Midterm
MGT 3040A
Conceptual (50% of total grade)
1- In words, what does an equity multiplier of 2 mean?
A)
B)
C)
D)
E)
Each dollar in equity the firm has supports $2 in assets.
Each dollar in assets the firm owns is supported by $2 in equity.
Each dollar in assets the firm owns is supported by $4 in equity.
Each dollar in equity the firm has supports fifty cents in assets.
Each dollar in assets the firm owns is supported by $2 in debt.
2- All else constant, return on equity will increase if the ______________________.
A)
B)
C)
D)
E)
profit margin decreases
return on assets increases
debt-equity ratio decreases
accounts receivable turnover increases
total asset turnover decreases
3- A financial manager is responsible for deciding whether or not new manufacturing
equipment should be purchased to replace existing equipment. The new
equipment would reduce labor expenses and would allow the firm to reduce its
investment in inventory. Which of the financial management areas would be
involved in the decision process?
I. Capital budgeting
II. Capital structure management
III. Working capital management
A) I only
B) I and II only
C) II and III only
D) I and III only
E) I, II, and III
4- Which of the following statements is/are false concerning partnerships?
I. Limited partners are responsible for all debts of the partnership.
II. Limited partners generally do not manage the partnership.
III. In a limited partnership, all partners share equally in the gains or losses.
A) I only
B) II only
C) I and II only
D) I and III only
E) I, II, and III
5- Of the following, which statement regarding agency costs is false?
A) An agency problem exists when there is a conflict of interest between the
stockholders and management of a firm.
B) An agency problem exists when there is a conflict of interest between a
principal and an agent.
C) An indirect agency cost occurs when firm management avoids risky projects
that would favorably affect the stock price because the managers are worried
about keeping their jobs.
D) A corporate expenditure that benefits stockholders but harms management is
an agency cost.
E) If agency costs get too high in the eyes of shareholders, they can begin a
proxy fight to replace existing management
6-
A)
B)
C)
D)
E)
Chrysler Canada's stockholders sell some of their shares to Kirk, another
investor
An investor buys stock in Chrysler Canada from his buddy
A firm sells stock to the public for the first time in an IPO
On September 25, 1995, 30.8 million shares of stock changed hands on the
TSX
Labatt's just announced what their upcoming quarterly dividend payment
will be
7- Two of the primary advantages of a sole proprietorship are the:
A) Ease of company formation and limited liability.
B) Ease of company formation and less regulation.
C) Ease of ownership transfer and less regulation.
D) Ease of ownership transfer and ease of company formation.
E) Ability to raise capital and less regulation.
8- Which of the following are characteristics of a liquid asset?
I. Can be converted into cash quickly
II. Can be converted into cash with little or no loss in value
III. Generally earn low returns
A) I and II only
B) II and III only
C) III only
D) I and III only
E) I, II, and III
9- Which of the following would decrease the financial leverage of a firm?
A) Total assets increase and the debt-to-equity ratio remains constant.
B) Total debt increases and total assets remain constant.
C) Net new equity is sold and existing bonds are paid off.
D) Net new bonds are sold and outstanding common stock is repurchased.
E) Net new bonds are sold and short-term notes payable are paid off.
10- In 2006, Griffin Company experienced negative cash flow from assets. It must be the
case that:
A) The company is not in financial distress.
B) Cash flow to creditors and cash flow to shareholders are both negative.
C) Griffin's interest payments were greater than its dividend payments.
D) Griffin's dividend payments were greater than its interest payments.
E) Operating cash flow was less than the combination of additions to net
working capital and net new capital expenditures.
11- If the market value of an asset exceeds the book value of that asset, then the sale of
the asset will:
A) Generate taxable income.
B) Result in a capital loss.
C) Cause a cash outflow for the firm.
D) Cause net profits to decline.
E) Cause operating cash flows to decrease.
12- Which of the following are included in cash flow from assets?
I. The payment of a dividend
II. A payment of a bill from a supplier
III. The payment of taxes
IV. Receipt of a payment from a customer
A) I and II only
B) I and III only
C) II and IV only
D) I, II, and III only
E) II, III, and IV only
13- Which of the following would be considered a use of cash?
