Financial Management: Comprehensive Final Exam
Fall 2008
Instructor: Jim Wehrley
Show Your Work!
Phase 1 of 3: Financial Foundation (mandatory)
1. (10 points) Develop the three following statements from the information provided
below: 1) 12/31/06 Balance Sheet; 2) 12/31/07 Balance Sheet; and 3) Fiscal Year
2007 Income Statement (Jan 1, 2007 - December 31, 2007). All the major classification
categories (e.g., current assets, gross profit) should be used.
At fiscal year end, December 31, 2006, Denver Clothing Retail, Inc. has $10,000 cash,
$1,000 in short term debt, $45,000 in inventory, $30,000 Accounts Payable, $49,000 long
term mortgage loan due in 2015, and $75,000 Property Plant and Equipment.
For the next fiscal year ending December 31, 2007, the company's sales equaled
$400,000. The cost of the clothing sold equaled $200,000 and selling general and
administrative expense equaled $100,000.
For simplification, there is no depreciation expense. The $49,000 and $1,000 debt stayed
the same all year. The company keeps its cash in a non-interest bearing checking
account. The interest rate was 10% for both loans. The income tax rate equaled 50%.
The company paid a $7,500 dividend at the end of fiscal year December 31, 2007. As of
December 31, 2007, all balance sheet items remained the same unless information is
provided that would change a category.
Phase 2 of 3: Financial Management: Comprehensive Final Exam
Fall 2008
Show Your Work!
Problems (2 points each)—Answer 15 of 23. Please cross out the questions you do
not want graded.
1. You deposit $100 in a bank on January 1, 2000 and you want to find the value of that
deposit January 1, 2006. If the interest rate is 5% annually, what is the future value of the
deposit on January 1, 2006?
2. You deposit $100 in a bank on January 1, 2000. If the interest rate is 5% nominal
annual rate, compounded quarterly, what is the future value of the deposit on January 1,
2006?
3. You have $15,000 in cash. You expect inflation to equal 12 percent for the next 15
years. How much cash will you need in 15 years to equal the buying power of the current
$15,000?
4. You notice that all your neighbors seem to need various items (e.g., tree limbs,
construction debris) hauled away. You are thinking of buying a dump truck for $35,000.
You estimate you could generate $10,000 a year cash flow (end of year) after paying for
all expenses including hiring someone to drive the truck. The estimated life of the truck
is 7 years with no salvage value. You would like an annual return of 12%. Should you
buy the dump truck? Explain.
5. Cemex, a large cement provider, issued a 10 percent coupon interest rate, 10-year
bond with a $1,000 par value. The market rate for a bond like this (risk level of company
and maturity rate) is 11 percent. How much should these bonds sell for in the
marketplace?
6. Alligators R Us is contemplating expansion through the issuance of debt/bonds. Your
broker calls you and suggests that you buy 10 bonds—price $1,150 for each bond, 11
percent coupon rate, $1,000 par value, interest paid annually. The bonds mature in 12
years. Calculate the Yield-to-Maturity (YTM) of these bonds.
For question 7 and 8, assume the company has a cost of capital of 10 percent, cost of debt
of 7 percent, and cost of equity of 12 percent.
Year
Initial Investment
(Year 0)
Year 1
Year 2
Year 3
Year 4
Year 5
Project A Cash Flows
($840,000)
$280,000
$280,000
$280,000
$280,000
$280,000
7. What is the NPV of project A? Is the project acceptable? Why?
8. What is the IRR of Project A? Is the project acceptable? Why?
9. Project the company’s 2009 sales, gross profit, and earnings per share (EPS). 2007
sales = $1,000 and sales are expected to grow 20% annually. Going forward, you expect
the gross profit margin to equal 40% and the net profit margin to equal 5%. The
company has 100 shares outstanding.
2009 (not 2008)
Projection
Sales
Gross Profit
EPS
10. You have a job offer from two firms. A) $20,000.00 per year (paid at the end of
year) with a $3,000 signing bonus. B) $22,000 per year (paid at the end of year) with no
signing bonus. If you anticipate staying at your first job for three years, which firm
would you go with? (Use an 8% discount rate)
11. Your great grandpa paid $100 a year (end of year) for 30 years for his life insurance
policy. He died the last day he made his payment. The day he died, the life insurance
company paid out the $6,000.00 value of the policy. If the life insurance company earned
a 10% annual return on the $100 annual payments, how much did the life insurance
company make off of your grandpa's life insurance policy? (Hint: compare the annuity
with the $6,000 at time period 30)
12. Your philosophy is to double your money every three years. If you accomplish this,
what is your annual rate of return?
