Study exam final

1. Which of the following is true regarding Investment Banks?

As of 2010, stand alone Investment banks are numerous.

2. We compute the profitability index of a capital-budgeting proposal by Initial outlay = $1,748.80

dividing the present value of the annual after-tax cash flows by the cost of the project.

Explanation: The profitability index is calculated as Net Present Value / Initial Outlay.

3. Project Sigma requires an investment of $1 million and has a NPV of $10. Project Delta requires an investment of $500,000 and has a NPV of $150,000. The projects involve unrelated new product lines.

What is your evaluation of these two projects?

Both projects should be accepted because they have positive NPV’s

Explanation: A positive NPV indicates the project is generating returns at the firms required rate of return and should be accepted.

4. Which of the following is most likely to occur if a firm over-invests in net working capital?

The return on investment will be lower than it should be.

Explanation: More funds will be allocated to current assets, which will make the firm’s relative return on investment (ROI) appear lower.

5. The Securities Investor Protection Corporation protects individuals from

Brokerage firm failures

6. If managers are making decisions to maximize shareholder wealth, then they are primarily concerned with making decisions that should:

Increase the market value of the firm’s common stock.

Explanation: Stock value increases are typically the most effective way to increase shareholder wealth.

7. Buying and selling in more than one market to make a riskless profit is called: Arbitrage

8. Given an accounts receivable turnover of 8 and annual credit sales of $362,000, the average collection period (360-day year) is

45 Days

Explanation: ACP = 360 / 8 = 45 Days

9. Delta Inc. is considering the purchase of a new machine which is expected to increase sales by $10,000 in addition to increasing non-depreciation expenses by $3,000 annually. Due to the sales increase, Delta expects its working capital to increase $1,000 during the life of the project. Delta will depreciate the machine using the straight-line method over the project’s five year life to a salvage value of zero. The machine’s purchase price is $20,000. The firm has a marginal tax rate of 34 percent, and its required rate of return is 12 percent. The machine’s initial cash outflow is:

$27,000

Explanation: Cash Outflow = (3000+20000+4000) = 27000
Note: Depreciation = 20000 x (1/5) = 4000

10. A company collects 60% of its sales during the month of the sale, 30% one month after the sale, and 10% two months after the sale. The company expects sales of $10,000 in August, $20,000 in September, $30,000 in October, and $40,000 in November. How much money is expected to be collected in October?

$25,000

Explanation: October sales = (10000 x 0.10) + (20000 x 0.30) + (30000 x 0.60) = 25000

11. Capital Structure Theory in general assumes that:

A firm’s value is determined by discounting the firm’s expected cash flows by the WACC.

Explanation: Businesses often discount cash flows at WACC to determine the valuation of a business.

12. Which of the following best describes why cash flows are utilized rather than accounting profits when evaluating capital projects?

Cash flows reflect the timing of benefits and costs more accurately than accounting profits.

13. Which of the following could offset the higher risk exposure a company would face if it’s current ratio and net working capital were relatively low?

Its current assets would need to be highly liquid.

Explanation: High liquidity assets, such as cash, decreases the risk of presented by low overall working capital.

14. When the impact of taxes is considered, as the firm takes on more debt

Cash flows will increase because taxes will decrease.

Explanation: Interest expenses are tax deductible, thus decreasing tax liabilities.

15. Accounting break-even analysis solves for the level of sales that will result in:

Net income = $0.00.

16. When calculating the weighted average cost of capital, which of the following has to be adjusted for taxes?

Debt

Explanation: Debt is multiplied by (1-Tax Rate) in the WACC formula.

17. Which of the following statements best represents what finance is about?

Creation and maintenance of economic wealth

18. Apple Two Enterprises expects to generate sales of $5,950,000 for fiscal 2014; sales were$3,450,000 in fiscal 2013. Assume the following figures for the fiscal year ending 2013: cash $70,000; accounts receivable $250,000; inventory $400,000; net fixed assets $520,000; accounts payable $235,000; and accruals $155,000. Use the percent-of-sales method to forecast cash for the fiscal year ending 2014.

$120,725

Explanation: 3450000 / 70000 = 0.0203 x 5950000 = 120,725

19. Aspects of demand risk controllable by the firm include:

Product quality

20. The Oviedo Thespians are planning to present performances of their Florida Revue on 2 consecutive nights in January. It will cost them $5,000 per night for theater rental, event insurance and professional musicians. The theater will also take 10% of gross ticket sales. How many tickets must they sell at $10.00 per ticket to raise $1,000 for their organization?

1,223 tickets

Explanation: 1000 = 10x – (0.1x + 10000)
x = 1223 tickets

21. Which of the following goals is in the best long-term interest of stockholders?

Maximizing of the market value of the existing shareholders’ common stock

Explanation: Shareholder value is all about making sound business decisions that will be reflected by a higher market value.

22. Compute the payback period for a project with the following cash flows, if the company’s discount rate is 12%.

Initial outlay = $450
Cash flows: Year 1 = $325
Year 2 = $65
Year 3 = $100

2.88

Explanation = 2.88 (use financial calculator or online payback period calculator).

23. If you have $20,000 in an account earning 8% annually, what constant amount could you withdraw each year and have nothing remaining at the end of five years?

$5,008.76

Explanation: Use an online annuity calculator or financial calculator to solve.

24. Which of the following best describes why cash flows are utilized rather than accounting profits when evaluating capital projects?

Cash flows reflect the timing of benefits and costs more accurately than accounting profits.

25. Which of the following financial ratios is the best measure of the operating effectiveness of a firm’s management?

Gross Profit Margin

Explanation: Gross profit is the most fundamental measurement of operational performance.

26. Which of the following is not part of the underwriting process?

The prospectus

27. Long-term financial plans typically encompass:

About 5 years.

Explanation: 5 years is the most common scope of long term financial planning.

28. Metals Corp. has $2,575,000 of debt, $550,000 of preferred stock, and $18,125,000 of common equity. Metals Corp.’s after-tax cost of debt is 5.25%, preferred stock has a cost of 6.35%, and newly issued common stock has a cost of 14.05%. What is Metals Corp.’s weighted average cost of capital?

12.78%

Explanation: Use online WACC calculator.

29. You just purchased a parcel of land for $10,000. If you expect a 12% annual rate of return on your investment, how much will you sell the land for in 10 years?

$31,060

Explanation: 10000 *(1+0.12)^10 = 31060

30. Which of the following is true about bonds?

They have a fixed maturity, and they pay an amount equal to the maturity value times the coupon rate each year.