Managerial Finance
Suggested Problems for Midterm 1. Which of the following is not correct about the figure below?
a. The role of board of directors is to monitor the management, especially CEO. b. Chief Operating Officer takes the role of president in many firms. c. Chief Financial Officer takes the role of Executive Vice President in many firms. d. CEO cannot take the role of the Chairman of the Board of Directors within a firm.
Answer: d 2. List the advantages of Proprietorships and Partnerships
a. Ease of formation b. Subject to few regulations c. No corporate income taxes
3. List the disadvantages of Proprietorships and Partnerships
a. Difficult to raise capital b. Unlimited liability c. Limited life
4. List the advantages of Corporation
a. Unlimited life b. Easy transfer of ownership c. Limited liability d. Ease of raising capital
5. List the disadvantages of Corporation
a. Double taxation b. Cost of setup and report filing
6. Which of the following is not correct about Balancing Shareholder Value and Society Interests?
a. The primary financial goal of management is shareholder wealth maximization, which translates to maximizing stock price.
b. Value of any asset is future value of cash flow stream to owners. c. Most significant decisions are evaluated in terms of their financial consequences. d. Stock prices change over time as conditions change and as investors obtain new
information about a companys prospects. e. Managers recognize that being socially responsible is not inconsistent with
maximizing shareholder value. Answer: b 7. Which of the following is not correct about Stock Prices and IntrinsicValue?
a. In equilibrium, a stocks price should equal its true or intrinsic value. b. Intrinsic value is a long-run concept. c. To the extent that investor perceptions are incorrect, a stocks price in the long
run may deviate from its intrinsic value. d. Ideally, managers should avoid actions that reduce intrinsic value, even if those
decisions increase the stock price in the short run. Answer: c 8. Please select the correct combination for (1), (2), (3) and (4) for the figure below.
a. (1): True, (2): perceived, (3): perceived, (4): intrinsic b. (1): True, (2): perceived, (3): true, (4): intrinsic c. (1): True, (2): true, (3): perceived, (4): intrinsic d. (1): True, (2): perceived, (3): perceived, (4): book
Answer: a
(1) Risk (2) Investor Cash Flows
(3) Risk
Managerial Actions, the Economic Environment, Taxes, and the Political Climate
Stocks (4) Value
Stocks Market Price
Market Equilibrium: Intrinsic Value = Stock Price
9. Which of the following is not correct about Some Important Business Trends recently? a. Corporate scandals have reinforced the importance of business ethics, and have
spurred additional regulations and corporate oversight. b. Increased globalization of business. c. The effects of ever-improving information technology have had a profound effect
on all aspects of business finance. d. Stockholders now have less control of corporate governance.
Answer: d 10. _____ are naturally inclined to act in their own best interests (which are not always the same as the interest of ______). (Managers, stockholders) 11. List the factors that affect managerial behavior in terms of the Conflicts Between Managers and Stockholders
a. Managerial compensation packages b. Direct intervention by shareholders c. The threat of firing d. The threat of takeover
12. Which of the following is not correct about the conflicts between Stockholders and Bondholders?
a. Stockholders are more likely to prefer riskier projects, because they receive more of the upside if the project succeeds.
b. Bondholders receive fixed payments and are more interested in limiting risk. c. Bondholders are particularly concerned about the use of additional equity. d. Bondholders attempt to protect themselves by including covenants in bond
agreements that limit the use of additional debt and constrain managers actions. Answer: c 13. In a well-functioning economy, capital flows efficiently from those who _____ capital to those who ______ it. (supply, demand) 14. Suppliers of capital are individuals and institutions with ______. These groups are saving money and looking for a rate of return on their investment. (excess funds) 15. Demanders or users of capital are individuals and institutions who need to raise funds to finance their ______. These groups are willing to pay a _____ on the capital they borrow. (investment opportunities, rate of return) 16. How is capital transferred between savers and borrowers?
