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Fundamental of Business Finance Final practice problems

Terms in this set (66)

You have a choice of three investments, all of which have equal lives and pay the same total dollar amount of cash flows. Investment A has small cash flows at the end and large cash flows at the beginning. Investment B has large cash flows at the end and small cash flows at the beginning. Investment C has the same cash flow each year. For all three investments, the total nominal dollars is the same. If you have the same required return for all three investments, which investment has the smallest present value?
Investment B
The goal of the financial management of the firm should be
maximize shareholders' wealth
Which of the following category(ies) of business owners enjoy the most limited legal liability?
common shareholders of a corporation
Profit maximization does not adequately describe the goal of the firm because____.
Only a and b above
a. profit maximization does not require the consideration of risk
b. profit maximization ignores the timing of a project's return (it's a short-term measure)
We discussed the Agency Problem and a Solution in Chapter 1. What does this mean?
Management and Ownership are separate in large companies, and Management must be given strong incentives to provide a fair return to the owners; example: Management must be required to purchase a substantial amount of common stock.
The secondary market is defined as _____; the capital market is the market where _____ are traded.
the market for the exchange of already-issued securities; long-term financial instruments
Financial intermediaries:
offer indirect securities (like a commercial bank)
If a company needs to raise capital from the financial markets and it wants to sell its debt or equity securities to any investor, whether an individual or professional investor, then the company is raising capital through a ________.
public offering.
A company issued a long-term corporate bond with a fixed interest rate. When the CFO of the company asked the investment banker ("IB") what factors determined the interest rate, the IB said, "The underlying nominal U.S. Treasury Bill rate is 1.00%, the default risk premium is 2.95%, the liquidity risk premium is 0.50%, and the maturity risk premium is 0.75%. The embedded inflation risk premium is 0.60%, so the real risk-free rate of interest is 0.40%". What is the interest rate on this corporate bond (based on the formula we studied in Chapter 2)?
Total = 1.00% + 2.95% + 0.50% + 0.75% = 5.20%
Lonnie/Terry calls a stockbroker and instructs her to purchase 100 shares of Chesapeake Energy Corporation common stock. This transaction occurs in the ______.
secondary market
Which financial statement represents an attempt to measure the net results of the firm's operations (revenues less expenses) over a given time period?
Income Statement
Which of the following items would be considered a source of cash?
An increase in Accounts Payable
What information does a firm's Balance Sheet provide?
An itemization of all of a firm's assets, liabilities, and equity as of the balance sheet date.
Use the tax rate schedule given below to determine the amount of taxes owed by a corporation that has $14,000,000 in taxable earnings.
$0 - $50,000 15%
$50,001 - $75,000 25%
$75,001 - $10,000,000 34%
over $10,000,000 35%
Additional surtax:
*5% surcharge on income between $200,000 and $500,000
*3% surcharge on income between $12,000,000 and $18,000,000.
Solution:
$ 50,000 x .15 = $ 7,500
$ 25,000 x .25 = $ 6,250
$ 9,925,000 x .34 = $ 3,374,500
$ 4,000,000 x .35 = $ 1,400,000
Plus surcharge:
$300,000 x .05 = $ 15,000
$2,000,000 x .03 = $ 60,000

d. $ 4,863,250
What elements comprised the change in Retained Earnings for BCC for 2010
Net Income less Income Dividends for 2010 = $270.0 less $30.0 = $240.0 Net Change
What was BCC's Free Cash Flow for 2010?
FCF = EBIT plus Depreciation less Income Taxes = $363.0 + $45.0 less $73.0 = $335.0 minus Change in Gross Fixed Assets of $100 (which is equal to $440 minus $340) minus the Change in Operating Working Capital of $152 [which is equal to the change in Cash of $115.0 plus the change in A/R of +$17 plus the change in Inventory of +$23.0 minus the change in Accounts Payable of +$3] = $83
Why is the quick ratio a more refined liquidity measure than the current ratio?
Inventories are generally among the least liquid of the firm's current assets.