I. Accounts receivable increase.
II. Accounts payable decrease.
III. Common stock and surplus increases.
IV. Net fixed assets decrease by the amount of depreciation.
A) I only
B) II only
C) I and II only
D) I and III only
E) I, III, and IV only
14- In a common size statement, the balance sheet may be expressed as a percentage of
____________ while the income statement may be expressed as a percentage of
____________.
A) liabilities plus equity; net income
B) assets; net income
C) sales; liabilities plus equity
D) liabilities plus equity; sales
E) liabilities; sales
15- All else the same, which of the following occurs when a firm buys inventory with
cash?
A) The quick ratio goes up if it was greater than one before the change.
B) The current ratio goes down if it was greater than one before the change.
C) The current ratio goes down if it was lower than one before the change.
D) The quick ratio goes up if it was lower than one before the change.
E) The quick ratio declines but the current ratio remains unchanged.
16- Golf Inc. and Golfanatics Corp. are close competitors. Last year, both had the same
level of cost of goods sold, but Golf Inc. turned its inventory over five times
during the year while Golfanatics turned its inventory over every 65 days. If the
objective is to keep inventory as low as possible (on average), which of the
following is true?
A) Golf Inc. did a better job since its inventory turnover was lower.
B) Golfanatics did a better job since its days' sales in inventory was lower.
C) Golf Inc. a better job since its days' sales in inventory was lower.
D) Golfanatics did a better job since its inventory turnover was lower.
E) Golf Inc. did a better job since its level of inventory was lower.
17- Monika has $6,000 in her investment account. She wants to withdraw her funds when
her account reaches $10,000. A decrease in the rate of return she earns will:
A) Increase the value of her account faster.
B) Cause her to wait longer before withdrawing her money.
C) Cause the present value of her account to decrease.
D) Allow her to withdraw more money sooner.
E) Cause the compounding effect to increase.
18- The future value will increase:
I. The longer the period of time.
II. The shorter the period of time.
III. The higher the rate of interest.
IV The lower the rate of interest.
A) I and III only.
B) I and IV only.
C) II and III only.
D)
II and IV only
19- The process of finding the present value of some future amount is often called
_____________.
A) growth
B) accumulation
C) discounting
D) compounding
E) reduction
20- The concept that a dollar received today is worth more than a dollar received
tomorrow is referred to as the:
A) Present value.
B) Simple interest value.
C) Compound value.
D) Time value of money.
E) Future value of money.
21- You are choosing between investments offered by two different banks. One promises
a return of 10% for three years using simple interest while the other offers a return
of 10% for three years using compound interest. You should:
A) Choose the simple interest option because both have the same basic interest
rate.
B) Choose the compound interest option because it provides a higher return.
C) Choose the compound interest option only if the compounding is for
monthly periods.
D) Choose the simple interest option only if compounding occurs more than
once a year.
E) Choose the compound interest option only if you are investing less than
$5,000.
22- Which one of the following statements concerning an ordinary annuity is true?
A) An ordinary annuity consists of equal payments that occur at the beginning
of each period over a set period of time.
B) If two annuities are equal in every way except that one is an ordinary
annuity and one is an annuity due, then the ordinary annuity will have a
larger future value than the annuity due.
C) The future value of an ordinary annuity can be computed by dividing the
future value of an annuity due by (1+r).
D) If two annuities are equal in every way except that one is an ordinary
annuity and one is an annuity due, then the ordinary annuity will have a
larger present value than the annuity due.
E) Most financial calculators can compute ordinary annuity problems but not
annuity due problems.
23- Which one of the following would have the greatest present value?
A) $1,000 today plus $100 a month for 2 years
B) $1,000 today plus $200 a month for a year
C) $1,000 today plus $400 a month for six months
D) $2,200 today plus $200 a month for six months
E) $2,200 today plus $100 a month for a year
24- Which of the following will increase the effective annual rate?
