Exam1 Fall 2013 Key
1. Seaweed Mfg., Inc. is currently operating at only 86 percent of fixed asset capacity. Fixed assets are
$387,000. Current sales are $510,000 and are projected to grow to $664,000. What amount must be spent on
new fixed assets to support this growth in sales?
Full capacity sales = $510,000/0.86 = $593,023.26
Capital intensity ratio = $387,000/$593,023.26 = 0.652588231
Fixed asset need = ($664,000  0.652588231) - $387,000 = $46,319
2. Dexter Mills issued 20-year bonds a year ago at a coupon rate of 10.2 percent. The bonds make semiannual
payments. The yield-to-maturity on these bonds is 9.2 percent. What is the current bond price?
N = 19*2; I/Y = 9.2/2; Pmt = 102/2; FV = 1000; Compute PV = 1,089.02
3. You are considering the following two mutually exclusive projects. Both projects will be depreciated using
straight-line depreciation to a zero book value over the life of the project. Neither project has any salvage
value.
Should you accept or reject these projects based on the profitability index?
Because these are mutually exclusive projects, the PI rule should not be applied.
4. It is commonly recommended that the managers of a firm compare the performance of their firm to that of its
peers. Increasingly, this is becoming a more difficult task. Explain some of the reasons why comparisons of
this type can frequently be either difficult to perform or produce misleading results.
Many firms are involved in multiple areas of business over diverse geographical locations thereby making it
difficult, if not impossible to identify a peer that has truly similar operations. Firms operating in different
areas may be subjected to various regulations which might affect also their operations. In addition, many
firms are cyclical in nature and have varying fiscal years which complicates the comparison of financial
statements. The financial results for a firm are also affected by various accounting practices and one-time
events, such as a merger, acquisition, or divestiture. If each of these differences between firms is not
handled properly, any resulting comparisons or conclusions can be faulty. So, while it is recommended that
peer analysis be conducted, doing so in a meaningful manner can present quite a challenge.
5. The Farmer's Market just paid an annual dividend of $5 on its stock. The growth rate in dividends is
expected to be a constant 5 percent per year indefinitely. Investors require a 13 percent return on the stock
for the first 3 years, a 9 percent return for the next 3 years, a 7 percent return thereafter. What is the current
price per share?
6. Explain why small shareholders should prefer cumulative voting over straight voting.
With straight voting, a shareholder must control a majority (50 percent plus one) of the outstanding shares
of stock to gain access to a seat on the board of directors. With cumulative voting, a shareholder can control
one seat on the board by controlling a lesser number of shares. The number of shares needed to obtain one
seat under cumulative voting is computed as [1/(N+1)] percent + 1 of the outstanding shares, where N is the
number of open seats. If for example, three seats are open, a shareholder only needs to control 25 percent, or
1/4th, of the outstanding shares plus one additional share to guarantee election to the board. Having a seat on
the board allows a shareholder to have some control over the direction and management of a firm.
7. You have your choice of two investment accounts. Investment A is a 5-year annuity that features end-ofmonth $2,500 payments and has an interest rate of 11.5 percent compounded monthly. Investment B is a
10.5 percent continuously compounded lump sum investment, also good for five years. How much would
you need to invest in B today for it to be worth as much as investment A five years from now?
FVA = $2,500  [{[1 + (0.115/12)]5  12 -1}/(0.115/12)] = $201,462.23
PV = $201,462.23 e-1  0.105 5 = $119,176.06
8. During 2011, RIT Corp. had sales of $565,600. Costs of goods sold, administrative and selling expenses, and
depreciation expenses were $476,000, $58,800, and $58,800, respectively. In addition, the company had an
interest expense of $112,000 and a tax rate of 32 percent. What is the operating cash flow for 2009? Ignore
any tax loss carry-back or carry-forward provisions.
