FIN 534 Week 1  Homework Chapter 1 to 17

Fin 534 (Week 1 Homework Assignment Chapter 1)

1. Which of the following statements is CORRECT?

a. One of the disadvantages of a sole proprietorship is that the proprietor is exposed to unlimited liability.

b. It is generally easier to transfer one’s ownership interest in a partnership than in a corporation.

c. One of the advantages of the corporate form of organization is that it avoids double taxation.

d. One of the advantages of a corporation from a social standpoint is that every stockholder has equal voting rights, i.e., “one person, one vote.”

e. Corporations of all types are subject to the corporate and personal income tax.

2. Which of the following would be most likely to lead to higher interest rates on all debt securities in the economy?

 a. Households start saving a larger percentage of their income.

b. Households start saving a larger percentage of their income.

c. The level of inflation begins to decline.

d. Corporations step up their expansion plans and thus increase their demand for capital.

e. The Federal Reserve uses monetary policy in an attempt to stimulate the economy.

 3. Which of the following statements is CORRECT?

a. If General Electric were to issue new stock this year it would be considered a secondary market transaction since the company already has stock outstanding.

b. Capital market transactions only include preferred stock and common stock transactions.

c. The distinguishing feature between spot markets versus futures markets transactions is the maturity of the investments. That is, spot market transactions involve securities that have maturities of less than one year, whereas futures markets transactions involve securities with maturities greater than one year.

d. Both NASDAQ “dealers” and NYSE “specialists” hold inventories of stocks.

e. An electronic communications network (ECN) is a physical location exchange.

4. Which of the following statements is CORRECT?

a. A good goal for a firm’s management is maximization of expected EPS.

b. Most business in the U.S. is conducted by corporations, and corporations’ popularity results primarily from their favorable tax treatment.

c. Because most stock ownership is concentrated in the hands of a relatively small segment of society, firms’ actions to maximize their stock prices have little benefit to society.

d. Corporations and partnerships have an advantage over proprietorships because a sole proprietor is exposed to unlimited liability, but the liability of all investors in the other types of businesses is more limited.

e. The potential exists for agency conflicts between stockholders and managers.

5. Which of the following statements is NOT CORRECT?

a. When a corporation’s shares are owned by a few individuals and are not traded on public markets, we say that the firm is “closely, or privately, held.”

b. “Going public” establishes a firm’s true intrinsic value, and it also insures that a highly liquid market will always exist for the firm’s shares.

c. When stock in a closely held corporation is offered to the public for the first time, the transaction is called “going public,” and the market for such stock is called the new issue market.

d. Publicly owned companies have shares owned by investors who are not associated with management, and public companies must register with and report to a regulatory agency such as the SEC.

e. It is possible for a firm to go public and yet not raise any additional new capital at the time.

 

FIN 534 – Homework Chapter 2

1. Which of the following statements is CORRECT?

a. Typically, a firm’s DPS should exceed its EPS.

b. Typically, a firm’s EBIT should exceed its EBITDA.

c. If a firm is more profitable than average (e.g., Google), we would normally expect to see its stock price exceed its book value per share.

d. If a firm is more profitable than most other firms, we would normally expect to see its book value per share exceed its stock price, especially after several years of high inflation.

e. The more depreciation a firm has in a given year, the higher its EPS, other things held constant.

2. Which of the following statements is CORRECT?

a. The statement of cash flows reflects cash flows from operations, but it does not reflect the effects of buying or selling fixed assets.

b. The statement of cash flows shows where the firm’s cash is located; indeed, it provides a listing of all banks and brokerage houses where cash is on deposit.

c. The statement of cash flows reflects cash flows from continuing operations, but it does not reflect the effects of changes in working capital.

d. The statement of cash flows reflects cash flows from operations and from borrowings, but it does not reflect cash obtained by selling new common stock.

e. The statement of cash flows shows how much the firm’s cash–the total of currency, bank deposits, and short-term liquid securities (or cash equivalents)–increased or decreased during a given year.

3. Which of the following statements is CORRECT?

a. Dividends paid reduce the net income that is reported on a company’s income statement.

b. If a company uses some of its bank deposits to buy short-term, highly liquid marketable securities, this will cause a decline in its current assets as shown on the balance sheet.

c. If a company issues new long-term bonds during the current year, this will increase its reported current liabilities at the end of the year.

d. Accounts receivable are reported as a current liability on the balance sheet.

e. If a company pays more in dividends than it generates in net income, its retained earnings as reported on the balance sheet will decline from the previous year’s balance.

4. Last year Roussakis Company’s operations provided a negative net cash flow, yet the cash shown on its balance sheet increased. Which of the following statements could explain the increase in cash, assuming the company’s financial statements were prepared under generally accepted accounting principles?

a. The company repurchased some of its common stock.

b. The company dramatically increased its capital expenditures.

c. The company retired a large amount of its long-term debt.

d. The company sold some of its fixed assets.

e. The company had high depreciation expenses.

5. Bartling Energy Systems recently reported $9,250 of sales, $5,750 of operating costs other than depreciation, and $700 of depreciation. The company had no amortization charges, it had $3,200 of outstanding bonds that carry a 5% interest rate, and its federal-plus-state income tax rate was 35%. In order to sustain its operations and thus generate sales and cash flows in the future, the firm was required to make $1,250 of capital expenditures on new fixed assets and to invest $300 in net operating working capital. By how much did the firm’s net income exceed its free cash flow?

a. $673.27

b. $708.70

c. $746.00

d. $783.30

e. $822.47

 

 

Homework Week 2 Chapter 3

1. Which of the following statements is CORRECT?

a. The ratio of long-term debt to total capital is more likely to experience seasonal fluctuations than is either the DSO or the inventory turnover ratio.

b. If two firms have the same ROA, the firm with the most debt can be expected to have the lower ROE.

c. An increase in the DSO, other things held constant, could be expected to increase the total assets turnover ratio.

d. An increase in the DSO, other things held constant, could be expected to increase the ROE.

e. An increase in a firm’s debt ratio, with no changes in its sales or operating costs, could be  expected to lower the profit margin.

2. Companies HD and LD have the same tax rate, sales, total assets, and basic earning power. Both companies have positive net incomes.  Company HD has a higher debt ratio and, therefore, a higher interest expense. Which of the following statements is CORRECT?

a. Company HD has a lower equity multiplier.

b. Company HD has more net income.

c. Company HD pays more in taxes.

d. Company HD has a lower ROE.

e. Company HD has a lower times interest earned (TIE) ratio.

3. Companies HD and LD have the same total assets, sales, operating costs, and tax rates, and they pay the same interest rate on their debt.  However, company HD has a higher debt ratio. Which of the following statements is CORRECT?

a. Given this information, LD must have the higher ROE.

b. Company LD has a higher basic earning power ratio (BEP).

c. Company HD has a higher basic earning power ratio (BEP).

d. If the interest rate the companies pay on their debt is more than their basic earning power (BEP), then Company HD will have the higher ROE.

e. If the interest rate the companies pay on their debt is less than their basic earning power (BEP), then Company HD will have the higher ROE.

