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Financial Management Questions

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True or False

1) If changes in the bankruptcy code make bankruptcy less costly to corporations,
then this would likely reduce the debt ratio of the average corporation.

2) The firm's financial risk may have both market risk and diversifiable risk components.

3) The bird-in-the-hand theory argues that investors prefer dividends because dividends
are taxed more favorably than capital gains.

4) Two firms with the same dividend and growth rate must also have the same stock price.

5) If a company has two classes of common stock, Class A and Class B, the stocks may pay different
dividends, but the two classes must have the same voting rights.

6) Gross working capital represents current assets used in operations.

7) The best and most comprehensive picture of a firm's liquidity position is shown by its cash budget,
which forecasts cash inflows and outflows.

8) Permanent current assets are those current assets that must be increased
when sales increase during an upswing.

9) A financial lease is a lease that does not provide for maintenance services, is not cancelable, a
nd is fully amortized over its life; also called a capital lease.

10) Warrants cannot be traded separately from the bond with which they are associated.

Multiple Choice: Enter correct answer in the space provided

1) A decrease in the debt ratio will generally have no effect on___________ .

a. Financial risk.
b. Total risk.
c. Business risk.
d. Market risk.
e. None of the above is correct. (It will affect each type of risk above.)

2) Texas Products Inc. has a division that makes burlap bags for the citrus industry.
The division has fixed costs of $10,000 per month, and it expects to sell 42,000 bags per month.
If the variable cost per bag is $2.00, what price must the division charge in order to break even?

a. $2.24
b. $2.47
c. $2.82
d. $3.15
e. $2.00

3) Simon Utility expects to have net income of $5 billion this year. The company has an
estimated capital budget of $4 billion, and its capital structure consists of 65 percent common equity and 35 percent debt.
If the company follows a strict residual dividend policy, what is the company's expected dividend payout ratio?

a. 0.00%
b. 35.00%
c. 48.00%
d. 65.00%
e. 100.00%

4) McKenna Motors is expected to pay a $1.00 per-share dividend at the end of the year (D1 = $1.00).
The stock sells for $20 per share and its required rate of return is 11 percent. The dividend is expected to
grow at a constant rate, g, forever. What is the growth rate, g, for this stock?

a. 5%
b. 6%
c. 7%
d. 8%
e. 9%

5) NOPREM Inc. is a firm whose shareholders don't possess the preemptive right.
The firm currently has 1,000 shares of stock outstanding; the price is $100 per share. The firm plans to issue
an additional 1,000 shares at $90.00 per share. Since the shares will be offered to the public at large, what is the
amount per share that old shareholders will lose if they are excluded from purchasing new shares?

a. $90.00
b. $5.00
c. $10.00
d. $0
e. $2.50

6) For the Cook County Company, the average age of accounts receivable is 60 days, the average age of
accounts payable is 45 days, and the average age of inventory is 72 days. Assuming a 365-day year, what is the
length of the firm's cash conversion cycle?

a. 87 days
b. 90 days
c. 65 days
d. 48 days
e. 66 days

7) A firm has $5,000,000 of inventory on average and annual sales of $30,000,000. Assume there are
365 days per year. What is the firm's inventory conversion period?
a. 30.25 days
b. 60.83 days
c. 45.00 days
d. 72.44 days
e. 55.25 days

8) Matheson Manufacturing Inc. is planning to borrow $12,000 from the bank. The bank offers the choice of a
12 percent discount interest loan or a 10.19 percent add-on, 1-year installment loan, payable in 4 equal quarterly payments.
What is the effective rate of interest on the 10.19 percent add-on loan?

a. 9.50%
b. 10.19%
c. 15.22%
d. 16.99%
e. 22.05%

9) The Random Corporation is setting its terms on a new issue with warrants. The bonds have a 30-year maturity
and semiannual coupon. Each bond will have 20 warrants attached that give the holder the right to purchase one share of Random stock per warrant.
Random's investment banker estimates that each warrant has a value of $14.20. A similar straight-debt issue would require a
10 percent coupon. What coupon rate must be set on the bonds so that the package will sell for $1,000?

