GRAND FIN650 MODULE 3 EXAMQuestion 1. Cyberhost Corporation’s sales were $225 million last year. If sales grow at 6% per year, how large (in millions) will they be 5 years later? A. $271.74 B. $286.05 C. $301.10 D. $316.16 E. $331.96 N 5 I/YR 6.0% PV $225.00 PMT $0.00 FV $301.00 2. Assume a project has normal cash flows. All else equal, which of the following statements is CORRECT? A. A project’s IRR increases as the WACC declines. B. A project’s NPV increases as the WACC declines. C. A project’s MIRR is unaffected by changes in the WACC. D. A project’s regular payback increases as the WACC declines. 3. A project’s discounted payback increase Aubey Aircraft recently announced that its net income increased sharply from the previous year, yet its net cash flow from operations declined. Which of the following could explain this performance? A. The company’s operating income declined. B. The company’s expenditures on fixed assets declined. C. The company’s cost of goods sold increased. D. The company’s depreciation and amortization expenses declined. 4. Which of the following statements is CORRECT? A. If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days’ sales outstanding will decline. B. If a security analyst saw that a firm’s days’ sales outstanding (DSO) was higher than the industry average and was also increasing and trending still higher, this would be interpreted as a sign of strength. C. If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days’ sales outstanding (DSO) will increase. D. There is no relationship between the days’ sales outstanding (DSO) and the average collection period (ACP). These ratios measure entirely different things. E. A reduction in accounts receivable would have no effect on the current ratio, but it would lead to an increase in the quick ratio. 5. Olivia Hardison, CFO of Impact United Athletic Designs, plans to have the company issue $500 million of new common stock and use the proceeds to pay off some of its outstanding bonds. Assume that the company, which does not pay any dividends, takes this action, and that total assets, operating income (EBIT), and its tax rate all remain constant. Which of the following would occur? A. The company’s taxable income would fall. B. The company’s interest expense would remain constant. C. The company would have less common equity than before. D. The company’s net income would increase. E. The company would have to pay less taxes. 6. One drawback of switching from a partnership to the corporate form of organization is the following: A. It subjects the firm to additional regulations. B. It cannot affect the amount of the firm’s operating income that goes to taxes. C. It makes it more difficult for the firm to raise additional capital. D. It makes the firm’s investors subject to greater potential personal liabilities. E. It makes it more difficult for the firm’s investors to transfer their ownership interests. 7. JG Asset Services is recommending that you invest $1,500 in a 5-year certificate of deposit (CD) that pays 3.5% interest, compounded annually. How much will you have when the CD matures? A. $1,781.53 B. $1,870.61 C. $1,964.14 D. $2,062.34 E. $2,165.46 N 5 I/YR 3.5% PV $1,500 PMT $0 FV $1,781.53 8. Which of the following statements is CORRECT? A. The maximum federal tax rate on personal income in 2010 was 50%. B. Since companies can deduct dividends paid but not interest paid, our tax system favors the use of equity financing over debt financing, and this causes companies’ debt ratios to be lower than they would be if interest and dividends were both deductible. C. Interest paid to an individual is counted as income for tax purposes and taxed at the individual’s regular tax rate, which in 2010 could go up to 35%, but dividends received were taxed at a maximum rate of 15%. D. The maximum federal tax rate on corporate income in 2010 was 50%. E. Corporations obtain capital for use in their operations by borrowing and by raising equity capital, either by selling new common stock or by retaining earnings. The cost of debt capital is the interest paid on the debt, and the cost of the equity is the dividends paid on the stock. Both of these costs are deductible from income when calculating income for tax purposes. 9. Collins Inc. is investigating whether to develop a new product. In evaluating whether to go ahead with the project, which of the following items should NOT be explicitly considered when cash flows are estimated? A. The company will produce the new product in a vacant building that was used to produce another product until last year. The building could be sold, leased to another company, or used in the future to produce another of the firm’s products. B. The project will utilize some equipment the company currently owns but is not now using. A used equipment dealer has offered to buy the equipment. C. The company has spent and expensed for tax purposes $3 million on research related to the new detergent. These funds cannot be recovered, but the research may benefit other projects that might be proposed in the future. D. The new product will cut into sales of some of the firm’s other products. E. If the project is accepted, the company must invest $2 million in working capital. However, all of these funds will be recovered at the end of the project’s life. 10. Which of the following items cannot be found on a firm’s balance sheet under current liabilities? A. Accounts payable. B. Short-term notes payable to the bank. C. Accrued wages. D. Cost of goods sold. E. Accrued payroll taxes. 