test 2 - ba323
2. Ajax Corp's sales last year were $510,000, its operating costs were $362,500, and its interest charges were $12,500. What was the firm's times-interest-earned (TIE) ratio?
11.80 Sales = $510,000 Operating costs = $362,500 Operating income (EBIT) = $147,500 Interest charges = $12,500 TIE ratio = EBIT/Interest = 11.80
2. Ryngard Corp's sales last year were $42,000, and its total assets were $16,000. What was its total assets turnover ratio (TATO)?
2.63 Sales = $42,000 Total assets = $16,000 TATO = Sales/Total assets = 2.63
2. River Corp's total assets at the end of last year were $480,000 and its net income was $32,750. What was its return on total assets?
6.82% Total assets = $480,000 Net income = $32,750 ROA = NI/Assets = 6.82%
2. Royce Corp's sales last year were $250,000, and its net income was $23,000. What was its profit margin?
9.20% Sales = $250,000 Net income = $23,000 Profit margin = NI/Sales = 9.20%
3. A. Butcher Timber Company hired your consulting firm to help them estimate the cost of equity. The yield on the firm's bonds is 6.75%, and your firm's economists believe that the cost of equity can be estimated using a risk premium of 3.85% over a firm's own cost of debt. What is an estimate of the firm's cost of equity from retained earnings?
Bond yield = 6.75% Risk premium = 3.85% rs = rd + Risk premium = 10.60%
2. Zero Corp's total common equity at the end of last year was $370,000 and its net income was $70,000. What was its ROE?
Common equity = $370,000 Net income = $70,000 ROE = NI/Equity = 18.92%
3. Assume that you are a consultant to Broske Inc., and you have been provided with the following data: D1 = $0.67; P0 = $45.00; and g = 8.00% (constant). What is the cost of equity from retained earnings based on the DCF approach?
D1 = $0.67 P0 = $45.00 g = 8.00% rs = D1/P0 + g = 9.49%
3. Teall Development Company hired you as a consultant to help them estimate its cost of capital. You have been provided with the following data: D1 = $1.45; P0 = $19.00; and g = 6.50% (constant). Based on the DCF approach, what is the cost of equity from retained earnings?
D1 = $1.45 P0 = $19.00 g = 6.50% rs = D1/P0 + g = 14.13%
3. You were hired as a consultant to Giambono Company, whose target capital structure is 40% debt, 15% preferred, and 45% common equity. The after-tax cost of debt is 6.00%, the cost of preferred is 7.50%, and the cost of retained earnings is 12.00%. The firm will not be issuing any new stock. What is its WACC?
Debt: Weights==> 40% , Costs==>6.00% Preferred: Weights==> 15% , Costs==>7.50% Common: Weights==> 45% , Costs==>12.00% WACC = wd × rd × (1 − T) + wp × r p + wc × rs = 8.93%
2. Herring Corporation has operating income of $235,000 and a 40% tax rate. The firm has short-term debt of $115,000, long-term debt of $321,000, and common equity of $436,000. What is its return on invested capital?
EBIT = $235,000 Tax rate = 40% Short-term debt = $115,000 Long-term debt = $321,000 Common equity = $436,000 ROIC = [EBIT(1 - T)]/(STD + LTD + E) = 16%
Assume that two firms are both following generally accepted accounting principles. Both firms commenced operations two years ago with $1 million of identical fixed assets, and neither firm sold any of those assets or purchased any new fixed assets. The two firms would be required to report the same amount of net fixed assets on their balance sheets as those statements are presented to investors.
False
Both interest and dividends paid by a corporation are deductible operating expenses, hence they decrease the firm's taxes.
False
Companies typically provide four basic financial statements: the fixed income statement, the current income statement, the balance sheet, and the cash flow statement.
False
EBITDA stands for earnings before interest, taxes, debt, and assets.
False
If a firm is reporting its income in accordance with generally accepted accounting principles, then its net income as reported on the income statement should be equal to its free cash flow.
False
The amount shown on the December 31, 2015 balance sheet as "retained earnings" is equal to the firm's net income for 2015 minus any dividends it paid
False
The balance sheet measures the flow of funds into and out of various accounts over time, while the income statement measures the firm's financial position at a point in time.
