BFIN300 - Q bank - Chap. 2+3+4 PDF

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Question bank for chap. 2+3+4 of Business Finance...

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Chapter 2 Financial Markets and Institutions MCQ 1) Capital allocation: You recently sold 100 shares of Microsoft stock to your brother at a

family reunion. At the reunion your brother gave you a check for the stock and you gave your brother the stock certificates. Which of the following best describes this transaction? a. This is an example of a direct transfer of capital. b. This is an example of a primary market transaction. c. This is an example of an exchange of physical assets. d. This is an example of a money market transaction.

2) Financial markets: 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. 3) Financial markets: 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.

4) Capital market instruments: Which of the following is an example of a capital market

instrument? a. Commercial paper. b. Preferred stock. c. U.S. Treasury bills. d. Banker's acceptances.

5) Money markets: Money markets are markets for

a. Foreign currencies. b. Consumer automobile loans. c. Common stocks. d. Short-term debt securities such as Treasury bills and commercial paper. 6) Financial markets: Which of the following statements is CORRECT? a. If you purchase 100 shares of Disney stock from your brother-in-law, this is an

example of a primary market transaction. b. If Disney issues additional shares of common stock through an investment banker,

this would be a secondary market transaction. c. The NYSE is an example of an over-the-counter market. d. As they are generally defined, money market transactions involve debt securities

with maturities of less than one year. 7) Financial markets: 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.

8) Hedge funds: 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 are not as highly regulated as most other types of financial

institutions. 9) Financial markets and institutions: 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. 10) Financial markets: Which of the following statements is CORRECT?

a. The New York Stock Exchange is an auction market, and it has a physical location. b. Home mortgage loans are traded in the money market. c. If an investor sells shares of stock through a broker, then it would be a primary market transaction. d. Capital markets deal only with common stocks and other equity securities.

11) IPOs: Which of the following statements is CORRECT?

a. The term "IPO" stands for Introductory Price Offered, and it is the price at which shares of a new company are offered to the public.

b. IPO prices are generally established by the market, and buyers of the new stock must pay the price that prevails at the close of trading on the day the stock is offered to the public. c. In a "Dutch auction," investors who want to buy shares in an IPO submit bids indicating how many shares they want to buy and the price they are willing to pay. The company determines how many shares it wants to sell. The highest price that enables the company to sell the desired number of shares is the price that all buyers must pay. d. It is possible that the price set in an IPO is so high that investors will refuse to buy the number of shares that the company wants to sell. In that case, the company is said to have "left money on the table." 12) Financial markets: Which of the following statements is CORRECT?

a. The most important difference between spot markets versus futures markets is the maturity of the instruments that are traded. 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. b. Capital market transactions involve only preferred stock or common stock. c. If General Electric were to issue new stock this year, this would be considered a secondary market transaction since the company already has stock outstanding. d. Both NASDAQ dealers and "specialists" on the NYSE hold inventories of stocks. 13) Ownership and going public: Which of the following statements is NOT CORRECT?

a. When a corporation's shares are owned by a few individuals, we say that the firm is "closely, or privately, held." b. "Going public" establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares. c. The stock of publicly owned companies must generally be registered with and reported to a regulatory agency such as the SEC.

d. When stock in a closely held corporation is offered to the public for the first time, the transaction is called "going public, or an IPO," and the market for such stock is called the new issue or IPO market. 14) Financial markets: Markets for long-term debts and corporate stocks are called:

a. Money markets. b. Capital markets. c. Secondary markets. d. Primary markets. 15) Financial markets: Investors trade stocks among themselves:

a. Money markets. b. Capital markets. c. Secondary markets. d. Primary markets. 16) Financial markets: A market where fair value and market value of stocks are equal:

a. Efficient Market b. Money Market c. Inefficient market d. Secondary Market. 17) Mutual Funds: ________pool money from investors and diversify across many asset classes

a. Commercial banks b. Car insurance companies c. Mutual funds d. ETFs

18) Exchange traded Funds: When a mutual fund becomes listed on the stock exchange it

becomes________ a. Hedge Funds.

