Towson University
Principles of Financial Management (Fin331)
Professor M. Rhee
Spring 2010
Exam I
Name_____________________________
ID#_________________
1.
Which of the following statements is CORRECT?
a. One of the disadvantages of incorporating your business is that you could become subject to the firm's liabilities in
the event of bankruptcy.
b. Sole proprietorships are subject to more regulations than corporations.
c. In any partnership, every partner has the same rights, privileges, and liability exposure as every other partner.
d. Corporations of all types are subject to the corporate income tax.
e. Sole proprietorships and partnerships generally have a tax advantage over corporations.
Answer: e
Some corporations (S corporations) are able to avoid the corporate income tax. Sole proprietorships and
partnerships pay personal income tax, but they avoid the corporate income tax.
2.
What is the sequential approach?
a. Profit maximization
b. Agency conflict
c. Efficient management
d. Satisfying stakeholders to maximize shareholder wealth maximization e.
e. None f the above
Answer: d
3.
The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to
a. Maximize its expected total corporate income.
b. Maximize its expected EPS.
c. Minimize the chances of losses.
d. Maximize the stock price per share over the long run
e. Maximize the stock price on a specific target date.
Answer: d
The primary operating goal should be to maximize the long-run stock price, or the intrinsic value.
4.
Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and
managers?
a. Pay managers large cash salaries and give them no stock options.
b. Change the corporation's formal documents to make it easier for outside investors to acquire a controlling interest in
the firm through a hostile takeover.
c. Beef up the restrictive covenants in the firm’s debt agreements.
d. Eliminate a requirement that members of the board of directors must hold a high percentage of their personal wealth
in the firm’s stock.
e. For a firm that compensates managers with stock options, reduce the time before options are vested, i.e., the time
before options can be exercised and the shares that are received can be sold.
Answer: b
Corporate takeovers are most likely to occur when a firm is underperforming. Managers who fear losing their
jobs will try to maximize shareholder wealth.
5.
Which of the following statements is CORRECT?
a. The four most important financial statements provided in the annual report are the balance sheet, income
statement, cash budget, and the statement of stockholders' equity.
b. The balance sheet gives us a picture of the firm’s financial position at a point in time.
c. The income statement gives us a picture of the firm’s financial position at a point in time.
d. The statement of cash flows tells us how much cash the firm must pay out in interest during the year.
e.
The statement of cash needs tells us how much cash the firm will require during some future period, generally a
month or a year.
Answer: b
6.
Other things held constant, which of the following actions would increase the amount of cash on a company’s balance
sheet?
a. The company repurchases common stock.
b. The company pays a dividend.
c. The company issues new common stock.
d. The company gives customers more time to pay their bills.
e. The company purchases a new piece of equipment.
Answer: c
7.
While preparing a pro forma B/S, you have realized that A > L+E, you want to balance the B/S with increased shortterm debt. What is (are) the problem(s) you may run into?
a.
Increased debt
b.
Increased liquidity
c.
Decreased profit
d.
Liquidity problem
e.
Both increased debt and liquidity problem
Answer: e
Increasing short-term debt will worsen current ratio (CA/CL), which might cause liquidity problem. Also, increase in
short-term debt means increase in total debt (short-term debt is a part of total debt).
8.
On 12/31/08, Hite Industries reported retained earnings of $525,000 on its balance sheet, and it reported that it had
$135,000 of net income during the year. On its previous balance sheet, at 12/31/07, the company had reported
$445,000 of retained earnings. No shares were repurchased during 2008. How much in dividends did the firm pay
during 2008?
a. $49,638
b. $52,250
c. $55,000
d. $57,750
e. $60,638
Answer: c
12/31/08 RE
$525,000
12/31/07 RE
445,000
Change in RE
$ 80,000
Net income for 2008
$135,000
Dividends = Net income – Change
$ 55,000
or
BEG RE
+ NE
- DIV
END RE
Dividends =
9.
