ADDITIONAL QUESTIONS/PROBLEMS
1. In order to help reduce the deficit and fund universal health care coverage, President Obama is expected to press Congress to “undo” the tax cuts of President George W. Bush, including the capital gains tax treatment of dividends. What would be the anticipated effect on corporate dividend policies if dividends were taxed as ordinary income?
a. Cash dividends would likely increase and stock repurchases would likely decrease
b. Cash dividends would likely decrease and stock repurchases would likely increase
c. Stock dividends would likely increase and stock splits would likely decrease
d. Stock dividends would likely decrease and stock splits would likely increase
e. No change in corporate dividend policy should be anticipated
2. Which of the following factors would tend to LOWER a firm's use of debt?
a. an increase in the fixed assets of the firm
b. a decrease in the business risk of the firm
c. a decrease in corporate tax rates
d. increased concern over dilution of control by shareholders
e. all of the above would encourage the use of MORE debt by the firm
3. The reason maximizing expected profits should not be your financial objective is that it
a. maximizes the amount of risk taken
b. ignores the amount of risk taken
c. minimizes the stockholders' required rate of return
d. maximizes the cost of debt
e. none of the above--your objective should be to maximize expected profits
4. Which of the following terms of credit has the HIGHEST effective interest cost?
a. 2/10 net 30
b. 3/10 net 45
c. 2/15 net 45
d. 3/15 net 60
e. all of the above have about the same cost
5. Firms generally choose to finance temporary assets with short-term debt because
a. matching the maturities of assets and liabilities reduces risk
b. short-term interest rates have traditionally been more stable than long-term interest rates
c. a firm which borrows heavily long-term is more apt to be unable to repay the debt than the firm which borrows heavily short-term
d. sales remain constant over the year, and financing requirements also remain constant
e. short-term interest rates have traditionally been higher than long-term interest rates
6. Ranking conflicts between the NPV and IRR methods are caused by differing
a. initial costs
b. reinvestment rate assumptions
c. timing of cash flows
d. all of the above
e. none of the above
7. Which of the following sources of funds is generally considered to be the MOST expensive for the firm?
a. the before-tax cost of debt
b. new preferred stock
c. retained earnings
d. new common stock
e. the cost is about the same if associated with the same company
8. "Character", one of the traditional five C's of credit analysis, refers to
a. the general economic climate and its effect on the applicant's ability to pay.
b. the financial strength of the applicant (i.e., net worth)
c. the willingness of the applicant to meet its financial obligations
d. the ability of the applicant to meet its financial obligations (i.e., liquidity and cash flow)
e. none of the above
9. The importance of a letter of credit in international trade is that the bank issuing the letter of credit
a. makes an unconditional promise to pay if certain conditions are met
b. effectively substitutes its own credit for that of a borrower
c. creates an environment of “trust” that the importer will receive the goods and the exporter will be paid for the goods
d. all of the above
e. none of the above
10. The primary goal of accounts receivable management should be
a. maximizing market share
b. maximizing shareholder wealth
c. minimizing investment in receivables
d. minimizing bad debt
e. none of the above
11. Which of the following statements is FALSE?
a. In addition to sales price, product quality, and advertising, credit policy is a major controllable variable which can affect product demand.
b. Sharp seasonal swings in sales and fast growth are two reasons why a firm's aging schedule and average collection period (days' sales outstanding) may show high variability.
c. Changes in a firm's collection policy can affect sales and working capital but will not affect the firm's cash balances.
d. Cash discounts can be used to influence a firm's sales volume and its average collection period (days' sales outstanding).
e. Firms which offer credit terms with a cash discount usually seek two benefits: (1) to attract more customers, and (2) to reduce their average collection period (days' sales outstanding).
12. Which of the following statements concerning commercial paper is FALSE?
a. Commercial paper is generally written for terms less than 270 days.
b. Commercial paper generally carries an interest rate BELOW the prime rate.
c. Commercial paper is sold to money market mutual funds, as well as to other financial institutions and nonfinancial corporations.
d. Commercial paper can be issued by any firm so long as it is willing to pay the going rate of interest.
e. All of the above statements are true.