11. Wansley Enterprises is considering a new project. The company has a beta of 1.0, and its sales and profits are positively correlated with the overall economy. The company estimates that the proposed new project would have a higher standard deviation and coefficient of variation than an average company project. Also, the new project’s sales would be countercyclical in the sense that they would be high when the overall economy is down and low when the overall economy is strong. On the basis of this information, which of the following statements is CORRECT? A. The proposed new project would have more stand-alone risk than the firm’s typical project. B. The proposed new project would increase the firm’s corporate risk. C. The proposed new project would increase the firm’s market risk. D. The proposed new project would not affect the firm’s risk at all. E. The proposed new project would have less stand-alone risk than the firm’s typical project. 12. Which of the following would, generally, indicate animprovement in a company’s financial position, holding other things constant? A. The total assets turnover decreases. B. The TIE declines. C. The DSO increases. D. The EBITDA coverage ratio increases. E. The current and quick ratios both decline. 12. Which of the following bank accounts has the lowest effective annual return? A. An account that pays 8% nominal interest with monthly compounding. B. An account that pays 8% nominal interest with annual compounding. C. An account that pays 7% nominal interest with daily (365-day) compounding. D. An account that pays 7% nominal interest with monthly compounding. E. An account that pays 8% nominal interest with daily (365-day) compounding. 13. You recently sold 100 shares of your new company, XYZ Corporation, to your brother at a family reunion. At the reunion your brother gave you a check for the stock and you gave your brother the stock certificates. Which of the following statements best describes this transaction? A. This is an example of an exchange of physical assets. B. This is an example of a primary market transaction. C. This is an example of a direct transfer of capital. D. This is an example of a money market transaction. E. This is an example of a derivatives market transaction 14. Assume that Congress recently passed a provision that will enable Barton’s Rare Books (BRB) to double its depreciation expense for the upcoming year but will have no effect on its sales revenue or tax rate. Prior to the new provision, BRB’s net income after taxes was forecasted to be $4 million. Which of the following best describes the impact of the new provision on BRB’s financial statements versus the statements without the provision? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes. A. Net fixed assets on the balance sheet will decrease. B. The provision will reduce the company’s net cash flow. C. The provision will increase the company’s tax payments. D. Net fixed assets on the balance sheet will increase. E. The provision will increase the company’s net income. 15. Considered alone, which of the following would increase a company’s current ratio? A. An increase in net fixed assets. B. An increase in accrued liabilities. C. An increase in notes payable. D. An increase in accounts receivable. E. An increase in accounts payable. 16. Kasper Film Co. is selling off some old equipment it no longer needs because its associated project has come to an end. The equipment originally cost $22,500, of which 75% has been depreciated. The firm can sell the used equipment today for $6,000, and its tax rate is 40%. What is the equipment’s after-tax salvage value for use in a capital budgeting analysis? Note that if the equipment’s final market value is less than its book value, the firm will receive a tax credit as a result of the sale. A. $5,558 B. $5,850 C. $6,143 D. $6,450 E. $6,772 % depreciated on equip.75% Tax rate 40% Equipment cost $22,500 −Accumulated deprec 16,875 Current book value of equipment $5,625 Market value of equipment 6,000 Gain (or loss):Market value − Book value $375 Taxes paid on gain (−) or credited (+) on loss -150 AT salvage value = market value +/− taxes $5,850 17. When evaluating a new project, firms should include in the projected cash flows all of the following EXCEPT: A. Previous expenditures associated with a market test to determine the feasibility of the project, provided those costs have been expensed for tax purposes. B. The value of a building owned by the firm that will be used for this project. C. decline in the sales of an existing product, provided that decline is directly attributable to this project. D. The salvage value of assets used for the project that will be recovered at the end of the project’s life. E. Changes in net working capital attributable to the project. 