FIN3320
Exam One; Chapters 1-4


1.  Which of the following statements is CORRECT?

               a. One of the advantages of the corporate form of organization is that it avoids double taxation.

b. It is easier to transfer one’s ownership interest in a partnership than in a corporation.

               C. One of the disadvantages of a sole proprietorship is that the proprietor is exposed to unlimited liability.

d. One of the advantages of a corporation from a social standpoint is that every stockholder has equal voting rights, i.e., “one person, one vote.”

e. Corporations of all types are subject to the corporate income tax.


2.  Which of the following actions would tend to reduce conflicts of interest between stockholders and bondholders?

A. Including restrictive covenants in the company’s bond indenture (which is the contract between the company and its bondholders).

b. Compensating managers with more stock options and less cash income.

                c. The passage of laws that make it harder for hostile takeovers to succeed.

d. A government regulation that banned the use of convertible bonds.

e. Have the firm use only long-term debt, e.g., debt that matures in 30 years or more rather than in less than one year.

 

3.  Which of the following statements is CORRECT?

                a. Bond covenants are a good way to resolve agency conflicts between stockholders and managers.

B. The bid price in a hostile takeover is generally above the price before the takeover attempt is announced because otherwise the takeover attempt would probably fail.

c. The bid price in a hostile takeover is generally below the price before the takeover attempt is announced because takeover targets are generally not very well managed companies.

d. Takeovers are more likely to be attempted if the target firm’s stock price is above its intrinsic value.

e. The efficiency of the U.S. economy would probably be increased if hostile takeovers were absolutely forbidden.

 

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

a. Maximize its expected total corporate income.

b. Maximize its expected EPS.

c. Minimize the chances of losses.

D.Maximize the stock price per share over the long run, which is the stock’s intrinsic value.

e. Maximize the stock price on a specific target date.

 

5.  Which of the following statements is CORRECT?

a. While the distinctions are becoming blurred, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties.

B. The NYSE operates as an auction market, whereas Nasdaq is an example of a dealer market.

c. Money market mutual funds usually invest their money in a well-diversified portfolio of liquid common stocks.

d. Money markets are markets for long-term debt and common stocks.

e. A liquid security is a security whose value is derived from the price of some other "underlying" asset.

 

6.  Which of the following statements is NOT CORRECT?

a. When a corporation's shares are owned by a few individuals, we say that the firm is "closely, or privately, held."

B. "Going public" establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares.

c. The stock of publicly owned companies must generally be registered with and reported to a regulatory agency such as the SEC.

d. When stock in a closely held corporation is offered to the public for the first time, the transaction is called "going public, or an IPO," and the market for such stock is called the new issue or IPO market.

e. It is possible for a firm to go public and yet not raise any additional new capital for the firm itself.


7.  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.

 

8.  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.


9.  On its 12/31/08 balance sheet, Barnes Inc showed $510 million of retained earnings, and exactly that same amount was shown the following year.  Assuming that no earnings restatements were issued, which of the following statements is CORRECT?

a. If the company lost money in 2008, it must have paid dividends.

b. The company must have had zero net income in 2008.

c. The company must have paid out half of its 2008 earnings as dividends.

d. The company must have paid no dividends in 2008.

E.Dividends could have been paid in 2008, but they would have had to equal the earnings for the year.

 

10.  Which of the following statements is CORRECT?

a. Typically, a firm’s DPS should exceed its EPS.

b. Typically, a firm’s net income should exceed its EBIT.

C. If a firm is more profitable than average (e.g., Google), we would normally expect to see its stock price exceed its book value per share.

d. If a firm is more profitable than most other firms, we would normally expect to see its book value per share exceed its stock price, especially after several years of high inflation.

e. The more depreciation a firm has in a given year, the higher its EPS, other things held constant.


11.  Superior Medical System's 2005 balance sheet showed total common equity of $2,050,000.  The company had 100,000 shares of stock outstanding which sold at a price of $57.25 per share.  By how much did the firm's market value and book value per share differ?

A. $36.75

b. $38.25

c. $39.50

d. $40.25

e. $51.00

            Market Value = 100,000 * 57.25 = $5,725,000 less book value of 2,050,000 = 3,675,000 / 100,000 = $36.75 per share


12.  Companies generate income from their "regular" operations and from things like interest on securities they hold, which is called non-operating income. Mitel Metals recently reported $9,000 of sales, $6,000 of operating costs other than depreciation, and $1,500 of depreciation.  The company had no amortization charges and no non-operating income.  It had issued $4,000 of bonds that carry a 7% interest rate, and its federal-plus-state income tax rate was 40%.   What was the firm's operating income, or EBIT? 

a. $1,100

b. $1,200

c. $1,300

d. $1,400

E. $1,500

                  9,000 – 6,000 – 1,500 = $1,500 EBIT

 

13.  Fine Breads Inc. paid out $26,000 common dividends during 2005, and it ended the year with $150,000 of retained earnings.  The prior year’s retained earnings were $145,000.  What was the firm's 2005 net income?

a. $30,000

B. $31,000

c. $32,000

d. $33,000

e. $34,000

                  $26,000 + (150,000 – 145,000) = $31,000

 

14.  Miller Metals recently reported $9,000 of sales, $6,000 of operating costs other than depreciation, and $1,500 of depreciation.  The company had no amortization charges, it had $4,000 of bonds that carry a 7% interest rate, and its federal-plus-state income tax rate was 40%.   What was its net cash flow? 