False
The fact that 70% of the interest income received by corporations is excluded from its taxable income encourages firms to finance with more debt than they would in the absence of this tax law provision.
False
True or False: Consider the following balance sheet, for Games Inc. Because Games has $800,000 of retained earnings, we know that the company would be able to pay cash to buy an asset with a cost of $200,000. CashInventoryAccounts receivable $50,000 $200,000 $250,000
False
4. Simms Corp. is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's projected IRR can be less than the WACC or negative, in both cases it will be rejected. Year 0 1 2 3 Cash flows -$1,025 $425 $425 $425
IRR = 11.76%
4. Harry's Inc. is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that if a project's projected NPV is negative, it should be rejected. WACC: 9.50% Year . Cash flows 0 -$1,000 1 $300 2 $300 3 $300 4 $300 5 $300
NPV = 0151.91
4. Tuttle Enterprises is considering a project that has the following cash flow and WACC data. What is the project's NPV? Note that if a project's projected NPV is negative, it should be rejected. WACC:11.50% Year . Cash flows 0 . -$1,000 1 $350 2 $350 3 $350 4 $350
NPV = 074.36
3. A company's perpetual preferred stock currently sells for $102.50 per share, and it pays an $8.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the issue price. What is the firm's cost of preferred stock?
Preferred stock price = $102.50 Preferred dividend = $8.00 Flotation cost = 5.00% rp = Dp/(Pp(1 - F)) = 8.22%
3. Bosio Inc.'s perpetual preferred stock sells for $85.00 per share, and it pays an $8.50 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 4.00% of the price paid by investors. What is the company's cost of preferred stock for use in calculating the WACC?
Preferred stock price = $85.00 Preferred dividend = $8.50 Flotation cost = 4.00% rp = Dp/(Pp(1 - F)) = 10.42%
2. Precision Aviation had a profit margin of 8.00%, a total assets turnover of 1.5, and an equity multiplier of 1.8. What was the firm's ROE?
Profit margin = 8.00% TATO = 1.50 Equity multiplier = 1.80 ROE = PM × TATO × Eq. Multiplier = 21.60%
2. Song Corp's stock price at the end of last year was $16.75 and its earnings per share for the year were $1.30. What was its P/E ratio?
Stock price = $16.75 EPS = $1.30 P/E = Stock price / EPS = 12.88
2. Hoagland Corp's stock price at the end of last year was $48.50, and its book value per share was $25.00. What was its market/book ratio?
Stock price = $48.50 Book value per share = $25.00 M/B ratio = Stock price / Book value per share = 1.94
2. Beranek Corp has $695,000 of assets (which equal total invested capital), and it uses no debt - it is financed only with common equity. The new CFO wants to employ enough debt to raise the total debt to total capital ratio to 40%, using the proceeds from borrowing to buy back common stock at its book value. How much must the firm borrow to achieve the target debt ratio?
$278,000 Total assets = Total invested capital = $695,000 Target total debt to total capital ratio = 40% Debt to achieve target ratio = Amount borrowed = Target % × Invested Capital = $278,000
2. X-1 Corp's total assets at the end of last year were $490,000 and its EBIT was 52,500. What was its basic earning power (BEP) ratio?
Total assets = $490,000 EBIT = $52,500 BEP = EBIT / Assets = 10.71%
2. Meyer Inc's total invested capital is $660,000, and its total debt outstanding is $185,000. The new CFO wants to establish a total debt to total capital ratio of 55%. The size of the firm will not change. How much debt must the company add or subtract to achieve the target debt to capital ratio?
Total invested capital = $660,000 Old debt = $185,000 Target debt to capital ratio = 55% Target amount of debt = Target debt % × Total invested capital = $363,000 Change in amount of debt outstanding = Target debt - Old debt = $178,000
2. If the CEO of a large, diversified, firm were filling out a fitness report on a division manager (i.e., "grading" the manager), which of the following situations would be likely to cause the manager to receive a better grade? In all cases, assume that other things are held constant. a. The division's basic earning power ratio is above the average of other firms in its industry. b. The division's total assets turnover ratio is below the average for other firms in its industry. c. The division's total debt to total capital ratio is above the average for other firms in the industry. d. The division's inventory turnover is 6×, whereas the average for its competitors is 8×. e. The division's DSO (days' sales outstanding) is 40 days, whereas the average for its competitors is 30 days.
a. The division's basic earning power ratio is above the average of other firms in its industry.