4.  Muscarella Inc. has the following balance sheet and income statement data:

Cash $ 14,000 Accounts payable $ 42,000

Receivables  70,000 Other current liabilities 28,000

Inventories 210,000 Total CL $ 70,000

Total CA $294,000 Long-term debt  70,000

Net fixed assets 126,000 Common equity 280,000

Total assets $420,000 Total liab. and equity $420,000

Sales $280,000

Net income $ 21,000

The new CFO thinks that inventories are excessive and could be lowered sufficiently to cause the

current ratio to equal the industry average, 2.70, without affecting either sales or net income. 

Assuming that inventories are sold off and not replaced to get the current ratio to the target level,

and that the funds generated are used to buy back common stock at book value, by how much

would the ROE change?

a. 4.28%

b. 4.50%

c. 4.73%

d. 4.96%

e. 5.21%

5.  Quigley Inc. is considering two financial plans for the coming year.  Management expects sales to be $301,770, operating costs to be $266,545, assets to be $200,000, and its tax rate to be 35%.  Under Plan A it would use 25% debt and 75% common equity.  The interest rate on the debt would be 8.8%, but the TIE ratio would have to be kept at 4.00 or more.  Under Plan B the maximum debt that met the TIE constraint would be employed.  Assuming that sales, operating costs, assets, the interest rate, and the tax rate would all remain constant, by how much would the ROE change in response to the change in the capital structure?

a. 3.83%

b. 4.02%

c. 4.22%

d. 4.43%

e. 4.65%

 

FIN 534 – Homework Chapter 4

1. A $50,000 loan is to be amortized over 7 years, with annual end-of-year payments. Which of these statements is CORRECT?

a. The annual payments would be larger if the interest rate were lower.

b. If the loan were amortized over 10 years rather than 7 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 7-year amortization plan.

c. The proportion of each payment that represents interest as opposed to repayment of principal would be lower if the interest rate were lower.

d. The last payment would have a higher proportion of interest than the first payment.

e. The proportion of interest versus principal repayment would be the same for each of the 7 payments.

2. Which of the following statements is CORRECT?

a. If you have a series of cash flows, each of which is positive, you can solve for I, where the solution value of I causes the PV of the cash flows to equal the cash flow at Time 0.

b. If you have a series of cash flows, and CF0 is negative but each of the following CFs is positive, you can solve for I, but only if the sum of the undiscounted cash flows exceeds the cost.

c. To solve for I, one must identify the value of I that causes the PV of the positive CFs to equal the absolute value of the PV of the negative CFs. This is, essentially, a trial-and-error procedure that is easy with a computer or financial calculator but quite difficult otherwise.

d. If you solve for I and get a negative number, then you must have made a mistake.

e. If CF0 is positive and all the other CFs are negative, then you cannot solve for I.

3. Riverside Bank offers to lend you $50,000 at a nominal rate of 6.5%, compounded monthly. The loan (principal plus interest) must be repaid at the end of the year. Midwest Bank also offers to lend you the $50,000, but it will charge an annual rate of 7.0%, with no interest due until the end of the year. How much higher or lower is the effective annual rate charged by Midwest versus the rate charged by Riverside?

a. 0.52%

b. 0.44%

c. 0.36%

d. 0.30%

e. 0.24%

 4. Steve and Ed are cousins who were both born on the same day, and both turned 25 today. Their grandfather began putting $2,500 per year into a trust fund for Steve on his 20th birthday, and he just made a 6th payment into the fund. The grandfather (or his estate’s trustee) will make 40 more $2,500 payments until a 46th and final payment is made on Steve’s 65th birthday. The grandfather set things up this way because he wants Steve to work, not be a “trust fund baby,” but he also wants to ensure that Steve is provided for in his old age.

Until now, the grandfather has been disappointed with Ed, hence has not given him anything. However, they recently reconciled, and the grandfather decided to make an equivalent provision for Ed. He will make the first payment to a trust for Ed today, and he has instructed his trustee to make 40 additional equal annual payments until Ed turns 65, when the 41st and final payment will be made. If both trusts earn an annual return of 8%, how much must the grandfather put into Ed’s trust today and each subsequent year to enable him to have the same retirement nest egg as Steve after the last payment is made on their 65th birthday?

a. $3,726

b. $3,912

c. $4,107

d. $4,313

e. $4,528

5. John and Daphne are saving for their daughter Ellen’s college education. Ellen just turned 10 at (), and she will be entering college 8 years from now (at ). College tuition and expenses at State U. are currently $14,500 a year, but they are expected to increase at a rate of 3.5% a year. Ellen should graduate in 4 years–if she takes longer or wants to go to graduate school, she will be on her own. Tuition and other costs will be due at the beginning of each school year (at , 9, 10, and 11).So far, John and Daphne have accumulated $15,000 in their college savings account (at ). Their long-run financial plan is to add an additional $5,000 in each of the next 4 years (at , 2, 3, and 4). Then they plan to make 3 equal annual contributions in each of the following years, , 6, and 7. They expect their investment account to earn 9%. How large must the annual payments at , 6, and 7 be to cover Ellen’s anticipated college costs?

a. $1,965.21

b. $2,068.64

c. $2,177.51

d. $2,292.12

e. $2,412.76

 

FIN 534 – Homework Chapter 5

1. Three $1,000 face value bonds that mature in 10 years have the same level of risk, hence their YTMs are equal. Bond A has an 8% annual coupon, Bond B has a 10% annual coupon, and Bond C has a 12% annual coupon. Bond B sells at par. Assuming interest rates remain constant for the next 10 years, which of the following statements is CORRECT?

a. Bond A’s current yield will increase each year.

b. Since the bonds have the same YTM, they should all have the same price, and since interest rates are not expected to change, their prices should all remain at their current levels until maturity.

c. Bond C sells at a premium (its price is greater than par), and its price is expected to increase over the next year.

d. Bond A sells at a discount (its price is less than par), and its price is expected to increase over the next year.

e. Over the next year, Bond A’s price is expected to decrease, Bond B’s price is expected to stay the same, and Bond C’s price is expected to increase.

2. Which of the following statements is CORRECT?

a. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is below the coupon rate than if it is above the coupon rate.

b. A callable 10-year, 10% bond should sell at a higher price than an otherwise similar non-callable bond.

c. Corporate treasurers dislike issuing callable bonds because these bonds may require the company to raise additional funds earlier than would be true if non-callable bonds with the same maturity were used.

d. Two bonds have the same maturity and the same coupon rate. However, one is callable and the other is not. The difference in prices between the bonds will be greater if the current market interest rate is above the coupon rate than if it is below the coupon rate.

e. The actual life of a callable bond will always be equal to or less than the actual life of a non-callable bond with the same maturity. Therefore, if the yield curve is upward sloping, the required rate of return will be lower on the callable bond.

3. Which of the following statements is CORRECT?

a. Assume that two bonds have equal maturities and are of equal risk, but one bond sells at par while the other sells at a premium above par. The premium bond must have a lower current yield and a higher capital gains yield than the par bond.

b. A bond’s current yield must always be either equal to its yield to maturity or between its yield to maturity and its coupon rate.

c. If a bond sells at par, then its current yield will be less than its yield to maturity.

d. If a bond sells for less than par, then its yield to maturity is less than its coupon rate.

e. A discount bond’s price declines each year until it matures, when its value equals its par value.

