FIN534 Final Exam

Question 1

4 out of 4 points

  
 Cazden Motors’ stock is trading at $30 a share. Call options on the company’s stock are also available, some with a strike price of $25 and some with a strike price of $35. Both options expire in three months. Which of the following best describes the value of these options?   
 Selected Answer:e. If Cazden’s stock price rose by $5, the exercise value of the options with the $25 strike price would also increase by $5.Correct Answer:e. If Cazden’s stock price rose by $5, the exercise value of the options with the $25 strike price would also increase by $5.   

Question 2

4 out of 4 points

  
 Which of the following statements is CORRECT?   
 Selected Answer:b.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.Correct Answer:b.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.Response Feedback:Rationale:Answer c is correct. See Figure 8−1 and the related discussion.   

Question 3

4 out of 4 points

  
 Which of the following statements is most correct, holding other things constant, for XYZ Corporation’s traded call options?   
 Selected Answer:e. The price of these call options is likely to rise if XYZ’s stock price rises.Correct Answer:e. The price of these call options is likely to rise if XYZ’s stock price rises.   

Question 4

4 out of 4 points

  
 To help estimate its cost of common equity, Maxwell and Associates recently hired you. You have obtained the following data: D0 = $0.90; P0 = $27.50; and gL = 7.00% (constant). Based on the dividend growth model, what is the cost of common from reinvested earnings?   
 Selected Answer:e. 10.50%Correct Answer:e. 10.50%Response Feedback:Rationale:D0$0.90P0$27.50g7.00%D1 = D0 × (1 + g)$0.963rs = D1/P0 + g10.50%   

Question 5

4 out of 4 points

  
 When working with the CAPM, which of the following factors can be determined with the most precision?   
 Selected Answer:c. The beta coefficient of “the market,” which is the same as the beta of an average stock.Correct Answer:c. The beta coefficient of “the market,” which is the same as the beta of an average stock.Response Feedback:Rationale:By definition, both the market and an average stock have betas of 1.0. Since we know this to be the case, we can obviously determine beta for the market or an average stock with precision.   

Question 6

4 out of 4 points

  
 As the winner of a contest, you are now CFO for the day for Maguire Inc. and your day’s job involves raising capital for expansion. Maguire’s common stock currently sells for $45.00 per share, the company expects to earn $2.75 per share during the current year, its expected payout ratio is 70%, and its expected constant growth rate is 6.00%. New stock can be sold to the public at the current price, but a flotation cost of 8% would be incurred. By how much would the cost of new stock exceed the cost of common from reinvested earnings?   
 Selected Answer:a. 0.37%Correct Answer:a. 0.37%Response Feedback:Rationale:Expected EPS1$2.75Payout ratio70%Current stk price$45.00g6.00%F8.00%D1$1.925rs = D1/P0 + g10.28%re = D1/(P0 × (1 − F)) + g10.65%Difference = re − rs0.37%   

Question 7

4 out of 4 points

  
 Ellmann Systems is considering a project that has the following cash flow and cost of capital (r) data. What is the project’s NPV? Note that if a project’s expected NPV is negative, it should be rejected.r:9.00%   Year0123Cash flows−$1,000$500$500$500   
 Selected Answer:a. $265.65Correct Answer:a. $265.65Response Feedback:Rationale:WACC:9.00%   Year0123Cash flows−$1,000$500$500$500NPV = $265.65   

Question 8

0 out of 4 points

  
 Which of the following statements is CORRECT? Assume that the project being considered has normal cash flows, with one outflow followed by a series of inflows.   
 Selected Answer:c. If Project A has a higher IRR than Project B, then Project A must also have a higher NPV.Correct Answer:b. If a project has normal cash flows and its IRR exceeds its cost of capital, then the project’s NPV must be positive.   

Question 9

0 out of 4 points

  
 Consider two projects, X and Y. Project X’s IRR is 19% and Project Y’s IRR is 17%. The projects have the same risk and the same lives, and each has constant cash flows during each year of their lives. If the cost of capital is 10%, Project Y has a higher NPV than X. Given this information, which of the following statements is CORRECT?   
 Selected Answer:a. The crossover rate must be less than 10%.Correct Answer:c. The crossover rate must be greater than 10%.Response Feedback:Rationale:Again, it is useful to draw NPV profiles that fit the description given in the question. Any number that meets the criteria will do.  As we can see from the graph, statement a is true; the other statements are false.   