a. 6.00%
b. 7.00%
c. 8.00%
d. 9.00%
e. 10.00%

10) Northeast Company has 200,000 shares of common stock and 50,000 warrants outstanding.
Each warrant entitles its owner to buy one share at a price of $20 before 2010. The firm's basic
earnings per share is $2.50. What is the firm's diluted earnings per share?

a. $2.50
b. $2.25
c. $1.50
d. $3.00
e. $2.00

Problem 1

Rollins Corporation has a target capital structure consisting of 20 percent debt, 20 percent preferred stock,
and 60 percent common equity. Assume the firm has insufficient retained earnings to fund the equity portion of its capital budget.
Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sell for $1,000. The firm could sell, at par, $100
preferred stock that pays a 12 percent annual dividend, but flotation costs of 5 percent would be incurred. Rollins' beta is 1.2,
the risk-free rate is 10 percent, and the market risk premium is 5 percent. Rollins is a constant growth firm that just paid a dividend of $2.00,
sells for $27.00 per share, and has a growth rate of 8 percent. The firm's policy is to use a risk premium of 4 percentage points when
using the bond-yield-plus-risk-premium method to find ks. Flotation costs on new common stock total 10 percent, and the firm's
marginal tax rate is 40 percent.

1a. What is Rollins' WACC,

1b What is Rollins' cost of preferred stock?

Problem 2

2) Brown & Sons recently reported sales of $100 million, and net income equal to $5 million. The
company has $70 million in total assets. Over the next year, the company is forecasting a 20 percent
increase in sales. Since the company is at full capacity, its assets must increase in proportion to sales.
The company also estimates that if sales increase 20 percent, spontaneous liabilities will increase by $2 million.
If the company's sales increase, its profit margin will remain at its current level. The company's
dividend payout ratio is 40 percent. Based on the AFN formula, how much additional capital must the
company raise in order to support the 20 percent increase in sales?

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The solution explains some financial management questions

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Rate of return

Question 10

What's the rate of return you would earn if you paid $950 for a perpetuity that pays $85 per year?

6.52%

7.25%

8.05%

8.95%

9.84%

Question 11

What is the future value of $1,500 after 5 years if the appropriate interest rate is 6%, compounded semiannually?

$1,819.33

$1,915.08

$2,015.87

$2,116.67

$2,222.50

Question 12

What annual payment would you have to receive in order to earn a 7.5% rate of return on a perpetuity that has a cost of $1,250?

$89.06

$93.75

$98.44

$103.36

$108.53

Question 13

Suppose you are buying your first house for $210,000, and are making a $20,000 down payment. You have arranged to finance the remaining amount with a 30-year, monthly payment, amortized mortgage at a 6.5% nominal interest rate. What will your equal monthly payments be (principal plus interest, excluding taxes and insurance)?

$1,083.84

$1,140.88

$1,200.93

$1,260.98

$1,324.02

Question 14

Your child's orthodontist offers you two alternative payment plans. The first plan requires a $4,000 immediate up-front payment. The second plan requires you to make monthly payments of $137.41, payable at the end of each month for 3 years. What nominal annual interest rate is built into the monthly payment plan?

12.31%

12.96%

13.64%

14.36%

15.08%

Question 15

Your sister turned 35 today, and she is planning to save $5,000 per year for retirement, with the first deposit to be made one year from today. She will invest in a mutual fund that will provide a return of 8% per year. She plans to retire 30 years from today, when she turns 65, and she expects to live for 25 years after retirement, to age 90. Under these assumptions, how much can she spend in each year after she retires? Her first withdrawal will be made at the end of her first retirement year

$47,888

$50,408

$53,061

$55,714

$58,500

Question 16

Other things held constant, which of the following actions would increase the amount of cash on a company's balance sheet?