3. Schalheim Sisters Inc. has always paid out all of its earnings as dividends, hence the firm has no retained earnings. This same situation is expected to persist in the future. The company uses the CAPM to calculate its cost of equity, its target capital structure consists of common stock, preferred stock, and debt. Which of the following events would REDUCE its WACC? a. The market risk premium declines. b. The flotation costs associated with issuing new common stock increase. c. The company's beta increases. d. Expected inflation increases. e. The flotation costs associated with issuing preferred stock increase.
a. The market risk premium declines.
4. Which of the following statements is CORRECT? a. The regular payback method recognizes all cash flows over a project's life. b. The discounted payback method recognizes all cash flows over a project's life, and it also adjusts these cash flows to account for the time value of money. c. The regular payback method was, years ago, widely used, but virtually no companies even calculate the payback today. d. The regular payback is useful as an indicator of a project's liquidity because it gives managers an idea of how long it will take to recover the funds invested in a project. e. The regular payback does not consider cash flows beyond the payback year, but the discounted payback overcomes this defect.
d. The regular payback is useful as an indicator of a project's liquidity because it gives managers an idea of how long it will take to recover the funds invested in a project.
4. Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows. a. A project's regular IRR is found by compounding the cash inflows at the WACC to find the terminal value (TV), then discounting this TV at the WACC. b. A project's regular IRR is found by discounting the cash inflows at the WACC to find the present value (PV), then compounding this PV to find the IRR. c. If a project's IRR is greater than the WACC, then its NPV must be negative. d. To find a project's IRR, we must solve for the discount rate that causes the PV of the inflows to equal the PV of the project's costs. e. To find a project's IRR, we must find a discount rate that is equal to the WACC.
d. To find a project's IRR, we must solve for the discount rate that causes the PV of the inflows to equal the PV of the project's costs.
Bauer Software's current balance sheet shows total common equity of $5,125,000. The company has 430,000 shares of stock outstanding, and they sell at a price of $27.50 per share. By how much do the firm's market and book values per share differ?
d. $15.58 Shares outstanding = 430,000 Price per share = $27.50 Total book common equity = $5,125,000 Book value per share = Total book equity/Number of shares = $5,125,000/ 430,000 = $11.92 Difference between book and market values = 27.50 - 11.92 = $15.58
Rao Construction recently reported $18.00 million of sales, $12.60 million of operating costs other than depreciation, and $3.00 million of depreciation. It had $8.50 million of bonds outstanding that carry a 7.0% interest rate, and its federal-plus-state income tax rate was 40%. What was Rao's operating income, or EBIT, in millions?
d.$2.40 Sales = $18.00 Operating costs excluding depreciation = 12.60 Depreciation = 3.00 Operating income (EBIT) = Sales - Operating costs excluding depreciation - Depreciation = 18 - 12.6 - 3 = $2.40
2. Companies E and P each reported the same earnings per share (EPS), but Company E's stock trades at a higher price. Which of the following statements is CORRECT? a. Company E probably has fewer growth opportunities. b. Company E is probably judged by investors to be riskier. c. Company E must have a higher market-to-book ratio. d. Company E must pay a lower dividend. e. Company E trades at a higher P/E ratio.
e. Company E trades at a higher P/E ratio.
4. Which of the following statements is CORRECT? a. If a project has "normal" cash flows, then its IRR must be positive. b. If a project has "normal" cash flows, then its MIRR must be positive. c. If a project has "normal" cash flows, then it will have exactly two real IRRs. d. The definition of "normal" cash flows is that the cash flow stream has one or more negative cash flows followed by a stream of positive cash flows and then one negative cash flow at the end of the project's life. e. If a project has "normal" cash flows, then it can have only one real IRR, whereas a project with "nonnormal" cash flows might have more than one real IRR.
e. If a project has "normal" cash flows, then it can have only one real IRR, whereas a project with "nonnormal" cash flows might have more than one real IRR.