b. Mutual Funds. c. Pension Funds. d. Exchange traded Funds. 19) Capital market instruments: Which of the following is an example of a money market

instrument? a. Common stock. b. Preferred stock. c. U.S. Treasury bills. d. Gold. 20) Capital market instruments: Which of the following is an example of a financial asset?

a. Car b. Gold c. Real estate d. Bond

Chapter 3 Income Statements, Cash Flow, and Taxes Topic 1: Finding a missing element in the income statements such as Sales, EBITDA, EBIT, EBT, Net Income, Interest Expense and Depreciation and Amortization Question 1 The financial manager at Hartco. Co, recently reported $180,000 of sales during the year 2016. The company had $18,500 of outstanding bonds carrying 6.75% interest rate. Operating costs were $87,000 other than depreciation, and the firm was facing $11,400 as depreciation. Noting that the federal-plus-state income tax rate was 40% Calculate the firm's net income at the end of the year 2016? Answer: Sales

$180,000

Operating costs

87,000

Depreciation

11,400

Operating income (EBIT) Interest charges Taxable income Taxes

Net income

$81,600 -1,156.25 $80,443.75 -32,177.5

$48,266.25

Question 2 Companies generate income from their "regular" operations and from other sources like interest earned on the securities they hold, which is called non-operating income. Lindley Textiles

recently reported $12,500 of sales, $7,250 of operating costs other than depreciation, and $1,000 of depreciation. The company had no amortization charges and no non-operating income. It had $8,000 of bonds outstanding that carry a 7.5% interest rate, and its federal-plus-state income tax rate was 40%. How much was Lindley's operating income, or EBIT? Answer: Sales Operating costs excluding dep. Depreciation Operating income (EBIT)

$12,500 $7,250 $1,000 $4,250

Question 3 Frederickson Office Supplies recently reported $12,500 of sales, $7,250 of operating costs other than depreciation, and $1,250 of depreciation. The company had no amortization charges and no non-operating income. It had $8,000 of bonds outstanding that carry a 7.5% interest rate, and its federal-plus-state income tax rate was 40%. How much was the firm's taxable income, or earnings before taxes (EBT)? Answer: Bonds Interest rate Sales Operating costs excluding depr'n Depreciation Operating income (EBIT) Interest charges Taxable income

$8,000.00 7.50% $12,500.00 $7,250.00 $1,250.00 $4,000.00 -$600.00 $3,400.00

Question 4 Rao Construction recently reported $20.50 million of sales, $12.60 million of operating costs other than depreciation, and $3-00 million of depreciation. It had $8.50 million of bonds outstanding that carry a 7.0% interest rate, and its federal-plus-state income tax rate was 40%. What was Rao's operating income, or EBIT, in millions?

Answer: Sales $20.50 Operating costs excluding depreciation $12.60 Depreciation 3.00 Operating income (EBIT) $ 4.90 Note that operating income is before interest and taxes. Question 5 Brown Office Supplies recently reported $15,500 of sales, $8,250 of operating costs other than depreciation, and $1,750 of depreciation. It had $9,000 of bonds outstanding that carry a 7.0% interest rate, and its federal-plus-state income tax rate was 40%. How much was the firm's earnings before taxes (EBT)? Answer: Bonds $9,000.00 Interest rate 7.00% Sales $15,500.00 Operating costs excluding depreciation 8,250.00 Depreciation 1,750.00 Operating income (EBIT) $ 5,500.00 Interest charges -630.00 EBT = Taxable income $ 4,870 Question 6 Emery Mining Inc. recently reported $150,000 of sales, $75,500 of operating costs other than depreciation, and $10,200 of depreciation. The company had $16,500 of outstanding bonds that carry a 7.25% interest rate, and its federal-plus-state income tax rate was 35%. How much was the firm's net income? Answer: Bonds Interest rate Tax rate Sales

$16,500 7.25% 35% $150,000

Operating costs excluding depreciation Depreciation Operating income (EBIT) Interest charges Taxable income Taxes Net income