4. Suppose a new company decides to raise a total of $200 million, with $100 million as common equity and $100 million as long-term debt. The debt can be mortgage bonds or debentures, but by an iron-clad provision in its charter, the company can never raise any additional debt beyond the original $100 million. Given these conditions, which of the following statements is CORRECT?

a. The higher the percentage of debt represented by mortgage bonds, the riskier both types of bonds will be and, consequently, the higher the firm’s total dollar interest charges will be.

b. If the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds, we could be certain that the firm’s total interest expense would be lower than if the debt were raised by issuing $100 million of debentures.

c. In this situation, we cannot tell for sure how, or whether, the firm’s total interest expense on the $100 million of debt would be affected by the mix of debentures versus first mortgage bonds. The interest rate on each of the two types of bonds would increase as the percentage of mortgage bonds used was increased, but the result might well be such that the firm’s total interest charges would not be affected materially by the mix between the two.

d. The higher the percentage of debentures, the greater the risk borne by each debenture, and thus the higher the required rate of return on the debentures.

e. If the debt were raised by issuing $50 million of debentures and $50 million of first mortgage bonds, we could be certain that the firm’s total interest expense would be lower than if the debt were raised by issuing $100 million of first mortgage bonds.

5. Cosmic Communications Inc. is planning two new issues of 25-year bonds. Bond Par will be sold at its $1,000 par value, and it will have a 10% semiannual coupon. Bond OID will be an Original Issue Discount bond, and it will also have a 25-year maturity and a $1,000 par value, but its semiannual coupon will be only 6.25%. If both bonds are to provide investors with the same effective yield, how many of the OID bonds must Cosmic issue to raise $3,000,000? Disregard flotation costs, and round your final answer up to a whole number of bonds.

a. 4,228

b. 4,337

c. 4,448

d. 4,562

e. 4,676

 

 

FIN 534 Homework Chapter 6

 1. Which of the following statements is CORRECT?

 a. If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.

 b. If you were restricted to investing in publicly traded common stocks, yet you wanted to minimize the riskiness of your portfolio as measured by its beta, then according to the CAPM theory you should invest an equal amount of money in each stock in the market. That is, if there were 10,000 traded stocks in the world, the least risky possible portfolio would include some shares of each one.

 c. If you formed a portfolio that consisted of all stocks with betas less than 1.0, which is about half of all stocks, the portfolio would itself have a beta coefficient that is equal to the weighted average beta of the stocks in the portfolio, and that portfolio would have less risk than a portfolio that consisted of all stocks in the market.

 d. Market risk can be eliminated by forming a large portfolio, and if some Treasury bonds are held in the portfolio, the portfolio can be made to be completely riskless.

 e. A portfolio that consists of all stocks in the market would have a required return that is equal to the riskless rate.

 2. Jane has a portfolio of 20 average stocks, and Dick has a portfolio of 2 average stocks. Assuming the market is in equilibrium, which of the following statements is CORRECT?

 a. Jane’s portfolio will have less diversifiable risk and also less market risk than Dick’s portfolio.

 b. The required return on Jane’s portfolio will be lower than that on Dick’s portfolio because Jane’s portfolio will have less total risk.

 c. Dick’s portfolio will have more diversifiable risk, the same market risk, and thus more total risk than Jane’s portfolio, but the required (and expected) returns will be the same on both portfolios.

 d. If the two portfolios have the same beta, their required returns will be the same, but Jane’s portfolio will have less market risk than Dick’s.

 e. The expected return on Jane’s portfolio must be lower than the expected return on Dick’s portfolio because Jane is more diversified.

 3. Stock X has a beta of 0.7 and Stock Y has a beta of 1.3. The standard deviation of each stock’s returns is 20%. The stocks’ returns are independent of each other, i.e., the correlation coefficient, r, between them is zero. Portfolio P consists of 50% X and 50% Y. Given this information, which of the following statements is CORRECT?

 a. Portfolio P has a standard deviation of 20%.

 b. The required return on Portfolio P is equal to the market risk premium (rM − rRF).

c. Portfolio P has a beta of 0.7.

 d. Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF.

e. Portfolio P has the same required return as the market (rM). 

4. Which of the following statements is CORRECT?

 a. When diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market.

 b. Portfolio diversification reduces the variability of returns on an individual stock.

 c. Risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihoods of unfavorable events.

 d. The SML relates a stock’s required return to its market risk. The slope and intercept of this line cannot be controlled by the firms’ managers, but managers can influence their firms’ positions on the line by such actions as changing the firm’s capital structure or the type of assets it employs.

 e. A stock with a beta of -1.0 has zero market risk if held in a 1-stock portfolio.

 5. Which of the following statements is CORRECT?

 a. If Mutual Fund A held equal amounts of 100 stocks, each of which had a beta of 1.0, and Mutual Fund B held equal amounts of 10 stocks with betas of 1.0, then the two mutual funds would both have betas of 1.0. Thus, they would be equally risky from an investor’s standpoint, assuming the investor’s only asset is one or the other of the mutual funds.

b. If investors become more risk averse but rRF does not change, then the required rate of return on high-beta stocks will rise and the required return on low-beta stocks will decline, but the required return on an average-risk stock will not change.

c. An investor who holds just one stock will generally be exposed to more risk than an investor who holds a portfolio of stocks, assuming the stocks are all equally risky. Since the holder of the 1-stock portfolio is exposed to more risk, he or she can expect to earn a higher rate of return to compensate for the greater risk.

d. There is no reason to think that the slope of the yield curve would have any effect on the slope of the SML.

e. Assume that the required rate of return on the market, rM, is given and fixed at 10%. If the yield curve were upward sloping, then the Security Market Line (SML) would have a steeper slope if 1-year Treasury securities were used as the risk-free rate than if 30-year Treasury bonds were used for rRF.

 

FIN 534 Week 4 Homework Chapter 7

 1. Which of the following statements is CORRECT?

a. The constant growth model takes into consideration the capital gains investors expect to earn on a stock.

b. Two firms with the same expected dividend and growth rates must also have the same stock price.

c. It is appropriate to use the constant growth model to estimate a stock’s value even if its growth rate is never expected to become constant.

d. If a stock has a required rate of return10 %, and if its dividend is expected to grow at a constant rate of 5%, this implies that the stock’s dividend yield is also 5%.

e. The price of a stock is the present value of all expected future dividends, discounted at the dividend growth rate.

2. Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?

 A B

 Price $25 $25

 Expected growth (constant) 10% 5%

 Required return 15% 15%

 a. Stock A’s expected dividend at is only half that of Stock B.

b. Stock A has a higher dividend yield than Stock B.

c. Currently the two stocks have the same price, but over time Stock B’s price will pass that of A.

d. Since Stock A’s growth rate is twice that of Stock B, Stock A’s future dividends will always be twice as high as Stock B’s.

e. The two stocks should not sell at the same price. If their prices are equal, then disequilibrium must exist.

3. Which of the following statements is CORRECT?

a. A major disadvantage of financing with preferred stock is that preferred stockholders typically have supernormal voting rights.

b. Preferred stock is normally expected to provide steadier, more reliable income to investors than the same firm’s common stock, and, as a result, the expected after-tax yield on the preferred is lower than the after-tax expected return on the common stock.

c. The preemptive right is a provision in all corporate charters that gives preferred stockholders the right to purchase (on a pro rata basis) new issues of preferred stock.

d. One of the disadvantages to a corporation of owning preferred stock is that 70% of the dividends received represent taxable income to the corporate recipient, whereas interest income earned on bonds would be tax free.