A. $2,232

b. $2,380

c. $2,471

d. $2,545

e. $2,618

                  9,000 – 6,000 – 1,500 = $1,500 EBIT

                    $1,500 EBIT - $280 Interest = $1,220 Profit Before Tax

                    $1,220 Profit Before Tax - $488 Tax = $732 Profit After Tax

                    $732 Profit After Tax plus $1500 Depreciation = $2,232 Cash Flow

 

15.  Which of the following items is NOT included in current assets?

A. Accounts payable.

b. Inventory.

c. Accounts receivable.

d. Cash.

e. Short-term, highly liquid, marketable securities.

 

16.  Rutland Corp's stock price at the end of last year was $30.25 and its earnings per share for the year were $2.45.  What was its P/E ratio? 

a. 11.65

b. 12.00

C. 12.35

d. 12.70

e. 13.05

                  $30.25 / $2.45 = 12.347 times

17.  Collins Inc's latest net income was $1 million, and it had 200,000 shares outstanding.  The company wants to pay out 40% of its income.  What dividend per share should the company declare?

a. $1.60

b. $1.70

c. $1.80

d. $1.90

E. $2.00

                  $1,000,000 * 40% = $400,000 / 200,000 = $2.00 per share

 

18.  Regan Corp's sales last year were $450,000, and its year-end receivables were $45,000.  On average, Regan's customers pay 10 days late (and thus they are charged a penalty).  How many days of "free" credit does Regan give its customers before they are late and thus assessed a penalty?  Base your answer on this equation:  DSO - Average days late = Days of free credit, use a 365-day year when calculating the DSO, and round to the closest whole number. 

a. 23 days

b. 25 days

C. 27 days

d. 29 days

e. 31 days

                  $450,000 / 365 = $ 1,232.88 sales per day

                    $45,000 / $1232.88 = 36.5 days less 10 days = 27 days rounded

 

19.  Which of the following statements is correct?

a. “Window dressing” is any action that improves a firm’s fundamental long-run position and thus increases its intrinsic value.

b. Using some of the firm’s cash to reduce long-term debt is an example of “window dressing.”

c. Borrowing using short-term notes payable and 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 an example of “window dressing.”

d. 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 an example of “window dressing.”

E. Borrowing on a long-term basis and using the proceeds to retire short-term debt could be an example of window dressing.

 

20.  Van Buren Company’s current ratio is 1.9.  Considered alone, which of the following actions would REDUCE the company’s current ratio?

a. Use cash to reduce short-term notes payable.

b. Use cash to reduce accounts payable.

C. Borrow using short-term notes payable and use the proceeds to reduce long-term debt.

d. Borrow using short-term notes payable and use the proceeds to reduce accruals.

e. Use cash to reduce accruals.

 

21.  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 debt 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, whereas the average for its competitors is 30.


22.  You observe that a firm’s ROE is above the industry average, but its profit margin and debt ratio are both below the industry average.  Which of the following statements is CORRECT?

A. Its total assets turnover must be above the industry average.

b. Its return on assets must equal the industry average.

c. Its TIE ratio must be below the industry average.

d. Its total assets turnover must be below the industry average.

e. Its total assets turnover must equal the industry average.

 

23. Beranek Corp has $720,000 of assets, and it uses no debt--it is financed only with common equity.  The new CFO wants to employ enough debt to raise the debt/assets 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?

a. $273,600

B.  $288,000

c. $302,400

d. $317,520

e. $333,396


Total assets                                                                                                                 $720,000

Target debt ratio                                                                                                                  40%

Debt to achieve target ratio = Amount borrowed = Target % × Assets =               $288,000


24. Garcia Industries has sales of $200,000 and accounts receivable of $18,500, and it gives its customers 25 days to pay.  The industry average DSO is 27 days, based on a 365-day year.  If the company changes its credit and collection policy sufficiently to cause its DSO to fall to the industry average, and if it earns 8.0% on any cash freed-up by this change, how would that affect its net income, assuming other things are held constant?

a. $241.45

b. $254.16

c. $267.54

d. $281.62

E.$296.44


Rate of return on cash generated                                                                       8.0%

Sales                                                                                                             $200,000

A/R                                                                                                                  $18,500

Days in Year                                                                                                           365

Sales/day = Sales/365 =                                                                                 $547.95

Company DSO = Receivables/Sales per day =                                                    33.8

Industry DSO                                                                                                        27.0

Difference = Company DSO – Industry DSO =                                                    6.8

Cash flow from reducing the DSO = Difference × Sales/day =                 $3,705.48

Additional Net Income = Return on cash × Added cash flow =                   $296.44

 

Alternative Calculation:

A/R at industry DSO                                                                                 $14,794.52

Change in A/R                                                                                            $3,705.48

Additional Net Income                                                                                  $296.44


25. Chang Corp. has $375,000 of assets, and it uses only common equity capital (zero debt).  Its sales for the last year were $595,000, and its net income was $25,000.  Stockholders recently voted in a new management team that has promised to lower costs and get the return on equity up to 15.0%.  What profit margin would the firm need in order to achieve the 15% ROE, holding everything else constant?

A. 9.45%

b. 9.93%

c. 10.42%

d. 10.94%

e. 11.49%


Total assets  = Equity because zero debt                                                   $375,000

Sales                                                                                                            $595,000

Net income                                                                                                    $25,000

Target ROE                                                                                                    15.00%

Net income req'd to achieve target ROE = Target ROE × Equity =           $56,250

Profit margin needed to achieve target ROE = NI/Sales =                          

Total assets  = Equity because zero debt                                                   $375,000

Sales                                                                                                            $595,000

Net income                                                                                                    $25,000

Target ROE                                                                                                   15.00%

Net income req'd to achieve target ROE = Target ROE × Equity =           $56,250

Profit margin needed to achieve target ROE = NI/Sales =                             9.45%