a. Direct transfers b. Investment banks c. Financial intermediaries
17. A _____ is a venue where goods and services are exchanged. (market)
18. A _____ is a place where individuals and organizations wanting to borrow funds are brought together with those having a surplus of funds. (financial market) 19. List the types of financial market
a. Physical assets vs. Financial assets b. Spot vs. Futures c. Money vs. Capital d. Primary vs. Secondary e. Public vs. Private
20. Which of the following is not correct about the Importance of Financial Markets?
a. Well-functioning financial markets facilitate the flow of capital from investors to the users of capital.
b. Markets provide savers with returns on their money saved/invested, which provide them money in the future.
c. Markets provide users of capital with the necessary funds to finance their investment projects.
d. Well-functioning markets promote economic growth. e. Economies with well-developed markets perform worse than economies with
poorly-functioning markets. Answer: e 21. Which of the following is not correct about the derivatives and their relationship with risk?
a. A derivative securitys value is derived from the price of another security (e.g., options and futures).
b. Derivatives can be used to hedge or reduce risk. c. An importer, whose profit falls when the dollar loses value, could purchase
currency futures that do well when the dollar weakens. d. Speculators can use derivatives to bet on the direction of future stock prices,
interest rates, exchange rates, and commodity prices. e. In many cases, hedging transactions produce high returns if you guess right, but
large losses if you guess wrong. Here, derivatives can increase risk. Answer: e 22. List the types of financial institutions
a. Investment banks b. Commercial banks c. Financial services corporations d. Credit unions e. Pension funds f. Life insurance companies g. Mutual funds h. Exchange traded funds i. Hedge funds j. Private equity companies
23. Explain the types of financial institutions (1) _____ engage in underwriting business and raising capital (Investment banks) (2) _____ engage in traditional banking business such as deposits in checking and savings account and CDs (Commercial banks) (3) _____ engage in the business of investment banks, commercial banks, brokerage firms and insurance companies. (Financial services corporation) (4) _____ are cooperative associations whose members have a common bond. They provide the cheapest source of funds available to individual borrowers. (Credit unions) (5) _____ are retirement plans funded by corporation or government for their workers. Corporation or government hire a trust department of commercial bank or life insurance corporation to run _____. (Pension funds) (6) _____ receive annual premiums from investors, invest in financial markets and provide returns back to beneficiaries. (Life insurance companies) (7) _____ and _____ receive money from investors and invest in financial markets to reduce risk and increase return from the economies of scale. (Mutual funds, hedge funds) (8) _____ are mutual funds traded in public exchange (Exchange traded funds) (9) _____ target small investors and are subject to SEC regulation, while _____ target large investors and are not regulated. (Mutual funds, hedge funds) (10) ____ are similar to hedge funds but buy an entire firm or group of firms using leverage. (Private equity companies) 24. Which of the following is not correct about Physical Location Stock Exchanges vs. Electronic Dealer-Based Markets?
a. Physical Location Stock Exchanges are also called Auction market b. The examples of Electronic Dealer-Based Markets are OTC market and
NASDAQ c. The differences between two markets are widening d. None of the above
Answer: c 25. Apple Computer decides to issue additional stock with the assistance of its investment banker. An investor purchases some of the newly issued shares. Is this a primary market transaction or a secondary market transaction? (Since new shares of stock are being issued, this is a primary market transaction, this is a primary market transaction) 26. An investor buys existing shares of Apple stock in the open market. Is this a primary or secondary market transaction? (Since no new shares are created, this is a secondary market transaction.)
27. Which of the following is not correct about IPO? a. An initial public offering (IPO) occurs when a company issues stock in the public
market for the first time. b. Going public enables a companys owners to raise capital from a wide variety
of outside investors. c. Once IPO completed, the stock trades in the secondary market. d. Private companies are subject to additional regulations and reporting requirements.