13. According to the residual theory of dividends
a. dividends are a residual after financing needs have been met
b. earnings remaining after payment of preferred stock dividends should be paid to common stockholders
c. dividend payments are a constant percentage of earnings per share
d. a dividend is the residual above the payout ratio
e. none of the above
14. Most investment banking firms do business in the
a. primary market
b. secondary market
c. money market
d. capital market
e. all of the above
15. Which of the following would NOT be expected to result in a dilution of stock price?
a. stock split
b. stock dividend
c. stock repurchase
d. sale of stock through an offering to existing shareholders at a 20% discount from the market price
e. all of the above would result in a dilution of stock price
16. Which of the following is NOT a typical attribute of an operating lease?
a. lease period equals the economic life of the asset
b. lease payments under the initial lease contract are insufficient to recover the full cost of the asset for the lessor
c. maintenance and insurance are the responsibility of the lessor
d. lessor retains the depreciation expense deduction
e. all of the above are attributes of an operating lease
17. The objective of offering a cash discount is to
a. reduce the number of bad checks received from customers
b. encourage customers to place their orders prior to the peak selling period
c. reduce the firm's level of receivables investment
d. reduce the firm's inventory carrying costs
e. none of the above
18. On 1/3/011, George instructed his broker to buy 100 shares of Company XYZ stock at $80 per share. On 3/20/011, the broker called George and informed him that unless he added some more money to his account with the broker, the broker would have to sell 100 shares of XYZ stock at a price of $60 per share. George told the broker to go ahead and sell the 100 shares of stock. The transactions that George has just participated in is a
a. margin purchase
b. call option exercise
c. put option exercise
d. short sale
e. none of the above
19. Which of the following factors does NOT influence a firm's financial structure?
a. The stability of sales
b. LIFO versus FIFO inventory valuation
c. The growth rate of sales
d. Attitudes of management and shareholders toward risk
e. All of the above influence financial structure
Problems
1. You have just taken out a four-year term loan for $500,000 at an 8% rate of interest. Construct a loan amortization table that includes a breakdown of the interest and principal payments. (10 points)
Year Payment Interest Principal Balance
0 -0- -0- -0- 500,000
1 150,960 40,000 110,960 389,040
2 150,960 31,123 119,837 269,203
3 150,960 21,536 129,424 139,779
4 150,960 11,182 139,778 1
2. What is the effective annual rate of interest on a $500,000 placement of 90-day commercial paper with a stated rate of interest of 10% if the interest is deducted in advance and a $2,000 placement fee is paid? (10 points)
11.96%
3. The Binder Company has the following balance sheet:
L-T Debt (8%) $ 3,000
Common Stock ($1 par) 400
Retained Earnings 2,600
Total Assets $ 6,000 Tot. Liab. & Equity $ 6,000
No dividend is paid on the common stock. The stock is currently selling for $12 per share and its historical beta is estimated to be 1.2 using daily price data. The current market rate of interest on the debt is 9% and the current debt will mature in 10 years. Binder has a 40% tax rate. The expected return on the market is 10% and the risk-free rate is 4%.
A. What is the market value of the debt? What is the market value of the Equity?
(5 points)
Value of Debt = $ 2,807
Value of Equity = $ 4,800
B. What is the WACC for Binder? (5 points)
Cost of Debt (after-tax) = 5.4%
Cost of Equity = 11.2%
WACC = 9.06%
4. X-Tech Corp. has the following balance sheet:
Debt (8%) $ 500,000
Common Stock ($1 par) 40,000
Retained Earnings 960,000
Total Assets $ 1,500,000 Total Liabs. & Equity $ 1,500,000
The current market rate of interest on X-Tech Corporation's debt is 7% and it matures in ten years. The last dividend paid by X-Tech Corp. was $3.00 and investors expect dividends to grow at a 4% rate similar to the economy overall. The company is in the 40% tax bracket.
A. If the current market price of X-Tech Corp. stock is $32 per share, what is the estimated required rate of return of X-Tech Corp. stockholders? (5 points)
13.75%
B. Assume your answer to Part A is 13%. What is the weighted average cost of capital (WACC) of X-Tech Corp? (10 points)
10.41%
5. You are considering starting a company and must decide on the means of financing its start-up. The amount of investment required is $2 million and you have settled on two alternative methods of financing the venture:
1) Sell 150,000 shares of the company's stock at $10 per share and borrow $½ million at an interest rate of 10%, or
2) Sell 100,000 shares of the company's stock at $10 per share and borrow $1 million at a 12% interest rate.
The fixed costs of running the operation will be $700,000 and variable costs will be 60% of sales. The tax rate is 40%.
A. At what level of sales will earnings per share be the same under each alternative?
(10 points)
$ 2,400,000
6. In 1999, the Moniker Corporation sold a $10 million, 20-year bond issue with a 10% interest rate. Management is now attempting to determine if it should call in the old bonds and issue new 8% bonds that will mature in 2019 (ten years). Flotation costs on the new issue will be $250,000 and there remains unamortized flotation costs of $110,000 for the old 10% bonds. The call premium on the old bonds is 4% of the face value. Moniker Corp. is in the 40% tax bracket. Since the bonds are held by a single bondholder (an insurance company), there will be no overlapping interest associated with the bond refunding. What are the relevant cash flows for analysis in the refunding decision? (15 points)
Year 0 Years 1-10
Net Cash Flows $( 446,000) $ 125,600
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