I. Increasing the frequency of the compounding
II. Decreasing the frequency of the compounding
III. Increasing the annual percentage rate
IV. Decreasing the annual percentage rate
A) I only
B) II only
C) I and III only
D) I and IV only
E) II and IV only
25- If you are borrowing money, which one of the following rates would you prefer?
A) 9% paid annually
B) 9% compounded semi-annually
C) 9% compounded quarterly
D) 9% compounded monthly
E) 9% compounded continuously
26- Which one of the following is correct concerning the annual percentage rate (APR)?
A) The APR is greater than the effective annual rate.
B) The APR formula for rate disclosure is [1 + (r / m)]m - 1.
C) The APR is the rate which lenders are required to disclose.
D) The APR is best used to compare offers from various lenders.
E) The APR considers all the effects of compounding.
27- Which of the following comparison statements is (are) true?
I. An annuity has equal payments, a perpetuity does not.
II. Both an annuity and a perpetuity have equal payments.
III. An annuity covers a longer period of time than a perpetuity.
IV. An annuity has a constant rate of return, a perpetuity does not.
A) I only
B) II only
C) I and III only
D) II and IV only
E) I and IV only
28- In words, what does a profit margin of 0.10 mean?
A) For each $1 of sales generated by the firm it incurs 10 cents in operating
expenses.
B) For each $1 of sales generated by the firm it earns 10 cents in net income.
C) For each $1 of profits generated by the firm pretax, it keeps 10 cents aftertax.
D) For each $1 of net income generated, 10 cents in sales are required.
E) The firm completely sells off its production level 10 times on average during
the year.
29- You have $500 that you would like to invest. You have two choices: Savings
account A which earns 8% compounded annually, or savings account B which
earns 7.75% compounded semiannually. Which would you choose and why?
A) A because it has a higher effective annual rate.
B) A because the future value in one year is lower.
C) B because it has a higher effective annual rate.
D) B because the future value in one year is lower.
E) B because it has the higher quoted rate.
30- Tomas wants to save $1,200 a year in a manner that maximizes his savings. To do
this, he should:
A) Deposit $1,200 into his savings account on the last day of each year.
B) Treat his $100 monthly savings deposits as an annuity due.
C) Treat his $100 monthly savings deposits as an ordinary annuity.
D) Deposit $300 into his account at the end of each quarter.
E) Deposit $600 into his account at the end of every six month period.
Problems (50% of total grade)
Use the following information to answer questions 1 through 3
Coogan, Inc.
2006 Income Statement
($ in millions)
Net sales
Less: Cost of goods sold
Less: Depreciation
Earnings before interest and taxes
Less: Interest paid
Taxable income
Less: Taxes
Net income
Addition to retained earnings
Dividends paid
$9,625
5,225
1,890
2,510
850
1,660
581
$1,079
$ 679
400
Coogan, Inc.
12/31/05 and 12/31/06 Balance Sheet
($ in millions)
Cash
2005
$1,455
2006
$260
Accounts rec.
Inventory
Total
Net fixed assets
2,460
1,405
$5,320
19,300
3,975
885
$5,120
21,720
Total assets
$24,620
$26,840
Accounts
payable
Notes payable
Total
Long-term debt
Common stock
Retained
earnings
Total liabilities
2005
$1,150
2006
$2,863
2,600
$3,750
7,000
5,500
8,370
1,628
$4,491
7,600
5,700
9,049
$24,620
$26,840
1- (3 points) What is the firm’s change in net working capital for 2006? ($ in millions)
Solution:
∆ in NWC = Ending NWC – Beginning NWC
= (5,120 – 4,491) – (5,320 – 3,750)
= 629- 1,570 = -$941 million
2- (3 points) What is the firm’s net capital spending for 2006? ($ in millions)
Solution:
NCS = Ending NFA – Beginning NFA + Depreciation
= 21,720 – 19,300 + 1,890
= 2,420 + 1,890 = $4,310 million
3- (3 points) What is the firm’s cash flow from assets for 2006? ($ in millions)
Solution:
Cash Flow from Assets = OCF – NCS - ∆ in NWC
= OCF – 4,310 – (-941)
OCF = EBIT + Depreciation – Taxes
= 2,510 + 1,890 – 581 = $3,819
Cash Flow from Assets = OCF – NCS - ∆ in NWC
= 3,819 – 4,310 – (-941) = $450 million
4- (4 points) A firm has an ROA of 9%, sales of $150, and total assets of $100. What is
its profit margin?
