# Finance questions: assets sold for less than book value, business risk, optimal capital structure and determining cash flows

An asset that is sold for less than book value at the end of a project's life will generate a loss for the firm and will cause an actual cash outflow attributable to the project.

True or False

Business risk" is differentiated from "financial risk" by the fact that financial risk reflects only the use of debt, while business risk reflects both the use of debt and such factors as sales variability, cost variability, and operating leverage.

True or False

The optimal capital structure is the one that simultaneously (1) maximizes the price of the firm's stock, (2) minimizes its WACC, and (3) maximizes its EPS.

True or False

In a capital budgeting analysis where part of the funds used to finance the project are raised as debt, failure to include interest expense as a cost in the cash flow statement when determining the project's cash flows will lead to an upward bias in the NPV. This statement would be true if "upward" were replaced with "downward."

True or False

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1) False. In the cash flow estimation, an asset sold for less than its book value would decrease the overall taxes. The company's taxes will be ...

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You will find the answer to this puzzling question inside...

Multiple choice

This is an old 2000 fall exam that will be used to study for a departmental final. I just need the multiple choice answers.

I do not need the 'work' shown as I will do that, just need something to let me know if the answer is right.

There are 40 questions ranging from easy to average in difficulty, as this is an intro to finance course.

1. A firm with net income of $100,000 pays out 26% of net income in dividends. If the firm has 34,000 shares of common stock outstanding, what is the dividend paid per share of stock?

A) $0.88

B) $0.77

C) $0.34

D) $1.25

E) $2.18

2. The financial ratio measured as net income divided by total assets is known as the firm's:

A) Profit margin.

B) Return on assets.

C) Return on equity.

D) Asset turnover.

E) Earnings before interest and taxes (EBIT).

Please see attached.

3. A $1000.00 Par Value bond with maturity of 7 years that pays a 8% semi-annual coupon when the yield to maturity is 6% should be priced at______.

A) $1112.96

B) $1048.77

C) $894.37

D) $1000.00

E) $983.48

4. All else staying the same, the magnitude of the price sensitivity of a bond to interest rate changes ________ as the coupon rate _________.

A) stays the same, increases

B) decreases, increases

C) increases, increases

D) decreases,decreases

E) increases, stays the same

5. Which of the following is FALSE regarding the underwriting of financial securities?

A) The issuing firm, not the underwriter, bears all the risk from adverse price movements in a firm commitment sale.

B) The method of marketing securities to the public is usually determined by the underwriter.

C) The underwriter, not the issuing firm, will generally set the price for the offering.

D) The spread earned by the underwriter is the difference between the price the underwriter pays for the security and the offering price of the security.

E) It is common for a number of underwriters to form a syndicate so that the risk in marketing a security issue is diversified across many investment banks rather than just the lead bank.

6. In a __________ , a firm wants to issue new public securities but needs the money at different stages over time, rather than all at once.

A) private placement

B) rights offering

C) shelf registration

D) firm commitment offering

E) multiplex cash offering

7. Which of the following statements is FALSE?

A) When comparing investments it is best not to rely solely on quoted rates.

B) Compounding typically leads to differences between quoted and effective rates.

C) The APR on a loan with monthly payments is less than the annual interest rate you actually pay.

D) The APR is the interest rate per period multiplied by the number of periods per year.

E) With monthly compounding, the APR will be larger than the effective annual rate.

8. What would your payment be on a 30-year, $250,000 loan at 10% interest compounded semiannually assuming the payments are made annually?

A) $ 2,240.25

B) $10,743.77

C) $22,402.50

D) $27,074.44

E) $35,348.16

9. When you were born, your dear old Aunt Minnie promised to deposit $500 into a savings account bearing a 5% compounded annual rate on each birthday, beginning with your first. You have just turned 21 and want the dough. However, it turns out that dear old (forgetful) Aunt Minnie made no deposits on your fifth and eleventh birthdays. How much is in the account right now?

A) $10,500.00

B) $15,953.74

C) $16,768.19

D) $17,859.63

E) $21,000.00

10. Your firm disposes of an asset which is worthless in the open market, but still has remaining undepreciated book value. The tax benefit to the firm from the writeoff on this asset is equal to the .

A) remaining book value.

B) tax rate multiplied by the remaining book value.

C) remaining book value divided by the tax rate.

D) salvage value multiplied by the tax rate.

E) There is no tax benefit to be realized, since the asset is worthless.

11. Given the following information and assuming straight-line depreciation to zero, what is the NPV for this project? Initial investment in fixed assets = $20,000; initial investment in net working capital = $5,000; life = 4 years; cost savings = $10,000 per year; salvage value = $4,000; tax rate = 35%; discount rate = 15%.