75,500 10,200 $64,300.00 -1,196.25 $63,103.75 -22,086.31 $41,017.44

Question 7 Last year Almazan Software reported $10.50 million of sales, $6.25 million of operating costs other than depreciation, and $1.30 million of depreciation. The company had $5.00 million of bonds that carry a 6.5% interest rate, and its federal-plus-state income tax rate was 35%. This year's data are expected to remain unchanged except for one item, depreciation, which is expected to increase by $0.70 million. By how much will net income change as a result of the change in depreciation? Answer: This problem can be worked very easily --just multiply the increase in depreciation by ( 1 – T) to get the decrease in net income: Change in depreciation $0.700 Tax rate 0.350 Reduction in net income $0.455 We can also get the answer a longer way, which explains things more clearly: Old New Change Bonds $5.000 $5.000 $0.000 Interest rate 0.065 0.065 0.000 Tax rate 0.350 0.350 0.000 Sales $10.500 $10.500 $0.000 Operating costs excluding depreciation $6.250 $6.250 $0.000 Depreciation $1.300 $2.000 $0.700 Operating income (EBIT) $2.950 $2.250 -$0.700 Interest charges $0.325 $0.325 $0.000 Taxable income $2.625 $1.925 -$0.700 Taxes $0.919 $0.674 -$0.245 Net income $1.706 $1.251 -$0.455

Topic 2: Finding a missing element in the Free Cash Flow (FCF) formula such as EBIT, Capital expenditures, and Change in NWC Question 1 Calculate net operating profit after taxes (NOPAT) if a firm has sales of $1,000,000, operating profit (EBIT) of $100,000, interest expense of $50,000, and a tax rate of 30%. Answer: NOPAT = $70,000 Question 2 PLI Corporation had net fixed assets of $2,000,000 at the end of 2006 and $1,800,000 at the end of 2005. In addition, the firm had a depreciation expense of $200,000 during 2006 and $180,000 during 2005. Using this information, how much was PLI's net fixed asset investment for 2006? Answer: Net fixed asset investment = $400,000 Question 3 Assume that Icon Co. 2014 current assets totaled for $40,000, they paid out $16,000 in the form of account payable and $4,000 as accruals and $5,000 in note payables and in 2015 they had a NWC of $27,500.

Calculate the change in net working capital Answer: NWC 2014= Current assets – (Account payable + Accruals) = 40,000 – (16,000 + 4000) = $20,000 NWC 2015= $27,500 Δ NWC = NWC2015 – NWC2014 = 27,500 – 20,000 = $7,500

Question 4 Prezas Company's balance sheet showed total current assets of $4,250, all of which were required in operations. Its current liabilities consisted of $975 of accounts payable, $600 of 6% short-term notes payable to the bank, and $250 of accrued wages and taxes. What was its net working capital? Answer: Current assets Accounts payable Accrued wages and taxes Net working capital

$4,250 975 250 $3,025

Question 5 Wu Systems has the following balance sheet. How much net working capital does the firm have? Cash $ 100 Accounts payable $ 200 Accounts receivable 650 Accruals 350 Inventory 550 Notes payable 350 Current assets $1,300 Current liabilities $ 900 Net fixed assets 1,000 Long-term debt 600 Common equity 300 Retained earnings 500 Total assets $2,300 Total liab. & equity $2,300 Answer: Net working capital = Current assets − AP − Accruals NWC = $1,300.00 − $550.00 NWC = $750 Question 6 C. F. Lee Inc. has the following income statement. How much after-tax operating income does the firm have? Sales $2,850.00 Costs 1,850.00

Depreciation EBIT Interest expense EBT Taxes (35%) Net income

192.00 $ 808.00 285.00 $ 523.00 183.05 $ 339.95

Answer: EBIT Tax rate EBIT(1 − T) =

$808.00 35% $525.20

Question 7 Kwok Enterprises has the following income statement. How much after-tax operating income does the firm have? Sales Costs Depreciation EBIT Interest expense EBT Taxes (40%) Net income