18. Which one of the following would NOT result in incremental cash flows and thus should NOT be included in the capital budgeting analysis for a new product? A. Revenues from an existing product would be lost as a result of customers switching to the new product. B. Shipping and installation costs associated with a machine that would be used to produce the new product. C. The cost of a study relating to the market for the new product that was completed last year. The results of this research were positive, and they led to the tentative decision to go ahead with the new product. The cost of the research was incurred and expensed for tax purposes last year. D. It is learned that land the company owns and would use for the new project, if it is accepted, could be sold to another firm. E. Using some of the firm’s high-quality factory floor space that is currently unused to produce the proposed new product. This space could be used for other products if it is not used for the project under consideration. 19. McPherson Company must purchase a new milling machine. The purchase price is $50,000, including installation. The machine has a tax life of 5 years, and it can be depreciated according to the following rates. The firm expects to operate the machine for 4 years and then to sell it for $12,500. If the marginal tax rate is 40%, what will the after-tax salvage value be when the machine is sold at the end of Year 4? Year Depreciation Rate 1 0.20 2 0.32 3 0.19 4 0.12 5 0.11 6 0.06 A. $ 8,878 B. $ 9,345 C. $ 9,837 D. $10,355 E. $10,900 Deprec Annunal Year-end Year Rate Basis Deprec Book Value 1 0.2 $50,000 $10,000 $40,000 2 0.32 50,000 16,000 24,000 3 0.19 50,000 9,500 14,500 4 0.12 50,000 6,000 8,500 5 0.11 50,000 5,500 3,000 6 0.06 50,000 3,000 0 1.00 50,000 Gross sales proceeds(Market value) $12,500 Book value, end of Year4 8,500 Profit $4,000 Tax on profit Rate = 40% 1,600 AT salvage value =market value +/-taxes $10,900 20. Which of the following statements is CORRECT? A. Typically, a firm’s DPS should exceed its EPS. B. Typically, a firm’s EBIT should exceed its EBITDA. C. If a firm is more profitable than average (e.g., Google), we would normally expect to see its stock price exceed its book value per share. D. If a firm is more profitable than most other firms, we would normally expect to see its book value per share exceed its stock price, especially after several years of high inflation. E. The more depreciation a firm has in a given year, the higher its EPS, other things held constant. 21. The WACC for two mutually exclusive projects that are being considered is 8%. Project K has an IRR of 20% while Project R’s IRR is 15%. The projects have the same NPV at the 8% current WACC. However, you believe that money costs and thus your WACC will also increase. You also think that the projects will not be funded until the WACC has increased, and their cash flows will not be affected by the change in economic conditions. Under these conditions, which of the following statements is CORRECT? A. You should delay a decision until you have more information on the projects, even if this means that a competitor might come in and capture this market. B. You should recommend Project R, because at the new WACC it will have the higher NPV. C. You should recommend Project K, because at the new WACC it will have the higher NPV. D. You should recommend Project K because it has the higher IRR and will continue to have the higher IRR even at the new WACC. E. You should reject both projects because they will both have negative NPVs under the new conditions. 22. Which of the following statements is CORRECT? A. Borrowing by using short-term notes payable and then using the proceeds to retire long-term debt is an example of “window dressing.” Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is another example of “window dressing.” B. Borrowing on a long-term basis and using the proceeds to retire short-term debt would improve the current ratio and thus could be considered to be an example of “window dressing.” C. Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is an example of “window dressing.” D. Using some of the firm’s cash to reduce long-term debt is an example of “window dressing.” E. “Window dressing” is any action that improves a firm’s fundamental, long-run position and thus increases its intrinsic value. 