4. Which of the following statements is CORRECT? a. One defect of the IRR method is that it does not take account of cash flows over a project's full life. b. One defect of the IRR method is that it does not take account of the time value of money. c. One defect of the IRR method is that it does not take account of the cost of capital. d. One defect of the IRR method is that it values a dollar received today the same as a dollar that will not be received until sometime in the future. e. One defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is often not valid.
e. One defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is often not valid.
4. Which of the following statements is CORRECT? a. One defect of the IRR method versus the NPV is that the IRR does not take account of cash flows over a project's full life. b. One defect of the IRR method versus the NPV is that the IRR does not take account of the time value of money. c. One defect of the IRR method versus the NPV is that the IRR does not take account of the cost of capital. d. One defect of the IRR method versus the NPV is that the IRR values a dollar received today the same as a dollar that will not be received until sometime in the future. e. One defect of the IRR method versus the NPV is that the IRR does not take proper account of differences in the sizes of projects.
e. One defect of the IRR method versus the NPV is that the IRR does not take proper account of differences in the sizes of projects.
3. The cost of equity raised by retaining earnings can be less than, equal to, or greater than the cost of external equity raised by selling new issues of common stock, depending on tax rates, flotation costs, the attitude of investors, and other factors.
false
3. The cost of preferred stock to a firm must be adjusted to an after-tax figure because 70% of dividends received by a corporation may be excluded from the receiving corporation's taxable income.
false
3. The firm's cost of external equity raised by issuing new stock is the same as the required rate of return on the firm's outstanding common stock.
false
3. The higher the firm's flotation cost for new common equity, the more likely the firm is to use preferred stock, which has no flotation cost, and retained earnings, whose cost is the average return on the assets that are acquired.
false
4. A basic rule in capital budgeting is that if a project's NPV exceeds its IRR, then the project should be accepted.
false
4. A firm should never accept a project if its acceptance would lead to an increase in the firm's cost of capital (its WACC).
false
4. Assuming that their NPVs based on the firm's cost of capital are equal, the NPV of a project whose cash flows accrue relatively rapidly will be more sensitive to changes in the discount rate than the NPV of a project whose cash flows come in later in its life.
false
4. Because "present value" refers to the value of cash flows that occur at different points in time, a series of present values of cash flows should not be summed to determine the value of a capital budgeting project.
false
4. Both the regular and the modified IRR (MIRR) methods have wide appeal to professors, but most business executives prefer the NPV method to either of the IRR methods.
false
4. Conflicts between two mutually exclusive projects occasionally occur, where the NPV method ranks one project higher but the IRR method puts the other one first. In theory, such conflicts should be resolved in favor of the project with the higher IRR.
false
4. Other things held constant, an increase in the cost of capital will result in a decrease in a project's IRR.
false
4. The phenomenon called "multiple internal rates of return" arises when two or more mutually exclusive projects that have different lives are being compared.
false
4. When evaluating mutually exclusive projects, the modified IRR (MIRR) always leads to the same capital budgeting decisions as the NPV method, regardless of the relative lives or sizes of the projects being evaluated.
false
3. Scanlon Inc.'s CFO hired you as a consultant to help her estimate the cost of capital. You have been provided with the following data: rRF = 4.10%; RPM = 5.25%; and b = 0.70. Based on the CAPM approach, what is the cost of equity from retained earnings?
rRF = 4.10% RPM = 5.25% b = 0.70 rs = rRF + b(RPM) = 7.78%
3. O'Brien Inc. has the following data: rRF = 5.00%; RPM = 6.00%; and b = 0.70. What is the firm's cost of equity from retained earnings based on the CAPM?
rRF = 5.00% RPM = 6.00% b = 0.70 rs = rRF + b(RPM) = 9.20%
2. . Which of the following statements is CORRECT? a. The use of debt financing will tend to lower the basic earning power ratio, other things held constant. b. A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure. c. If two firms have identical sales, interest rates paid, operating costs, and assets, but differ in the way they are financed, the firm with less debt will generally have the higher expected ROE. d. The numerator used in the TIE ratio is earnings before taxes (EBT). EBT is used because interest is paid with post-tax dollars, so the firm's ability to pay current interest is affected by taxes. e. All else equal, increasing the total debt to total capital ratio will increase the ROA.
b. A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure.
4. Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT? a. A project's IRR increases as the WACC declines. b. A project's NPV increases as the WACC declines. c. A project's MIRR is unaffected by changes in the WACC. d. A project's regular payback increases as the WACC declines. e. A project's discounted payback increases as the WACC declines.
b. A project's NPV increases as the WACC declines.
3. Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting? a. Long-term debt. b. Accounts payable. c. Retained earnings. d. Common stock. e. Preferred stock.
b. Accounts payable.
Which of the following items is NOT normally considered to be a current asset? a. Accounts receivable. b. Inventory. c. Bonds. d. Cash. e. Short-term, highly-liquid, marketable securities.
c. Bonds.
4. Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows. a. A project's NPV is found by compounding the cash inflows at the IRR to find the terminal value (TV), then discounting the TV at the WACC. b. The lower the WACC used to calculate it, the lower the calculated NPV will be. c. If a project's NPV is less than zero, then its IRR must be less than the WACC. d. If a project's NPV is greater than zero, then its IRR must be less than zero. e. The NPV of a relatively low-risk project should be found using a relatively high WACC.
c. If a project's NPV is less than zero, then its IRR must be less than the WACC.
2. If a bank loan officer were considering a company's loan request, which of the following statements would you consider to be CORRECT? a. The lower the company's inventory turnover ratio, other things held constant, the lower the interest rate the bank would charge the firm. b. Other things held constant, the higher the days sales outstanding ratio, the lower the interest rate the bank would charge. c. Other things held constant, the lower the total debt to total capital ratio, the lower the interest rate the bank would charge. d. The lower the company's TIE ratio, other things held constant, the lower the interest rate the bank would charge. e. Other things held constant, the lower the current ratio, the lower the interest rate the bank would charge the firm.
c. Other things held constant, the lower the total debt to total capital ratio, the lower the interest rate the bank would charge.
2. Which of the following would, generally, indicate an improvement in a company's financial position, holding other things constant? a. The TIE declines. b. The DSO increases. c. The quick ratio increases. d. The current ratio declines. e. The total assets turnover decreases.
c. The quick ratio increases.
Vasudevan Inc. recently reported operating income of $4.80 million, depreciation of $1.20 million, and had a tax rate of 40%. The firm's expenditures on fixed assets and net operating working capital totaled $0.6 million. How much was its free cash flow, in millions?
c. $3.48 EBIT = $4.80 Tax rate = 40% Depreciation = $1.20 Capex + NOWC = $0.60 FCF = EBIT(1 - T) + Deprec - (Capex + NOWC) = (4.8)(.6) + (1.2) - (.6) = 3.48
Brown Office Supplies recently reported $19,500 of sales, $8,250 of operating costs other than depreciation, and $1,750 of depreciation. It had $9,000 of bonds outstanding that carry a 7.0% interest rate, and its federal-plus-state income tax rate was 40%. How much was the firm's earnings before taxes (EBT)?
c.$8,870 Bonds = $9,000.00 Interest rate = 7.00% Sales = $19,500 Operating costs excluding depr'n = $8,250.00 Depreciation = $1,750.00 Operating income (EBIT) = $9,500.00 Interest charges = (bond)(interest rate) = 9000(.07) = -$630.00 EBT = Sales - Operating costs excluding depr - depreciation - Interest charges 19500 - 8250 - 1750 - 630 = $8,870
4. Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows. a. A project's regular IRR is found by compounding the initial cost at the WACC to find the terminal value (TV), then discounting the TV at the WACC. b. A project's regular IRR is found by compounding the cash inflows at the WACC to find the present value (PV), then discounting the TV to find the IRR. c. If a project's IRR is smaller than the WACC, then its NPV will be positive. d. A project's IRR is the discount rate that causes the PV of the inflows to equal the project's cost. e. If a project's IRR is positive, then its NPV must also be positive.
d. A project's IRR is the discount rate that causes the PV of the inflows to equal the project's cost.