Earnings before interest and taxes = Net income = $565,600 - $476,000 - $58,800 - $58,800 = -$28,000
Operating cash flow = -$28,000 + $58,800 - $0 = $30,800
9. Identify the four primary determinants of a firm's growth and explain how each factor could either add to or
limit the growth potential of a firm.
The four factors are:
10. How might agency problems arise in partnerships?
Agency conflicts typically arise when there is a separation between the ownership and the management of a
business. In a general partnership, especially if the partnership is small, there is less of a chance of an
agency conflict if all the partners are involved with the business on a regular basis. However, in a limited
partnership, the opportunity exists for an agency problem to arise between the general and the limited
partners.
11. Explain the conditions that would need to exist for the Treasury yield curve to be downward sloping.
A downward sloping Treasury yield curve exists when current inflation rates are high but are expected to
decline in the future. The decline in the inflation premium must be significant enough to overcome the rising
interest rate risk premium as the time to maturity increases.
12. The most recent financial statements for Heng Co. are shown here:
Assets and costs are proportional to sales. The company maintains a constant 45 percent dividend payout
ratio and a constant debt-equity ratio. What is the maximum increase in sales that can be sustained next year
assuming no new equity is issued?
Return on equity = $13,068/$74,250 = 0.176
Retention ratio = 1 - .45 = .55
Sustainable growth rate = (0.176  .55)/[1 - (0.176  .55)] = .107174
Maximum increase in sales = $55,000  .107174 = $5,894.60
13. A project that provides annual cash flows of $12,600 for 12 years costs $65,000 today. At what rate would
you be indifferent between accepting the project and rejecting it?
14. The profitability index (PI) of a project is 1.0. What do you know about the project's net present value
(NPV) and its internal rate of return (IRR)?
If the PI is equal to 1.0, then the NPV = 0 and the IRR = Required return.
15. You expect to receive $9,000 at graduation in 2 years. You plan on investing this money at 10 percent until
you have $60,000. How many years will it be until this occurs?
$60,000 = $9,000  (1 + .10)t; t = 19.90 years
Total time = 2 + 19.90 = 21.90 years
16. Assume you are the financial officer of a major firm. The president of the firm has just stated that she
wishes to reduce the firm's investment in current assets since those assets provide little, if any, return to the
firm. How would you respond to this statement?
While it is true that current assets provide a low rate of return, those assets are essential to the firm's
liquidity. Should the liquid assets be reduced too low, the firm could face a much greater problem than a
low rate of return. That problem would be the inability to meet the firm's financial obligations which could
even result in a bankruptcy due to a lack of cash flow.
17. What lesson does the future value formula provide for young workers who are looking ahead to retiring
some day?
The future value formula is: FV = PV (1 + r)t. Time is the exponent. While the rate of return is important
and has a direct affect on the growth of an investment account, time is critical. To maximize retirement
income, workers need to commence saving when they are young so that reinvested earnings have time to
compound.
18. Explain the difference between the effective annual rate (EAR) and the annual percentage rate (APR). Of
the two, which one has the greater importance and why?
The APR is a stated rate and is computed as (r  n), where r is the rate per period and n is the number of
periods per year. The EAR considers compounding and is computed as (1 + r)n - 1, where r is the rate per
period and n is the number of periods per year. The effective annual rate will always be higher than the
annual percentage rate as long as the account is compounded more than once a year and the interest rate is
greater than zero. The EAR is the equivalent rate based on annual compounding. The EAR has greater
importance because it is the actual cost of a loan.
19. The Burger Hut has sales of $29 million, total assets of $43 million, and total debt of $13 million. The profit
margin is 11 percent. What is the return on equity?