 Estimated %(must be changed to force Calculated Price to equal the Actual Market Price)$15.00Year012345Dividend growth rate (insert correct values)10%10%10%5%5%Calculated dividends (D0 has been paid)$1.00????? = D4/(rs − g4). Find using Estimatedrs. ?Total CFs???PVs of CFs when discounted at Estimatedrs???Calculated = Sum of PVs =$0.00 A positive number will be here when dividends are estimated. The Calculated Price will equal the Actual Market Price once the correct rs has been found.RapidgrowthActual Market Price, P0:Normal growth

e. One of the advantages to financing with preferred stock is that 70% of the dividends paid out are tax deductible to the issuer.

4. Church Inc. is presently enjoying relatively high growth because of a surge in the demand for its new product. Management expects earnings and dividends to grow at a rate of 25% for the next 4 years, after which competition will probably reduce the growth rate in earnings and dividends to zero, i.e., The company’s last dividend, D, was $1.25, its beta is 1.20, the market risk premium is 5.50%, and the risk-free rate is 3.00%. What is the current price of the common stock?

a. $26.77

b. $27.89

c. $29.05

d. $30.21

e. $31.42

5. Your boss, Sally Maloney, treasurer of Fred Clark Enterprises (FCE), asked you to help her estimate the intrinsic value of the company’s stock. FCE just paid a dividend of $1.00, and the stock now sells for $15.00 per share. Sally asked a number of security analysts what they believe FCE’s future dividends will be, based on their analysis of the company. The consensus is that the dividend will be increased by 10% during Years 1 to 3, and it will be increased at a rate of 5% per year in Year 4 and thereafter. Sally asked you to use that information to estimate the required rate of return on the stock, rs, and she provided you with the following template for use in the analysis.Sally told you that the growth rates in the template were just put in as a trial, and that you must replace them with the analysts’ forecasted rates to get the correct forecasted dividends and then the estimated TV. She also notes that the estimated value for rs, at the top of the template, is also just a guess, and you must replace it with a value that will cause the Calculated Price shown at the bottom to equal the Actual Market Price. She suggests that, after you have put in the correct dividends, you can manually calculate the price, using a series of guesses as to the Estimatedrs. The value of rs that causes the calculated price to equal the actual price is the correct one. She notes, though, that this trial-and-error process would be quite tedious, and that the correct rs could be found much faster with a simple Excel model, especially if you use Goal Seek. What is the value of rs?

a. 11.84%

b. 12.21%

c. 12.58%

d. 12.97%

e. 13.36%

 

FIN 534 Week 5 Homework Chapter 8

1. Which of the following statements is CORRECT?

a. Put options give investors the right to buy a stock at a certain strike price before a specified date.

b. Call options give investors the right to sell a stock at a certain strike price before a specified date.

c. Options typically sell for less than their exercise value.

d. LEAPS are very short-term options that were created relatively recently and now trade in the market.

e. An option holder is not entitled to receive dividends unless he or she exercises their option before the stock goes ex dividend.

2. Which of the following statements is CORRECT?

a. If the underlying stock does not pay a dividend, it makes good economic sense to exercise a call option as soon as the stock’s price exceeds the strike price by about 10%, because this permits the option holder to lock in an immediate profit.

b. Call options generally sell at a price less than their exercise value.[11] 

c. If a stock becomes riskier (more volatile), call options on the stock are likely to decline in value.

d. Call options generally sell at prices above their exercise value, but for an in-the-money option, the greater the exercise value in relation to the strike price, the lower the premium on the option is likely to be.

e. Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock.

3. Which of the following statements is CORRECT?

a. An option’s value is determined by its exercise value, which is the market price of the stock less its striking price. Thus, an option can’t sell for more than its exercise value.

b. As the stock’s price rises, the time value portion of an option on a stock increases because the difference between the price of the stock and the fixed strike price increases.

c. Issuing options provides companies with a low cost method of raising capital.

d. The market value of an option depends in part on the option’s time to maturity and also on the variability of the underlying stock’s price.[12] [13] 

e. The potential loss on an option decreases as the option sells at higher and higher prices because the profit margin gets bigger.

4. The current price of a stock is $22, and at the end of one year its price will be either $27 or $17. The annual risk-free rate is 6.0%, based on daily compounding. A 1-year call option on the stock, with an exercise price of $22, is available. Based on the binominal model, what is the option’s value?

a. $2.43

b. $2.70

c. $2.99

d. $3.29

e. $3.62

5. An analyst wants to use the Black-Scholes model to value call options on the stock of Ledbetter Inc. based on the following data:

The price of the stock is $40.

The strike price of the option is $40.

The option matures in 3 months ().

The standard deviation of the stock’s returns is 0.40, and the variance is 0.16.

The risk-free rate is 6%.

Given this information, the analyst then calculated the following necessary components of the Black-Scholes model:

d

d

N(d

1) = 0.56946

N(d

2) = 0.49003

N(d

1) and N(d2) represent areas under a standard normal distribution function. Using the Black-Scholes model, what is the value of the call option?

a. $2.81

b. $3.12

c. $3.47

d. $3.82

e. $4.20

 

FIN 534 Week 5 Homework Chapter 9

1. Bankston Corporation forecasts that if all of its existing financial policies are followed, its proposed capital budget would be so large that it would have to issue new common stock. Since new stock has a higher cost than retained earnings, Bankston would like to avoid issuing new stock. Which of the following actions would REDUCE its need to issue new common stock?

a. Increase the dividend payout ratio for the upcoming year.

b. Increase the percentage of debt in the target capital structure.

c. Increase the proposed capital budget.

d. Reduce the amount of short-term bank debt in order to increase the current ratio.

e. Reduce the percentage of debt in the target capital structure.

2. LaPango Inc. estimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of the following projects (A, B, and C) should the company accept?

a. Project B, which is of below-average risk and has a return of 8.5%.

b. Project C, which is of above-average risk and has a return of 11%.

c. Project A, which is of average risk and has a return of 9%.

d. None of the projects should be accepted.

e. All of the projects should be accepted.

3. Which of the following statements is CORRECT?

a. When calculating the cost of preferred stock, a company needs to adjust for taxes, because preferred stock dividends are deductible by the paying corporation.

b. All else equal, an increase in a company’s stock price will increase its marginal cost of retained earnings, rs.

c. All else equal, an increase in a company’s stock price will increase its marginal cost of new common equity, re.

d. Since the money is readily available, the after-tax cost of retained earnings is usually much lower than the after-tax cost of debt.

e. If a company’s tax rate increases but the YTM on its non-callable bonds remains the same, the after-tax cost of its debt will fall.

4. Which of the following statements is CORRECT?

a. Since debt capital can cause a company to go bankrupt but equity capital cannot, debt is riskier than equity, and thus the after-tax cost of debt is always greater than the cost of equity.

b. The tax-adjusted cost of debt is always greater than the interest rate on debt, provided the company does in fact pay taxes.

c. If a company assigns the same cost of capital to all of its projects regardless of each project’s risk, then the company is likely to reject some safe projects that it actually should accept and to accept some risky projects that it should reject.

d. Because no flotation costs are required to obtain capital as retained earnings, the cost of retained earnings is generally lower than the after-tax cost of debt.

e. Higher flotation costs tend to reduce the cost of equity capital.