The company repurchases common stock.

The company pays a dividend.

The company issues new common stock.

The company gives customers more time to pay their bills.

The company purchases a new piece of equipment.

Question 17

On its 2007 balance sheet, Barngrover Books showed $510 million of retained earnings, and exactly that same amount was shown the following year. Assuming that no earnings restatements were issued, which of the following statements is CORRECT?

If the company lost money in 2007, they must have paid dividends.

The only possibility is that the company had zero net income in 2007.

The company must have paid out half of its earnings as dividends.

The company must have paid no dividends in 2007.

Dividends could have been paid in 2007, but they would have had to equal the earnings for the year.

Question 18

A security analyst obtained the following information from Prestopino Products' financial statements:
â?¢ Retained earnings at the end of 2006 were $700,000, but retained earnings at the end of 2007 had declined to $320,000.
â?¢ The company does not pay dividends.
â?¢ The company's depreciation expense is its only non-cash expense; it has no amortization charges.
â?¢ The company has no non-cash revenues.
â?¢ The company's net cash flow (NCF) for 2007 was $150,000.
On the basis of this information, which of the following statements is CORRECT?

Prestopino had negative net income in 2007

Prestopino's depreciation expense in 2007 was less than $150,000.

Prestopino had positive net income in 2007, but its income was less than its 2006 income.

Prestopino's NCF in 2007 must be higher than its NCF in 2006.

Prestopino's cash on the balance sheet at the end of 2007 must be lower than the cash it had on the balance sheet at the end of 2006.

Question 19

Which of the following statements is CORRECT?

The income of certain small corporations that qualify under the Tax Code is completely exempt from corporate income taxes. Thus, the federal government receives no tax revenue from these businesses.

All businesses, regardless of their legal form of organization, are taxed under the Business Tax Provisions of the Internal Revenue Code.

Small businesses that qualify under the Tax Code can elect not to pay corporate taxes, but then their owners must report their pro rata shares of the firm's income as personal income and pay taxes on that income.

Congress recently changed the tax laws to make dividend income received by individuals exempt from income taxes. Prior to the enactment of that law, corporate income was subject to double taxation, where the firm was first taxed on the income and stockholders were taxed again on the income when it was paid to them as dividends.

All corporations other than non-profit corporations are subject to corporate income taxes, which are 15% for the lowest amounts of income and 35% for the highest amounts of income.

Question 20

Which of the following statements is CORRECT?

Dividends paid reduce the net income that is reported on a company's income statement.

If a company uses some of its bank deposits to buy short-term, highly liquid marketable securities, this will cause a decline in its current assets as shown on the balance sheet.

If a company issues new long-term bonds during the current year, this will increase its reported current liabilities at the end of the year.

Accounts receivable are reported as a current liability on the balance sheet.

If a company pays more in dividends than it generates in net income, its retained earnings as reported on the balance sheet will decline from the previous year's balance.

Question 21

Hunter Manufacturing Inc.'s December 31, 2006, balance sheet showed total common equity of $2,050,000 and 100,000 shares of stock outstanding. During 2007, Hunter had $250,000 of net income, and it paid out $100,000 as dividends. What was the book value per share at 12/31/07, assuming that Hunter neither issued nor retired any common stock during 2007?

$20.90

$22.00

$23.10

$24.26

$25.47

Question 22

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)?

$3,230.00

$3,400.00

$3,570.00

$3,748.50

$3,935.93

Question 23

You observe that a firm's ROE is above the industry average, but its profit margin and debt ratio are both below the industry average. Which of the following statements is CORRECT?

Its total assets turnover must be above the industry average.

Its return on assets must equal the industry average.

Its TIE ratio must be below the industry average.

Its total assets turnover must be below the industry average.

Its total assets turnover must equal the industry average.

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