# Financial Foundation

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```							           Financial Management: Comprehensive Final Exam
MW 2:00 Class; Fall, 2006, Sarah Rose
Instructor: Jim Wehrley

1. (10 points) Develop the three following statements from the information provided
below: 1) 12/31/06 Balance Sheet; 2) 12/31/07 Balance Sheet; and 3) Fiscal Year
2007 Income Statement (Jan 1, 2007 - December 31, 2007). All the major classification
categories (e.g., current assets, gross profit) should be used.

At fiscal year end, December 31, 2006, Denver Clothing Retail, Inc. has \$10,000 cash,
\$1,000 in short term debt, \$45,000 in inventory, \$30,000 Accounts Payable, \$49,000 long
term mortgage loan due in 2015, and \$75,000 Property Plant and Equipment.

For the next fiscal year ending December 31, 2007, the company's sales equaled
\$400,000. The cost of the clothing sold equaled \$200,000 and selling general and

For simplification, there is no depreciation expense. The \$49,000 and \$1,000 debt stayed
the same all year. The company keeps its cash in a non-interest bearing checking
account. The interest rate was 10% for both loans. The income tax rate equaled 50%.
The company paid a \$7,500 dividend at the end of fiscal year December 31, 2007. As of
December 31, 2007, all balance sheet items remained the same unless information is
provided that would change a category.
Problems (3 points each)

1. You deposit \$100 in a bank on January 1, 2000 and you want to find the value of that
deposit January 1, 2006. If the interest rate is 5%, what is the future value of the deposit
on January 1, 2006?

2. You deposit \$100 in a bank on January 1, 2000. If the interest rate is 5% nominal
annual rate, compounded quarterly, what is the future value of the deposit on January 1,
2006

3. You have \$15,000 in cash. You expect inflation to equal 12 percent for the next 15
years. How much cash will you need in 15 years to equal the buying power of the current
\$15,000?

4. You notice that all your neighbors seem to need various items (e.g., tree limbs,
construction debris) hauled away. You are thinking of buying a dump truck for \$35,000.
You estimate you could generate \$10,000 a year cash flow (end of year) after paying for
all expenses including hiring someone to drive the truck. The estimated life of the truck
is 7 years with no salvage value. You would like an annual return of 12%. Should you

5. Cemex, a large cement provider, issued a 10 percent coupon interest rate, 10-year
bond with a \$1,000 par value. The market rate for a bond like this (risk level of company
and maturity rate) is 11 percent. The company is selling 100,000 of these bonds. How
much should these bonds sell for in the marketplace?
6. Alligators R Us is contemplating expansion through the issuance of debt/bonds. Your
broker calls you and suggests that you buy 10 bonds—price \$1,150 for each bond, 11
percent coupon rate, \$1,000 par value, interest paid annually. The bonds mature in 12
years. Calculate the Yield-to-Maturity (YTM). Are the bonds selling at a discount or

7. You forecast that Google’s P/E ratio will be 30 in five years. You also estimate that
Google’s EPS will be \$14.00. Using the P/E ratio, how much will Google be worth in
five years?

For question 8 and 9, assume the company has a cost of capital of 10 percent.

Year                 Project A Cash Flows
Initial Investment
(Year 0)             (\$840,000)
Year 1                \$280,000
Year 2                \$280,000
Year 3                \$280,000
Year 4                \$280,000
Year 5                \$280,000

8. What is the NPV of project A? Is the project acceptable? Why?

9. What is the IRR of Project A? Is the project acceptable? Why?

10. The cash flow of an investment is \$100 today. You expect cash flow to grow at 4%
annually. Furthermore, your required return is 11%. What is the value of the investment
today?

1. List three decisions a company could make to increase its financial leverage?

2. What does buying back bonds do to a company’s capital structure? Explain.

3. What is the difference between a junk bond and secured bonds?

4. How does collateral relate to risk and return?

5. A company retires \$100 of long-term debt and issues \$100 of stock. How does the
current ratio change? Explain.

6. A company buys a building for \$1 million. In order to buy the building, the
company uses \$500,000 of cash and sells another building for \$500,000. How does
the debt ratio change? Explain.
7. The stock price of Starbucks increased from\$40 per share to \$45 per share? How
does the company’s capital structure change? Explain.

8. From an investor’s viewpoint, what is more risky—Home Depot common stock or
Home Depot bond? Explain.

9. From Home Depot’s perspective, is the cost of debt higher than the cost of equity?
Explain.

10. How does a commercial lender at a bank or other financial institution determine
whether a company should be approved for a commercial (i.e., business) loan? Hint:
Capital, Character, Conditions, Collateral, and Commitment.

11. A company’s ROE and ROA are the same. What does this tell you about the
company’s capital structure?

12. The gross profit margin is increasing and the net profit margin is decreasing.
Why or how might this happen?
13. A company’s average age of inventory is increasing and gross profit margin is
decreasing. Why or how might this happen?

14. What does it mean, “. . . ability to service debt”? What is debt service? What
portion of debt service is on the income statement?

15. What could happen if a company violates its covenants?

16. If a company does not have strong liquidity, is it a good candidate for issuing
debt and retiring stock in equal amounts?

17. If a company is having liquidity problems, would buying back bonds and issuing
stock in the same amount be a good idea? Explain.
18. If a company is adjusting its capital structure by issuing more stock, what is the
importance of the stock price?

19. A company would like to finance inventory. What type of debt or loan would
you recommend? Explain.

20. Define the following types of risk: business, liquidity, default, market, interest

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