TUTORIAL EXAM 1 1. An increase in financial leverage generally results in a higher return on equity (ROE). Top of Form נ True נ False 2. A company’s return on assets should be greater than its return on equity. Top of Form נ True נ False 3. An optimal current ratio should be greater than 1.0. Top of Form נ True נ False 4. GoodTimes Inc. has asset turnover of 0.5 times a net profit margin of 10% and average total assets of $100 what is its net income (assuming no unusual items)? Top of Form נ $50 נ $500 נ $5 נ The answer cannot be determined with the information provided 5. Which of the following ratios appears on a common-size balance sheet? I. Debt to asset ratio II. Net working capital to total assets III. Net profit margin Top of Form נ I II III נ I only נ I and III נ III only 6. Common-size financial statements are constructed in order to: Top of Form נ Adjust for inflation and risk נ Facilitate comparisons of different-sized companies נ To comply with SEC requirements נ All of the above 7. A company builds a new plant and finances its construction by issuing stock. Which ratio is least likely to be affected all else being equal? Top of Form נ Current ratio נ Debt to equity ratio נ Debt to asset ratio נ Net fixed assets to total assets 8. A company has net working capital of $0 current liabilities of $25 and total assets equal to $100. What is its current ratio? Top of Form נ 0.0 נ 1.0 נ 0.5 נ 4.0 9. Analysis of a company’s financial statements: Below are simplified versions of the balance sheet and income statement for Toys by Tom Inc. Use this information to answer question 9. Sales in 2003 were $10 000. Therefore the compounded average growth rate is: .gif” alt=”https://eproduct.hbsp.harvard.edu/eproduct/product/finance/content/item/4282/toys_by_tom_financial_statements.png”> Top of Form נ 8.6% נ 6.7% נ 6.3% נ Not enough information available 10. Analysis of a company’s financial statements: Below are simplified versions of the balance sheet and income statement for Toys by Tom Inc. Use this information to answer question 10. A 15% increase in inventory turns for Toys by Tom Inc. would bring this ratio to ____ suggesting ________ in ________. .gif” alt=”https://eproduct.hbsp.harvard.edu/eproduct/product/finance/content/item/4282/toys_by_tom_financial_statements.png”> Top of Form נ 109 days; a deterioration; profitability נ 3.9 days; a deterioration; profitability נ 4.8 times; an improvement; efficiency נ 3.9 times; an improvement; efficiency 11. The cash cycle measures the days required to produce finished goods or delivered services. Top of Form נ True נ False 12. In general an increase in a liability is a source of funds. Top of Form נ True נ False 13. The sustainable growth rate is the maximum growth rate achievable over an extended period of time. Top of Form נ True נ False 14. The cash conversion cycle is calculated as: Top of Form נ Days in Inventory Collection Period נ Days in Inventory – Payables Period נ Days in Inventory Collection Period – Payables Period נ None of the above 15. Which of following are sources of cash in a statement of sources and uses? I. Collection of accounts receivables II. Reduction of long-term debt III. Payment of dividends IV. Reduction in the cash account Top of Form נ I only נ II and III נ III and IV נ I and IV 16. Which of the following actions all else being equal will increase the sustainable growth rate? Top of Form נ Increasing asset turnover נ Reducing dividend payout נ Increasing leverage נ All of the above 17. Biases can and should always be eliminated in financial forecasts. Top of Form נ True נ False 18. Which of the following is commonly forecasted as a percent of sales: Top of Form נ Common stock נ Gross profit נ Long-term debt נ Revolving credit 19. External funding needs are computed as: Top of Form נ Projected total assets – (projected liabilities projected net worth) נ Projected total assets – (actual liabilities net worth) נ Projected current assets – (projected current liabilities net worth) נ None of the above 20. “Real” activities create cash for a business while “financial” activities distribute cash within the company. Top of Form נ True נ False 21. The item that roughly divides “real” from “financial” activities on an income statement is: Top of Form נ EBIT נ Interest Expense נ SG&A Expense נ None of the above 22. The cost of debt is generally lower than the cost of equity. Top of Form נ True נ False 23. The Static Tradeoff theory of capital structure implies that firms with higher business risk have should have lower leverage. Top of Form נ True נ False 24. A share repurchase is financially equivalent to a dividend. Top of Form נ True נ False 25. The Pecking Order Theory of capital structure implies a unique optimum capital structure. Top of Form נ True נ False 26. A firm is all equity financed with 10 000 outstanding shares with a market value of $20 each. Its net income was $30 000 and it decides to pay a cash dividend of $2 000. Calculate the value of each share after the dividend payout. Top of Form נ $22.8 נ $20.0 נ $19.8 נ 27. Grandma’s Applesauce Inc. has a 0.60 probability of a good year with operating cash flow of $50 000; and 0.40 probability of a bad year with operating cash flow of $30 000. The company has a debt of $35 000 with 8 percent interest due next year. Assuming the company has no means of servicing its debt other than operations and a 0% tax rate which of the following