FSA 3321 (Moore)
Exam 4
Summer II - 2004
Fourth Examination – Finance 3321
Summer II (Moore)
Thursday or Friday Final Exam:
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Code of Student Conduct is in force during this exam. Students providing or accepting
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above statement and agree to abide by the stipulated terms.
Student’s Signature:
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Where indicated, use the financial statement for Dell-U-Dead, Inc. (a large computer
manufacturer and distributor that sells in both the wholesale and retail markets).
Multiple Choice Format Examples:
Clearly Circle the BEST response (letter) for each of the following questions:
1. Which of the following types of market return measures would be most appropriate for
estimating Beta for a large firm (greater than $4 billion market capitalization)?
a. S&P 500 monthly return
b. New York Stock Exchange Monthly Return
c. Dow Jones Industrial Average’s monthly return
d. A broad-based market composite return with representation of small, medium and
large cap firms
e. The 3-month treasury yield
2. What is the main disadvantage of using daily returns to compute the firm’s Beta?
a. The data is not available to the public
b. Daily returns are inconsistent with the theoretical model
c. Daily returns are computed only on a Monday through Friday basis, and weekends
(when markets are closed) renders the model useless
d. Daily returns are “noisy” and provide less explanatory power than longer-term
measures.
e. The true value of a firm’s Beta changes on a daily basis.
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FSA 3321 (Moore)
Exam 4
Summer II - 2004
3. Assume the market return and risk-free rate remain unchanged. Which of the following
must be true if the firm’s Beta suddenly changes from 1.8 to 0.9?
a. The firms cost of equity declines by 50%
b. The firm’s cost of debt increases in direct proportion to the decrease in the cost of
equity because the WACC must remain constant
c. The WACC of the firm decreases
d. The value of the equity doubles
e. The share price will decrease
4. Which is incorrect regarding the Abnormal Earnings Growth valuation model?
a. Although the model incorporates cumulative dividend earnings, it is still appropriate
for valuing firms that don’t pay dividends
b. A firm that, on average, has earned more than its Ke has negative AEG
c. A firm that, on average, has earned less than its Ke has negative AEG
d. A firm with forecast earnings growth less than Ke will increase shareholder value by
increasing dividends.
e. A decrease in the cost of sales percentage will increase the AEG
5. Which of the following types of investment funds would have junk bonds representing a
high percentage of its portfolio value?
a. Income Funds
b. Balanced Funds
c. Municipal Funds
d. Investment Grade Corporate Bond Funds
e. Hi Yield Corporate Bond Funds
6. Which of the following should, per recent regulatory statutes, no longer be a reason sellside analysts make overly optimistic forecasts?
a. Conflicts of interests
b. 5 martini lunches
c. Herding
d. Under-confidence
e. Fears over access to information from corporations
7. Which component of an Interest and Principal strips faces prepayment risk?
a. The interest payment stream
b. The principal payment
c. Both principal and interest payment streams
d. Neither
e. The interest payment stream and only when principal is defaulted
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FSA 3321 (Moore)
Exam 4
Summer II - 2004
8. Old Reliable Manufacturing Company's stock has a market price of $20 per share and a
book value of $10 per share. If its cost of equity capital is 15 percent and its book value is
expected to grow at 5 percent per year indefinitely, what is the market’s assessment of its
steady state return on equity?
a. 25%
b. 30%
c. 35%
d. 40%
e. 45%
9. YouPay is a publicly traded internet-based garage sale intermediary. It’s Market-to-Book
ratio is 7. Assuming YouPay has a cost of equity capital of 15% and that its Return on
equity has been consistently at 21% for the past 3 years. What growth rate in book
value (per year) must YouPay average in the long run in order to support its current
stock price?
a. 2%
b. 5%
c. 6%
d. 10%
e. 14%
10. You have just computed the Beta of a stock to be 1.5 and the estimate of the relevant
risk-free rate is 3%. The expected market return next period is 2% and the long-run
market risk premium is expected to hold at its historical level of 7%. What is the
appropriate estimate of the firm’s Ke?
a. 1.5%
b. 3%
c. 7%
d. 10.5%
e. 13.5%
11. The appropriate collateral a bank would use on a 10-year term loan to a rail car
manufacturer would be:
a. Accounts Receivable
b. Inventory
c. Working Capital
d. Lease rail cars
e. all of the above
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FSA 3321 (Moore)
Exam 4
Summer II - 2004
12. “Thou shall not” protective covenants are loan contract provisions set by the lender that
restrict firms from undertaking certain actions during the life of the loan agreement.
Which of the following covenants would satisfy this definition?
a. The firm must maintain a current ratio greater than 2
b. Working capital must be greater than 10% of total assets
c. Fixed assets used as collateral may not be sold by the firm
d. Interest payments must be satisfied before dividends can be paid
e. The firm must not default on its debt
Use the following information to answer questions 13-15
Altman’s Z-Score model for Credit Ratings is defined as follows:
 Working Capital 
 Retained Earnings 
Z  score = 1.2
. 
  14