5. Cranberry Corp. has two divisions of equal size: a computer manufacturing division and a data processing division. Its CFO believes that stand-alone data processor companies typically have a WACC of 8%, while stand-alone computer manufacturers typically have a 12% WACC. He also believes that the data processing and manufacturing divisions have the same risk as their typical peers. Consequently, he estimates that the composite, or corporate, WACC is 10%. A consultant has suggested using an 8% hurdle rate for the data processing division and a 12% hurdle rate for the manufacturing division. However, the CFO disagrees, and he has assigned a 10% WACC to all projects in both divisions. Which of the following statements is CORRECT?

a. While the decision to use just one WACC will result in its accepting more projects in the manufacturing division and fewer projects in its data processing division than if it followed the consultant’s recommendation, this should not affect the firm’s intrinsic value.

b. The decision not to adjust for risk means, in effect, that it is favoring the data processing division. Therefore, that division is likely to become a larger part of the consolidated company over time.

c. The decision not to adjust for risk means that the company will accept too many projects in the manufacturing division and too few in the data processing division. This will lead to a reduction in the firm’s intrinsic value over time.

d. The decision not to risk-adjust means that the company will accept too many projects in the data processing business and too few projects in the manufacturing business. This will lead to a reduction in its intrinsic value over time.

e. The decision not to risk adjust means that the company will accept too many projects in the manufacturing business and too few projects in the data processing business. This may affect the firm’s capital structure but it will not affect its intrinsic value.

 

FIN 534 Week 6 Homework Chapter 10

1. Which of the following statements is CORRECT?

a. The internal rate of return method (IRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.

b. The payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects.

c. The discounted payback method is generally regarded by academics as being the best single method for evaluating capital budgeting projects.

d. The net present value method (NPV) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.

e. The modified internal rate of return method (MIRR) is generally regarded by academics as being the best single method for evaluating capital budgeting projects.

2. Projects A and B have identical expected lives and identical initial cash outflows (costs). However, most of one project’s cash flows come in the early years, while most of the other project’s cash flows occur in the later years. The two NPV profiles are given below:

Which of the following statements is CORRECT?

a. More of Project A’s cash flows occur in the later years.

b. More of Project B’s cash flows occur in the later years.

c. We must have information on the cost of capital in order to determine which project has the larger early cash flows.

d. The NPV profile graph is inconsistent with the statement made in the problem.

e. The crossover rate, i.e., the rate at which Projects A and B have the same NPV

3. Suppose a firm relies exclusively on the payback method when making capital budgeting decisions, and it sets a 4-year payback regardless of economic conditions. Other things held constant, which of the following statements is most likely to be true?

a. It will accept too many short-term projects and reject too many long-term projects (as judged by the NPV).

b. It will accept too many long-term projects and reject too many short-term projects (as judged by the NPV).

c. The firm will accept too many projects in all economic states because a 4-year payback is too low.

d. The firm will accept too few projects in all economic states because a 4-year payback is too high.

e. If the 4-year payback results in accepting just the right set of projects under average economic conditions, then this payback will result in too few long-term projects when the economy is weak.

4. You are on the staff of Camden Inc. The CFO believes project acceptance should be based on the NPV, but Steve Camden, the president, insists that no project should be accepted unless its IRR exceeds the project’s risk-adjusted WACC. Now you must make a recommendation on a project that has a cost of $15,000 and two cash flows: $110,000 at the end of Year 1 and – $100,000 at the end of Year 2. The president and the CFO both agree that the appropriate WACC for this project is 10%. At 10%, the NPV is $2,355.37, but you find two IRRs, one at 6.33% and one at 527%, and a MIRR of 11.32%. Which of the following statements best describes your optimal recommendation, i.e., the analysis and recommendation that is best for the company and least likely to get you in trouble with either the CFO or the president?

a. You should recommend that the project be rejected because its NPV is negative and its IRR is less than the WACC.

b. You should recommend that the project be rejected because, although its NPV is positive, it has an IRR that is less than the WACC.

c. You should recommend that the project be accepted because (1) its NPV is positive and (2) although it has two IRRs, in this case it would be better to focus on the MIRR, which exceeds the WACC. You should explain this to the president and tell him that the firm’s value will increase if the project is accepted.

d. You should recommend that the project be rejected. Although its NPV is positive it has two IRRs, one of which is less than the WACC, which indicates that the firm’s value will decline if the project is accepted.

e. You should recommend that the project be rejected because, although its NPV is positive, its MIRR is less than the WACC, and that indicates that the firm’s value will decline if it is accepted.

5. A firm is considering Projects S and L, whose cash flows are shown below. These projects are mutually exclusive, equally risky, and not repeatable. The CEO wants to use the IRR criterion, while the CFO favors the NPV method. You were hired to advise the firm on the best procedure. If the wrong decision criterion is used, how much potential value would the firm lose?

WACC: 6.00%

Year 0 1 2 3 4

CFS -$1,025 $380 $380 $380 $380

CFL -$2,150 $765 $765 $765 $765

a. $188.68

b. $198.61

c. $209.07

d. $219.52

e. $230.49

 

FIN 534 Week 6 Homework Chapter 11

1. Which of the following statements is CORRECT?

a. An externality is a situation where a project would have an adverse effect on some other part of the firm’s overall operations. If the project would have a favorable effect on other operations, then this is not an externality.

b. An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank’s other offices to decline.

c. The NPV method automatically deals correctly with externalities, even if the externalities are not specifically identified, but the IRR method does not. This is another reason to favor the NPV.

d. Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not specifically identified. However, the payback method does not.

e. Identifying an externality can never lead to an increase in the calculated NPV.

2. Taussig Technologies is considering two potential projects, X and Y. In assessing the projects’ risks, the company estimated the beta of each project versus both the company’s other assets and the stock market, and it also conducted thorough scenario and simulation analyses. This research produced the following data:

Project X Project Y

Expected NPV $350,000 $350,000

Standard deviation (σ

NPV) $100,000 $150,000

Project beta (vs. market) 1.4 0.8

Correlation of the project cash flows with cash flows from currently existing projects. Cash flows are not correlated with the cash flows from existing projects. Cash flows are highly correlated with the cash flows from existing projects.

Which of the following statements is CORRECT?

a. Project X has more stand-alone risk than Project Y.

b. Project X has more corporate (or within-firm) risk than Project Y.

c. Project X has more market risk than Project Y.

d. Project X has the same level of corporate risk as Project Y.

e. Project X has less market risk than Project Y.

3. Which of the following statements is CORRECT?

a. If an asset is sold for less than its book value at the end of a project’s life, it will generate a loss for the firm, hence its terminal cash flow will be negative.

b. Only incremental cash flows are relevant in project analysis, the proper incremental cash flows are the reported accounting profits, and thus reported accounting income should be used as the basis for investor and managerial decisions.

c. It is unrealistic to believe that any increases in net working capital required at the start of an expansion project can be recovered at the project’s completion. Working capital like inventory is almost always used up in operations. Thus, cash flows associated with working capital should be included only at the start of a project’s life.

d. If equipment is expected to be sold for more than its book value at the end of a project’s life, this will result in a profit. In this case, despite taxes on the profit, the end-of-project cash flow will be greater than if the asset had been sold at book value, other things held constant.

e. Changes in net working capital refer to changes in current assets and current liabilities, not to changes in long-term assets and liabilities. Therefore, changes in net working capital should not be considered in a capital budgeting analysis.