is true? Top of Form נ Shareholders expected claim is $12 200 נ Creditors expected claim is $37 800 נ Creditors expected claim is $34 680 נ None of the above 28. The owners of a firm facing a high probability of bankruptcy prefer to invest in ____ projects because ______. Top of Form נ safer; riskier projects make bankruptcy more likely נ no new; the firm is likely to go bankrupt anyway נ risky; the shareholders have little to lose and might win if successful נ risky; creditors prefer taking a gamble rather than having the company default 29. Which of the following expresses the value of a levered firm (VL) in the Static Tradeoff model of optimal capital structure? [Note: VU denotes the value of the unlevered firm; CFD denotes expected costs of financial distress; and PV denotes present value.] Top of Form נ VL = PV(Tax Shield) – PV(CFD) נ VL = VU PV(Tax Shield) / PV(CFD) נ VL = VU PV(Tax Shield) – PV(CFD) נ VL = VU PV(Tax Shield) 30. A company has net income of $20 000 and a tax rate of 35 percent. Its total debt is $25 000 with principal payments of $5 000 due at the end of each year and an annual interest rate of 8%. What will be the company’s interest tax shield in the upcoming year? Top of Form נ $8 750 נ $700 נ $9 450 נ $2 450 31. Which of the following is correct? I. Tax shields make debt financing more attractive all else equal. II. A firm’s debt ratio falls when it uses excess cash to pay dividends. III. The cost of equity is low for firms that pay no dividends all else equal. IV. Bankruptcy costs decrease the benefits of debt financing all else equal. Top of Form נ I and IV נ I II and IV נ I III and IV נ I II III and IV 32. The Pecking Order Theory of capital structure rests on an assumption of Top of Form נ Agency costs נ Barriers to entry נ Asymmetric information נ Tax shields and cost of financial distress 33. Which of the following are equivalent under M&M proposition I? Top of Form נ Maximizing firm value and maximizing firm profit נ Maximizing firm value and minimizing the cost of capital נ Minimizing firm’s cost of capital and minimizing firm’s debt burden נ Maximizing profit and minimizing taxes 34. Share repurchases and dividend payouts are most likely to differ in their Top of Form נ effects on a firm’s capital structure נ effects on corporate taxes נ effects on corporate cash flow נ effects on shareholders’ personal taxes 35. A perpetuity is a stream of cash flows that lasts forever. Top of Form נ True נ False 36. The higher the opportunity cost of capital the higher the NPV. Top of Form נ True נ False 37. A project with an internal rate of return greater than the cost of capital should always be accepted. Top of Form נ True נ False 38. The phenomenon of compounding connotes which of the following? Top of Form נ Investment of principal for a prolonged period. נ Interest earned over a prolonged period. נ Earning income on previously earned income. נ Rising interest rates over time. 39. If you invest $2 000 today for three years at 5% interest paid annually you will earn a total of $_____ in interest. Assume you re-invest all interest. Top of Form נ 205.00 נ 300.00 נ 315.25 נ 500.00 40. Enterprise Free Cash Flows should include: I. Capital expenditures II. Financing costs III. Taxes IV. Working capital requirements Top of Form נ I and IV נ I II and IV נ I III and IV נ I II III IV 41. You are trying to decide whether to accept or reject a one-year project. The project is estimated to generate $5 000 in incremental gross profit which includes $200 in depreciation. Incremental SG&A expense is $400. At a 35% tax rate the after-tax incremental cash flow is: Top of Form נ $2 990 נ $3 190 נ $3 250 נ $3 510 42. You are saving money for a down payment on a house. Suppose you want to have total savings of $20 000 in 10 years time and you have currently $5 000. What annual interest rate do you need to earn on your initial investment assuming you contribute no additional savings? Top of Form נ 10.0% נ 18.5% נ 12.5% נ 15.0% 43. What is the present value of a growing perpetuity that makes a payment of $100 in the first year which thereafter grows at 3% per year? Apply a discount rate of 7%. Top of Form נ $ 2 000 נ $ 3 500 נ $ 2 500 נ $ 4 000 44. A company’s beta (from the CAPM) is affected by its capital structure. Top of Form נ True נ False 45. The cost of capital for an all-equity-financed company that pays no dividends is zero. Top of Form נ True נ False 46. The beta for the market as a whole equals 1.0. Top of Form נ True נ False 47. What is the risk premium for a stock where נ the risk free rate is 5.1% נ the equity market risk premium is 5.0% נ the beta of the stock is 1.2 Top of Form נ 11.1% נ 6.1% נ 6.0% נ 12.1% 48. What is the expected return on a risky investment where נ the risk free rate is 5.1% נ the investment’s beta is 1.4 נ the equity market risk premium is 5.0% נ the cost of debt is 4.5% Top of Form נ 10.8% נ 9.6% נ 12.1% נ 9.2% 49. Which is a commonly used proxy for the “risk-free rate”? Top of Form נ the average historical interest rate on long-term government bonds נ the current market rate interest rate on a government-insured savings account נ the current yield to maturity on a long-term government bond נ the rate of return on a low volatility stock 50. In the CAPM the parameter beta measures: Top of Form נ non-systematic (diversifiable) risk נ systematic (non-diversifiable) risk נ total risk נ risk-adjusted stock returns
