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Document Sample
Business Finance Name ________________________
Examination One
Spring 2003
Select the best answer for each of the following questions. Mark your selection on the examination. Also
record your selection on the answer sheet. Show all work on the problems. Turn in your examination
when you are finished; keep the answer sheet. Answer keys will be posted ten minutes after the exam is
completed. Your score will be based on your answers on the exam and not on the answer sheet.
3 points per question
1. A firm has an inventory turnover of 22.1; the industry average is 32.0. As a financial analyst,
what conclusions could you draw from this situation?
a. The firm is more profitable than the industry on average.
b. The firm may lose sales periodically due of being out of inventory.
c. The firm may have too much inventory.
d. The firm has too few current assets.
e. The firm’s cost of goods sold exceeds the industry’s on average.
2. A firm's fixed charge coverage has steadily decreased over the past 5 years, from 10 times at the
end of December 1997 to 5 times at the end of 2002. What would a financial analyst be MOST
justified in concluding?
a. The firm’s risk of default has increased.
b. The firm’s sales have increased.
c. The firm’s profitability has increased.
d. The firm has become safer for its creditors.
e. The firm's financial position has improved.
3. What can be concluded from the following Fixed Asset Turnover (FATO) and Total Asset
Turnover (TATO) ratios for the XYZ Company and its industry?
2001 2000 1999 Industry
FATO 8.0x 7.6x 7.2x 7.0x
TATO 4.2x 4.0x 3.8x 3.6x
a. The firm’s asset utilization is worse than the industry and declining.
b. The firm’s asset utilization is better than the industry but declining.
c. The firm’s asset utilization is better than the industry and improving.
d. The firm’s asset utilization is worse than the industry but improving.
4. Due to increasing competition, the XYZ Company has recently experienced a drop in its profit
margin. If XYZ wants to keep its return on equity (ROE) constant, it must:
a. increase its current ratio.
b. decrease its debt to total assets.
c. reduce its average collection period.
d. none of the above will keep ROE constant.
e. increase its total asset turnover.
5. An upward sloped yield curve suggests that securities with longer maturities should have higher
yields that shorter- term securities. This is the basic premise of the ______________
a. Classical Theory of Interest
b. Market Segmentation Theory
c. Expectations Theory
d. Preferred Maturity Theory
e. Liquidity Preference Theory
6. Security A has a higher yield or expected rate of return than Security B. What might explain this
difference in rate of return?
a. Security A has greater liquidity than Security B.
b. Security A has a shorter maturity than Security B.
c. Security A has a lower real rate of return than Security B.
d. Security A is a US Treasury bill and Security B is a corporate security.
e. Security A has more default risk than Security B.
7. Assume that on January 12, 2003 Standard and Poor changed the rating on Ford Motor
Company’s long-term debt from AA to A. Which of the following statements BEST describes
the effect that this announcement would have on the yields of Ford’s long-term debt?
a. The yield on Ford’s long-term debt should decline due to a decline in the maturity premium.
b. The yield on Ford’s long-term debt should decline due to a decline in the default risk
premium.
c. The yield on Ford’s long-term debt should increase due to an increase in the liquidity
premium.
d. The yield on Ford’s long-term debt should increase due to an increase in the default risk
premium.
8. You deposit money in your savings account at the credit union. The credit union lends these
funds along with others to your brother so that he can buy a car. This is an example of:
a. Personal finance
b. Direct finance
c. Semi-direct finance
d. Indirect finance
e. Pseudo finance
9. In normal or average market circumstances, which of the following securities should have the
lowest yield (or current market interest rate)?
a. BBB-rated corporate bonds with 25 years remaining until maturity
b. AAA-rated corporate bonds with 5 years remaining until maturity
c. 30 year US Treasury bonds
d. 90-day US Treasury bills
10. A financial analyst is given the following ratios for a firm and its industry.
Firm Industry
Current 2.4 2.0
Quick 1.0 1.6
Which of the following statements best represent the conclusion that the analyst could draw from
these ratios?
a. The firm uses its fixed assets very effectively.
b. The firm is relatively illiquid relative to the industry.
c. The firm’s inventory is larger than the industry on average.
d. The firm is more profitable than the industry.
e. The firm is a poor credit risk.
8 points
11. Johnstown Chemicals, Inc., has a current ratio of 2.5, a quick ratio of 1.5, and an inventory
turnover of 10. Johnstown's total assets are $14 million and its debt ratio is 0.25. (The firm has
no long-term debt.) What is Johnstown's sales figure?
a. $40.00 million f. $35.00 million
b. $30.00 million g. $20.00 million
c. $22.50 million h. $25.00 million
d. $15.00 million
e. $27.50 million
6 points
12. Epsilon Co.'s records have recently been destroyed by fire. Given the following bits of
information saved from the inferno, determine Epsilon's net income for 1999.
