221 FIN Fall 2009 Exam 1
Multiple Choice Identify the choice that best completes the statement or answers the question. 1. Relaxant Inc. operates as a partnership. Now the partners have decided to convert the business into a corporation. Which of the following statements is CORRECT? A. Relaxant's shareholders (the ex-partners) will now be exposed to less liability. B. The company will probably be subject to fewer regulations and required disclosures. C. Assuming the firm is profitable, none of its income will be subject to federal income taxes. D. The firm's investors will be exposed to less liability, but they will find it more difficult to transfer their ownership. E. The firm will find it more difficult to raise additional capital to support its growth.
2. The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to A. Maximize its expected total corporate income. B. Maximize its expected EPS. C. Minimize the chances of losses. D. Maximize the stock price per share over the long run, which is the stock's intrinsic value. E. Maximize the stock price on a specific target date.
3. Which of the following statements is CORRECT? A. In a typical partnership, liability for other partners' misdeeds is limited to the amount of a particular partner's investment in the business. B. In a limited partnership, the limited partners have voting control, while the general partner has operating control over the business, and the limited partners are individually responsible, on a pro rata basis, for the firm's debts in the event of bankruptcy. C. A slow-growth company, with little need for new capital, would be more likely to organize as a corporation than would a faster growing company. D. Partnerships have more difficulty attracting large amounts of capital than corporations because of such factors as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and selling) of partnership interests. E. A major disadvantage of a partnership relative to a corporation is the fact that federal income taxes must be paid by the partners rather than by the firm itself.
4. Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and managers? A. Pay managers large cash salaries and give them no stock options. B. Change the corporation's formal documents to make it easier for outside investors to acquire a controlling interest in the firm through a hostile takeover. C. Beef up the restrictive covenants in the firm's debt agreements. D. Eliminate a requirement that members of the board of directors must hold a high percentage of their personal wealth in the firm's stock. E. For a firm that compensates managers with stock options, reduce the time before options are vested, i.e., the time before options can be exercised and the shares that are received can be sold.
5. Other things held constant, which of the following actions would increase the amount of cash on a companys balance sheet? A. The company repurchases common stock. B. The company pays a dividend. C. The company issues new common stock. D. The company gives customers more time to pay their bills. E. The company purchases a new piece of equipment.
6. A loss incurred by a corporation A. Must be carried forward unless the company has had 2 loss years in a row. B. Can be carried back 2 years, then carried forward up to 20 years following the loss. C. Can be carried back 5 years and forward 3 years. D. Cannot be used to reduce taxes in other years except with special permission from the IRS. E. Can be carried back 3 years or forward 10 years, whichever is more advantageous to the firm.
7. On its 12/31/08 balance sheet, Barnes Inc showed $510 million of retained earnings, and exactly that same amount was shown the following year. Assuming that no earnings restatements were issued, which of the following statements is CORRECT? A. If the company lost money in 2008, it must have paid dividends. B. The company must have had zero net income in 2008. C. The company must have paid out half of its 2008 earnings as dividends. D. The company must have paid no dividends in 2008. E. Dividends could have been paid in 2008, but they would have had to equal the earnings for the year.
8. Last year, Delip Industries had (1) negative 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 inventories. B. The company had a sharp increase in its accrued liabilities. C. The company sold a new issue of common stock. D. The company made a large capital investment early in the year. E. The company had a sharp increase in depreciation expenses.
9. A start-up firm is making an initial investment in new plant and equipment. Assume that currently its equipment must be depreciated on a straight-line basis over 10 years, but Congress is considering legislation that would require the firm to depreciate the equipment over 7 years. If the legislation becomes law, which of the following would occur in the year following the change? A. The firms operating income (EBIT) would increase. B. The firms taxable income would increase. C. The firms cash flow would increase. D. The firms tax payments would increase. E. The firms reported net income would increase.
