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Fin 403 Spring 2012 ID#: _______________________________ Name: _______________________________ Take-home Final Exam (Charles, Jason B. Suppose you...

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1 Fin 403 ID#: _______________________________ Spring 2012 Name: _______________________________ Take-home Final Exam (Charles, Jason B.) I. Short essays For the following four questions, please first answer if the statement is “True” or “False”, then explain why it is true or false. 1. Suppose you are analyzing two firms in the same industry. Firm A has a profit margin of 10% versus a margin of 8% for Firm B. Firm A's debt ratio is 70% versus one of 20% for Firm B. Based only on these two facts, you cannot reach a conclusion as to which firm is better managed, because the difference in debt, not better management, could be the cause of Firm A's higher profit margin. 2. The greater the number of compounding periods within a year, then (1) the greater the future value of a lump sum investment at Time 0 and (2) the greater the present value of a given lump sum to be received at some future date. 3. A stock with a beta equal to -1.0 has zero systematic (or market) risk. 4. A bond has a $1,000 par value, makes annual interest payments of $100, has 5 years to maturity, cannot be called, and is not expected to default. The bond should sell at a premium if market interest rates are below 10% and at a discount if interest rates are greater than 10%. 5. According to the basic DCF stock valuation model, the value an investor should assign to a share of stock is dependent on the length of time he or she plans to hold the stock. 6. For capital budgeting and cost of capital purposes, the firm should always consider retained earnings as the first source of capital--i.e., use these funds first--because retained earnings have no cost to the firm.
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2 II. Problem solving: (Please show all your detailed calculations/steps to earn the full credit) 7. Last year XYZ Corp had $145,000 of assets, $315,000 of sales, $22,000 of net income, and a debt-to-total-assets ratio of 36%. The new CFO believes a new computer program will enable it to reduce costs and thus raise net income to $32,500. Assets, sales, and the debt ratio would not be affected. By how much would the cost reduction improve the ROE? 8. Jordan Inc has the following balance sheet and income statement data: Cash $ 14,000 Accounts payable $ 32,000 Receivables 70,000 Other current liab. 28,000 Inventories 270,000 Total CL $ 60,000 Total CA $354,000 Long-term debt 140,000 Net fixed assets 126,000 Common equity 280,000 Total assets $480,000 Total liab. and equity $480,000 Sales $280,000 Net income $21,000 The new CFO thinks that inventories are excessive and could be lowered sufficiently to cause the current ratio to equal the industry average, 2.87, without affecting either sales or net income. Assuming that inventories are sold off and not replaced to get the current ratio to the target level, and that the funds generated are used to buy back common stock at book value, by how much would the ROE change? 9. You agree to make $1650 at the beginning of each quarter into a bank account. At the end of the 24th month, you will have $14,000 in your account. If the bank compounds interest quarterly, what nominal annual interest rate will you be earning? 10. John and Mary are saving for their daughter Hellen's college education. Hellen just turned 11 at (t = 0), and she will be entering college 7 years from now (at t = 7). College tuition and expenses at State U. are currently $15,500 a year, but they are expected to increase at a rate of 3% a year. Hellen should graduate in 4 years--if she takes longer or wants to go to graduate school, she will be on her own. Tuition and other costs will be due at the beginning of each school year (at t = 7, 8, 9, and 10). So far, John and Mary have accumulated $17,000 in their college savings account (at t = 0). Their long-run financial plan is to add an additional $4,000 in each of the next 3 years (at t = 1, 2, and 3). Then they plan to make 3 equal annual contributions in each of the following years, t = 4, 5, and 6. They expect their investment account to earn 9.5%. How large must the annual payments at t = 4, 5, and 6 be to cover Hellen's anticipated college costs? 11. XYZ Corp has a beta of 1.25 and is currently in equilibrium. The required rate of return on the stock is 12.50% versus a required return on an average stock of 11.00%. Now the required return on an average stock increases by 40.0% (not percentage points). Neither betas nor the risk-free rate change. What would XYZ's new required return be?
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