A firm that wants to know if it has enough cash to meet its bills (i.e., short-term obligations or payables) would be most likely to use which kind/category of ratio?
liquidity
Embrex Pharmaceuticals Corp. in 2010 had Credit Sales of $22,850,000; Cash of $643,000; Inventories of $2,820,000; and Total Current Assets of $4,313,000. There are 300 days in this company's fiscal year and the only other Current Asset it had was Accounts Receivable. What is this company's Average Collection Period, and what does this ratio mean?
Average Collection Period = (Accounts Receivable balance/ (Average Sales per Day)
Accounts Receivable = Current Assets less Cash less Inventories
= $4,313,000 - $643,000 - $2,820,000
= $850,000
Average Sales per Day = Total Annual Sales divided by 365
= $22,850,000 / 300 = $76,166.67
So, Average Collection Period = $850,000 divided by $76,166.67
= 11.16 days
b. 11.2 days; it takes on average about 11.2 days to collect a credit sale.
If a company's Average Collection Period is higher than its industry average, then the company may be:
offering credit terms to its customers that are too lenient.
One way to understand the total risk for a company is to divide it into two parts: diversifiable risk and undiversifiable risk. Which of the following choices is/are example(s) of diversifiable risk for Toyota Motors ("TM"), the auto/truck manufacturer?
The risk that Hyundai Motors will develop lower-cost, more fuel-efficient, and more stylish cars than TM.
The appropriate measure of risk according to the capital asset pricing model ("CAPM") is:
The beta statistic.
Marquis Aircraft Corp. ("MAC") manufactures aircraft. Two years ago it sold an initial offering of $50 million of common stock in order to finance the expansion of its production plants. For the past year, its common stock has had an average beta of 2.32, and its current stock price is $32.75. Investors believe the beta of 2.32 is expected to continue, and their expected market return for all stocks is 14 percent. The current interest rate on U.S. Treasury notes/bonds is 4.55 percent which is expected to continue. Given these assumptions, what required return would investors believe is appropriate for MAC stock?
Required Return = Risk Free Return + [ Beta x (Market Return less Risk Free Return)]
= 4.55% + [ 2.32 x ( 14.00% less 4.55%)]
= 4.55% + [ 2.32 x 9.45% ]
= 4.55% + 21.9240%
= 26.4740%
e. 26.47 percent.
Calculate the Total Expected Return for an investment in Movie Productions LLC which has four possible outcomes.
Probability Return Expected Return
.30 12 % 3.60
.35 15 % 5.25 %
.20 23 % 4.60 %
.15 55 % 8.25 %
21.70 %
What is the standard deviation for the expected return for the investment in Movie Productions LLC in the previous problem? (Note: Make sure you have the correct answer for the expected return).
14.51%
Which if the following bond provisions will make a bond more desirable to investors, other things being equal?
The bond is convertible.
Which of the following is NOT a definition of yield to maturity?
discount rate that equates the present value of future cash flows with a bond's face value.
A bond has a coupon rate of 7.50 percent, has a $1,000 face value and has 11 years to maturity. The yield to maturity on this bond is 9.50 percent. What is the price of this bond in the market? Assume semi-annual interest payments and round to the closest answer.
PMT = $1,000 x .0750 = $75.00 div.by 2 = $37.50
N = 11 x 2 = 22
I = 9.50 div. by 2 = 4.75
FV = 1,000
Calculate PV = -865.3171 = $865.32
d. $865.32
If the market price of a bond decreases, then ______.
the yield to maturity increases.
The market price is $923.98 for a bond which matures in 21 years and which has a par value of $1,000 and which has a coupon rate of interest of 9.75 percent paid annually. What is the bond's expected rate of return for an investor who buys the bond?
N = 21
PV = -923.98
PMT = 1,000 x .0975 = 97.50
FV = 1,000
Calculate I = 10.6707%
A preferred pays a fixed dividend of $4.75. If investors in the market required this preferred stock to earn a 5.50% rate of return, what would be its market price?
Price = $4.75/0.0550
= $86.3636
Preferred stock differs from common stock in that ____.
Preferred stock dividends are usually set at a fixed or constant rate or fixed dollar amount.
One of the main axioms of Finance is that _____.
We cannot expect to be compensated by additional return unless we are willing to take on additional risk; or, investors will not take on additional risk unless they expect to be compensated fairly for that additional risk.