Return on equity = (.11 × $29m)/($43m - $13m) = 10.63 percent
20. Compare and contrast the NYSE with NSADAQ.
The NYSE is an auction market where sell orders are matched with buy orders. The NYSE has a physical
trading floor located on Wall Street in New York City. NASDAQ is a dealer market which is solely
electronic and therefore has no physical trading floor. Dealers buy and sell for their own inventory. The
listing requirements of the NYSE are more stringent than those of NASDAQ and thus the NYSE tends to
list larger firms with smaller firms being listed on NASDAQ. Note however, that larger firms can, and do,
opt to remain on NASDAQ even though they qualify for NYSE listing.
Exam1 Fall 2013 Summary
Category
# of Questions
AACSB: Analytic
10
AACSB: Ethics
1
AACSB: Reflective Thinking
8
AACSB: Reflective thinking
1
Blooms: Analyze
9
Blooms: Apply
8
Blooms: Evaluate
1
Blooms: Understand
2
Difficulty: 1 Easy
6
Difficulty: 2 Medium
13
Difficulty: 3 Hard
1
EOC: 2-19
1
EOC: 3-2
1
EOC: 4-17
1
EOC: 4-8
1
EOC: 5-20
1
EOC: 6-49
1
EOC: 7-6
1
EOC: 8-10
1
Learning Objective: 01-03 The financial implications of the different forms of business organization.
1
Learning Objective: 01-04 The conflicts of interest that can arise between managers and owners.
1
Learning Objective: 02-01 The difference between accounting value (or "book" value) and market value.
1
Learning Objective: 02-04 How to determine a firms cash flow from its financial statements.
1
Learning Objective: 03-02 How to compute and; more importantly; interpret some common ratios.
1
Learning Objective: 03-04 Some of the problems and pitfalls in financial statement analysis.
1
Learning Objective: 04-01 How to apply the percentage of sales method.
1
Learning Objective: 04-03 The determinants of a firms growth.
1
Learning Objective: 04-03 The determinants of a firms growth.
1
Learning Objective: 05-01 How to determine the future value of an investment made today.
1
Learning Objective: 05-04 How long it takes for an investment to reach a desired value.
1
Learning Objective: 06-01 How to determine the future and present value of investments with multiple cash flows.
1
Learning Objective: 06-04 How interest rates are quoted (and misquoted).
1
Learning Objective: 07-02 Bond values and yields and why they fluctuate.
1
Learning Objective: 07-05 The term structure of interest rates and the determinants of bond yields.
1
Learning Objective: 08-01 How stock prices depend on future dividends and dividend growth.
1
Learning Objective: 08-02 How to value stocks using multiples.
1
Learning Objective: 09-05 The internal rate of return criterion and its strengths and weaknesses.
1
Learning Objective: 09-07 The profitability index and its relation to net present value.
2
Ross - Chapter 01
2
Ross - Chapter 02
2
Ross - Chapter 03
2
Ross - Chapter 04
3
Ross - Chapter 05
2
Ross - Chapter 06
2
Ross - Chapter 07
2
Ross - Chapter 08
2
Ross - Chapter 09
3
Section: 1.4
1
Section: 1.5
1
Section: 2.1
1
Section: 2.4
1
Section: 3.3
1
Section: 3.5
1
Section: 4.3
1
Section: 4.4
2
Section: 5.1
1
Section: 5.3
1
Section: 6.3
2
Section: 7.1
1
Section: 7.7
1
Section: 8.1
1
Section: 8.2
1
Section: 9.5
1
Section: 9.6
1
Section: 9.7
1
Topic: Agency conflict
1
Topic: Annual and effective rates
1
Topic: Bond price
1
Topic: Cash flow to creditors
1
Topic: Determinants of growth
1
Topic: Exchanges
1
Topic: Fixed asset need
1
Topic: Future value
1
Topic: Internal rate of return
1
Topic: Liquidity
1
Topic: Operating cash flow
1
Topic: Peer analysis
1
Topic: Present value
1
Topic: Profitability index
2
Topic: Return on equity
1
Topic: Stock price
1
Topic: Sustainable growth rate
1
Topic: Time period
1
Topic: Treasury yield curve
1
Topic: Voting
1