Answer: d 28. Which of the following is not correct about the stock market efficiency?
a. Securities are normally in equilibrium and are underpriced. b. Investors cannot beat the market except through good luck or better information. c. From efficiency continuum, small companies are highly inefficient because they
are not followed by many analysts. Also, they do not have much contact with investors.
d. From efficiency continuum, large companies are highly efficient because they are followed by many analysts and have good communications with investors.
Answer: a 29. You hear in the news that a medical research company received FDA approval for one of its products. If the market is highly efficient, can you expect to take advantage of this information by purchasing the stock? (No. If the market is efficient, this information will already have been incorporated into the companys stock price. So, its probably too late for her to capitalize on the information. 30. A small investor has been reading about a hot IPO that is scheduled to go public later this week. She wants to buy as many shares as she can get her hands on, and is planning on buying a lot of shares the first day once the stock begins trading. Would you advise her to do this? (Probably not. The long-run track record of hot IPOs is not that great, unless you are able to get in on the ground floor and receive an allocation of shares before the stock begins trading. It is usually hard for small investors to receive shares of hot IPOs before the stock begins trading.) 31. _____ provides a snapshot of a firms financial position at one point in time. (Balance sheet) 32. _____ summarizes a firms revenues and expenses over a given period of time. (Income statement) 33. _____ reports the impact of a firms activities on cash flows over a given period of time. (Statement of cash flows) 34. _____ shows how much of the firms earnings were retained, rather than paid out as dividends. (Statement of stockholders equity)
35. Federal income tax system is divided into _ and _ (individual taxes, corporate taxes) 36. Which of the following is not correct about Corporate and Personal Taxes?
a. Both have a progressive structure. b. Progressive structure means that the higher the income, the lower the marginal tax
rate. c. For corporate taxes, rates begin at 15% and rise to 35% for corporations with
income over $10 million, although corporations with income between $15 million and $18.33 million pay a marginal tax rate of 38%. They are also subject to state tax (around 5%).
d. For personal taxes, rates begin at 10% and rise to 35% for individuals with income over $373,650. Personal taxes may be subject to state tax.
Answer: b 37. Which of the following is not correct about the Tax Treatment of Various Uses and Sources of Funds?
a. For interest paid, they are tax deductible for corporations (paid out of pre-tax income), but usually not for individuals (interest on home loans being the exception).
b. For interest earned, they are usually fully taxable (an exception being interest from a municipal bonds).
c. For dividends paid, they are paid out of before-tax income. d. For dividends received, most investors pay 15% taxes through 2012. The rate is
scheduled to rise after 2012. Answer: c 38. Which of the following is not correct about the Tax Treatment on dividends received in 2012?
a. Investors in the 10% or 15% tax bracket pay 0% on qualified dividends through 2012.
b. Dividends are paid out of EBIT which has already been taxed at the corporate level, this is a form of double taxation.
c. A portion of dividends received by corporations is tax excludable, in order to avoid triple taxation.
d. None of the above Answer: b 39. Since corporate incomes can fluctuate widely, the Tax Code allows firms to carry losses ____ to offset profits in previous years or ____ to offset profits in the future. (back, forward)
40. Which of the following is not correct about tax issues on capital gains? a. Capital gains are defined as the profits from the sale of assets not normally
transacted in the normal course of business. b. Capital gains for individuals are generally taxed as interest income if held for a
year or less c. Capital gains for individuals are generally taxed at the capital gains rate if held for
more than a year. d. Corporations face somewhat different rules.
Answer: b 41. ______ provides a snapshot of a firms financial position at one point in time. (Balance sheet) 42. _____ summarizes a firms revenues and expenses over a given period of time. (Income statement) 43. _____ reports the impact of a firms activities on cash flows over a given period of time. (Statement of cash flows) 44. _____ shows how much of the firms earnings were retained, rather than paid out as dividends. (Statement of stockholders equity) 45. Depreciation and amortization are considered as ________, so they should be added back to net income when we calculate the statement of cash flows. (noncash charge) 46. Which of the following is not correct about the conclusions about DLeons financial condition from its statement of cash flows given in Chapter 3 powerpoint slides?
a. Net cash from operations = -$164,176, mainly because of negative net income. b. The firm borrowed $700,808 to meet its cash requirements. c. Even after borrowing, the cash account fell by $50,318. d. None of the above
Answer: b 47. Given the following information, calculate total dividend payment in 2011 and 2012.