4. Temple Corp. is considering a new project whose data are shown below. The equipment that would be used has a 3-year tax life, would be depreciated by the straight-line method over its 3- year life, and would have a zero salvage value. No new working capital would be required. Revenues and other operating costs are expected to be constant over the project’s 3-year life. What is the project’s NPV?

Risk-adjusted WACC 10.0%

Net investment cost (depreciable basis) $65,000

Straight-line deprec.rate 33.3333%

Sales revenues, each year $65,500

Operating costs (excl. deprec.), each year $25,000

Tax rate 35.0%

a. $15,740

b. $16,569

c. $17,441

d. $18,359

e. $19,325

5. Florida Car Wash is considering a new project whose data are shown below. The equipment to be used has a 3-year tax life, would be depreciated on a straight-line basis over the project’s 3- year life, and would have a zero salvage value after Year 3. No new working capital would be required. Revenues and other operating costs will be constant over the project’s life, and this is just one of the firm’s many projects, so any losses on it can be used to offset profits in other units. If the number of cars washed declined by 40% from the expected level, by how much would the project’s NPV decline? (Hint: Note that cash flows are constant at the Year 1 level, whatever that level is.)

WACC 10.0%

Net investment cost (depreciable basis) $60,000

Number of cars washed 2,800

Average price per car $25.00

Fixed op. cost (excl. deprec.) $10,000

Variable op. cost/unit (i.e., VC per car washed) $5.375

Annual depreciation $20,000

Tax rate 35.0%

a. $28,939

b. $30,462

c. $32,066

d. $33,753

e. $35,530

 

FIN 534 Week 7 Homework Chapter 12

1. Which of the following statements is CORRECT?

a. Perhaps the most important step when developing forecasted financial statements is to determine the breakdown of common equity between common stock and retained earnings.

b. The first, and perhaps the most critical, step in forecasting financial requirements is to forecast future sales.

c. Forecasted financial statements, as discussed in the text, are used primarily as a part of the managerial compensation program, where management’s historical performance is evaluated.

d. The capital intensity ratio gives us an idea of the physical condition of the firm’s fixed assets.

e. The AFN equation produces more accurate forecasts than the forecasted financial statement method, especially if fixed assets are lumpy, economies of scale exist, or if excess capacity exists.

2. Which of the following statements is CORRECT?

a. The sustainable growth rate is the maximum achievable growth rate without the firm having to raise external funds. In other words, it is the growth rate at which the firm’s AFN equals zero.

b. If a firm’s assets are growing at a positive rate, but its retained earnings are not increasing, then it would be impossible for the firm’s AFN to be negative.

c. If a firm increases its dividend payout ratio in anticipation of higher earnings, but sales and earnings actually decrease, then the firm’s actual AFN must, mathematically, exceed the previously calculated AFN.

d. Higher sales usually require higher asset levels, and this leads to what we call AFN. However, the AFN will be zero if the firm chooses to retain all of its profits, i.e., to have a zero dividend payout ratio.

e. Dividend policy does not affect the requirement for external funds based on the AFN equation.

3. Which of the following statements is CORRECT?

a. When we use the AFN equation, we assume that the ratios of assets and liabilities to sales (A0*/S0 and L0*/S0) vary from year to year in a stable, predictable manner.

b. When fixed assets are added in large, discrete units as a company grows, the assumption of constant ratios is more appropriate than if assets are relatively small and can be added in small increments as sales grow.

c. Firms whose fixed assets are “lumpy” frequently have excess capacity, and this should be accounted for in the financial forecasting process.

d. For a firm that uses lumpy assets, it is impossible to have small increases in sales without expanding fixed assets.

e. There are economies of scale in the use of many kinds of assets. When economies occur the ratios are likely to remain constant over time as the size of the firm increases.

Economic Ordering Quantity model for establishing inventory levels demonstrates this relationship.

4. Last year Jain Technologies had $250 million of sales and $100 million of fixed assets, so its FA/Sales ratio was 40%. However, its fixed assets were used at only 75% of capacity. Now the company is developing its financial forecast for the coming year. As part of that process, the company wants to set its target Fixed Assets/Sales ratio at the level it would have had had it been operating at full capacity. What target FA/Sales ratio should the company set?

a. 28.5%

b. 30.0%

c. 31.5%

d. 33.1%

e. 34.7% 

5. Howton&Howton Worldwide (HHW) is planning its operations for the coming year, and the CEO wants you to forecast the firm’s additional funds needed (AFN). The firm is operating at full capacity. Data for use in the forecast are shown below. However, the CEO is concerned about the impact of a change in the payout ratio from the 10% that was used in the past to 50%, which the firm’s investment bankers have recommended. Based on the AFN equation, by how much would the AFN for the coming year change if HHW increased the payout from 10% to the new and higher level? All dollars are in millions.

Last year’s $300.0 Last year’s accounts payable $50.0

Sales growth 40% Last year’s notes payable $15.0

Last year’s total * $500.0 Last year’s accruals $20.0

Last year’s profit 20.0% Initial payout ratio 10.0%

a. $31.9

b. $33.6 [P4] 

c. $35.3

d. $37.0

e. $38.9

 

 

FIN 534 Week 7 Homework Chapter 13

1. Suppose Leonard, Nixon, & Shull Corporation’s projected free cash flow for next year is $100,000, and FCF is expected to grow at a constant rate of 6%. If the company’s weighted average cost of capital is 11%, what is the value of its operations?

a. $1,714,750

b. $1,805,000

c. $1,900,000

d. $2,000,000

e. $2,100,000

2. Leak Inc. forecasts the free cash flows (in millions) shown below. If the weighted average cost of capital is 11% and FCF is expected to grow at a rate of 5% after Year 2, what is the Year 0 value of operations, in millions? Assume that the ROIC is expected to remain constant in Year 2 and beyond (and do not make any half-year adjustments).

Year: 1 2

Free cash flow: -$50 $100

a. $1,456

b. $1,529

c. $1,606

d. $1,686

e. $1,770

3. Based on the corporate valuation model, the value of a company’s operations is $1,200 million. The company’s balance sheet shows $80 million in accounts receivable, $60 million in inventory, and $100 million in short-term investments that are unrelated to operations. The balance sheet also shows $90 million in accounts payable, $120 million in notes payable, $300 million in long-term debt, $50 million in preferred stock, $180 million in retained earnings, and $800 million in total common equity. If the company has 30 million shares of stock outstanding, what is the best estimate of the stock’s price per share?

a. $24.90

b. $27.67

c. $30.43

d. $33.48

e. $36.82

Market Value of +
MV of of debt + MV of preferred + MV of + 50M + MV Equity
=> MV – 420M – (assume book value of debt debt)
=> share /30 = $27.67(d)

4. Based on the corporate valuation model, the value of a company’s operations is $900 million. Its balance sheet shows $70 million in accounts receivable, $50 million in inventory, $30 million in short-term investments that are unrelated to operations, $20 million in accounts payable, $110 million in notes payable, $90 million in long-term debt, $20 million in preferred stock, $140 million in retained earnings, and $280 million in total common equity. If the company has 25 million shares of stock outstanding, what is the best estimate of the stock’s price per share?

a. $23.00

b. $25.56

c. $28.40

d. $31.24

e. $34.36

5. Vasudevan Inc. forecasts the free cash flows (in millions) shown below. If the weighted average cost of capital is 13% and the free cash flows are expected to continue growing at the same rate after Year 3 as from Year 2 to Year 3, what is the Year 0 value of operations, in millions?