4. Which of the following statements is CORRECT? a. An NPV profile graph shows how a project's payback varies as the cost of capital changes. b. The NPV profile graph for a normal project will generally have a positive (upward) slope as the life of the project increases. c. An NPV profile graph is designed to give decision makers an idea about how a project's risk varies with its life. d. An NPV profile graph is designed to give decision makers an idea about how a project's contribution to the firm's value varies with the cost of capital. e. We cannot draw a project's NPV profile unless we know the appropriate WACC for use in evaluating the project's NPV.
d. An NPV profile graph is designed to give decision makers an idea about how a project's contribution to the firm's value varies with the cost of capital.
2. Considered alone, which of the following would increase a company's current ratio? a. An increase in net fixed assets. b. An increase in accrued liabilities. c. An increase in notes payable. d. An increase in accounts receivable. e. An increase in accounts payable.
d. An increase in accounts receivable.
Which of the following items cannot be found on a firm's balance sheet under current liabilities? a. Accounts payable. b. Short-term notes payable to the bank. c. Accrued wages. d. Cost of goods sold. e. Accrued payroll taxes.
d. Cost of goods sold.
4. Which of the following statements is CORRECT? a. The internal rate of return method (IRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects. b. The payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects. c. The discounted payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects. d. The net present value method (NPV) is generally regarded by academics as being the best single method for evaluating capital budgeting projects. e. The modified internal rate of return method (MIRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
d. The net present value method (NPV) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.
3. The before-tax cost of debt, which is lower than the after-tax cost, is used as the component cost of debt for purposes of developing the firm's WACC.
false
3. The cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on all outstanding debt.
false
2. Your sister is thinking about starting a new business. The company would require $425,000 of assets, and it would be financed entirely with common stock. She will go forward only if she thinks the firm can provide a 13.5% return on the invested capital, which means that the firm must have an ROE of 13.5%. How much net income must be expected to warrant starting the business?
Assets = Equity = $425,000 Target ROE = 13.5% Required net income = Target ROE × Equity = $57,375
4. Which of the following statements is CORRECT? a. Projects with "normal" cash flows can have only one real IRR. b. Projects with "normal" cash flows can have two or more real IRRs. c. Projects with "normal" cash flows must have two changes in the sign of the cash flows, e.g., from negative to positive to negative. If there are more than two sign changes, then the cash flow stream is "nonnormal." d. The "multiple IRR problem" can arise if a project's cash flows are "normal." e. Projects with "nonnormal" cash flows are almost never encountered in the real world.
a. Projects with "normal" cash flows can have only one real IRR.
2. Casey Communications recently issued new common stock and used the proceeds to pay off some of its short-term notes payable. This action had no effect on the company's total assets or operating income. Which of the following effects would occur as a result of this action? a. The company's current ratio increased. b. The company's times interest earned ratio decreased. c. The company's basic earning power ratio increased. d. The company's equity multiplier increased. e. The company's total debt to total capital ratio increased.
a. The company's current ratio increased.
2. Which of the following statements is CORRECT? a. Borrowing by using short-term notes payable and then using the proceeds to retire long-term debt is an example of "window dressing." Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is another example of "window dressing." b. Borrowing on a long-term basis and using the proceeds to retire short-term debt would improve the current ratio and thus could be considered to be an example of "window dressing." c. Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase fixed assets is an example of "window dressing." d. Using some of the firm's cash to reduce long-term debt is an example of "window dressing." e. "Window dressing" is any action that does not improve a firm's fundamental long-run position and thus increases its intrinsic value.
b. Borrowing on a long-term basis and using the proceeds to retire short-term debt would improve the current ratio and thus could be considered to be an example of "window dressing."
2. A firm's new president wants to strengthen the company's financial position. Which of the following actions would make it financially stronger? a. Increase accounts receivable while holding sales constant. b. Increase EBIT while holding sales and assets constant. c. Increase accounts payable while holding sales constant. d. Increase notes payable while holding sales constant. e. Increase inventories while holding sales constant.
b. Increase EBIT while holding sales and assets constant.