Solution:
ROA = 0.09 = PM x TAT = (NI / SALES) x (SALES / TA) = NI / 100
NI = $9
PM = (NI / SALES) = ($9 / $150) = 0.06 = 6%
5- (5 points) A firm has sales of $700, total assets of $500, and a debt/equity ratio of 3.
If its return on equity is 17%, what is its net income?
Solution:
(TD / TE) = 3 = (TA – TE) / TE = (TA / TE) – 1 = 3
(TA / TE) = 4, (500 / TE) = 4, TE = $125
ROE = 0.17 = (NI / 125), NI = $21.25
6- (8 points) Analysts expect Marble Comics to pay shareholders $1.00 per share at the
end of the first year, $1.50 per share at the end of second year and $2.00 per share at the
end of the third year. After that, the dividend will be $2.50 annually forever. Given a
discount rate of 10%, what is the value of the stock today?
Solution:
PV of Perpetuity = (PMT / r) = ($2.5 / 0.1) = $25
Using the financial calculator
CF0 = 0
CF1 = $1
CF2 = $1.5
CF3 = $27 ($2+$25)
I = 10
N=3
NPV = $22.43
7- (6 points) Mr. Smith just won a "Name That Tune" contest with a grand prize of
$380,000. However, the contest stipulates that the winner will receive $150,000
immediately, and $25,000 at the beginning of each of the next 10 years. Assuming that
he can earn 5% on his money, how much has he actually won?
Solution:
2nd BEG
PMT = 25,000
N = 10
I=5
PV = $202,695.54
PV of your winnings = $150,000 + $202,695.54 = $352,695.54
8- (5 points) Your recently departed rich, eccentric uncle has left for you in his will a
large sum of money. Unfortunately, rather than give you this sum of money
immediately, he has instructed the executor of the will to pay you $10,000 in one
year. This payment is to grow by 9% each year and to be made each year
forever. If the appropriate discount rate is 10%, how much have you actually
inherited?
Solution:
PV of perpetuity with growth = [C / (r-g)]
= [$10,000 / (0.1 – 0.09)] = $1,000,000
9- (7 points) An Ontario resident earned $5,000 in dividends in 2006. His regular income
was $150,000, the federal tax rate is 29%, the provincial tax rate is 11.6%, and the
Ontario dividend tax credit is 5.13%. Calculate the following:
ithe dollar amount of the federal tax payable
iithe dollar amount of the provincial tax payable
iiithe tax rate on dividends
Solution:
Actual dividends
$5,000
Gross up to 25%
1,250
(5,000 x 0.25)
Grossed up dividends
$6, 250
Federal tax at 29%
1,812.5 (6,250 x 0.29)
Less dividend tax credit
(833.13) (0.13333 x $6,250)
Federal tax payable
$979.37
Provincial tax at 11.6%
725
(6,250 x 0.116)
Less dividend tax credit
(320.63) (6,250 x 0.0513)
Provincial tax payable
$404.37
Total tax
$1,383.74 (979.37 + 404.37)
Therefore, the tax rate on dividends = ($1,383.74 / $5,000) = 27.67%
10- (6 points) Strapped for cash, your neighbour makes you the following offer. He
would like to borrow $15,000 today. He will repay the $15,000 by making yearly
payments with the first payment being for $1,200 at the end of this year. The payments
will grow by 11% every year thereafter. If the appropriate discount rate is 14%, how
long will it take for your neighbour to repay the loan?
Solution:
PV = [C / (r-g)] [ 1 – ( 1+g / 1+r)^T]
15,000 = (1,200 / 0.03) [1- (1.11 / 1.14)^T]]
0.375 = 1 – (0.973684)^T
(0.973684)^T = 0.625
Take LN of both sides of the equation
T = LN(0.625) / LN(0.973684) = (-0.470004 / -0.026665)
T = 17.63 years