Exam 1 Solutions - Exam Code: A Spring 2002 Exam 1 1. Enron...

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Exam Code: A Spring 2002 – Exam 1 1. Enron was one of the largest companies in the Unites States based on total revenues. Its bankruptcy is also one of the largest. A prime factor that lead to Enron's problem was its extensive use of partnerships, which allowed the firm to move assets and debts off of its own balance sheets (I.e., off-balance sheet financing), and to inflate profits and hide losses. * A. True B. False 2. An advantage of a sole proprietorship, versus a corporation, is that ownership of the sole proprietorship can be passed from one generation to the next, unlike ownership in a corporation, thus giving it unlimited life. A. True * B. False 3. An agency relationship arises whenever one or more individuals, called principals, hire another individual or organization, called an agent, to perform some service and delegate decision-making authority to that agent. In financial management, the primary agency relationships are between (1) stockholders and managers and (2) managers (on behalf of stockholders) and debtholders. * A. True B. False 4. There is a direct relationship between the price of a firm's stock and the level of net income, earnings per share, and dividends paid. For instance, if a firm takes on a project that leads to higher net income, which leads to higher earnings per share, and which then allows the firm to pay higher dividends, then the price of the firm's stock will automatically increase. A. True * B. False 5. Assume that over the coming year a firm changes its production process and that this deceases its cost of goods sold as a percentage of sales and thus increases its profit margin. According to the Du Pont equation, if the firm also increases its debt to equity ratio (i.e., leverage or equity multiplier), it will also increase it ROE. A. True * B. False 6. Net Operating Working Capital concentrates on those current assets and liabilities used in the operations of the firm. In general, we can say that this is equal to all current assets minus those current liabilities that do not charge interest. All other things constant, an increase in Net Operating Working Capital will increase the firm's Gross Investment in Operating Capital and reduce the firm's Free Cash Flow. * A. True B. False FIN 3403 - 2002 Spring Term - Exam 1 Page 1 of 20 Pages
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Exam Code: A 7. Assume that a firm simply replaces some of its long-term debt with an equal amount of short-term debt. Under these conditions, we know that its fixed and total asset turnover ratios, its total debt ratio, and its basic earnings power will remain constant. However, it is still possible for such measures as its EBITDA coverage ratio, ROA, and ROE to increase, decrease, or remain constant. * A.
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This note was uploaded on 02/10/2011 for the course FIN 3403 taught by Professor Tapley during the Spring '06 term at University of Florida.

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Exam 1 Solutions - Exam Code: A Spring 2002 Exam 1 1. Enron...

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