FINC 3331 PDF

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Chapter 1 1. Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and managers? Change the corporation's formal documents to make it easier for outside investors to acquire a controlling interest in the firm through a hostile takeover. Feedback: Corporate takeovers are most likely to occur when a firm is underperforming. Managers who fear losing their jobs will try to maximize shareholder wealth. 2. Which of the following statements is CORRECT? One advantage of forming a corporation is that equity investors are usually exposed to less liability than they would be in a partnership. Feedback: Corporations have limited liability; however, they face more regulations than the other forms of organization. Sole proprietorships do not pay corporate taxes. 3. Which of the following mechanisms would be most likely to help motivate managers to act in the best interests of shareholders? Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries. 4. The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to Maximize the stock price per share over the long run, which is the stock's intrinsic value. Response Feedback: The primary operating goal should be to maximize the long-run stock price, or the intrinsic value. 5. Relaxant Inc. operates as a partnership. Now the partners have decided to convert the business into a corporation. Which of the following statements is CORRECT? Relaxant's shareholders (the ex-partners) will now be exposed to less liability. 6. Which of the following could explain why a business might choose to operate as a corporation rather than as a sole proprietorship or a partnership? Corporations generally find it easier to raise large amounts of capital. Feedback: Outsiders thinking about investing in a business are generally not willing to be subjected to unlimited liability, and they also want to be able to sell their shares should they choose to do so. Corporations provide these advantages, hence firms that need large amounts of capital that must be raised in capital markets generally choose to incorporate. 7. Which of the following actions would be most likely to reduce conflicts between stockholders and bondholders? Including restrictive covenants in the company's bond indenture (which is the contract between the company and its bondholders). 8. Which of the following statements is CORRECT? One danger of starting a proprietorship is that you may be exposed to personal liability if the business goes bankrupt. This problem would be avoided if you formed a corporation to operate the business. 9. Which of the following statements is CORRECT? Sole proprietorships and partnerships generally have a tax advantage over corporations.

Feedback: Some corporations (S corporations) are able to avoid the corporate income tax. Sole proprietorships and partnerships pay personal income tax, but they avoid the corporate income tax. 10. Which of the following statements is CORRECT? It is usually easier to transfer ownership in a corporation than in a partnership. Feedback: If ownership in a proprietorship or partnership is transferred, the basic documents under which the firm operates must be rewritten, whereas for a corporation the seller simply sells shares to a buyer. 11. Which of the following statements is CORRECT? One of the disadvantages of a sole proprietorship is that the proprietor is exposed to unlimited liability. 12. Which of the following actions would be likely to reduce conflicts of interest between stockholders and managers? The composition of the board of directors is changed from all inside directors to all outside directors, and the directors are compensated with stock rather than cash.

Chapter 2 1. Which of the following is an example of a capital market instrument? Preferred stock. 2. A publicly owned corporation is a company whose shares are held by the investing public, which may include other corporations as well as institutional investors. True 3. The term IPO stands for "individual purchase order," as when an individual (as opposed to an institution) places an order to buy a stock. False 4. Hedge funds are somewhat similar to mutual funds. The primary differences are that hedge funds are less highly regulated, have more flexibility regarding what they can buy, and restrict their investors to wealthy, sophisticated individuals and institutions. True 5. If you wanted to know what rate of return stocks have provided in the past, you could examine data on the Dow Jones Industrial Index, the S&P 500 Index, or the NASDAQ Index. True 6. A financial intermediary is a corporation that takes funds from investors and then provides those funds to those who need capital. A bank that takes in demand deposits and then uses that money to make long-term mortgage loans is one example of a financial intermediary. True 7. Which of the following is a primary market transaction? IBM issues 2,000,000 shares of new stock and sells them to the public through an investment banker. 8. Money markets are markets for Short-term debt securities such as Treasury bills and commercial paper. 9. 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? This is an example of a direct transfer of capital. 10. Primary markets are large and important, while secondary markets are smaller and less important. False