$445,000
135,000
x
$525,000
$ 55,000
Shrives Publishing recently reported $10,750 of sales, $5,500 of operating costs other than depreciation, and $1,250 of
depreciation. The company had $3,500 of bonds that carry a 6.25% interest rate, and its federal-plus-state income tax
rate was 35%. During the year, the firm had expenditures on capital expenditure and net working capital that totaled
$1,550. These expenditures were necessary for it to sustain operations and generate future sales and cash flows. What
was its free cash flow?
a. $1,873
b. $1,972
c. $2,076
d. $2,185
e. $2,300
Answer: e
Bonds
$3,500.00
Interest rate
6.25%
Tax rate
35.00%
Sales
Operating costs excluding depreciation
Depreciation
Operating income (EBIT)
$10,750.00
5,500.00
1,250.00
$ 4,000.00
Δ Capex + NWC =
Tax rate =
$1,550.00
35%
FCF = EBIT * (1 - T) - ∆ NFA - ∆ CA + ∆ CL
∆ NFA = Δ Capex - Deprec, Δ NWC = (∆ CA - ∆ CL)
FCF = EBIT * (1-T) - (Δ Capex - Deprec) - (∆ CA - ∆ CL) = EBIT * (1-T) - Δ Capex + Deprec - Δ NWC
FCF = EBIT*(1 – T) + Deprec. – Δ Capex - Δ NWC
FCF = EBIT(1 – T) + Deprec. – (Δ Capex + Δ NWC)
FCF = $2,600 + $1,250 – $1,550
Free cash flow = $2,300
or
FCF = EBIT(1 – T) + Deprec. – (Δ Capex + Δ NWC)
FCF = $2,600 + $1,250 – $1,550
Free cash flow = $2,300
10.
Moose Industries faces the following tax schedule:
Taxable Income
Up to $50,000
$50,000-$75,000
$75,000-$100,000
$100,000-$335,000
$335,000-$10,000,000
$10,000,000-$15,000,000
Tax on Base
of Bracket
$0
7,500
13,750
22,250
113,900
3,400,000
Percentage on
Excess above Base
15%
25
34
39
34
35
Last year the company realized $10,000,000 in operating income (EBIT). Its annual interest expense is $1,500,000.
What was the company’s net income for the year?
a. $4,809,874
b. $5,063,025
c. $5,329,500
d. $5,610,000
e. $5,890,500
Answer: d
Operating income
$10,000,000
Interest expense
$1,500,000
Taxable income = Operating income – Interest expense
Taxable income = Operating income – Interest expense
Taxable income = $8,500,000
Taxable
Income
$0
$50,000
$75,000
$100,000
$335,000
$10,000,000
$15,000,000
$18,333,333
Tax on Base
of Bracket
$0
7,500
13,750
22,250
113,900
3,400,000
5,150,000
6,416,667
% on
Excess above Base
15%
25%
34%
39%
34%
35%
38%
35%
Tax on base = $113,900
Tax on excess base = $2,776,100
Tax liability = $2,890,000
Net income = Taxable income – Taxes
Net income = $5,610,000
11.
The term “additional funds needed (AFN)” is generally defined as follows:
a. Funds that are obtained automatically from routine business transactions.
b. Funds that a firm must raise externally from non-spontaneous sources, i.e., by borrowing or by selling new stock,
to support operations.
c. The amount of assets required per dollar of sales.
d. The amount of internally generated cash in a given year minus the amount of cash needed to acquire the new
assets needed to support growth.
e. A forecasting approach in which the forecasted percentage of sales for each balance sheet account is held constant.
Answer: b
12.
Spontaneously generated funds are generally defined as follows:
a. Assets required per dollar of sales.
b. A forecasting approach in which the forecasted percentage of sales for each item is held constant.
c. Funds that a firm must raise externally through borrowing or by selling new common or preferred stock.
d. Funds that arise out of normal business operations from its suppliers, employees, and the government, and they
include spontaneous increases in accounts payable and accruals.
e. The amount of cash raised in a given year minus the amount of cash needed to finance the additional capital
expenditures and working capital needed to support the firm’s growth.