Question 10

4 out of 4 points

  
 Weston Clothing Company is considering manufacturing a new style of shirt, whose data are shown below. The equipment to be used would be depreciated by the straight-line method over its 3-year life and would have a zero salvage value, and no new working capital would be required. Revenues and other operating costs are expected to be constant over the project’s 3-year life. However, this project would compete with other Weston’s products and would reduce their pre-tax annual cash flows. What is the project’s NPV? (Hint: Cash flows are constant in Years 1-3.)Cost of capital10.0%Pre-tax cash flow reduction for other products (cannibalization)$5,000Investment cost (depreciable basis)$80,000Straight-line deprec. rate33.333%Sales revenues, each year for 3 years$67,500Annual operating costs (excl. deprec.)$25,000Tax rate35.0%   
 Selected Answer:b. $3,828Correct Answer:b. $3,828Response Feedback:Rationale: t = 0t = 1t = 2t = 3Investment (Basis)WACC = 10%−$80,000   Sales revenues $67,500$67,500$67,500− Cannibalization cost 5,0005,0005,000− Operating costs (excl. deprec.)25,00025,00025,000− Basis × rate = deprec.Rate = 33.33%26,66726,66726,667Operating income (EBIT) $10,833$10,833$10,833− TaxesRate = 35% 3,7923,7923,792After-tax EBIT $ 7,042$ 7,042$ 7,042+ Depreciation             26,66726,66726,667Cash flow−$80,000$33,708$33,708$33,708NPV$3,828       

Question 11

4 out of 4 points

  
 Laramie Labs uses a risk-adjustment when evaluating projects of different risk. Its overall (composite) WACC is 10%, which reflects the cost of capital for its average asset. Its assets vary widely in risk, and Laramie evaluates low-risk projects with a risk-adjusted project cost of capital of 8%, average-risk projects at 10%, and high-risk projects at 12%. The company is considering the following projects:ProjectRiskExpected ReturnAHigh15%BAverage12%CHigh11%DLow  9%ELow  6%Which set of projects would maximize shareholder wealth?   
 Selected Answer:e. A, B, and D.Correct Answer:e. A, B, and D.Response Feedback:Rationale:Statement b is true; the others are false. The following table shows the required return for each project on the basis of its risk level.  ExpectedReq’d Return ProjectRiskReturnfor This RiskDecisionAHigh15%12%AcceptBAverage12%10%AcceptCHigh11%12%RejectDLow9%8%AcceptELow6%8%Reject   

Question 12

4 out of 4 points

  
 Which of the following statements is CORRECT?   
 Selected Answer:c.Cannibalization, as described in the text, is a type of externality that is not against the law, and any harm it causes is done to the firm itself.Correct Answer:c.Cannibalization, as described in the text, is a type of externality that is not against the law, and any harm it causes is done to the firm itself.   

Question 13

4 out of 4 points

  
 Which of the following is NOT one of the steps taken in the financial planning process?   
 Selected Answer:b.Consult with key competitors about the optimal set of prices to charge, i.e., the prices that will maximize profits for our firm and its competitors.Correct Answer:b.Consult with key competitors about the optimal set of prices to charge, i.e., the prices that will maximize profits for our firm and its competitors.   

Question 14

4 out of 4 points

  
 Decker EnterprisesBelow are the simplified current and projected financial statements for Decker Enterprises. All of Decker’s assets are operating assets. All of Decker’s current liabilities are operating liabilities.       Income statementCurrentProjected    Salesna         1,500    Costsna         1,050    Profit before taxna            450    Taxesna            135    Net incomena            315    Dividendsna               95           Balance sheetsCurrentProjected  CurrentProjectedCurrent assets         100            115 Current liabilities          70              81Net fixed assets     1,200         1,440 Long-term debt        300           360    Common stock        500           500    Retained earnings        430           650If Decker had a financing surplus, it could remedy the situation by     
 Selected Answer:b. paying a special dividendCorrect Answer:b. paying a special dividend   

Question 15

4 out of 4 points

  
 The term “additional funds needed (AFN)” is generally defined as follows:   
 Selected Answer:a.Funds that a firm must raise externally from non-spontaneous sources, i.e., by borrowing or by selling new stock to support operations.Correct Answer:a.Funds that a firm must raise externally from non-spontaneous sources, i.e., by borrowing or by selling new stock to support operations.   

