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FINAL Practice Questions

FINAL Practice Questions - FINAL FIN470 Spring 2010 1...

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FINAL FIN470 Spring 2010 1. Suppose you own stock in a company. The current price per share is $25. Another company has just announced that it wants to buy your company and will pay $35 per share to acquire all the outstanding stock. Your company’s management immediately begins fighting off this hostile bid. Is management acting in the shareholders’ best interests? Why or why not? The goal of management should be to maximize the share price for the current shareholders. If management believes that it can improve the profitability of the firm so that the share price will exceed $35, then they should fight the offer from the outside company. If management believes that this bidder or other unidentified bidders will actually pay more than $35 per share to acquire the company, then they should still fight the offer. However, if the current management cannot increase the value of the firm beyond the bid price, and no other higher bids come in, then management is not acting in the interests of the shareholders by fighting the offer. Since current managers often lose their jobs when the corporation is acquired, poorly monitored managers have an incentive to fight corporate takeovers in situations such as this. 2. Braam Fire Prevention Corp. has a profit margin of 6.80 percent, total asset turnover of 1.95, and ROE of 18.27 percent. What is this firm’s debt–equity ratio? This question gives all of the necessary ratios for the DuPont Identity except the equity multiplier, so, using the DuPont Identity: ROE = (PM)(TAT)(EM) ROE = .1827 = (.068)(1.95)(EM) EM = .1827 / (.068)(1.95) = 1.38 D/E = EM – 1 = 1.38 – 1 = 0.38 3. Seaweed Mfg., Inc., is currently operating at only 95 percent of fixed asset capacity. Current sales are $550,000. How fast can sales grow before any new fixed assets are needed? To determine full capacity sales, we divide the current sales by the capacity the company is currently using, so: Full capacity sales = $550,000 / .95 Full capacity sales = $578,947 The maximum sales growth is the full capacity sales divided by the current sales, so: Maximum sales growth = ($578,947 / $550,000) – 1 Maximum sales growth = .0526 or 5.26% 4. What happens to a future value if you increase the rate r? What happens to a present value? The future value rises (assuming it’s positive); the present value falls. 5. Suppose the following bond quotes for IOU Corporation appear in the financial page of today’s newspaper. Assume the bond has a face value of $1,000 and the current date is April 15, 2009. What is the yield to maturity of the bond? What is the current yield? The bond has 14 years to maturity, so the bond price equation is: EST Vol Company (Ticker) Coupon Maturity Last Price Last Yield (000s) IOU (IOU) 7.2 Apr 15, 2023 108.96 ?? 1,827
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P = $1,089.60 = $36(PVIFA R% ,28 ) + $1,000(PVIF R% ,28 ) Using a spreadsheet, financial calculator, or trial and error we find: R = 3.116% This is the semiannual interest rate, so the YTM is: YTM = 2 × 3.116% =
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FINAL Practice Questions - FINAL FIN470 Spring 2010 1...

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