Answer: d
13.
Clayton Industries is planning its operations for next year, and the CEO wants you to forecast the firm's additional
funds needed (AFN). Data for use in your forecast are shown below. Based on the AFN equation, what is the AFN for
the coming year? Dollars are in millions.
Last year’s sales = S0
$350
Last year’s accounts payable
$40
Sales growth rate = g
30%
Last year’s notes payable
$50
Last year’s total assets = A*0
$500
Last year’s accruals
$30
Last year’s profit margin = M
5%
Target payout ratio
60%
a. $102.8
b. $108.2
c. $113.9
d. $119.9
e. $125.9
Answer: d
Last year's sales = S0
$350
Sales growth rate = g
30%
Forecasted sales = S0 × (1 + g)
$455
ΔS = change in sales = S1 − S0 = S0 × g
$105
Last year's total assets = A*0 = A*0 since full capacity
$500
Forecasted total assets = A*1 = A*0 × (1 + g)
$650
Last year's accounts payable
$40
Last year's notes payable. Not spontaneous, so does not enter AFN calculation
$50
Last year's accruals
$30
L*0 = payables + accruals
$70
Profit margin = M
5.0%
Target payout ratio
60.0%
Retention ratio = (1 − Payout)
40.0%
AFN = (A*0/S0)ΔS – (L*0/S0)ΔS – Margin × S1 × (1 − Payout)
AFN = $150.0 – $21.0 – $9.1 = $119.9
14.
Which of the following would, generally, indicate an improvement in a company’s financial position, holding other
things constant?
a. The TIE declines.
b. The DSO increases.
c. The quick ratio increases.
d. The current ratio declines.
e. The total assets turnover decreases.
Answer: c
15.
Casey Communications recently issued new common stock and used the proceeds to pay off some of its short-term
notes payable. This action had no effect on the company’s total assets or operating income. Which of the following
effects would occur as a result of this action?
a. The company’s current ratio increased.
b. The company’s times interest earned ratio decreased.
c. The company’s basic earning power ratio increased.
d. The company’s equity multiplier increased.
e. The company’s debt ratio increased.
Answer: a
16.
Ajax Corp's sales last year were $435,000, its operating costs were $362,500, and its interest charges were $12,500.
What was the firm's times-interest-earned (TIE) ratio?
a. 4.72
b. 4.97
c. 5.23
d. 5.51
e. 5.80
Answer: e
Sales
$435,000
Operating costs
$362,500
Operating income (EBIT)
$72,500
Interest charges
$12,500
IE ratio = EBIT/Interest =
5.80
17.
Last year Harrington Inc. had sales of $325,000 and a net income of $19,000, and its year-end assets were $250,000.
The firm's total-debt-to-total-assets ratio was 45.0%. Based on the DuPont equation, what was the ROE?
a. 13.82%
b. 14.51%
c. 15.23%
d. 16.00%
e. 16.80%
Answer: a
Sales
$325,000
Assets
$250,000
Net income
$19,000
Debt ratio
45.0%
Debt = Debt % × Assets =
$112,500
Equity = Assets − Debt =
$137,500
Profit margin = NI/Sales =
5.85%
TATO
1.30
Equity multiplier = Assets/Equity =
1.82
ROE
13.82%
18.
Wie Corp's sales last year were $315,000, and its year-end total assets were $355,000. The average firm in the industry
has a total assets turnover ratio (TAT) of 2.4. The firm's new CFO believes the firm has excess assets that can be sold
so as to bring the TAT down to the industry average without affecting sales. By how much must the assets be reduced
to bring the TAT to the industry average, holding sales constant?
a. $201,934
b. $212,563
c. $223,750
d. $234,938
e. $246,684
Answer: c
Sales
$315,000
Actual total assets
Target TATO = Sales/Total assets =
Target assets = Sales/Target TATO =
Asset reduction = Actual assets − Target assets =
$355,000
2.40
$131,250
$223,750
19.