10. Vasudevan Inc. recently reported operating income of $5.95 million, depreciation of $1.20 million, and had a tax rate of 40%. The firm's expenditures on fixed assets and net working capital totaled $0.6 million. How much was its free cash flow, in millions? A. $4.13 B. $4.38 C. $4.17 D. $3.63 E. $3.59
11. On 12/31/08, Hite Industries reported retained earnings of $502,500 on its balance sheet, and it reported that it had $135,000 of net income during the year. On its previous balance sheet, at 12/31/07, the company had reported $445,000 of retained earnings. No shares were repurchased during 2008. How much in dividends did the firm pay during 2008? A. $78,275 B. $89,125 C. $83,700 D. $96,100 E. $77,500
12. A company with a 39% tax rate buys preferred stock in another company. The preferred stock has a before-tax yield of 9%. What is the preferred stocks after-tax return? A. 8.66% B. 6.12% C. 7.95% D. 9.38% E. 6.75%
13. Garner Grocers began operations in 2005. Garner has reported the following levels of taxable income (EBT) over the past several years. The corporate tax rate was 34% each year. Assume that the company has taken full advantage of the Tax Codes carry-back, carry-forward provisions, and assume that the current provisions were applicable in 2005. What is the amount of taxes the company paid in 2008? Year 2005 2006 2007 2008 A. B. C. D. E. $295,800 $272,850 $288,150 $255,000 $201,450 Taxable Income -$2,750,000 $200,000 $500,000 $2,800,000
14. Last year, Martyn Company had $140,000 in taxable income from its operations, $50,000 in interest income, and $100,000 in dividend income. Using the corporate tax rate table given below, what was the companys tax liability for the year? Taxable Income Tax on Base of Bracket $0-$50,000 $0 $50,000-$75,000 7,500 $75,000-$100,000 13,750 $100,000-$335,000 22,250 $335,000-$10,000,000 113,900 $10,000,000-$15,000,000 3,400,000 $15,000,000-$18,333,333 5,150,000 Over $18,333,333 6,416,667 A. B. C. D. E. $69,050 $75,265 $64,907 $70,431 $80,098 Percentage on Excess above Base 15% 25 34 39 34 35 38 35
15. Casey Communications recently issued new common stock and used the proceeds to pay off some of its short-term notes payable. This action had no effect on the companys total assets or operating income. Which of the following effects would occur as a result of this action? A. The companys current ratio increased. B. The companys times interest earned ratio decreased. C. The companys basic earning power ratio increased. D. The companys equity multiplier increased. E. The companys debt ratio increased.
16. A firms new president wants to strengthen the companys financial position. Which of the following actions would make it FINANCIALLY stronger? A. Increase accounts receivable while holding sales constant. B. Increase EBIT while holding sales and assets constant. C. Increase accounts payable while holding sales constant. D. Increase notes payable while holding sales constant. E. Increase inventories while holding sales constant.
17. Amram Companys current ratio is 2.0. Considered alone, which of the following actions would LOWER the current ratio? A. Borrow using short-term notes payable and use the proceeds to reduce accruals. B. Borrow using short-term notes payable and use the proceeds to reduce long-term debt. C. Use cash to reduce accruals. D. Use cash to reduce short-term notes payable. E. Use cash to reduce accounts payable.
18. You observe that a firms ROE is above the industry average, but its profit margin and debt ratio are both below the industry average. Which of the following statements is CORRECT? A. Its total assets turnover must be above the industry average. B. Its return on assets must equal the industry average. C. Its TIE ratio must be below the industry average. D. Its total assets turnover must be below the industry average. E. Its total assets turnover must equal the industry average.
19. Taggart Technologies is considering issuing new common stock and using the proceeds to reduce its outstanding debt. The stock issue would have no effect on total assets, the interest rate Taggart pays, EBIT, or the tax rate. Which of the following is likely to occur if the company ahead goes with the stock issue? A. The ROA will decline. B. Taxable income will decline. C. The tax bill will increase. D. Net income will decrease. E. The times-interest-earned ratio will decrease.
