MGT 3470 B Midterm 2
Conceptual (40% of total grade, 2 points each)
1- Which of the following are arguments for a high dividend payout?
I. A current dividend is worth more than a future dividend.
II. Some clientele groups prefer current income.
III. Flotation costs exist in the real world.
IV. Uncertainty surrounds the future.
A) I and II only
B) II and IV only
C) I, II, and III only
D) I, II, and IV only
E) I, II, III, and IV
2- A stock has a normal trading range of $60 to $75. The stock is currently selling at $41
a share. It would be common for a firm in this situation to:
A) Repurchase outstanding shares.
B) Change its dividend policy.
C) Issue a one-time special dividend.
D) Increase the number of outstanding shares via a stock split.
E) Issue a liquidating dividend to lower the value of the firm.
3- Rank the following goals in increasing order of importance in a compromise dividend
policy.
I. Avoid dividend cuts
II. Maintain a target debt/equity ratio
III. Avoid the need to sell equity
IV. Avoid cutting back on positive NPV projects
A) IV, II, I, III
B) II, III, IV, I
C) IV, I, II, III
D) I, II, IV, III
E) IV, I, III, II
4- The date on which the board of directors passes a resolution authorizing payment of a
dividend to the shareholders is the ____________ date.
A) ex-rights
B) ex-dividend
C) record
D) payment
E) declaration
5-
KLO, Inc. has three separate divisions. All three divisions produce sufficient cash
flows to fund their own operations. Management was just approached and
asked if they would be receptive to selling division three. Management
accepted the offer and now wants to distribute some of the excess funds
from that sale to the shareholders. Management is most likely to:
A) Declare a liquidating dividend.
B) Declare a special dividend.
C) Increase the regular dividend.
D) Declare a stock dividend.
E) Do a stock split.
6- For the past four years Doodle Dee has paid quarterly dividends of $.25 a share. The
company just announced that dividends are being increased by 8%. As a result,
the market price of Doodle Dee stock increased. The increase in the share price is
generally attributed to the:
A) Increase in the current dividend amount.
B) Change in the dividend policy.
C) Information content of the dividend.
D) Residual effect of the dividend.
E) Reinvestment of the dividend amount.
7- Stewie's has always paid their suppliers in 30 days. The company just hired a new
financial officer who is changing the policy such that suppliers will now be paid
in 45 days. This change will ______ the accounts payable period and _______ the
cash cycle.
A) Increase; not affect
B) Increase; increase
C) Increase; decrease
D) Decrease; increase
E) Decrease; decrease
8- Which one of the following will decrease the operating cycle?
A) An easing of the accounts receivable collection policy
B) Additional inventories are kept on hand
C) The customer discount for early payment is discontinued
D) Suppliers offer a bonus discount for early payment
E) The inventory turnover changes from 9 to 10
9- Which of the following statements is (are) correct concerning a flexible short-term
financial policy?
I. A flexible policy is most appropriate when shortage costs are low relative to
carrying costs.
II. A flexible policy entails the use of marketable securities.
III. A flexible policy requires more short-term bank loans than does a restrictive
policy.
IV. The optimal current asset holdings are higher under a flexible policy than
under a restrictive policy.
A) I and II only
B) I and III only
C) II and III only
D) II and IV only
E) I, II, and IV only
10- Kae owns a wholesale nursery that sells potted plants to large retail outlets. These
sales are seasonal in nature. Kae cannot afford to wait for payment from the
retailers as they often take 60 days or more to pay. Kae has only been in business
for three years. Due to the nature of her business, Kae's bank is not willing to
accept responsibility for collecting the receivables. The type of financing that is
most appropriate for Kae's situation is:
A) Commercial paper.
B) An assignment of receivables.
C) Accounts receivable factoring.
D) Floor plan financing.
E) A bank loan secured with a blanket lien.
11- Which of the following are sources of cash?
I. Increase in inventory
II. Decrease in accounts payable
III. Decrease in accounts receivable
IV. Increase in fixed assets
A) II only
B) III only
C) I and IV only
D) I, II, and IV only
E) III and IV only
12- Which of the following statements are true concerning credit policy?
I. A firm that begins to offer credit to its customers does not increase its total sales
as a result of the credit offering.
II. A seller must have a source of financing sufficient to cover any accounts
receivable balance created by introducing a credit policy.
III. The cost of sales will initially be delayed when a credit policy is first adopted.
IV. A customer who forfeits a cash discount is accepting a high cost for credit
financing.
A) I and II only
B) II and IV only
C) I, II, and III only
D) I, II, and IV only
E) I, II, III, and IV
13- The optimal amount of credit to be granted can be located graphically at the point
where the:
A) Opportunity costs of credit are minimized.
B) Sum of the opportunity cost and the carrying cost is minimized.
C) Difference between the opportunity cost and the carrying costs of credit are
maximized.
D) Sum of the opportunity cost and the carrying costs is maximized.
E) Carrying costs of credit are equal to zero.
14- Which one of the following is the normal order of events when a firm is collecting an
account receivable from a customer?
I. Legal action
II. Phone call
III. Collection agency
IV. Delinquency letter
A) II, IV, III, I
B) III, IV, I, II
C) IV, III, II, I
D) IV, III, I, II
E) IV, II, III, I
15- A firm currently has a cash only credit policy. The firm is considering adopting a
credit policy which will extend credit to customers for 45 days and grant the credit
customers who pay in 15 days or less a discount. Which of the following variables used
in the analysis of this proposal are outside of the control of the firm?