3. Bankston Corporation forecasts that if all of its existing financial policies are followed, its proposed capital budget would be so large that it would have to issue new common stock. Since new stock has a higher cost than retained earnings, Bankston would like to avoid issuing new stock. Which of the following actions would REDUCE its need to issue new common stock? a. Increase the dividend payout ratio for the upcoming year. b. Increase the percentage of debt in the target capital structure. c. Increase the proposed capital budget. d. Reduce the amount of short-term bank debt in order to increase the current ratio. e. Reduce the percentage of debt in the target capital structure.
b. Increase the percentage of debt in the target capital structure.
4. Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows. a. The longer a project's payback period, the more desirable the project is normally considered to be by this criterion. b. One drawback of the payback criterion for evaluating projects is that this method does not properly account for the time value of money. c. If a project's payback is positive, then the project should be rejected because it must have a negative NPV. d. The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem. e. If a company uses the same payback requirement to evaluate all projects, say it requires a payback of 4 years or less, then the company will tend to reject projects with relatively short lives and accept long-lived projects, and this will cause its risk to increase over time.
b. One drawback of the payback criterion for evaluating projects is that this method does not properly account for the time value of money.
4. Which of the following statements is CORRECT? a. The shorter a project's payback period, the less desirable the project is normally considered to be by this criterion. b. One drawback of the payback criterion is that this method does not take account of cash flows beyond the payback period. c. If a project's payback is positive, then the project should be accepted because it must have a positive NPV. d. The regular payback ignores cash flows beyond the payback period, but the discounted payback method overcomes this problem. e. One drawback of the discounted payback is that this method does not consider the time value of money, while the regular payback overcomes this drawback.
b. One drawback of the payback criterion is that this method does not take account of cash flows beyond the payback period.
Which of the following statements is CORRECT? a. The four most important financial statements provided in the annual report are the balance sheet, income statement, cash budget, and the statement of stockholders' equity. b. The balance sheet gives us a picture of the firm's financial position at a point in time. c. The income statement gives us a picture of the firm's financial position at a point in time. d. The statement of cash flows tells us how much cash the firm must pay out in interest during the year. e. The statement of cash needs tells us how much cash the firm will require during some future period, generally a month or a year.
b. The balance sheet gives us a picture of the firm's financial position at a point in time.
Which of the following statements is CORRECT? a. Assets other than cash are expected to produce cash over time, and the amounts of cash they eventually produce should be exactly the same as the amounts at which the assets are carried on the books. b. The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firm's future earnings and dividends, and the riskiness of those cash flows. c. The annual report is an internal document prepared by a firm's managers solely for the use of its creditors/lenders. d. The four most important financial statements provided in the annual report are the balance sheet, income statement, cash budget, and statement of stockholders' equity. e. Prior to the Enron scandal in the early 2000s, companies would put verbal information in their annual reports, along with the financial statements. That verbal information was often misleading, so today annual reports can contain only quantitative information--audited financial statements.
b. The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firm's future earnings and dividends, and the riskiness of those cash flows.
3. For a typical firm, which of the following sequences is CORRECT? All rates are after taxes, and assume that the firm operates at its target capital structure. a. rs > re > rd > WACC. b. re > rs > WACC > rd. c. WACC > re > rs > rd. d. rd > re > rs > WACC. e. WACC > rd > rs > re.
b. re > rs > WACC > rd.
Which of the following statements is CORRECT? a. The balance sheet for a given year is designed to give us an idea of what happened to the firm during that year. b. The balance sheet for a given year tells us how much money the company earned during that year. c. The difference between the total assets reported on the balance sheet and the liabilities reported on this statement tells us the current market value of the stockholders' equity, assuming the statements are prepared in accordance with generally accepted accounting principles (GAAP). d. If a company's statements were prepared in accordance with generally accepted accounting principles (GAAP), the market value of the stock equals the book value of the stock as reported on the balance sheet. e. The assets section of a typical company's balance sheet begins with cash, then lists the assets in the order in which they will probably be converted to cash, with the longest lived assets listed last.
e. The assets section of a typical company's balance sheet begins with cash, then lists the assets in the order in which they will probably be converted to cash, with the longest lived assets listed last.
2. Which of the following would indicate an improvement in a company's financial position, holding other things constant? a. The inventory and total assets turnover ratios both decline. b. The total debt to total capital ratio increases. c. The profit margin declines. d. The times-interest-earned ratio declines. e. The current and quick ratios both increase.
e. The current and quick ratios both increase.