Chapter 3 1. 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? $4.90 2. 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 operating working capital? $3,025 3. 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 operating 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? $2,300 4. Over the years, O'Brien Corporation's stockholders have provided $20,000,000 of capital, when they purchased new issues of stock and allowed management to retain some of the firm's earnings. The firm now has 1,000,000 shares of common stock outstanding, and it sells at a price of $38.50 per share. How much value has O'Brien's management added to stockholder wealth over the years, i.e., what is O'Brien's MVA? $18,500,000 5. On the balance sheet, total assets must always equal the sum of total liabilities and equity. True 6. Wu Systems has the following balance sheet. How much net operating working capital does the firm have? Cash Accounts receivable Inventory Current assets Net fixed assets

$ 100 650

Accounts payable Accruals

550 Notes payable $1,300 Current liabilities 1,000

Long-term debt Common equity

_____ Total assets

Retained earnings

$2,300 Total liab. & equity

$ 200 350 350 $ 900 600 300 500 $2,300

$750 7. Two metrics that are used to measure a company's financial performance are net income and cash flow. Accountants emphasize net income as calculated in accordance with generally accepted accounting principles. Finance people generally put at least as much weight on cash flows as they do on net income. True 8. Assets other than cash are expected to produce cash over time, but the amount of cash they eventually produce could be higher or lower than the amounts at which the assets are carried on the books. True 9. Other things held constant, which of the following actions would increase the amount of cash on a company's balance sheet? The company issues new common stock. 10. Typically, the statement of stockholders' equity starts with total stockholders' equity at the beginning of the year, adds net income, subtracts dividends paid, and ends up with total stockholders' equity at the end of the year. Over time, a profitable company will have earnings in excess of the dividends it pays out, and will result in a substantial amount of retained earnings shown on the balance sheet True

Chapter 4 1. The balance sheet and income statement shown below are for Koski Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over.

Balance Sheet (Millions of $) Assets Cash and securities Accounts receivable Inventories Total current assets Net plant and equipment Total assets Liabilities and Equity Accounts payable Accruals Notes payable Total current liabilities

2014 $ 2,500 11,500 16,000 $30,000 $20,000 $50,000 $ 9,500 5,500 7,000 $22,000

Long-term bonds Total liabilities Common stock Retained earnings Total common equity Total liabilities and equity Income Statement (Millions of $) Net sales Operating costs except depreciation Depreciation Earnings bef interest and taxes (EBIT) Less interest Earnings before taxes (EBT) Taxes Net income Other data: Shares outstanding (millions) Common dividends Int rate on notes payable & L-T bonds Federal plus state income tax rate Year-end stock price

$15,000 $37,000 $ 2,000 11,000 $13,000 $50,000 2014 $87,500 81,813 1,531 $ 4,156 1,375 $ 2,781 973 $ 1,808

500.00 $632.73 6.25% 35% $43.39

Refer to Exhibit 4.1. What is the firm's days sales outstanding? Assume a 365-day year for this calculation. 47.97 Rationale: DSO = Accounts receivable/(Sales/365) = 47.97 Refer to Exhibit 4.1. What is the firm's dividends per share? $1.27 Response Feedback: Rationale: DPS = Common dividends paid/Shares outstanding = $1.27 Refer to Exhibit 4.1. What is the firm's EPS? $3.62 Response Feedback: Rationale: EPS = Net income/Common shares outstanding = $3.62

Refer to Exhibit 4.1. What is the firm's ROA? 3.62% Rationale: ROA = Net income/Total assets = 3.62% High current and quick ratios always indicate that the firm is managing its liquidity position well. False It might have too much liquidity. Liquid assets generally provide low returns.

Refer to Exhibit 4.1. What is the firm's profit margin? 2.07% Response Feedback: Rationale: Profit margin = Net income/Sales = 2.07%

Refer to Exhibit 4.1. What is the firm's P/E ratio? 12.0 Response Feedback: P/E ratio = Price per share/Earnings per share = 12.0 We actually fixed the P/E ratio at 12 in order to get a stock price. Either the price or the P/E ratio must be fixed or the model becomes very complicated and a stock pricing equation is required.

Refer to Exhibit 4.1. What is the firm's quick ratio?