I. Discount percent
II. Default rate
III.
Increase in sales
IV. Credit period
A) I and III only
B) I and IV only
C) II and III only
D) II and IV only
E) I, II, III, and IV
16- Suppose your firm is offered terms of 2/10 net 30 on its purchases. Assuming that
your firm intends to buy on credit, good cash management practice suggests that a
rational purchaser should pay only on which of the following days?
I. Day 2
II. Day 9
III. Day 10
IV. Day 20
V. Day 30
A) I, II, or V only
B) III or V only
C) II only
D) V only
E) I or II only
17- Upon graduation with your finance degree, you take a position with a medium-sized
manufacturing concern. You find that there are several pieces of inventory
required in the manufacturing process that make up a small percentage of physical
inventory, but a large percentage of inventory value. Anxious to impress your
boss, you suggest the firm use the ______________ of inventory management.
A) EOQ model
B) derived demand model
C) shortage cost model
D) inventory depletion model
E) ABC model
18- Of the following, a firm _______________ will likely have the most liberal credit
policy.
A) that has a core group of customers, who purchase inventory on a frequent
basis
B) that is presently operating its manufacturing facilities at maximum capacity
C) that is a wholesaler of fresh flowers
D) that is experiencing severe cash flow problems due to tremendous growth
E) whose operating costs are almost all variable costs
19- Which of the following is considered a carrying cost for the firm when it grants
credit?
I. The required return on receivables
II. Losses from bad debts
III. The cost of managing credit
IV. The cost of managing credit collections
A) I and III only
B) II and IV only
C) I, II, and IV only
D) II, III, and IV only
E) I, II, III, and IV
20- The restocking quantity that minimizes the firm's total inventory costs is called the:
A) Shortage cost quantity.
B) Carrying cost quantity.
C) Economic order quantity.
D) Speculation quantity.
E) Special-order quantity.
Problems (60% of total grade)
1- If a firm needs $10 million for a new investment and it has a target capital
structure (D/E = 0.75). The firm’s net income = $8 million. How much does the
firm payout in dividends? What is the firm’s dividend payout ratio? (5 points)
Solution:
Dividends = $2.286 million, DPR = 28.57%
2- It is August 1, 2007. A firm expects sales over the next 4 months to be as follows:
Month
August
September
October
November
Sales Amount
$130,000
$80,000
$90,000
$95,000
Sales in June and July were $100,000 and $120,000 respectively. Twenty five
percent of these sales will be collected in the month of sale, 35% will be collected
in the first month after sale, and 40% will be collected two months after sale. A
4.5% discount is given for accounts paid in the first month after sale. The firm
purchases inventory of 70% of next month’s expected sales for cash. Wages,
taxes, and expenses are $45,000 per month. Depreciation is $30,000 per month.
Currently, $7,000 of cash is on hand. A minimum balance of $14,000 is required.
Complete a cash budget for August, September, and October. (13 points)
Solution:
Total collections ($)
Total disbursements
($)
Cash surplus
(deficit) ($)
August
112,610
101,000
September
111,452.5
108,000
October
101,240
111,500
4,610
8,062.5
-2,197.5
3- A firm has a $900,000 operating loan with a 15% compensating balance requirement.
The quoted interest rate is 7.5%. The firm needs to borrow $350,000 for inventory
for one year. How much does the firm actually need to borrow? What is the
interest rate the firm is effectively paying? (6 points)
Solution:
The firm needs to borrow $411,764.71
Firm’s effective interest rate = 8.82%
Use the following information to solve problems 4 and 5
Inventory
A/R
A/P
Beginning
$27,000
$21,000
$10,000
Ending
$28,000
$22,000
$14,000
Credit sales = $175,000 and cost of goods sold = $125,000.
4- Calculate the firm’s operating cycle and cash cycle? (8 points)
Solution:
Operating cycle = 125 days, cash cycle = 90 days
5- If the firm factors receivables by discounting them 3.5%. What is the effective rate of
interest? (5 points)
Solution:
EAR = 33.64%
6- The Trektronics store begins each 24 days with 250 units in stock. This stock is
depleted each 24 days and reordered. If the carrying cost per unit $28 per year and
the fixed order cost is $95, what is the total carrying cost? What is the restocking
cost? What is Trektronics’ total cost? Should Trektronics increase or decrease its
order size? If so, by how many units? What will Trektronics’ total cost be if it
orders inventory based on EOQ? What does this result imply about the store’s
carrying and restocking costs? (12 points)
Solution
TCC = $3,500, TRC = $1,444.79, TC = $4,944.79
Decrease number of units ordered by 89 units, EOQ = 161 units
TC (under EOQ) = $2,254 + $2,243.47 = $4,497.47
This result implies that the firm has high carrying costs in comparison to its
restocking (shortage) costs
7- A firm offers credit terms of 3/15 net 60. Stewie purchases $100 worth of raw
materials. Bank financing is available at 16%. Calculate the nominal cost of
foregoing the discount, the firm’s effective annual interest rate, the bank’s
effective annual interest rate, the real dollar cost of not taking the discount, and
the real dollar cost of bank financing. Which course of action will Stewie take?
Why? (11 points)
Solution:
Nominal cost of forgoing the discount = 25.09%
Firm EAR = 28.03%
Bank EAR = 17.17%
Real dollar cost of forgoing the discount = $3
Real dollar cost of bank financing = $1.91
Stewie will choose bank financing because it costs less