20. Ajax Corp's sales last year were $460,000, its operating costs were $362,500, and its interest charges were $12,500. What was the firm's times-interest-earned (TIE) ratio? A. 7.80 B. 7.18 C. 8.19 D. 7.72 E. 9.75
21. Garcia Industries has sales of $167,500 and accounts receivable of $18,500, and it gives its customers 25 days to pay. The industry average DSO is 27 days, based on a 365-day year. If the company changes its credit and collection policy sufficiently to cause its DSO to fall to the industry average, and if it earns 8.0% on any cash freed-up by this change, how would that affect its net income, assuming other things are held constant? A. $508.32 B. $405.68 C. $488.77 D. $386.13 E. $518.09
22. Wie Corp's sales last year were $365,000, and its year-end total assets were $355,000. The average firm in the industry has a total assets turnover ratio (TATO) of 2.4. The firm's new CFO believes the firm has excess assets that can be sold so as to bring the TATO down to the industry average without affecting sales. By how much must the assets be reduced to bring the TATO to the industry average, holding sales constant? A. $202,917 B. $221,179 C. $213,063 D. $160,304
E. $184,654
23. Chang Corp. has $375,000 of assets, and it uses only common equity capital (zero debt). Its sales for the last year were $520,000, and its net income was $25,000. Stockholders recently voted in a new management team that has promised to lower costs and get the return on equity up to 15.0%. What profit margin would the firm need in order to achieve the 15% ROE, holding everything else constant? A. 10.71% B. 9.41% C. 10.82% D. 8.11% E. 12.66%
24. Last year Harrington Inc. had sales of $325,000 and a net income of $19,000, and its year-end assets were $250,000. The firm's total-debt-to-total-assets ratio was 67.5%. Based on the DuPont equation, what was the ROE? A. 21.98% B. 18.94% C. 23.38% D. 22.68% E. 22.22%
25. You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would increase the calculated value of the investment? A. The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for 10 years rather than 5 years, hence that each payment is for $10,000 rather than for $20,000. B. The discount rate decreases. C. The riskiness of the investment's cash flows increases. D. The total amount of cash flows remains the same, but more of the cash flows are received in the later years and less are received in the earlier years. E. The discount rate increases.
26. A U.S. Treasury bond will pay a lump sum of $1,000 exactly 3 years from today. The nominal interest rate is 6%, semiannual compounding. Which of the following statements is CORRECT? A. The periodic interest rate is greater than 3%. B. The periodic rate is less than 3%. C. The present value would be greater if the lump sum were discounted back for more periods. D. The present value of the $1,000 would be smaller if interest were compounded monthly rather than semiannually. E. The PV of the $1,000 lump sum has a higher present value than the PV of a 3-year, $333.33 ordinary annuity.
27. You are considering two equally risky annuities, each of which pays $5,000 per year for 10 years. Investment ORD is an ordinary (or deferred) annuity, while Investment DUE is an annuity due. Which of the following statements is CORRECT? A. The present value of ORD must exceed the present value of DUE, but the future value of ORD may be less than the future value of DUE. B. The present value of DUE exceeds the present value of ORD, while the future value of DUE is less than the future value of ORD. C. The present value of ORD exceeds the present value of DUE, and the future value of ORD also exceeds the future value of DUE. D. The present value of DUE exceeds the present value of ORD, and the future value of DUE also exceeds the future value of ORD. E. If the going rate of interest decreases from 10% to 0%, the difference between the present value of ORD and the present value of DUE would remain constant.