Question 16

4 out of 4 points

  
 Which of the following is NOT normally regarded as being a barrier to hostile takeovers?   
 Selected Answer:b. Abnormally high executive compensation.Correct Answer:b. Abnormally high executive compensation.   

Question 17

4 out of 4 points

  
 David Rose Inc. forecasts a capital budget of $500,000 next year with forecasted net income of $400,000. The company wants to maintain a target capital structure of 30% debt and 70% equity. If the company follows the residual dividend policy, how much in dividends, if any, will it pay?   
 Selected Answer:c. $50,000Correct Answer:c. $50,000Response Feedback:Rationale:% Debt30%% Debt70%Capital budget$500,000Net income$400,000Equity requirement = Cap Bud × % Equity =$350,000Dividends = NI − Equity requirement =$50,000   

Question 18

4 out of 4 points

  
 Harvey’s Industrial Plumbing Supply’s target capital structure consists of 40% debt and 60% equity. Its capital budget this year is forecast to be $650,000. It also wants to pay a dividend of $225,000. If the company follows the residual dividend policy, how much net income must it earn to meet its capital requirements, pay the dividend, and keep the capital structure in balance?   
 Selected Answer:a. $615,000Correct Answer:a. $615,000Response Feedback:Rationale:Capital budget$650,000% Equity60%Dividends to be paid$225,000Required net income = Dividends + (Capital budget × % Equity)$615,000   

Question 19

4 out of 4 points

  
 Which of the following should not influence a firm’s dividend policy decision?   
 Selected Answer:a. The fact that much of the firm’s equipment has been leased rather than bought and owned.Correct Answer:a. The fact that much of the firm’s equipment has been leased rather than bought and owned.   

Question 20

4 out of 4 points

  
 Eccles Inc.Eccles Inc., a zero growth firm, has an expected EBIT of $100,000 and a corporate tax rate of 30%. Eccles uses $500,000 of 12.0% debt, and the cost of equity to an unlevered firm in the same risk class is 16.0%.Refer to the data for Eccles Inc.What is the firm’s cost of equity according to MM with corporate taxes?   
 Selected Answer:d. 32.0%Correct Answer:d. 32.0%Response Feedback:Rationale:Tc: 30%EBIT:  $100,000rsU:  16%Debt: $500,000VU = EBIT(1 – T)/rsU =VU = $100,000(0.7)/0.16 =$437,500​VL = VU + TD =VL =  $437,500 + 0.3($500,000) =$587,500S =VE =  VL – D =  S = $587,500 – $500,000 =$87,500  rsL = rsU + (rsU – rd)(1 – T)(D/S) =   rsL = 16% + (16% – 12%)(0.7)($500,000/$87,500) = 32.0%     

Question 21

4 out of 4 points

  
 The following information has been presented to you about the Gibson Corporation.Total assets$3,000 millionTax rate40%Operating income (EBIT)$800 millionDebt ratio0%Interest expense$0 millionWACC10%Net income$480 millionM/B ratio1.00×Share price$32.00EPS = DPS$3.20The company has no growth opportunities (g = 0), so the company pays out all of its earnings as dividends (EPS = DPS). The consultant believes that if the company moves to a capital structure financed with 20% debt and 80% equity (based on market values) that the cost of equity will increase to 11% and that the pre-tax cost of debt will be 10%. If the company makes this change, what would be the total market value (in millions) of the firm?   
 Selected Answer:c. $4,800Correct Answer:c. $4,800Response Feedback:Rationale:Step 1:Find the new WACC: WACC = wcrs + wd(1 − T)rd = (0.8(0.11)) + (0.2(1 − 0.4)0.10) = 0.10.  Step 2:Find the free cash flow: Because there is no growth, there is no investment in capital, hence FCF is equal to NOPAT: FCF = NOPAT − Investment in capital = EBIT(1 − T) −0 = $800(1 − 0.4) = $480 million.  Step 3:Find the new value of the firm: V = FCF/(WACC − g) = $480/0.10 = $4,800 million.   

Question 22

4 out of 4 points

  
 Which of the following statements concerning capital structure theory is NOT CORRECT?   
 Selected Answer:c. Under MM with corporate taxes, rs increases with leverage, and this increase exactly offsets the tax benefits of debt financing.Correct Answer:c. Under MM with corporate taxes, rs increases with leverage, and this increase exactly offsets the tax benefits of debt financing.   

