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    Study Questions for Financial Management

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    FINANCIAL MANAGEMENT STUDY QUESTIONS
    1. Current Ratio:
    How would the following actions affect a firm's current ratio?
    a. Inventory is sold at cost.
    b. The firm takes out a bank loan to pay its accounts due.
    c. A customer pays its accounts receivable.
    d. The firm uses cash to purchase additional inventories.

    2: Using Percentage of Sales:
    Eagle Sports Supply has the following financial statements. Assume that Eagle's assets are proportional to its sales.

    ? What are Eagle's required external funds if it maintains a dividend payout ratio of 70 percent and plans a growth rate of 15 percent in 2007?

    ? If Eagle chooses not to issue new shares of stock, what variable must be the balancing item? What will its value be?

    ? Now suppose that the firm plans instead to increase long-term debt only to $1,100 and does not wish to issue any new shares of stock. Why must the dividend payment now be the balancing item? What will its value be?

    3. Sustainable Growth:
    Plank's Plants had net income of $2,000 on sales of $50,000 last year.
    The firm paid a dividend of $500. Total assets were $100,000, of which $40,000 was financed by debt.
    ? What is the firm's sustainable growth rate?
    ? If the firm grows at its sustainable growth rate, how much debt will be issued next year?
    ? What would be the maximum possible growth rate if the firm did not issue any debt next year?

    4. Sources and Uses of Cash:
    State how each of the following events would affect the firm's balance sheet. State whether each change is "a source" or "a use of cash".

    ? An automobile manufacturer increases production in response to a forecast increase in demand. Unfortunately, the demand does not increase. Source or use of cash?

    ? Competition forces the firm to give customers more time to pay for their purchases. Source or use of cash?

    ? The firm sells a parcel of land for $100,000. The land was purchased 5 years earlier for $200,000. Source or use of cash?

    ? The firm repurchases its own common stock. Source or use of cash?

    ? The firm pays its quarterly dividend. Source or use of cash?

    ? The firm issues $1 million of long-term debt and uses the proceeds to repay a short-term bank loan. Source or use of cash?

    5. NPV and IRR:
    A project that costs $3,000 to install will provide annual cash flows of $800 for each of the next 6 years.
    ? Is this project worth pursuing if the discount rate is 10 percent?

    ? How high can the discount rate be before you would reject the project?

    6. Cash Flows:
    Canyon Tours showed the following components of working capital last year:

    ? What was the change in net working capital during the year?

    ? If sales were $36,000 and costs were $24,000, what was cash flow for the year? Ignore taxes.

    7. Sensitivity Analysis.
    A project currently generates sales of $10 million; variable costs equal to 50 percent of sales, and fixed costs of $2 million. The firm's tax rate is 35 percent. What are the effects of the following changes on after-tax profits and cash flow?

    ? Sales increase from $10 million to $11 million.

    ? Variable costs increase to 65 percent of sales.

    8. Risk and Return.
    True or false? Explain or qualify as necessary.

    ? Investors demand higher expected rates of return on stocks with more variable rates of return.

    ? The capital asset pricing model predicts that a security with a beta of zero will provide an expected return of zero.

    ? An investor who puts $10,000 in Treasury bills and $20,000 in the market portfolio will have a portfolio beta of 2.0.

    ? Investors demand higher expected rates of return from stocks with returns that are highly exposed to macroeconomic changes.

    ? Investors demand higher expected rates of return from stocks with returns that are very sensitive to fluctuations in the stock market.

    9. Calculating WACC:
    Reactive industries have the following capital structure. Its corporate tax rate is 35%. What is its WACC?

    10. Bankruptcy:
    True or false?
    ? When a company becomes bankrupt, it is usually in the interests of the equity holders to seek liquidation rather than reorganization.

    ? A reorganization plan must be presented for approval by each class of creditor.
    ? The Internal Revenue Service has first claim on the company's assets in the event of bankruptcy.

    ? In reorganization, creditors may be paid off with a mixture of cash and securities.

    ? When a company is liquidated, one of the most valuable assets to be sold is often the tax loss carry-forward.

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