No. of shares
EPS
DPS
Stock price
Lease payments
2012
100,000
-$1.602
$0.11
$2.25
$40,000
2011
100,000
$0.88
$0.22
$8.50
$40,000
a. 2012: $15,000, 2011: $22,000 b. 2012: $11,000, 2011: $22,000 c. 2012: $11,000, 2011: $25,000 d. 2012: $14,000, 2011: $23,000
Answer: b 48. Given the financial statement information in Chapter 3 powerpoint slides, calculate the after-tax operating income in 2011 and 2012? (After-tax operating income=EBIT*(1-Tax Rate) After-tax operating income in 2011=$190,428*(1-0.4)=$114,257 After-tax operating income in 2012=-$130,948*(1-0.4)=-$78,569) 49. Given the financial statement information in Chapter 3 powerpoint slides, calculate the net operating working capital (NOWC) in 2011 and 2012? (NOWC in 2011=Current Assets-(Current Liabilities-Notes Payable)
=($57,600+$351,200+$715,200)-($481,600-$200,000)=$842,400) 50. Given the financial statement information in Chapter 3 powerpoint slides, calculate the free cash flow in 2012.
? ?
? ? ?
? ????
?
? ? ?
? ??? NOWC
esexpenditur
Capital
onamortizati
and Depr. T)EBIT(1 FCF
FCF12 = [-$130,948(1 0.4) + $116,960] [($1,202,950 $491,000) + $70,642] = -$744,201 51. What does it mean by positive free cash flow? (The firm is generating more than enough cash to finance its current investment in fixed assets and working capital) 52. Which of the following is not correct about the performance measures for evaluating managers?
a. Accounting statements insufficient for evaluating managers performance because they reflect market values.
b. Market Value Added (MVA) is the difference between market value and book value of a firms common equity.
c. Market value is equal to the multiplication between current stock price and the number of shares outstanding.
d. Economic Value Added (EVA) is the estimate of a business true economic profit for a given year.
Answer: a 53. Given the financial statement information in Chapter 3 powerpoint slides, calculate DLeons MVA in 2011 and 2012?
(MVA11= ($8.50 x 100,000) $663,768= $186,232 MVA12= ($2.25 x 100,000) $492,592= -$267,592)
54. Which of the following is not correct about the relationship between EVA and MVA? a. If EVA is positive, then AT operating income > cost of capital needed to produce
that income. b. Negative EVA on annual basis helps to ensure MVA is positive. c. MVA is applicable to entire firm, while EVA can be calculated on a divisional
basis as well. d. None of the above
Answer: b 55. Given the financial statement information in Chapter 3 powerpoint slides, does DLeon pay its suppliers on time? (Probably not. A/P increased 260%, over the past year, while sales increased by only 76%. If this continues, suppliers may cut off DLeons trade credit.) 56. Given the financial statement information in Chapter 3 powerpoint slides, does it appear that DLeons sales price exceeds its cost per unit sold? (NO, the negative after-tax operating income and decline in cash position shows that DLeon is spending more on its operations than it is taking in.) 57. Which of the following is not correct if DLeons sales manager decided to offer 60- day credit terms to customers, rather than 30-day credit terms?
a. If competitors match terms, and sales remain constant, then accounts receivable would decrease and cash would increase.
b. If competitors dont match, and sales double, then inventory and fixed assets would go up to meet increased sales in the short-run.
c. If competitors dont match, and sales double, then accounts receivable would go up while cash would go down in the short-run.
d. If competitors dont match, and sales double, then collections increase and the companys cash position would improve in the long-run.
