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Study Questions for Financial Management

See the attached file for problems.
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.


Solution Summary

The solution explains various questions in financial management