0.64 Response Feedback: Quick ratio = (CA − Inventory)/CL = 0.64

Refer to Exhibit 4.1. What is the firm's ROE? 13.91% ROE = Net income/Common equity = 13.91% Refer to Exhibit 4.1. What is the firm's book value per share? $26.00 BVPS = Common equity/Shares outstanding = $26.00 Hoagland Corp's stock price at the end of last year was $33.50, and its book value per share was $25.00. What was its market/book ratio? 1.34 Response Feedback: Rationale: Stock price $33.50 Book value per share $25.00 M/B ratio = Stock price/Book value per share = 1.34 Determining whether a firm's financial position is improving or deteriorating requires analyzing more than the ratios for a given year. Trend analysis is one method of examining changes in a firm's performance over time. True Refer to Exhibit 4.1. What is the firm's inventory turnover ratio? 5.47 Inventory turnover ratio = Sales/Inventory = 5.47

Refer to Exhibit 4.1. What is the firm's total assets turnover? 1.75 Total assets turnover ratio = TATO = Sales/Total assets = 1.75

Chapter 5 You have a chance to buy an annuity that pays $5,000 at the beginning of each year for 5 years. You could earn 4.5% on your money in other investments with equal risk. What is the most you should pay for the annuity? $22,938 You are offered a chance to buy an asset for $7,250 that is expected to produce cash flows of $750 at the end of Year 1, $1,000 at the end of Year 2, $850 at the end of Year 3, and $6,250 at the end of Year 4. What rate of return would you earn if you bought this asset? 6.05% If a bank compounds savings accounts quarterly, the effective annual rate will exceed the nominal rate. True You want to quit your job and go back to school for a law degree 4 years from now, and you plan to save $3,500 per year, beginning immediately. You will make 4 deposits in an account that pays 5.7% interest. Under these assumptions, how much will you have 4 years from today? $16,112 How much would $20,000 due in 50 years be worth today if the discount rate were 7.5%? $537.78 You plan to invest in bonds that pay 6.0%, compounded annually. If you invest $10,000 today, how many years will it take for your investment to grow to $30,000? 18.85 You have a chance to buy an annuity that pays $2,500 at the end of each year for 3 years. You could earn 5.5% on your money in other investments with equal risk. What is the most you should pay for the annuity? $6,744.83 Jose now has $500. How much would he have after 6 years if he leaves it invested at 5.5% with annual compounding? $689.42 How much would $100, growing at 5% per year, be worth after 75 years? $3,883.27 What is the present value of the following cash flow stream at a rate of 12.0%? One of the four most fundamental factors that affect the cost of money as discussed in the text is the expected rate of inflation. If inflation is expected to be relatively high, then interest rates will tend to be relatively low, other things held constant. False The Federal Reserve tends to take actions to increase interest rates when the economy is very strong and to decrease rates when the economy is weak. True

Suppose the real risk-free rate is 4.20%, the average expected future inflation rate is 3.10%, and a maturity risk premium of 0.10% per year to maturity applies, i.e., MRP = 0.10%(t), where t is the number of years to maturity, hence the pure expectations theory is NOT valid. What rate of return would you expect on a 4-year Treasury security? Disregard crossproduct terms, i.e., if averaging is required, use the arithmetic average. 7.70% During periods when inflation is increasing, interest rates tend to increase, while interest rates tend to fall when inflation is declining. True If the Treasury yield curve were downward sloping, the yield to maturity on a 10-year Treasury coupon bond would be higher than that on a 1-year T-bill. False The four most fundamental factors that affect the cost of money are (1) production opportunities, (2) time preferences for consumption, (3) risk, and (4) the skill level of the economy's labor force. False Since yield curves are based on a real risk-free rate plus the expected rate of inflation, at any given time there can be only one yield curve, and it applies to both corporate and Treasury securities. False The real risk-free rate is 3.05%, inflation is expected to be 2.75% this year, and the maturity risk premium is zero. Ignoring any cross-product terms, what is the equilibrium rate of return on a 1-year Treasury bond? 5.80% One of the four most fundamental factors that affect the cost of money as discussed in the text is the risk inherent in a given security. The higher the risk, the higher the security's required return, other things held constant. True If the pure expectations theory is correct, a downward-sloping yield curve indicates that interest rates are expected to decline in the future. True Because the maturity risk premium is normally positive, the yield curve is normally upward sloping. True The risk that interest rates will decline, and that decline will lead to a decline in the income provided by a bond portfolio as interest and maturity payments are reinvested, is called "reinvestment rate risk." True...