Answer: EBIT Tax rate EBIT(1 − T) =

$600.00 40% $360

$2,250 1,400 250 $ 600 70 $ 530 212 $ 318

Topic 3: Calculating Free Cash Flow (FCF) Question 1 During 2006, NICO Corporation had EBIT of $100,000, a change in net fixed assets of $400,000, an increase in net current assets of $100,000, an increase in spontaneous current liabilities of $400,000, a depreciation expense of $50,000, and a tax rate of 30%. Based on this information, Calculate NICO's free cash flow. Answer: FCF = -$30,000 Question 2 Calculate a firm's free cash flow if it has net operating profit after taxes of $60,000, depreciation expense of $10,000, net fixed asset investment requirement of $40,000, a net current asset requirement of $30,000 and a tax rate of 30%. Answer: FCF = $0 Question 3 Vasudevan Inc. recently reported operating income of $2.75 million, depreciation of $1.20 million, and had a tax rate of 40%. The firm's expenditures on fixed assets and net working capital totaled $0.6 million. How much was its free cash flow, in millions? Answer: FCF = EBIT(1 – T) + Deprec. – (Capex + NWC) EBIT $2.75 Tax rate 40% Depreciation $1.20 Capex + NW $0.60 FCF = $2.25

Question 4 Hartzell Inc. had the following data for 2007, in millions: Net income = $600; after-tax operating income [EBIT (1-T)] = $700; and Total assets = $2,000. Information for 2008 is as follows: Net income = $825; after-tax operating income [EBIT (1-T)] = $925; and Total assets = $2,500. How much free cash flow did the firm generate during 2008? Answer: EBIT(1 − T) 2,007 2,008 Change = Net invest. in FA + NWC Total assets $2,000 $2,500 $500 2008 FCF = EBIT(1 − T) − Net investment in FA + NWC 2008 FCF = $925 − $500 2008 FCF = $425 Question 5 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 fixed assets 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? Answer: Bonds Interest rate Tax rate

$3,500.00 6.25% 35.00%

Sales $10,750.00 Operating costs excluding depreciation 5,500.00 Depreciation 1,250.00 Operating income (EBIT) $ 4,000.00 Δ Capex + NWC = $1,550.00 Tax rate = 35% FCF = EBIT(1 – T) + Deprec. – (Δ Capex + Δ NWC) FCF = $2,600 + $1,250 – $1,550

Free cash flow = $2,300 Question 6 Houston Pumps recently reported $185,250 of sales, $140,500 of operating costs other than depreciation, and $9,250 of depreciation. The company had $35,250 of outstanding bonds that carry a 6.75% interest rate, and its federal-plus-state income tax rate was 35%. In order to sustain its operations and thus generate future sales and cash flows, the firm was required to spend $15,250 to buy new fixed assets and to invest $6,850 in net working capital. What was the firm's free cash flow? Answer: Tax rate 35% Required addition to net working capital $6,850 Required capital expenditures (fixed assets) $15,250 Sales Operating costs excluding depreciation Depreciation Operating income (EBIT)

$185,250 140,500 9,250 $ 35,500

FCF = EBIT(1 − T) + Deprec. – CapEx – Δ Net WC FCF = $23,075.00 + $9,250 – $15,250 – $6,850 FCF = $10,225 Question 7 Watson Oil recently reported (in millions) $8,250 of sales, $5,750 of operating costs other than depreciation, and $650 of depreciation. The company 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 future sales and cash flows, the firm was required to make $1,250 of capital expenditures on new fixed assets and to invest $300 in net working capital. By how much did the firm's net income exceed its free cash flow?

Answer: Bonds Interest rate Tax rate Required capital expenditures (fixed assets) Required addition to net working capital Sales Operating costs excluding depreciation Depreciation Operating income (EBIT) Interest charges Taxable income (EBT) Taxes Net income

$3,200 5% 35% $1,250 $300 $8,250.00 5,750.00 650.00 $1,850.00 160.00 $1,690.00 591.50 $1,098.50

FCF = EBIT(1 − T) + Deprec. – CapEx – Δ Net WC FCF = $1,202.50 + $650 – $1,250 – -$300 = $302.50 Difference between net income and FCF = $796.00 Question 8 Computer Wor...