A) $ 777

B) $1,444

C) $2,899

D) $4,111

E) $6,501

12. The managers of Poncho Parts, Inc. plan to manufacture engine blocks for classic cars from the 1960s era. They expect to sell 250 blocks annually for the next 5 years at a sales price of $3,000. The necessary foundry and machining equipment will cost a total of $800,000 and will be depreciated on a straight-line basis to zero over the project's life. The firm expects to be able to dispose of the manufacturing equipment for $150,000 at the end of the project. Labor and materials costs total $500 per engine block, fixed costs are $125,000 per year. Assume a 35% tax rate and a 12% discount rate. What is the expected after-tax cash flow to the firm from the sale of equipment in year 5?

A) $ 65,000

B) $ 97,500

C) $100,000

D) $115,000

E) $120,125

13. All else the same, a higher corporate tax rate _____________________.

A) will decrease the WACC of a firm with some debt in its capital structure

B) will increase the WACC of a firm with some debt in its capital structure

C) will not affect the WACC of a firm with some debt in its capital structure

D) will decrease the WACC of a firm with no debt in its capital structure

E) will change the WACC of a firm with some debt in its capital structure, but the direction is unclear.

14. The (pretax) cost of debt for a firm _____________________________.

A) is always greater than the cost of equity

B) normally cannot be observed, directly or indirectly, in the marketplace

C) is equal to the yield to maturity on the firm's outstanding bonds

D) is greater than the average coupon rate on the firm's outstanding bonds

E) is equal to the average coupon rate on the firm's outstanding bonds

15. A firm is considering a project that will generate perpetual cash flows of $25,000 per year beginning next year. The project has the same risk as the firm's overall operations and must be financed externally. Equity costs 15% and debt costs 6% on an after-tax basis. The firm's D/E ratio is 1.2. What is the most the firm can pay for the project and still earn its required return?

A) $212,250

B) $247,747

C) $276,500

D) $366,250

E) $412,750

16. Your employer is considering an investment in new manufacturing equipment. The equipment costs $220,000 and will provide annual after-tax cash flows of $50,000 at the end of each of the next 7 years. The firm's market value debt/equity ratio is 25%, its cost of equity is 14%, and its pretax cost of debt is 7%. The firm's combined marginal federal and state tax rate is 40%. Assume the project is of approximately the same risk as the firm's existing operations. What is the NPV of the proposed project?

A) $ 6,297

B) $ 7,899

C) $ 9,156

D) $13,436

E) $15,984

17. A firm needs to purchase equipment for its 2,000 drive-ins nationwide. The total cost of the equipment is $2 million. It is estimated that the after-tax cash inflows from the project will be $210,000 annually in perpetuity. The market value debt-to-assets ratio is 40%. The firm's cost of equity is 13% and its pretax cost of debt is 8%. The tax rate is 34%. Assume the project is of similar risk to the firm's existing operations. What is the weighted average cost of capital?

A) 6.09%

B) 8.73%

C) 8.95%

D) 9.05%

E) 9.91%

18. If cash flow from operations is $7,300, net capital spending is -$3,500, and net working capital declines by $1,600, what is cash flow from assets?

A) $ 2,200

B) $ 5,400

C) $ 9,200

D) $10,800

E) $12,400

19. A firm paid $12 million in dividends during 2002, while also making net common stock repurchases of $9 million. What was the cash flow to stockholders for 2002?

A) -$ 3 million

B) $ 9 million

C) $12 million

D) $17 million

E) $21 million

20. The process of finding the present value of some future amount is often called ______________.

A) growth

B) discounting

C) accumulation

D) compounding

E) reduction

21. You will receive a $250,000 inheritance in 25 years. You can invest that money today at 8% compounded annually. What is the present value of your inheritance?

A) $ 17,491.53

B) $ 29,767.15

C) $ 36,504.48

D) $ 65,492.34

E) $100,000.00

22. You just won the lottery and want to put some money away for your child's college education. College will cost $75,000 in 15 years. You can earn 7% compounded annually. How much do you need to invest today?

A) $19,828.18

B) $21,763.07

C) $23,690.82

D) $25,258.17

E) $27,183.45

23. The financial leverage of a firm will ______________________ .

I. decrease as the debt/equity ratio increases

II. decrease as the firm's retained earnings account grows

III. decrease if the firm has negative net income

A) I only

B) II only

C) III only

D) I and II only

E) II and III only

24. The optimal capital structure is the mixture of debt and equity which:

I. Maximizes the value of the firm.

II. Maximizes the firm's weighted average cost of capital.

III. Maximizes the market price of the firm's bonds.

A) I only

B) III only

C) I and II only

D) I and III only

E) I, II and III

Use the following information for Questions #25-27

A firm has expected EBIT = $910, an unlevered cost of capital of 12%, and debt with a face and market value of $2,000 paying an 8.5% annual coupon. The tax rate is 34%.