Year: 1 2 3

Free cash flow: -$20 $42 $45

a. $586

b. $617

c. $648

d. $680

e. $714

 

FIN 534 Week 8 Homework Chapter 14

1. Which of the following statements about dividend policies is CORRECT?

a. Modigliani and Miller argue that investors prefer dividends to capital gains because dividends are more certain than capital gains. They call this the ―bird-in-the hand‖ effect.

b. One reason that companies tend to avoid stock repurchases is that dividend payments are taxed at a lower rate than gains on stock repurchases.

c. One advantage of dividend reinvestment plans is that they allow shareholders to avoid paying taxes on the dividends that they choose to reinvest.

d. One key advantage of a residual dividend policy is that it enables a company to follow a stable dividend policy.

e. The clientele effect suggests that companies should follow a stable dividend policy.

2. Which of the following statements is CORRECT?

a. One disadvantage of dividend reinvestment plans is that they increase transactions costs for investors who want to increase their ownership in the company.

b. One advantage of dividend reinvestment plans is that they enable investors to postpone paying taxes on the dividends credited to their account.

c. Stock repurchases can be used by a firm that wants to increase its debt ratio.

d. Stock repurchases make sense if a company expects to have a lot of profitable new projects to fund over the next few years, provided investors are aware of these investment opportunities.

e. One advantage of an open market dividend reinvestment plan is that it provides new equity capital and increases the shares outstanding.

3. Which of the following statements is CORRECT?

a. When firms are deciding on the size of stock splits—say whether to declare a 2-for-1 split or a 3-for-1 split, it is best to declare the smaller one, in this case the 2-for-1 split, because then the after-split price will be higher than if the 3-for-1 split had been used.

b. Back before the SEC was created in the 1930s, companies would declare reverse splits in order to boost their stock prices. However, this was determined to be a deceptive practice, and it is illegal today.

c. Stock splits create more administrative problems for investors than stock dividends, especially determining the tax basis of their shares when they decide to sell them, so today stock dividends are used far more often than stock splits.

d. When a company declares a stock split, the price of the stock typically declines—by about 50% after a 2-for-1 split—and this necessarily reduces the total market value of the equity.

e. If a firm’s stock price is quite high relative to most stocks—say $500 per share—then it can declare a stock split of say 10-for-1 so as to bring the price down to something close to $50. Moreover, if the price is relatively low—say $2 per share—then it can declare a ―reverse split‖ of say 1-for-25 so as to bring the price up to somewhere around $50 per share.

4. Which of the following statements is CORRECT?

a. If a firm follows the residual dividend policy, then a sudden increase in the number of profitable projects is likely to reduce the firm’s dividend payout.

b. The clientele effect can explain why so many firms change their dividend policies so often.

c. One advantage of adopting the residual dividend policy is that this policy makes it easier for corporations to develop a specific and well-identified dividend clientele.

d. New-stock dividend reinvestment plans are similar to stock dividends because they both increase the number of shares outstanding but don’t change the firm’s total amount of book equity.

e. Investors who receive stock dividends must pay taxes on the value of the new shares in the year the stock dividends are received.

5. DeAngelo Corp.’s projected net income is $150.0 million, its target capital structure is 25% debt and 75% equity, and its target payout ratio is 65%. DeAngelo has more positive NPV projects than it can finance without issuing new stock, but its board of directors had decreed that it cannot issue any new shares in the foreseeable future. The CFO now wants to determine how the maximum capital budget would be affected by changes in capital structure policy and/or the target dividend payout policy. Versus the current policy, how much larger could the capital budget be if (1) the target debt ratio were raised to 75%, other things held constant, (2) the target payout ratio were lowered to 20%, other things held constant, and (3) the debt ratio and payout were both changed by the indicated amounts.[P5] 

Increase in Capital Budget

Increase Debt Lower Payout Do Both to 75% to 20%___________________

a. $114.0 $73.3 $333.9

b. $120.0 $77.2 $351.5

c. $126.4 $81.2 $370.0

d. $133.0 $85.5 $389.5

e. $140.0 $90.0 $410.0

 

FIN 534 Week 8 Homework Chapter 15

1. Which of the following statements best describes the optimal capital structure?

a. The optimal capital structure is the mix of debt, equity, and preferred stock that maximizes the company’s earnings per share (EPS).

b. The optimal capital structure is the mix of debt, equity, and preferred stock that maximizes the company’s stock price.

c. The optimal capital structure is the mix of debt, equity, and preferred stock that minimizes the company’s cost of equity.

d. The optimal capital structure is the mix of debt, equity, and preferred stock that minimizes the company’s cost of debt.

e. The optimal capital structure is the mix of debt, equity, and preferred stock that minimizes the company’s cost of preferred stock.

2. Which of the following statements is CORRECT?

a. A firm can use retained earnings without paying a flotation cost. Therefore, while the cost of retained earnings is not zero, its cost is generally lower than the after-tax cost of debt.

b. The capital structure that minimizes a firm’s weighted average cost of capital is also the capital structure that maximizes its stock price.

c. The capital structure that minimizes the firm’s weighted average cost of capital is also the capital structure that maximizes its earnings per share.

d. If a firm finds that the cost of debt is less than the cost of equity, increasing its debt ratio must reduce its WACC.

e. Other things held constant, if corporate tax rates declined, then the Modigliani-Miller tax-adjusted tradeoff theory would suggest that firms should increase their use of debt.

3. Which of the following statements is CORRECT?

a. In general, a firm with low operating leverage also has a small proportion of its total costs in the form of fixed costs.

b. There is no reason to think that changes in the personal tax rate would affect firms’ capital structure decisions.

c. A firm with high business risk is more likely to increase its use of financial leverage than a firm with low business risk, assuming all else equal.

d. If a firm’s after-tax cost of equity exceeds its after-tax cost of debt, it can always reduce its WACC by increasing its use of debt.

e. Suppose a firm has less than its optimal amount of debt. Increasing its use of debt to the point where it is at its optimal capital structure will decrease the costs of both debt and equity financing.

4. Companies HD and LD have identical amounts of assets, operating income (EBIT), tax rates, and business risk. Company HD, however, has a much higher debt ratio than LD. Company HD’s basic earning power ratio (BEP) exceeds its cost of debt (rd). Which of the following statements is CORRECT?

a. Company HD has a higher return on assets (ROA) than Company LD.

b. Company HD has a higher times interest earned (TIE) ratio than Company LD.

c. Company HD has a higher return on equity (ROE) than Company LD, and its risk, as measured by the standard deviation of ROE, is also higher than LD’s.

d. The two companies have the same ROE.

e. Company HD’s ROE would be higher if it had no debt.

