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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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Solution Summary

The solution explains some financial management questions