23. Tucker Electronic System’s current balance sheet shows total common equity of $3,125,000. The company has 125,000 shares of stock outstanding, and they sell at a price of $52.50 per share. By how much do the firm’s market and book values per share differ? A. $27.50 B. $28.88 C. $30.32 D. $31.83 E. $33.43 Shares outstanding 125,000 Price per share $52.50 Total book common equity $3,125,000 Book value per share $25.00 Difference between book and market values$27.50 24. Which of the following statements is CORRECT? A. It is generally more expensive to form a proprietorship than a corporation because, with a proprietorship, extensive legal documents are required. B. Corporations face fewer regulations than sole proprietorships. C. One disadvantage of operating a business as a sole proprietorship is that the firm is subject to double taxation, at both the firm level and the owner level. D. One advantage of forming a corporation is that equity investors are usually exposed to less liability than in a regular partnership. E. If a regular partnership goes bankrupt, each partner is exposed to liabilities only up to the amount of his or her investment in the business. 25. Which of the following statements is CORRECT? A. Capital market instruments include both long-term debt and common stocks. B. An example of a primary market transaction would be your uncle transferring 100 shares of Wal-Mart stock to you as a birthday gift. C. The NYSE does not exist as a physical location; rather, it represents a loose collection of dealers who trade stocks electronically. D. If your uncle in New York sold 100 shares of Microsoft through his broker to an investor in Los Angeles, this would be a primary market transaction. E. While the two frequently perform similar functions, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise large blocks of capital from investors. 26. Which of the following statements is CORRECT? A. Corporations are at a disadvantage relative to partnerships because they have to file more reports to state and federal agencies, including the Securities and Exchange Administration, even if they are not publicly owned. B. In a regular partnership, liability for the firm’s debts is limited to the amount a particular partner has invested in the business. C. A fast-growth company would be more likely to set up as a partnership for its business organization than would a slow-growth company. D. Partnerships have difficulty attracting capital in part because of their unlimited liability, the lack of impermanence of the organization, and difficulty in transferring ownership. E. A major disadvantage of a partnership relative to a corporation as a form of business organization is the high cost and practical difficulty of its formation. 27. Danielle’s Sushi Shop last year had (1) a negative net cash flow from operations, (2) a negative free cash flow, and (3) an increase in cash as reported on its balance sheet. Which of the following factors could explain this situation? A. The company had a sharp increase in its depreciation and amortization expenses. B. The company had a sharp increase in its inventories. C. The company had a sharp increase in its accrued liabilities. D. The company sold a new issue of common stock. E. The company made a large capital investment early in the year. 28. Which of the following statements is CORRECT? A. Hedge funds are legal in Europe and Asia, but they are not permitted to operate in the United States. B. Hedge funds have more in common with commercial banks than with any other type of financial institution. C. Hedge funds have more in common with investment banks than with any other type of financial institution. D. Hedge funds are legal in the United States, but they are not permitted to operate in Europe or Asia. E. The justification for the “light” regulation of hedge funds is that only “sophisticated” investors with high net worths and high incomes are permitted to invest in these funds, and such investors supposedly can do the necessary “due diligence” on their own rather than have it done by the SEC or some other regulator. 29. Lucy’s Music Emporium opened its doors on January 1, 2012, and it was granted permission to use the same depreciation calculations for shareholder reporting and income tax purposes. The company planned to depreciate its fixed assets over 20 years, but in December 2012 management realized that the assets would last for only 15 years. The firm’s accountants plan to report the 2012 financial statements based on this new information. How would the new depreciation assumption affect the company’s financial statements? A. The firm’s reported net fixed assets would increase. B. The firm’s EBIT would increase. C. The firm’s reported 2012 earnings per share would increase. D. The firm’s cash position in 2012 and 2013 would increase. E. The firm’s net liabilities would increase.