Exam IName
FINANCE 5023
Summer 2008
Multiple Choice -- Circle the letter of the BEST answer (3 points each)
1.A current ratio that is above average and a quick (acid-test) ratio that is below average would indicate that the firm
a.is using too much debt financing
b.should tighten-up its credit policy
c.is not keeping its costs under control
d.is holding excessive inventories
e.not enough information is given to know what might be wrong
2.You are considering loaning the Compass Company $25,000 for sixty days. The financial ratios you would probably be MOST interested in are
a.debt ratio and inventory turnover
b.current ratio and quick ratio
c.net profit margin and debt ratio
d.times interest earned and inventory turnover
e.times interest earned and debt ratio
3.You are looking at diversifying your portfolio. Below are several different industries that you have considered investing in, along with the correlation coefficient of each with your current portfolio. Which of the following would achieve the MOST reduction in the risk of your portfolio?
a.computers, +1.0
b.chemicals, +0.8
c.transportation, +0.6
d.real estate, +0.2
e.paper products, 0.0
4.Which of the following actions would increase the firm's need for external capital?
a.A decrease in the dividend payout ratio.
b.An increase in the profit margin.
c.An increase in the inventory turnover.
d.A decrease in the average collection period.
e.None of the above would reduce the firm's need for external funding.
5.The basic idea behind the percentage of sales approach to financial planning is
a.that all balance sheet and income statement accounts will change by some percent of sales.
b.to plug different sales scenarios into past financial statements and determine how changes in sales would have affected the firm.
c.to separate the balance sheet and income statement accounts into two groups, those that vary with sales and those that do not.
d.that asset levels should be estimated first with sales projections then prepared as a percentage of the change in asset levels.
e.that there is a one-to-one correlation between sales growth and income growth.
6.Which of the following statements about risk is NOT true?
a.Risk requires the possibility of at least one outcome less favorable than the expected value.
b. Risk requires the possibility of more than one outcome.
c.Risk is one of the determinants of the required rate of return.
d.Risk aversion is generally assumed in finance to be a characteristic of the investor.
e.All of the above statements are true.
- A conversion option on a convertible bond acts as a
- put option on the underlying stock
- call option on the underlying stock
- put option on the underlying bond
- call option on the underlying bond
- none of the above
8.If the expected rate of return on a stock exceeds the required rate of return,
a.The stock is experiencing supernormal growth
b.The stock should be sold
c.The company is probably not trying to maximize price per share
d.The stock is a good buy
e.None of the above
9.Which of the following statements is NOT true about the systematic risk of an asset?
a.It is less than the total risk.
b.It cannot be diversified away.
c.It is measured by the standard deviation of returns.
d.It depends on the asset's covariance with market returns.
e.All of the above statements are true.
10.The yield to maturity is
- the rate of interest that equates the price of the bond with the discounted cash flows
- the expected rate to be earned if held to maturity
- the rate that is used to determine the market price of the bond
- equal to the current yield for bonds priced at par
e.all of the above
11.Indicate the effect that each of the following would have on a company’s bond ratings. Assume that each action is independent of any others. (5 points)
ActionIncreaseDecreaseNo Effect
The current ratio increases from 2.0x to 2.8x X
The time interest earned ratio decreases
from 3.1x to 2.7x X
The company issues preferred stock X
The debt/assets ratio increases from 33% to 51% X
The return on assetsdecreases from 8.2% to 6.6% X
12.Your finance professor makes you the following offer: He will give you $2,000 at the end of each year for the next five years if you agree to pay him back $2,000 at the end of each of the following ten years.
A.Should you accept this offer if your opportunity cost of funds is 10%? (7 points)
PV of what you get = $ 7,581.57
PV of what you pay = $ 7630.59
B.Under what circumstances would this offer have the same appeal to your finance professor? That is, if it is a good (bad) deal for you, how can it also be a good (bad) deal for him? (3 points)
13.You run a retirement community and are negotiating with a client, Jill, who wishes to reside at your complex when she retires in ten years at age 65. Actuarial statistics indicate that she will probably die at age 80. Costs of caring for each client are estimated to be $15,000 per year. Jill's salary is $32,000 per year. If you require a $10,000 down payment today and have a 6% investment opportunity cost, what proportion of Jill's annual income should she pay to you each year between now and when she retires? Assume that all cash flows occur at year-end (except for the down payment). (15 points)
Payment = $9,694.05 or 30.29%
14.William "Bill" Williams plans to start a printing business. Since industry standards often provide an indication of what a firm's balance sheet will look like, Bill Williams has obtained the industry ratios for the printing industry to prepare a balance sheet. Using the ratios below, complete the balance sheet below assuming that net income will be $120,000.
(10 points)
Current Ratio: 3 times
Average Collection Period: 45 days
Inventory Turnover (based on sales): 6 times
Current Liabilities to Net Worth: 25%
Total Debt/Total Assets: 50%
Return on Equity: 7.50%
Net Profit Margin: 3.33%
─────────────────────────────────────────────────────────
Cash 155,119A/P 400,000
A/R 444,280 L-T Debt1,200,000
Inventory 600,601Total Debt1,600,000
Total Current Assets1,200,000 Net Worth1,600,000
Fixed Assets2,000,000
Total Liabs.
Total Assets3,200,000 & Equity3,200,000
15.You have the following expectations about market returns and interest rates on T-bills:
T-billsMarket
Probability RFProbability RM
0.1 2% 0.1 -10%
0.2 3% 0.2 10%
0.4 5% 0.4 15%
0.2 6% 0.2 20%
0.1 10% 0.1 25%
The Angel Company of San Angelo owns and operates the town's only television station. The dividend just paid (i.e., D0) was $2, but since competition in the TV industry is expanding rapidly via cable and wireless capabilities, you expect the dividend to remain constant for the next five years, after which time you think dividends will decline at a 6% rate indefinitely thereafter. The beta of Angel Company is 1.3.
A.What rate of return should you require on the stock of Angel Company? (5 points)
16.05%
B.Assume your answer to part (A) is 14%. How much would you be willing to pay for a share of Angel Company's stock? (10 points)
$ 11.74
C.How would your answer to part (B) change if you only intended to hold the stock for five years? Don't do any calculations, just explain in words and why. (5 points)
16.The Lorrie Company had the following financial statements for 2007:
Income Statement:
Sales$500,000
Costs 400,000
Taxable Income 100,000
Taxes (40%) 40,000
Net Income$ 60,000
Balance Sheet:
Cash$ 25,000Accounts Payable$ 75,000
Account Receivable 100,000Notes Payable 60,000
Inventory 125,000Total Current Liabs.$135,000
Total Current Assets$250,000
Long-term Debt$ 90,000
Fixed Assets$200,000Common Stock$ 98,000
Retained Earnings$127,000
Total Assets$450,000Total Liabs. & Equity$450,000
All costs, assets and accounts payable are proportional to sales, while Notes payable and L-T Debt is not (a financing choice). Lorrie Company maintains a constant 60% dividend payout ratio. Next year's sales (2008) are estimated to be $540,000. Fill out the proforma balance sheet for the end of 2008, including the projected amount of Additional Funds Needed (AFN). (10 points)
Cash 27,000 Accounts Payable 81,000
Account Receivable108,000 Notes Payable 60,000
Inventory135,000 Total Curr. Liabs.141,000
Total Current Assets270,000
Long-term Debt 90,000
Fixed Assets216,000 Common Stock 98,000
Retained Earnings152,920
Add’l Funds Needed 4,080
Total Assets486,000 Total Liabs. & Eq.486,000