Return on equity 20.0%
Assets/net worth 2.0
Profit margin 5.0%
Total assets $80 million
a. $4.00 million f. $7.00 million
b. $3.00 million g. $2.00 million
c. $9.00 million h. $8.00 million
d. $6.00 million
e. $5.00 million
6 points
13. The Local Company is a relatively small, privately owned firm. In 2002 Local had an after-tax
income of $250,000, and 100,000 shares were outstanding. The owners were trying to determine
the equilibrium market value for Local's stock, prior to taking the company public. A similar
firm that is publicly traded had a price/earnings ratio of 7.0. Using only the information given,
estimate the market value of one share of Local's stock.
a. $ 12.50 f. $ 15.00
b. $ 20.00 g. $ 10.00
c. $ 25.00 h. $ 30.00
d. $ 12.50
e. $ 17.50
8 points
14. Coastal Packaging ‘s ROE last year was only 3 percent, but its management has developed a new
operating plan designed to improve things. The new plan calls for a total debt ratio of 60 percent,
which will result in interest charges of $400,000 per year. Management projects an EBIT of
$1,000,000 on sales of $10,000,000 and it expects to have a total asset turnover ratio of 2.0.
Under these conditions, the average tax rate will be 40 percent. If the changes are made, what
return on equity will Coastal earn?
a. 18.00% f. 8.00%
b. 20.00% g. 25.00%
c. 10.00% h. 12.00%
d. 15.00%
e. 22.50%
6 points
15. Interest rates on five-year Treasury securities are currently 4.0 percent, while interest rates on
thirty-year Treasury securities are currently 7.0 percent. If the pure expectations theory is correct,
what does the market believe that twenty five-year securities will be yielding five years from
now?
a. 7.750% f. 7.300%
b. 6.600% g. 8.500%
c. 8.330% h. 8.000%
d. 8.750%
e. 7.600%
6 points
16. A Treasury bond that matures in 10 years has a yield of 5.00 percent. A 10-year corporate bond
has a yield of 9.50 percent. Assume that the liquidity premium on the corporate bond is 0.30
percent. What is the default risk premium on the corporate bond?
a. 2.70% f. 4.20%
b. 3.40% g. 3.70%
c. 5.30% h. 3.20%
d. 2.90%
e. 4.00%
8 points
17. You are considering a new product for your firm to sell. It should cause a 15% increase in your
profit margin but it will also require a 50% increase in total assets. You expect to finance this
asset growth entirely by debt. If the following ratios were computed before the change, what will
be the new ROE if the new product is sold but sales remain constant?
Profit margin = 15.00 percent
Total asset turnover = 2.0
Equity multiplier =2
a. 69.0% f. 46.0%
b. 36.8% g. 24.0%
c. 55.2% h. 23.0%
d. 82.8%
e. 55.2%
6 points
18. The real risk-free rate is 2.0 percent. Inflation is expected to be 2.5 percent this year, 2.8 percent
next year and 3.0 percent thereafter. The maturity risk premium is estimated to be 0.0005 x (t-1),
where t = the number of years to maturity, what is the nominal interest rate on a 15-year Treasury
bond?
a. 6.477% f. 6.222%
b. 5.653% g. 5.965%
c. 6.427% h. 7.653%
d. 6.172%
e. 5.915%
8 points
19. A firm has the following balance sheet:
Cash $250 Accounts payable $200
Accounts receivable 250 Notes payable 500
Inventory 500 Long-term debt 800
Fixed assets 2,000 Common stock 400
Retained earnings 1,100
------ -------
$3,000 $3,000
Fixed assets are being used at 100% of capacity. Sales for the year just ended were $1,500. Sales
are expected to grow at a rate of 6% next year. The profit margin is 5% and the dividend payout
ratio is 40%. What will be the outside funding requirement?
a. $198.00 f. $225.15
b. $107.55 g. $120.30
c. $142.80 h. $147.85
d. $202.95
e. $175.40
8 points
20. Given the following balance sheet, determine the amount of growth that the firm could
experience without needing external funds. Current sales are $1,000, profit margin is 20%, and
dividend payout ratio is 40%.
Cash $250 Accounts payable $200
Accounts receivable 250 Notes payable 500
Inventories 500 Mortgage bonds 800
Net fixed assets 2,000 Common stock 500
Retained earnings 1,000
$3,000 $3,000
a. 2.64% f. 1.32%
b. 3.32% g. 2.04%
c. 1.74% h. 3.99%
d. 4.48%
e. 5.50%
FORMULA SHEET
PM = Net Income Current Ratio = Current Assets
Sales Current Liabilities
TATO = Sales Quick Ratio = Current Assets - Inventory
Assets Current Liabilities
ROA = Net Income EM = Assets = 1/(1-D/A)
Total Assets Equity
ROE = Net Income ACP = Accounts Receivable
Total Equity Credit Sales/360
Inventory Turnover = Sales Times Interest Earned = EBIT
Inventory Interest Charges
Capital Intensity ratio = Assets/Sales = 1 / TATO
BEP = EBIT / Total Assets EVA = NOPAT – [Capital Cost x Assets]
AFN = (A/S0)S – (L/S0)S – PM(S1)RR
ANSWER SHEET
1. ______ 3 pts 11. ______ 8 pts
2. ______ 3 pts 12. ______ 6 pts
3. ______ 3 pts 13. ______ 6 pts
4. ______ 3 pts 14. ______ 8 pts
5. ______ 3 pts 15. ______ 6 pts
6. ______ 3 pts 16. ______ 6 pts
7. ______ 3 pts 17. ______ 8 pts
8. ______ 3 pts 18. ______ 6 pts
9. ______ 3 pts 19. ______ 8 pts
10. ______ 3 pts 20. ______ 8 pts.