Kutrate Retailers Inc. just paid an annual dividend last year of $3.25 per share on its common stock. The dividends for this company are expected to grow at a constant rate of 4% indefinitely. If the required return on this stock is 17%, what is the estimated price for this stock today?
P0 = D0 x ( 1 + g )/ (Kcs - g)
= $3.25 x (1.04)/ (.17 - .04)
= $3.3800/( 0.13)
= $26.00
The stock price for a company's common stock is $32.00 per share. Investors expect a dividend of $3.50 per share to be paid at the end of the upcoming year, and they also expect management to grow the dividend by 6% per year. What total return (in percentage terms to 2 decimal places) would an investor expect over the next year if the investor paid $32.00 per share today?
Kcs = (D1/ P0) + g
= ($ 3.50/$32.00) + .06
= .109375 + .06
= .169375
= 16.9375%
One way to describe the cost of capital is to define it as ____.
the rate of return that must be earned on additional investments if the firm's value is to remain unchanged.
A company's "capital structure" refers to _______
the mix of debt, preferred stock and common stock capital issued by the company to finance its assets.
Chapter 10 covered Capital Budgeting Evaluation Techniques. Which evaluation technique(s) does(do) not explicitly consider the Time Value of Money investment principles?
Payback Period
Cory is a real estate developer who bought an old city residential block which has ten houses on it which have deteriorated over the years. Because this city block is close to a new office building complex that is being developed, Cory would like to tear down the old houses and build new housing. Cory's attorney says the city's zoning ordinances will support either building new zero-lot-line stand-alone town-homes or else building multiple-family housing such as an apartment complex, but not both. Cory has done the financial analysis and believes a town-home project would be a better investment. This situation is an example of ______, and in this situation the ______ investment evaluation technique may be unreliable.
mutually exclusive projects; Internal Rate of Return
What is the Net Present Value of a capital investment project that has the following total after-tax cash flows for a company that requires a 14% rate of return on the project? Would it be a good investment?
Year 0 1 2 3 4
Cash ($360,000) $228,000 $173,000 $135,500 $110,000
I = 21 CF0 = -350,000 CF1 = 228,000 CF2 = 173,000 CF3 = 135,500 CF4 = 110,000
Calculate NPV = +129,705.35 = +$129,705.35
since NPV > 0 it is a good investment
Professional Presentation Technology, Inc. is considering the manufacture of a new multi-functional projector for use in school classrooms as well as for salespersons in business. The proposed project to develop this new system has the following estimated cash flows:
Initial Cash Outlay = $3,500,000
Differential Cash Flows for Year 1 = $700,000; Year 2 = $1,900,000; Year 3 = $3,000,000; Year 4 = $200,000
The Company's required return is 25%. Compute the internal rate of return for the project.
I = 25
CF0 = -2,500,000
CF1 = 700,000
CF2 = 1,900,000
CF3 = 3,000,000
CF4 = 200,000
Calculate IRR = 23.3665 = 23.37%
Two investment projects were evaluated by the management of your company as to their respective value as an investment.
Project X Project Y
Initial Cash Outlay $8,500,000 $10,400,000
New Jobs 379 226
Net Present Value $4,150,000 $5,160,000
IRR 33.00% 21.00%
Project Life 6 years 5 years
Local Taxes $250,000/year $175,000/year
Created
Project Y because its Net Present Value is greater than Project X.
Which of the following cash flows are not considered in the calculation of the initial cash outlay for a capital investment proposal?
cost of issuing new bonds if the project is financed by a new bond issue.
Which of the following is/are considered a relevant cash flow(s) in determining whether or not to continue with a new product development project?
Cost of new manufacturing equipment for this product to be purchased.
Which of the following are included in the terminal cash flow?
A) the expected salvage value of the asset.
B) any tax payments or receipts associated with the salvage value of the asset.
C) recapture of any working capital increase included in the initial outlay.
In evaluating an investment in a proposed business project, we evaluate ______ instead of _______.
Expected Free Cash Flows as defined; accounting net income.
Financing a portion of a firm's assets with securities bearing a fixed rate of return in hopes of increasing the return to stockholders refers to:
financial leverage.
Operating leverage refers to:
the incurrence of fixed operating costs in the firm's income stream.