5. Which of the following statements is CORRECT?

a. Generally, debt-to-total-assets ratios do not vary much among different industries, although they do vary among firms within a given industry.

b. Electric utilities generally have very high common equity ratios because their revenues are more volatile than those of firms in most other industries.

c. Drug companies (prescription, not illegal!) generally have high debt-to-equity ratios because their earnings are very stable and, thus, they can cover the high interest costs associated with high debt levels.

d. Wide variations in capital structures exist both between industries and among individual firms within given industries. These differences are caused by differing business risks and also managerial attitudes.

e. Since most stocks sell at or very close to their book values, book value capital structures are almost always adequate for use in estimating firms’ costs of capital.

 

FIN 534 Week 9 Homework Chapter 16

1. Swim Suits Unlimited is in a highly seasonal business and the following summary balance sheet data show its assets and liabilities at peak and off-peak seasons (in thousands of dollars):

Peak Off-Peak

Cash $ 50 $ 30

Marketable securities 0 20

Accounts receivable 40 20

Inventories 100 50

Net fixed assets 500 500

Total assets $690 $620

Payables and accruals $ 30 $ 10

Short-term bank debt 50 0

Long-term debt 300 300

Common equity 310 310

Total claims $690 $620

From this data we may conclude that

a. Swim Suits’ current asset financing policy calls for exactly matching asset and liability maturities.

b. Swim Suits’ current asset financing policy is relatively aggressive; that is, the company finances some of its permanent assets with short-term discretionary debt.

c. Swim Suits follows a relatively conservative approach to current asset financing; that is, some of its short-term needs are met by permanent capital.

d. Without income statement data, we cannot determine the aggressiveness or conservatism of the company’s current asset financing policy.

e. Without cash flow data, we cannot determine the aggressiveness or conservatism of the company’s current asset financing policy.

2. Which of the following statements is CORRECT?

a. A firm that makes 90% of its sales on credit and 10% for cash is growing at a constant rate of 10% annually. Such a firm will be able to keep its accounts receivable at the current level, since the 10% cash sales can be used to finance the 10% growth rate.

b. In managing a firm’s accounts receivable, it is possible to increase credit sales per day yet still keep accounts receivable fairly steady, provided the firm can shorten the length of its collection period (its DSO) sufficiently.

c. Because of the costs of granting credit, it is not possible for credit sales to be more profitable than cash sales.

d. Since receivables and payables both result from sales transactions, a firm with a high receivables-to-sales ratio must also have a high payables-to-sales ratio.

e. Other things held constant, if a firm can shorten its DSO, this will lead to a higher current ratio.

3. Halka Company is a no-growth firm. Its sales fluctuate seasonally, causing total assets to vary from $320,000 to $410,000, but fixed assets remain constant at $260,000. If the firm follows a maturity matching (or moderate) working capital financing policy, what is the most likely total of long-term debt plus equity capital?

a. $260,642

b. $274,360

c. $288,800

d. $304,000

e. ) $320,000

Lower total asset range $320,000

Upper total asset range $410,000

Minimum total + Min. CA = $320,000  = LT Debt + Equity

A maturity matching policy implies that fixed assets and permanent current assets are financed with long-term sources.  This is its most likely level of long-term financing.

4. Your consulting firm was recently hired to improve the performance of Shin-SoenenInc, which is highly profitable but has been experiencing cash shortages due to its high growth rate. As one part of your analysis, you want to determine the firm’s cash conversion cycle. Using the following information and a 365-day year, what is the firm’s present cash conversion cycle?

Average inventory = $75,000

Annual sales = $600,000

Annual cost of goods sold = $360,000

Average accounts receivable = $160,000

Average accounts payable = $25,000

a. 120.6 days

b. 126.9 days

c. 133.6 days

d. 140.6 days

e. 148.0 days

Avg. inventory =  $75,000  Annual sales =  $600,000

Avg. receivables =  $160,000  Annual COGS =  $360,000

Avg. payables =  $25,000  Days in year =  365

Inv. conv. /(COGS/365)  76.0

+ /(Sales/365)  97.3

– Payables /(COGS/365)  -25.3

Cash conversion cycle (CCC)  148.0

5. Affleck Inc.’s business is booming, and it needs to raise more capital. The company purchases supplies on terms of 1/10 net 20, and it currently takes the discount. One way of getting the needed funds would be to forgo the discount, and the firm’s owner believes she could delay payment to 40 days without adverse effects. What would be the effective annual percentage cost of funds raised by this action? (Assume a 365-day year.)

a. 10.59%

b. 11.15%

c. 11.74%

d. 12.36%

e. 13.01%

Discount %  1%  Net days  20

Discount days  10  Actual days to payment  40

EAR = [1 + Disc. %/(100 – Disc. %)][365/(Actual days – Disc. Period)] – %

 

FIN 534 Week 10 Homework Chapter 17 

1. In Japan, 90-day securities have a 4% annualized return and 180-day securities have a 5% annualized return. In the United States, 90-day securities have a 4% annualized return and 180-day securities have an annualized return of 4.5%. All securities are of equal risk, and Japanese securities are denominated in terms of the Japanese yen. Assuming that interest rate parity holds in all markets, which of the following statements is most CORRECT?

a. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market.

b. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 180-day forward market.

c. The yen-dollar exchange rate in the 90-day forward market equals the yen-dollar exchange rate in the 180-day market.

d. The spot rate equals the 90-day forward rate.

e. The spot rate equals the 180-day forward rate.

2. If the spot rate of the Israeli shekel is 5.51 shekels per dollar and the 180-day forward rate is 5.97 shekels per dollar, then the forward rate for the Israeli shekel is selling at a ________________ to the spot rate.

a. premium of 8%

b. premium of 18%

c. discount of 18%

d. discount of 8%

e. premium of 16%

3. Stover Corporation, a U.S. based importer, makes a purchase of crystal glassware from a firm in Switzerland for 39,960 Swiss francs, or $24,000, at the spot rate of 1.665 francs per dollar. The terms of the purchase are net 90 days, and the U.S. firm wants to cover this trade payable with a forward market hedge to eliminate its exchange rate risk. Suppose the firm completes a forward hedge at the 90-day forward rate of 1.682 francs. If the spot rate in 90 days is actually 1.638 francs, how much will the U.S. firm have saved or lost in U.S. dollars by hedging its exchange rate exposure?

a. -$396

b. -$243

c. $0

d. $243

e. $638

4. A product sells for $750 in the United States. The exchange rate is $1 to 1.65 Swiss francs. If purchasing power parity (PPP) holds, what is the price of the product in Switzerland?

a. 123.75 Swiss francs

b. 454.55 Swiss francs

c. 750.00 Swiss francs

d. 1,237.50 Swiss francs

5. Chen Transport, a U.S. based company, is considering expanding its operations into a foreign country. The required investment at is $10 million. The firm forecasts total cash inflows of $4 million per year for 2 years, $6 million for the next 2 years, and then a possible terminal value of $8 million. In addition, due to political risk factors, Chen believes that there is a 50% chance that the gross terminal value will be only $2 million and a 50% chance that it will be $8 million. However, the government of the host country will block 20% of all cash flows. Thus, cash flows that can be repatriated are 80% of those projected. Chen’s cost of capital is 15%, but it adds one percentage point to all foreign projects to account for exchange rate risk. Under these conditions, what is the project’s NPV?

a. $1.01 million

b. $2.77 million

c. $3.09 million

d. $5.96 million

e. $7.39 million