Answer: a
58. Which of the following is not correct about DLeons financing its expansion? a. DLeon financed its expansion with external capital. b. DLeon issued equity which reduced its financial strength and flexibility. c. DLeon would still have to finance its increase in assets if they had broken even
in 2012 because the firm made an investment of $711,950 in net fixed assets. d. None of the above
Answer: b 59. Which of the following is not correct if DLeon depreciates fixed assets over 7 years (as opposed to the current 10 years)?
a. No effect on physical assets. b. Fixed assets on the balance sheet would increase. c. Net income would decline. d. Tax payments would decline. e. Cash position would improve.
Answer: b 60. Which of the following is not correct about the use of ratios?
a. Ratios standardize numbers and facilitate comparisons. b. Ratios are used to highlight weaknesses and strengths. c. Ratio comparisons should be made through time but should not be made with
competitors. d. Examples of ratio comparisons are Trend analysis, Industry analysis and
Benchmark (peer) analysis Answer: c 61. Which of the following is not correct about the Five Major Categories of Ratios and the Questions They Answer?
a. Liquidity ratios can answer the question, Can we make required payments? b. Asset management ratios measure the right amount of assets vs. sales c. Debt management ratios measure the right mix of debt and equity d. Profitability ratios can answer the question, Do unit costs exceed sales, and are
sales low enough as reflected in PM, ROE, and ROA? e. Market value ratios can answer the question, Do investors like what they see as
reflected in P/E and M/B ratios? Answer: d
62. Which of the following is not correct about Appraising Profitability with Operating Margin, Profit Margin, and Basic Earning Power?
2013E 2012 2011 Ind.
Operating margin 7.0% -2.2% 5.6% 7.3% Profit margin 3.6% -2.7% 2.6% 3.5% Basic earning power 14.1% -4.6% 13.0% 19.1% a. Operating margin was very bad in 2012. It is projected to improve in 2013, but it
is still projected to remain above the industry average. b. Profit margin was very bad in 2012 but is projected to exceed the industry average
in 2013. Looking good. c. BEP removes the effects of taxes and financial leverage, and is useful for
comparison. d. BEP projected to improve, yet still below the industry average. There is
definitely room for improvement. Answer: a
63. Which of the following is not correct about the Effects of Debt on ROA and ROE?
a. Holding assets constant, if debt increases, equity declines b. Holding assets constant, if debt increases, interest expense increases which leads
to an increase in net income. c. ROA declines (due to the reduction in net income). d. ROE may increase or decrease (since both net income and equity decline).
Answer: b
64. Which of the following is not correct about the problems with ROE? a. ROE and shareholder wealth are correlated, but problems can arise when ROE is
the sole measure of performance. b. ROE does not consider risk and the amount of capital invested. c. Given these problems, reliance on ROE may discourage managers to make
investments that do not benefit shareholders. d. Analysts have looked to develop other performance measures, such as EVA.
Answer: c 65. Which of the following is not correct about analyzing the market value ratios?
a. P/E: How much investors are willing to pay for $1 of earnings. b. M/B: How much investors are willing to pay for $1 of book value equity. c. For each ratio, the higher the number, the better. d. P/E and M/B are high if ROE is low and risk is high.
Answer: d 66. _______ focuses on expense control, asset utilization and debt utilization. (The DuPont Equation) 67. Which of the following is not correct about the comments on liquidity ratios?
2013E 2012 2011 Ind.
Current ratio 2.34x 1.20x 2.30x 2.70x Quick ratio 0.84x 0.39x 0.85x 1.00x a. Liquidity ratios are expected to improve but still below the industry average. b. Liquidity position is weak. c. Liquidity ratios have constantly risen from 2011 till 2013E. d. None of the above
Answer: c 68. Which of the following is not correct about the comments on inventory turnover?