25. What is the value of the firm?

A) 5,685

B) 3,247

C) 7,787

D) 4,372

E) 6,493

26. What is the cost of equity?

A) 10.9%

B) 13.3%

C) 11.6%

D) 12.2%

E) 14.5%

27. What is the weighted average cost of capital?

A) 12.6%

B) 11.2%

C) 10.6%

D) 13.4%

E) 14.5%

28. The primary goal of financial management is to:

A) Maximize current sales.

B) Maximize the market value of the owners' equity.

C) Avoid financial distress.

D) Minimize operational costs.

E) Maintain steady earnings growth.

29. According to the balance sheet model of the firm, Business Finance may be thought of as the analysis of three primary subject areas. Which of the following correctly lists these areas?

A) Capital structure, capital budgeting, security analysis

B) Capital budgeting, capital structure, capital spending

C) Capital budgeting, capital structure, working capital management

D) Capital structure, working capital management, capital rationing

E) Capital budgeting, capital spending, working capital management

30. As illustrated using the dividend growth model, the total return on a share of common stock is comprised of a ___________; in this model, the capital gains yield is the same as the ___________.

A) capital gains yield and a dividend growth rate; dividend yield.

B) capital gains growth rate and a dividend growth rate; dividend growth rate.

C) dividend payout ratio and a required rate of return; the marginal income tax rate.

D) dividend yield and the present dividend; total return less the dividend yield.

E) dividend yield and a capital gains yield; dividend growth rate.

31. The current price of XYZ stock is $80.00. Dividends are expected to grow at 5% indefinitely and the most recent dividend was $2.75. What is the required rate of return on XYZ stock using the Dividend Growth Model?

A) 7.3%

B) 8.6%

C) 9.5%

D) 10.6%

E) 11.2%

32. Your company is offering the following credit terms to your customers:

"3/15, net 60". This means....

A) If the invoice is not paid by the 60th day from its receipt, the total invoice cost will increase by 3%; if the invoice is paid by the 15th day, the customer may pay just the cost of the invoice.

B) If the invoice is paid by the 15th day from its receipt, the customer may take a 3% discount off the invoice cost; if the invoice is not paid until the 60th day, the customer must add 3% to the invoice cost.

C) If the invoice is paid by the 15th day from its receipt, the customer may take a 3% discount off the invoice cost; otherwise, the full invoice cost is due not later than the 60th day.

D) None of the above.

33. A company maintains an average inventory of 5,000 units for sale to its customers. The carrying cost per item per year is estimated to be $9. The firm places an order for 30,000 units on the first of each month, and the order cost is $200. What is the economic order quantity (EOQ)?

A) 1,250 units

B) 2,000 units

C) 2,400 units

D) 4,000 units

E) 7,500 units

34. Your firm decides to ease its credit policy from net 30 days to net 45 days. All else the same, this action will increase the firm's ______________ .

A) cash cycle and inventory period

B) cash and operating cycles

C) accounts payable period and operating cycle

D) operating cycle and inventory period

E) accounts receivable period and inventory period

35. A firm reported sales of $20,000 in November, $30,000 in December, and projects sales of $40,000 for January, $50,000 for February, and $35,000 for March. The firm's cost of goods sold every month is equal to 75% of the next month's sales. The firm collects its receivables in 60 days and pays its payables in 30 days. The firm begins January 1 with $50,000 in cash. All sales and purchases are on credit.

What is the accounts payable balance at the end of January?

A) $26,250

B) $30,000

C) $37,500

D) $45,250

E) $50,000

36. Net present value _____________.

A) is equal to the initial investment in a project

B) is equal to the present value of the project benefits

C) is equal to zero when the discount rate used is equal to the IRR

D) is simplified by the fact that future cash flows are easy to estimate

E) requires the firm set an arbitrary cutoff point for determining whether an investment is acceptable

37. You are considering a project that costs $600 and has expected cash flows of $224, $250.88 and $280.99 over the next three years. If the appropriate discount rate for the project's cash flows is 12%, what is the net present value of this project?

A) The NPV is negative

B) $ 0.00

C) $ 9.34

D) $49.34

E) $84.75

Please use the following information for Question #38

Project Year 0 Year 1 Year 2 Year 3

A -$700 $300 $300 $300

B -$950 $400 $400 $450

38. Based on the payback rule, which of the following is FALSE?

A) With a payback cutoff of 1.5 years, both projects are unacceptable.

B) With a payback cutoff of 3 years, both projects are acceptable.

C) With a payback cutoff of 2 years, neither project is acceptable.

D) Since both projects pay back, the NPV of both must be positive.

E) You would be indifferent between the two projects.

39. The excess return required on a risky asset over that earned on a risk-free asset is called :

A) Risk premium.

B) Return premium.

C) Excess return.

D) Average return.

E) Variance.

40. You purchased 500 shares of preferred stock on January 1, 2002, for $50 per share. The stock pays an annual dividend of $8 per share. On December 31, 2002, the market price is $54 per share. What is your percentage return on investment for the year?

A) 4%

B) 8%

C) 16%

D) 20%

E) 24%