Towson, Inc. currently has $1,600,000 in accounts receivables and its days sales outstanding (DSO) is 20 days. If
accounts receivable comprise 50% of the company’s current assets and Towson has $4,800,000 in net fixed assets,
what is its total asset turnover ratio?
a.
2.651x
b. 3.650x
c.
3.520x
d. 2.921x
e.
3.920x
Answer: b
DSO = (A/R)/(Annual Sales/365), 20 = $1,600,000/(Annual Sales/365), Annual Sales = $29,200,000.
Assets=CA+(Net) Fixed Assets, TAT = Sales/Assets = $29,200,000/($1,600,000*2 + $4,800,000) = 3.650x
20.
Which of the following is a primary market transaction?
a. You sell 200 shares of IBM stock on the NYSE through your broker.
b. You buy 200 shares of IBM stock from your brother. The trade is not made through a broker--you just give him
cash and he gives you the stock.
c. IBM issues 2,000,000 shares of new stock and sells them to the public through an investment banker.
d. One financial institution buys 200,000 shares of IBM stock from another institution. An investment banker
arranges the transaction.
e. IBM sells 2,000,000 shares of treasury stock to its employees when they exercise options that were granted in
prior years.
Answer: c
21.
What is the opportunity cost of Project A if it is expected to yield 10%, while the yields from other projects range from
6.5% to 11.5% with the mean 9% and 5% standard deviation?
a. 10%
b. 6.5%
c. 11.5%
d. 9%
e. 9.3%
Answer: c
The opportunities forgone in the choice of one expenditure over others
22.
You recently sold 200 shares of Disney stock, and the transfer was made through a broker. This is an example of:
a. A money market transaction.
b. A primary market transaction.
c. A secondary market transaction.
d. A futures market transaction.
e. An over-the-counter market transaction.
Answer: c
23.
Which of the following statements is CORRECT?
a. Hedge funds are legal in Europe and Asia, but they are not permitted to operate in the United States.
b. Hedge funds are legal in the United States, but they are not permitted to operate in Europe or Asia.
c. Hedge funds have more in common with investment banks than with any other type of financial institution.
d. Hedge funds have more in common with commercial banks than with any other type of financial institution.
e. Hedge funds are not as highly regulated as most other types of financial institutions. The justification for this light
regulation is that only "sophisticated" investors (i.e., those with high net worths and high incomes) are permitted
to invest in these funds, and such investors supposedly can do any necessary "due diligence" on their own rather
than have it done by the SEC or some other regulator.
Answer: e
24.
Which of the following statements is CORRECT?
a. While the distinctions are becoming blurred, investment banks generally specialize in lending money, whereas
commercial banks generally help companies raise capital from other parties.
b. The NYSE operates as an auction market, whereas Nasdaq is an example of a dealer market.
c. Money market mutual funds usually invest their money in a well-diversified portfolio of liquid common stocks.
d. Money markets are markets for long-term debt and common stocks.
e. A liquid security is a security whose value is derived from the price of some other "underlying" asset.
Answer: b
25.
Dell has an inventory period of 1 month, and an account receivable period of 0 (zero) months. It also has a payable
period of 6 months. What are the cash conversion cycle period and the interest expense for Dell if they have annual net
total (credit) sales volume of $10 billion? The market interest rate is 6.0%.
a. -5.0, $-250 m
b. 6.0, $300m
c.
1.0, $100m
d. 3.0, $150m
e.
0.0, $100m
Answer: a
Cash conversion Cycle = inventory period + account receivable period – account payable period = 1 + 0 – 6 = -5.0.
Interest expense = $10 billion * 0.06 * (5/12) = $250 million