 Total Assets 

Total Assets 
EBIT 
Sales 

 Market Value Equity 

 3.3
. 
  0.6
  10

 Total Assets
 Book Value Liabilities
 Total Assets
13. Which of the following is correct regarding the use of Altman’s Z-Score?
a. A company with a score of 2.6 is twice as likely to get credit as a company with a 1.3
b. A company with a score of 1.0 is more credit worthy than a company with a 5.0
c. A company with a 3.3 is considered to be a low credit risk (in terms of bankruptcy)
d. A company with a 2.3 is considered to be a low credit risk (in terms of bankruptcy)
e. A company with a 1.3 is considered to be a low credit risk (in terms of bankruptcy)
14. Which of the following corporate activities will unambiguously raise the firm’s Z-score
a. Decreasing Inventory while sales decline
b. Selling un-needed Assets and using the proceeds to pay of debt
c. Increasing working capital without incurring more current liabilities
d. Increasing total assets with borrowed funds
e. Increasing dividends (assuming no information asymmetry or signalling)
15. Which of the following would best describe the problems associated with loan officers and
bankers focusing only on the current z-score to make credit decisions?
a. It becomes a self-fulfilling prophecy
b. Established, profitable companies will get credit funds while young firms without a
long track-record may be denied access to traditional cost-effective financing
c. It gives firms incentives to manage earnings and accounts for the purpose of making
the z-score look better than it really is (cooking the books)
d. all of the above
e. none of the above
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FSA 3321 (Moore)
Exam 4
Summer II - 2004
16. The intrinsic P/E multiple would be computed using:
a. Trailing EPS
b. The Current market price you observe
c. The Forecast Book value per share you prepare
d. The Intrinsic Market Price you estimate
e. The normal earnings you estimate
17. You are comparing the published P/E multiple with the intrinsic P/E multiple based on
your valuation of a company and they differ. Both ratios use the same earnings
denominator. Which of the following must be true.
a. Intrinsic P/E > Published P/E implies you believe the firm is overvalued
b. Intrinsic P/E < Published P/E implies you believe the firm is undervalued
c. The published P/E must be wrong
d. The intrinsic P/E must be wrong
e. None of the above must be true
18. You used the AEG model to value a non-dividend paying company that has Ke of 10% and
assumed the AEG after year 7 would be equal to zero. In performing sensitivity analysis,
you want to see the effect including a constant AEG perpetuity from year 8 onward of
$0.20 per share. The incremental impact on your intrinsic valuation would be:
a. $0.20 increase in the price per share
b. $2.00 increase in the price per share
c. $1.13 increase in the price per share
d. $11.30 increase in the price per share
e. $20.00 increase in the price per share
19. Which of the following is incorrect regarding passive investors?
a. They spend less time performing fundamental analysis that active investors
b. Portfolio diversification and rebalancing is key to their success
c. They are price takers
d. They spend a lot of time trying to find mis-priced securities
e. They are strong believers in market efficiency
20. Which of the following is a consequence of a firm having its debt rating lowered from AA
to B grade?
a. Access to capital in the debt market will become more restricted
b. Assessed default risk has increased
c. The WACC will likely increase
d. All of the above
e. None of the above
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FSA 3321 (Moore)
Exam 4
Summer II - 2004
Short Problem 1 (Show all work)
Use the AEG model and the following information to estimate a share value for General
Motors at the end of 1986. Assume dividends are paid on the last day of the year.
General Electric Co.
In this case, abnormal earnings growth is expected to grow at a 5 percent rate after 1989. Assume a
cost of equity equal to 15%
Forecasts of EPS DPS
1986 1987 1988
1989
Dps
Eps
1.33
3.20
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1.46
3.75
1.70
4.36
FSA 3321 (Moore)
Exam 4
Summer II - 2004
Short Problem 2 (Show all work)
Use the information provided to answer the following credit worthiness questions regarding
Dell-U-Dead Inc. The financial statements are on the following pages.
 Working Capital 
 Retained Earnings 
Z  score = 1.2
. 
  14