Question 23

4 out of 4 points

  
 Blueline Publishers is considering a recapitalization plan. It is currently 100% equity financed but under the plan it would issue long-term debt with a yield of 9% and use the proceeds to repurchase common stock. The recapitalization would not change the company’s total assets, nor would it affect the firm’s basic earning power, which is currently 15%. The CFO believes that this recapitalization would reduce the WACC and increase stock price. Which of the following would also be likely to occur if the company goes ahead with the recapitalization plan?   
 Selected Answer:c. The company’s cost of equity would increase.Correct Answer:c. The company’s cost of equity would increase.   

Question 24

4 out of 4 points

  
 Brothers Breads has the following data. What is the firm’s cash conversion cycle?Inventory conversion period =50 daysAverage collection period =17 daysPayables deferral period =25 days   
 Selected Answer:e. 42 daysCorrect Answer:e. 42 daysResponse Feedback:Rationale:Inventory conversion period =50 daysAverage collection period =17 daysPayables deferral period =25 daysCCC = Inv. conv. period + Avg. coll. period − Pay. def. period = 42 days   

Question 25

4 out of 4 points

  
 Hinkle Corporation buys on terms of 2/15, net 60 days. It does not take discounts, and it typically pays on time, 60 days after the invoice date. Net purchases amount to $550,000 per year. On average, what is the dollar amount of total trade credit (costly + free) the firm receives during the year, i.e., what are its average accounts payable? (Assume a 365-day year, and note that purchases are net of discounts.)   
 Selected Answer:a. $90,411Correct Answer:a. $90,411Response Feedback:Rationale:Purchases$550,000Net days60Discount %2%Days to payment60Discount days15Days/Year365Purchases/day = $550,000/365 = $1,507 Average trade credit = Average A/P = Days to payment × Net purchases/day = $90,411   

Question 26

4 out of 4 points

  
 Mark’s Manufacturing’s average age of accounts receivable is 45 days, the average age of accounts payable is 40 days, and the average age of inventory is 69 days. Assuming a 365-day year, what is the length of its cash conversion cycle?   
 Selected Answer:e. 74 daysCorrect Answer:e. 74 daysResponse Feedback:Rationale:CCC = Inv. conv. period + Avg. coll. period − Pay. deferral periodAge of receivables = Avg. coll. period =45 daysAge of inventory = Inv. conv. period =69 daysAge of payables = Pay. def. period =40 daysCCC = Inv. conv. period + Avg. coll. period − Pay. def. period = 74 days   

Question 27

4 out of 4 points

  
 Suppose Yates Inc., a U.S. exporter, sold a consignment of antique American muscle-cars to a Japanese customer at a price of 143.5 million yen, when the exchange rate was 140 yen per dollar. In order to close the sale, Yates agreed to make the bill payable in yen, thus agreeing to take some exchange rate risk for the transaction. The terms were net 6 months. If the yen fell against the dollar such that one dollar would buy 154.4 yen when the invoice was paid, what dollar amount would Yates actually receive after it exchanged yen for U.S. dollars?   
 Selected Answer:b. $929,404Correct Answer:b. $929,404Response Feedback:Rationale:Time line:  Calculate the amount received in U.S. dollars after the 143,500,000 yen are exchanged for dollars at the spot rate of 154.4 yen, when the invoice is paid. 143,500,000/154.4 = $929,404.15 ≈ $929,404.   

Question 28

4 out of 4 points

  
 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?   
 Selected Answer:c. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market.Correct Answer:c. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market.   

Question 29

4 out of 4 points

  
 If it takes $0.71 U.S. dollars to purchase one Swiss franc, how many Swiss francs can one U.S. dollar buy?   
 Selected Answer:e. 1.41Correct Answer:e. 1.41Response Feedback:Rationale:Dollars should sell for 1/0.71, or 1.41 Swiss francs per dollar.   

Question 30

4 out of 4 points

  
 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.   
 Selected Answer:b. discount of 8%Correct Answer:b. discount of 8%Response Feedback:Rationale:(5.97 − 5.51)/5.51 = 0.083 ≈ 8%. Because one can obtain more Israel shekels for a dollar in the forward market, the forward currency is selling at an 8% discount to the spot rate.