Which of the following statements is CORRECT? a. The focal point of the income statement is the cash account, because that account cannot be manipulated by "accounting tricks." b. The reported income of two otherwise identical firms cannot be manipulated by different accounting procedures provided the firms follow generally accepted accounting principles (GAAP). c. The reported income of two otherwise identical firms must be identical if the firms are publicly owned, provided they follow procedures that are permitted by the Securities and Exchange Commission (SEC). d. If a firm follows generally accepted accounting principles (GAAP), then its reported net income will be identical to its reported cash flow. e. The income statement for a given year is designed to give us an idea of how much the firm earned during that year.
e. The income statement for a given year is designed to give us an idea of how much the firm earned during that year.
Prezas Company's balance sheet showed total current assets of $3,000, all of which were required in operations. Its current liabilities consisted of $975 of accounts payable, $600 of 6% short-term notes payable to the bank, and $250 of accrued wages and taxes. What was its net operating working capital?
e. $1,775 nowc = ca - (cl - account payable) = 3000 - ((975+600+250) - 600) = 1,775
Brown Fashions Inc.'s December 31, 2015 balance sheet showed total common equity of $4,050,000 and 225,000 shares of stock outstanding. During 2015, the firm had $450,000 of net income, and it paid out $100,000 as dividends. What was the book value per share at 12/31/15, assuming no common stock was either issued or retired during 2015?
e. $19.56 common equity $4,050,000 net income $450,000 dividends $100,000 Shares outstanding 225,000 (4,050,000 + 450,000 -100,000)/(225,000)= $19.56
Over the years, O'Brien Corporation's stockholders have provided $20,000,000 of capital, when they purchased new issues of stock and allowed management to retain some of the firm's earnings. The firm now has 1,000,000 shares of common stock outstanding, and it sells at a price of $43.50 per share. How much value has O'Brien's management added to stockholder wealth over the years, i.e., what is O'Brien's MVA?
e. $23,500,000 Total book value of equity $20,000,000 Stock price per share $43.50 Shares outstanding 1,000,000 Market value of equity = Stock price * Number of shares = $43,500,000 MVA = Market value of equity - Book value of equity = $23,500,000
2. A decline in a firm's inventory turnover ratio suggests that it is improving both its inventory management and its liquidity position, i.e., that it is becoming more liquid.
false
2. High current and quick ratios always indicate that the firm is managing its liquidity position well.
false
2. If a firm sold some inventory for cash and left the funds in its bank account, its current ratio would probably not change much, but its quick ratio would decline.
false
2. If a firm sold some inventory on credit as opposed to cash, there is no reason to think that either its current or quick ratio would change.
false
2. In general, it's better to have a low inventory turnover ratio than a high one, as a low ratio indicates that the firm has an adequate stock of inventory relative to sales and thus will not lose sales as a result of running out of stock.
false
2. Other things held constant, the higher a firm's total debt to total capital ratio [measured as (Short-term debt + Long-term debt)/(Debt + Preferred stock + Common equity)], the higher its TIE ratio will be.
false
2. The basic earning power ratio (BEP) reflects the earning power of a firm's assets after giving consideration to financial leverage and tax effects.
false
2. The more conservative a firm's management is, the higher its total debt to total capital ratio [measured as (Short-term debt + Long-term debt)/(Debt + Preferred stock + Common equity)] is likely to be.
false
2. The operating margin measures operating income per dollar of assets.
false
3. For capital budgeting and cost of capital purposes, the firm should always consider retained earnings as the first source of capital (i.e., use these funds first) because retained earnings have no cost to the firm.
false
3. Funds acquired by the firm through retaining earnings have no cost because there are no dividend or interest payments associated with them, and no flotation costs are required to raise them, but capital raised by selling new stock or bonds does have a cost.
false
3. Suppose you are the president of a small, publicly-traded corporation. Since you believe that your firm's stock price is temporarily depressed, all additional capital funds required during the current year will be raised using debt. In this case, the appropriate marginal cost of capital for use in capital budgeting during the current year is the after-tax cost of debt.
false