 Total Assets 

Total Assets 
EBIT 
Sales 

 Market Value Equity 

 3.3
. 
  0.6
  10

 Total Assets
 Book Value Liabilities
 Total Assets
Required:
Part A:
Compute the Z-score for Dell-U-Dead for 2001 and 2002.
Part B:
Evaluate both whether their credit worthiness has improved (or declined) and
identify the major sources of the change from 2001 to 2002.
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FSA 3321 (Moore)
Exam 4
Summer II - 2004
Dell-U-Dead Computer Corporation
Balance Sheet (in Millions) (1 February 20XX)
ASSETS
Current Assets:
Cash and equivalents
Short-term Investments
Accounts Receivable (net)
Inventories
Other
2002
2001
$ 3,641
273
2,269
278
1,419
$ 4,910
525
2,424
400
1,467
Total Current Assets
$ 7,877
$ 9,726
$ 5,658
$ 3,499
$13,535
$13,670
$ 5,075
1,600
444
300
100
$ 4,286
1,550
192
450
300
Total Current Liabilities
$ 7,519
$ 6,778
Non-Current Liabilities:
Total Non-Current Liabilities
$ 1,322
$ 1,270
$ 8,841
$ 8,048
$ 5,605
(2,249)
1,364
( 26)
$ 4,795
--839
(12)
Total Stockholders’ Equity
$ 4,694
$ 5,622
Total Liabilities & Stockholders’ Equity
$13,535
$13,670
Non-Current Assets:
Total non-current assets
Total Assets
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accounts Payable
Accrued Liabilities
Unearned Revenues
Notes Payable – Current
Other
Total Liabilities
Stockholders’ Equity:
Common Stock Issued and Outstanding
Treasury Stock
Retained Earnings
Other Comprehensive Income
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FSA 3321 (Moore)
Exam 4
Summer II - 2004
Dell-U-Dead Computer Corporation
Income Statement (in Millions**)
For the Year Ending February 1, 20XX)=
Net Revenue
Less: Cost of Goods Sold
Gross Profit
Operating Expenses
Selling, General and Administrative
Lease Expenses
Research, Development and Engineering
Special charges
Total operating expenses
Operating Income
Investment and other income (loss), net of tax
2002
2001
$31,168
25,661
$31,888
25,445
$ 5,507
$ 6,433
$ 1,900
884
452
482
$ 2,400
793
482
105
$ 3,718
$ 3,780
$ 1,789
(58)
$ 2,663
581
Income before taxes and cumulative effect
of change in accounting principle
$ 1,731
Provision for income taxes
485
$ 3,194
958
Income before cumulative effect of change
in accounting principle
$ 1,246
Cumulative effect of change in accounting principle
---
$ 2,236
59
Net Income
Earnings Per Common Share:
Basic EPS
Diluted EPS
Weighted Average Shares Outstanding:
Basic
Diluted
Market Price Per Share
**
$ 1,246
$ 2,177
$ 0.48
$ 0.26
$ 0.87
$ 0.79
2,602
4,543
2,582
2,746
$35.00
$60.00
All items in millions of dollars except Earnings per Share data
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