13. Your uncle would like you to invest in a start-up company. He claims your portion
of the investment would be worth $2,000,000 in ten years. If you would like a 15 percent
annual return, how much would you be willing to invest today?
14. Your uncle would like you to invest in a start-up company. He claims your portion
of the investment would be worth $2,000,000 in ten years. If you invest $700,000, what
is your expected annual return?
15. If the inflation rate is 8 percent per year for 5 years, how much money do you need in
5 years to equal $1 today?
16. A major business publication reported a 24% annual rate of inflation based on a
recent 2% monthly increase in the CPI (consumer price index). What is the correct or
effective annual rate of increase?
17. Calculate the value (i.e., stock price) of a stock given the following information:
Current dividend (time period 0) = $3 per share, growth rate of dividend = 5% per year,
PE ratio = 10, EPS = $4, and required return equals 8%. Solve using the Gordon Growth
Model
Fiscal Year End
2006—
12/31/06 at
11:58 p.m.
Transaction: 12/31/06 11:59 p.m.
Obtain a $400 long term loan and
buy back $400 of stock (i.e., buy
back or reduce stock)
Total Assets
$2,000
Total Liabilities
$800
Equity
Sales
$2,000
Net Income
$100
Shares
400
Note: Above boxes will not be part of the grade; however, filling in the boxes may help
you develop your answers.
Use the table above to answer questions 18 and 19.
18. Using the current ratio as a measure of liquidity, will the transaction improve
liquidity? Explain.
19. Using the Return on Equity (ROE) ratio as a measure of performance, will the
transaction improve the company’s performance? Explain.
20. The goal is for your company to earn net income of $400,000. You expect your net
profit margin to equal 5 percent. Revenue must equal how much to reach your goal?
21. The goal is for your company’s annual EPS (Earnings Per Share) to equal $5.00.
There are 1,000 shares outstanding. Sales are expected to reach $200,000 per year. What
does your net profit margin have to equal to reach your goal?
22. The gross profit margin for ABC Co. equals _________. If the industry average
gross profit margin equals 50%, does ABC Co. have a strong gross profit margin?
ABC Co
Income Statement
Sales
Cost of Goods Sold
Gross Profit
Operating Expenses
SGA
Operating Income
Other Inc (Expense)
EBIT
Interest Expense
Earnings Before Tax
Income Tax (benefit)
Net Income
Average Shares
Outstanding
YE 2007
$2,000,000 100.00%
$900,000
45.00%
$1,100,000
$400,000
$700,000
$0
$700,000
$20,000
$680,000
$136,000
$544,000
10,000
23. Calculate the value (i.e., stock price) of a stock given the following information:
Current dividend (time period 0) = $3 per share, growth rate of dividend = 5% per year,
PE ratio = 10, EPS = $4, and required return equals 8%. Solve using the PE ratio
Phase 3 of 3: Financial Management: Comprehensive Final Exam
(3 points each): Answer 20 of the 25 questions in this section. Please cross out
the questions you do not want me to grade.
1. List three decisions a company could make to increase its financial leverage?
2. A company retires $100 of long-term debt and issues $100 of stock. How does the
current ratio change? Explain.
3. A company buys a building for $1 million. In order to buy the building, the
company uses $500,000 of cash and sells another building for $500,000. How does
the debt ratio change? Explain.
4. A company has a debt ratio of .1 and times interest earned ratio of 1.0. The
financial manager goes to the bank and takes out a loan. The debt ratio is now .9. Do
you think the company’s cost of debt (%) will increase? Explain.
5. How might a financial manager use the yield curve to help him/her determine what
financing alternatives to use?
6. What is the importance of a company’s stock price if a company is considering a
secondary offering (issuing stock)? Explain your answer.
7. The stock price of Starbucks increased from $40 per share to $45 per share? How
does the company’s capital structure change? Explain.