28. Suppose you have $2,000 and plan to purchase a 10-year certificate of deposit (CD) that pays 4.0% interest, compounded annually. How much will you have when the CD matures? A. $2,516.42 B. $2,960.49 C. $3,641.40 D. $3,019.70 E. $2,634.83
29. Suppose a State of California bond will pay $1,000 eight years from now. If the going interest rate on these 8-year bonds is 7.3%, how much is the bond worth today? A. $478.06 B. $631.72 C. $569.12 D. $500.82 E. $529.28
30. Suppose the U.S. Treasury offers to sell you a bond for $3,000. No payments will be made until the bond matures 10 years from now, at which time it will be redeemed for $4,600. What interest rate would you earn if you bought this bond at the offer price? A. 3.58% B. 4.32% C. 4.37% D. 5.46% E. 4.11%
31. Janice has $5,000 invested in a bank that pays 5.2% annually. How long will it take for her funds to triple? A. 25.36 years B. 21.67 years C. 26.22 years D. 19.72 years E. 20.59 years
32. You just inherited some money, and a broker offers to sell you an annuity that pays $5,200 at the end of each year for 20 years. You could earn 5% on your money in other investments with equal risk. What is the most you should pay for the annuity? A. $55,731.00 B. $74,524.02 C. $64,803.49 D. $60,267.25 E. $69,987.77
33. What's the rate of return you would earn if you paid $3,680 for a perpetuity that pays $85 per year? A. 2.01% B. 1.99% C. 2.73% D. 2.15% E. 2.31%
34. Your father is about to retire, and he wants to buy an annuity that will provide him with $91,000 of income a year for 25 years, with the first payment coming immediately. The going rate on such annuities is 5.15%. How much would it cost him to buy the annuity today? A. $1,248,843.27 B. $1,408,270.07 C. $1,474,697.91 D. $1,328,556.67 E. $1,169,129.87
35. Your uncle has $1,025,000 and wants to retire. He expects to live for another 25 years, and he also expects to earn 7.5% on his invested funds. How much could he withdraw at the beginning of each of the next 25 years and end up with zero in the account? A. $85,538.08 B. $65,864.32 C. $88,104.22 D. $103,501.08 E. $73,562.75
36. Your girlfriend just won the Florida lottery. She has the choice of $16,600,000 today or a 20 -year annuity of $1,050,000, with the first payment coming one year from today. What rate of return is built into the annuity? A. 2.75% B. 2.73% C. 2.52% D. 2.35% E. 2.54%
37. Your uncle will sell you his bicycle shop for $240,000, with "seller financing," at a 6.0% nominal annual rate. The terms of the loan would require you to make 12 equal end-of-month payments per year for 4 years, and then make an additional final (balloon) payment of $50,000 at the end of the last month. What would your equal monthly payments be? A. $3,722.60 B. $4,712.16 C. $4,476.55 D. $3,675.48 E. $4,146.70
38. Your child's orthodontist offers you two alternative payment plans. The first plan requires a $4,000 immediate up-front payment. The second plan requires you to make monthly payments of $137.41, payable at the end of each month for 3 years. What nominal annual interest rate is built into the monthly payment plan? A. 17.81% B. 12.06% C. 14.36% D. 17.52% E. 15.08%
39. Your sister turned 35 today, and she is planning to save $20,000 per year for retirement, with the first deposit to be made one year from today. She will invest in a mutual fund that's expected to provide a return of 7.5% per year. She plans to retire 30 years from today, when she turns 65, and she expects to live for 25 years after retirement, to age 90. Under these assumptions, how much can she spend each year after she retires? Her first withdrawal will be made at the end of her first retirement year. A. $200,362.24 B. $155,837.30 C. $183,665.39 D. $185,520.60 E. $157,692.51
40. Steve and Ed are cousins who were both born on the same day, and both turned 25 today. Their grandfather began putting $3,800 per year into a trust fund for Steve on his 20th birthday, and he just made a 6th payment into the fund. The grandfather (or his estate's trustee) will make 40 more $3,800 payments until a 46th and final payment is made on Steve's 65th birthday. The grandfather set things up this way because he wants Steve to work, not be a ""trust fund baby,"" but he also wants to ensure that Steve is provided for in his old age. Until now, the grandfather has been disappointed with Ed, hence has not given him anything. However, they recently reconciled, and the grandfather decided to make an equivalent provision for Ed. He will make the first payment to a trust for Ed today, and he has instructed his trustee to make 40 additional equal annual payments until Ed turns 65, when the 41st and final payment will be made. If both trusts earn an annual return of 8%, how much must the grandfather put into Ed's trust today and each subsequent year to enable him to have the same retirement nest egg as Steve after the last payment is made on their 65th birthday? A. $6,909 B. $5,889 C. $5,153 D. $5,663 E. $5,833
FIN 221 Fall 2009 Exam 1 Answer Section
MULTIPLE CHOICE 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. A D D B C B E C C C E C D A A B B A C A C A C C B D D B C C B C E D A D B C D D