2013E 2012 2011 Ind.
Inventory turnover 4.1x 4.70x 4.8x 6.1x a. Inventory turnover is below industry average. b. DLeon might have new inventory, or its control might be strong. c. No improvement is currently forecasted. d. None of the above
Answer: b 69. Which of the following is not correct about the appraisal of DSO?
2013E 2012 2011 Ind.
DSO 45.6 38.2 37.4 32.0 a. DSO have not constantly risen from 2011 till 2013E. b. DLeon collects on sales too slowly, and is getting worse. c. DLeon has a poor credit policy. d. None of the above.
Answer: a 70. Which of the following is not correct about evaluating the FA Turnover and TA Turnover Ratios?
2013E 2012 2011 Ind.
FA Turnover 8.6x 6.4x 10.0x 7.0x TA Turnover 2.0x 2.1x 2.3x 2.6x a. FA Turnover and TA Turnover have constantly decreased from 2011 till 2013E. b. FA turnover is projected to exceed the industry average. c. TA turnover is below the industry average. It is caused by excessive currents
assets (Accounts Receivable and Inventories) in 2013E. d. None of the above
Answer: a 71. Which of the following is not correct about DLeons Debt Management Ratios vs. the Industry Averages?
2013E 2012 2011 Ind.
D/A 44.2% 82.8% 54.8% 50.0% TIE 7.0x -1.0x 4.3x 6.2x a. D/A has constantly been above industry average from 2011 till 2013E. b. TIE was below industry average in 2011 and 2012. c. D/A and TIE are better than the industry average in 2013E. d. None of the above
Answer: a 72. Ryngard Corp’s sales last year were $38,000, and its total assets were $16,000. What was its total assets turnover ratio (TATO)? Solution>
Sales $38,000 Total assets $16,000 TATO = Sales/Total assets = 2.38
73. Beranek Corp has $720,000 of assets, and it uses no debt–it is financed only with common equity. The new CFO wants to employ enough debt to raise the debt/assets ratio to 40%, using the proceeds from borrowing to buy back common stock at its book value. How much must the firm borrow to achieve the target debt ratio?
Solution> Total assets $720,000 Target debt ratio 40% Debt to achieve target ratio = Amount borrowed = Target % × Assets =$288,000
74. Ajax Corp’s sales last year were $435,000, its operating costs were $362,500, and its interest charges were $12,500. What was the firm’s times-interest-earned (TIE) ratio? Solution>
Sales $435,000 Operating costs $362,500 Operating income (EBIT) $72,500 Interest charges $12,500 TIE ratio = EBIT/Interest = 5.80
75. Royce Corp’s sales last year were $280,000, and its net income was $23,000. What was its profit margin?
Solution> Sales $280,000 Net income $23,000
Profit margin = NI/Sales = 8.21% 76. River Corp’s total assets at the end of last year were $415,000 and its net income was $32,750. What was its return on total assets?
Solution> Total assets $415,000 Net income $32,750 ROA = NI/Assets = 7.89%
77. X-1 Corp’s total assets at the end of last year were $405,000 and its EBIT was 52,500. What was its basic earning power (BEP) ratio?
Solution> Total assets $405,000 EBIT $52,500 BEP = EBIT/Assets = 12.96%
78. Zero Corp’s total common equity at the end of last year was $405,000 and its net income was $70,000. What was its ROE? Solution>
Common equity $405,000 Net income $70,000 ROE = NI/Equity = 17.28%
79. Song Corp’s stock price at the end of last year was $23.50 and its earnings per share for the year were $1.30. What was its P/E ratio? Solution>
Stock price $23.50 EPS $1.30 P/E = Stock price/EPS 18.08
80. Hoagland Corp’s stock price at the end of last year was $33.50, and its book value per share was $25.00. What was its market/book ratio?
Solution> Stock price $33.50 Book value per share $25.00 M/B ratio = Stock price/Book value per share = 1.34
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