Chapter 1:
1. Three major advantages and two disadvantages of the corporate business form?
a. Advantages
i.
Limited Liability protects owners from losing more than they invest
ii.
Can achieve large size due to marketability of stock
iii.
ownership is readily transferable.
b. Disadvantages
i.
Double taxation because both corporate profits and dividends paid to owners are
taxed, although the dividends are taxed at a reduced rate
ii.
Subject to more government regulation
2. According to the textbook, what is the primary objective of a corporation and what is the
ultimate benchmark for measuring this objective?
a. The primary object is shareholder wealth maximization and benchmark for measuring
this objective is stock price
3. What are the three elements that affect the corporate’s value?
a. Its size of the expected future cash flow,
b. The timing of cash flows counts,
c. the risk of the cash flows matters
4. Name three ways in which businesses can raise money from external sources when they need it
for expansion or project funding.
a. Direct Transfer
b. Through Investment Bank
c. Through Financial Intermediary
5. While interest rate actions by the Federal Reserve captures most headlines, what is the most
common method for the Federal Reserve Board to try to influence the economy and what does
that action entail?
a. Establish or set up the target rates for the federal reserve.
b. Change the interest rate or the discount rate which is charged to the banks when the
business cycle changes.
Sensitivity: Internal
Chapter 2:
6. Three major component of Cash flow Statements
a. Operating Activities
It includes the adjustment of net income by adding back the item which has no cash flow impact
to business like depreciation.
b. Financing Activities.
It includes borrowing, debts and dividend which has cash inflow and outflow impact.
c. Investing Activates.
It includes the purchasing, acquisition and sale of equipment’s land building which impact cash
flow of the business.
7. Rao Corporation
Net operating Working Capital = Current assets required in production - Noninterest-bearing
current liabilities
Current assets required in production = Current assets - short-term investment
Current assets required in production = $130 - $30
Current assets required in production = $100
Noninterest-bearing current liabilities = Accounts Payable + Accruals
Noninterest-bearing current liabilities = $20 + $20
Noninterest-bearing current liabilities = $40
Net operating Working Capital = $100 - $40
Net operating Working Capital = $60
8. TSW Inc
Free cash flow = NOPAT - Net investment in operating capital
Net investment in operating capital = Total operating capital completed year - Total operating
capital last year
Net investment in operating capital = $2500 - $2000
Net investment in operating capital = $500
Sensitivity: Internal
Free cash flow = $925 - $500
Free cash flow = $425
9. Bae Inc.
Net operating profit after tax = Earnings before interest after taxes.
Net operating profit after tax = $455
Sales
Costs
Depreciation
EBIT
Taxes (35% of EBIT)
Net operating profit after tax
2,000.00
(1,200.00)
(100.00)
700.00
(245.00)
455.00
10. HHH Inc.
Sales
$12,500
Operating cost including depreciation
($7,025)
EBIT
$5,475
investor-supplied operating assets (or capital), $18,750
WACC
9.50%
Income Tax Rate
40%
EVA = EBIT(1 – T) – Investor Capital x WACC
EVA = $5,475 (1-40%) - $18,750 x 9.5%
EVA = $3,285.00 x $1,781.25
EVA = $1,503.75
Sensitivity: Internal
Chapter 3.
11. How much debt must the company add or subtract to achieve the target debt ratio?
Target amount of debt – Present Debt = Amount of debt the company must add or subtract to achieve
the target debt ratio.
A.
B.
C.
D.
Total assets = $625,000
Present debt = $185,000
Target debt ratio = 55%
Target amount of debt = $625,000 X 55%
Target amount of debt = $343,750
Amount of debt the company must add or subtract to achieve the target debt ratio = Target amount of
debt – Present Debt
Amount of debt the company must add or subtract to achieve the target debt ratio = $343,750 $185,000
Amount of debt the company must add or subtract to achieve the target debt ratio = $158,750
12.
Credit Period
Sales
Receivables
DSO (($60,000 x 365)/$425,000)
DSO – Credit Period = days early or late
51.53 – 45 = 6.53 days late
13. What was its profit margin on sales?
Net Income / Sales = Profit Margin
$23,000/$320,000 = 0.071875 = 7.19%
Sensitivity: Internal
45
$425,000
$60,000
51.53
14. What was the firm's times interest earned (TIE) ratio?
Sales
$435,000
Operating Cost
$362,500
EBIT ($435,000 - $362,500) $72,500
Interest
EBIT / Interest Expenses = Time Interest Earned Ratio
$72,500/$12,500 = 5.8
Sensitivity: Internal
$12,500