) all assets as well as spontaneous liabilities as shown on the balance sheet are expected to grow proportionally with sales. Further, your boss estimates she will need to raise $2 million externally by issuing new debt or common stock next year. If the above assumptions hold, what rate of sales growth is your boss expecting? (Hint: You can use the AFN equation to help answer this problem.) Select one: a. 12.50% b. 15.25% c. 18.00% d. 23.15% e. 31.96%

e. 31.96%

e. 31.96% AFN = (A*/S0) DS - (L*/S0)DS - MS1(1 - d). DS/S0 = g. S1 = S0(1 + g). Find g = ? AFN = A*(g) - L*(g) - M(S0)(1 + g)(1 - d) $2 = $8g - $1g - 0.03($10)(1 + g)(0.6) $2 = $8g - $1g - $0.18(1 + g) $2 = $7g - $0.18 - $0.18g $2.18 = $6.82g $2.18/$6.82 = g g = 31.96%.

If D1 = $1.25, g (which is constant) = 5.5%, and P0 = $44, what is the stock's expected total return for the coming year?

e. 8.34%

Assets-in-Place include tangible assets such as: a. Building b. Inventory c. Land d. Machines e. All of the above

e. All of the above

Which of the following is likely to decrease the AFN in a given year? a. The company increases its retention ratio b. The company's profit margin increases c. The company's sales growth is reduced d. Both statements b and c are correct e. All of the statements are correct

e. All of the statements are correct Increase in retention ratio, increase in profit margin, reduction in sales growth, will all decrease the AFN in a given year

Assume that investors become increasingly risk averse, so that the market risk premium increases. Also, assume that the risk-free rate and expected inflation remain the same. Which of the following is most likely to occur? a. The required rate of return will decline for stocks that have betas less than 1.0. b. The required rate of return on the market, rM will remain the same. c. The required rate of return for each stock in the market will increase by an amount equal to the increase in the market risk premium. d. Answers a and b are correct. e. None of the statements above is correct.

e. None of the statements above is correct.

Jefferson City Computers has developed a forecasting model to determine the additional funds it needs in the upcoming year. All else being equal, which of the following factors is likely to increase its additional funds needed (AFN)? Select one: a. A sharp increase in its forecasted sales and the company's fixed assets are at full capacity. b. A reduction in its dividend payout ratio. c. The company reduces its reliance on trade credit that sharply reduces its accounts payable. d. Statements a and b are correct. e. Statements a and c are correct.

e. Statements a and c are correct. AFN = (A*/S)DS - (L*/S)DS - (M)(S1)(RR). Statement a is correct. If the company expects a sharp increase in sales, then current assets must increase. However, if in addition to that, fixed assets are at full capacity, the companys fixed assets will also have to increase. (It may need to build a new factory.) Therefore, the first term in the AFN formula will have a higher value, so AFN will be higher. Statement b is false. If the firms dividend payout ratio decreases, (RR) will increase. This will increase the value of the third term in the AFN formula. Since the third term gets larger, AFN will decrease. Statement c is correct. If the company reduces its trade credit, it is reducing its accounts payable. If accounts payable decreases (although, usually we assume it is a spontaneous liability), spontaneous liabilities, L*, will be smaller. If L* is smaller, the entire second term is smaller; therefore, AFN will increase.

A sinking fund ______ the risk to an investor and shortens the average maturity.

reduces

R. E. Lee recently took his company public through an initial public offering. He is expanding the business quickly to take advantage of an otherwise unexploited market. Growth for his company is expected to be 40 percent for the first three years and then he expects it to slow down to a constant 15 percent. The most recent dividend (D0) was $0.75. Based on the most recent returns, the beta for his company is approximately 1.5. The risk-free rate is 8 percent and the market risk premium is 6 percent. What is the current price of Lee's stock?

rs = rRF + RPM(b) = 8% + 6%(1.5) = 17%. D1 = $0.75(1.4) = $1.05. D2 = $0.75(1.4)^2 = $1.47. D3 = $0.75(1.4)^3 = $2.058. D4 = $0.75(1.4)^3(1.15) = $2.3667. P3 = D4/rs - g = $2.3667/(0.17 - 0.15) = $118.335. Key Strokes: $0 CFj0 $1.05 CFj1 $1.47 CFj2 $120.39 CFj3 ($2.058 + $118.335) 17 I/YR P0 = $77.14

FCF Formula

sales revenues - operating costs - operating taxes - required investments in operating capital.

What is the weighted average cost of capital (WACC)?

the average rate of return required by all of the company's investors.

Free Cash Flows (FCF)

the cash flows that are available (or free) for distribution to all investors (stockholders and creditors).

Greatest price risk?

zero coupon bonds have greater price risks than coupon bonds and annuities 10 yr $1000 face value zero coupon bond

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