8. How does a commercial lender at a bank or other financial institution determine
whether a company should be approved for a commercial (i.e., business) loan? Hint:
The seven 7 C’s of lending may help you answer this questions-- Credit, Capacity,
Capital, Character, Conditions, Collateral, and Commitment.
9. A company’s ROE and ROA are the same. What does this tell you about the
company’s capital structure?
10. A company’s average age of inventory is increasing and gross profit margin is
decreasing. Why or how might this happen?
11. Define covenant. What could happen if a company violates its covenants?
12. If a company does not have strong liquidity, is it a good candidate for retiring or
buying back stock? Explain.
13. If a company is raising funds and adjusting its capital structure by issuing more
stock, what is the importance of the stock price?
14. A company would like to finance inventory. What type of debt or loan would you
recommend?
15. Provide an example of each of the types of risk listed below:
a.
Business
b.
Liquidity
c.
Default
d.
Market
e.
Interest rate
f.
Purchasing power.
16. You own 100% (1,000 shares) of XYZ, Inc.. You purchased all the shares for $100
per share when the company went public. The company needs more capital ($100,000)
and is going to have a secondary offering. If the stock price is $40 per share for the
secondary offering and you don’t buy any of the new shares, what percentage ownership
will you have in the company after the secondary offering is complete?
17. Complete one column in the table below. Answer either increase, decrease, or no
change.
Return on Equity (ROE)
Earnings Per Share (EPS)
Debt Ratio (TL/TA)
Liquidity
Dividend Payment
A=
C=
E=
G=
Buyback Stock
B=
D=
F=
H=
Explain your EPS answer to either C or D.
18. If a company has too much debt, how would it affect a) cost of debt, b) cost of
equity, and c) the overall cost of capital? Explain
19. If a company has too little debt, how would it affect a) cost of debt, b) cost of equity,
and c) the overall cost of capital?
20. Which is a riskier investment from an investor perspective, bond or stock? Explain.
21. Which type of financing is more expensive for a company, debt/bond financing or
stock financing? Explain.
22.
Current
Total Assets
Total
Liabilities
Equity
Net Income
Shares
Outstanding
EPS ($x.xx)
ROE (x.xx%)
You own 100
shares, what
% of the
company do
you own?
Scenario 1
Scenario 2
Buy back
200 shares
at a stock
price of
$50.00
Buy back
500 shares
at a stock
price of
$20.00
Scenario 3
Issue 200
Shares
(secondary
offering) at a
stock price
of $50.00
Scenario 4
Issue 500
shares at a
stock price
of $20.00
$50,000
$20,000
$30,000
$3,000
1,000
23. What are the lessons from the prior question?
24. Why don’t companies simply buy back as many shares as possible when their stock
price is low?
25.
a. List three reasons why companies may complete a cash budget.
b. Analyze the cash budget on the following page. Note: you must complete the cash
budget before analyzing the budget. Cash Budgeting assumptions
1. Sales: March $40,000; April $40,000; May $60,000; June $80,000; July $200,000
2. Sales: 25% for cash, 50% collected in one month, 25% in 2 months
3. Other cash receipts: $0 per month
4. No Accounts Payable: cash purchases: May $50,000, June $50,000, July $50,000
5. Rent: $5,000 per month
6. Wages and Salaries: May, $10,000; June, $10,000; July, $10,000
7. Tax Payment: June, $10,000
8. Purchase Equipment: July, $10,000
9. No interest due during the 3 month period
10. Principal payment: July, $10,000
11. Beginning cash balance in May: $10,000
12. Minimum cash balance: $20,000
MAR
APR
MAY
JUN
JUL
MAR
APR
MAY
JUN
JUL
MAY
JUN
JUL
Sales
Collections
Cash
Lagged 1 month
Lagged 2 months
Other cash receipts
Total cash receipts
Purchases
Cash Purchases
Payments of A/P
Lagged 1 month
Lagged 2 months
Rent payments
Wages and Salaries
Tax payments
Fixed-asset outlays
Interest payments
Cash dividend payments
Principal payments
Total cash disbursements
Total cash receipts
Less: Total cash
disbursements
Net cash flow
Add: Beginning cash
Ending cash
Less: Minimum cash
balance
Excess cash balance OR
(Required total financing)