As described in the textbook, the four sources or determinants of business risk include all but which of the following?
Volatility of interest rates.
Sailcraft Inc. produces sailboats and has fixed costs of $6,125,000 per year. The company's Sales are $8,500,000, and Variable Production Costs $4,200,000 and Variable Selling Costs are $500,000. Its boats sell for an average price of $28,500 per unit and have an average total variable cost per unit of $15,759. What is the company's operating break-even point in unit sales AND dollar sales?
Operating Break-Even in units = $6,125,000/($28,500 - $15,759)
= 480.7315 boats
Operating Break-Even in Sales = $6,125,000/
[1 - ($4,700,000/$8,500,000)] . = $6,125,000/0.44706
= $13,700,622
Which of the following is an example of fixed costs?; Which is an example of variable costs?
Depreciation; Direct Labor
Jones Corporation declared a dividend of $1.00 per share on January 1. The date of record is January 15th, and the payment date is February 1st. The most likely ex-dividend date is:
January 13th
The "bird-in-the-hand" dividend theory suggests that
high dividends increase stock value because shareholders are more certain of the dividend yield than of potential future capital gains.
A stock repurchase maybe viewed as
A) a dividend decision when the firm has excess cash.
B) a financing decision when the firm wants to alter its capital structure.
Stock splits such as "3 for 2" or "2 for 1" ______
increase the number of shares to stockholders.
Dividend policy is influenced by _______.
A) a company's investment opportunities.
B) a firm's capital structure mix.
C) a company's availability of internally generated funds.
The principle of matching the cash flow-generating characteristics of an asset with the maturity of the source of financing used to finance its acquisition is called the _______.
hedging principle
Which of the following is/are an advantage(s) in the use of current liabilities to finance assets? Which of the following would be a disadvantage in the use of current liabilities?
More flexibility, lower interest costs; Higher risk of illiquidity (i.e., higher re-financing risks)
The effective annual cost of not taking advantage of "3/25, net 60" credit terms offered by a vendor/supplier is (use a 365-day fiscal year) ________________ . Calculate to 5 decimal places.
Effective cost = 3%/(100% - 3%) x 365 / ( 60 less 25)
= 0.03093 x 10.42857
= 0.32256
= 32.26%
Ellison Corporation has a supplier that has offered these trade credit terms: "3/15, net 45". What do these credit terms mean?
If you pay the invoice by the 15th day from its receipt the company may take a 3% discount off the invoice cost, otherwise the total amount of the invoice is due not later than the 45th day from receipt.
Katmerc Development Corp. needs $40,000,000 for working capital requirements and will borrow under its short-term bank line of credit for eight (8) months. The loan will carry an 8 percent per year annual interest rate. The Company has to maintain a compensating balance equal to 15% of the total amount borrowed. The Company needs to also borrow the amount of cash for its compensating balance. What is the effective annual interest rate for this loan? Round to whole dollars. Compute the interest rate to two decimal places.
Amount Borrowed = X = $40,000,000 + .15X
$40,000,000 = .85X
$40,000,000/.85 = X = $47,058,824
Interest Expense = $47,058,824 x .08 x 8/12 = $3,764,706 x 8/12 = $2,509,804
Effective Annual Interest Rate = $2,509,804/ $40,000,000 x 12/8 = .06275 x 12/8= 9.41%
Factors that impact the size of a company's investment in Accounts Receivable include ____.
the percentage of credit sales; the level of sales; and credit and collection policies.
Which of the following are short-term promissory notes sold by large corporations in the U.S.? Which are short-term promissory notes sold by the U.S. federal government? These securities are commonly used for ______.
Commercial Paper; U.S. Treasury Bills; Short-term investments
Which of the following would be an example of the "precautionary motive" for a company holding cash balances?
Anticipating a labor strike.
According to the textbook authors, the two major objectives for a company's cash management are ____.
maintain adequate cash balances to meet disbursement requirements and reduce idle cash balances to a minimum.
Assume a company receives paper-based checks through the U.S. Postal Service mail operations from its customers and does not use electronic imaging to process these checks through the banking system. For this company, a lockbox system can be used to help a company manage its cash more efficiently by reducing ____ float; What kind of float would a company try and increase?
Mail, processing, transit; disbursing
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