DEPARTMENT OF FINANCE, INSURANCE & LAW
COLLEGE OF BUSINESS
ILLINOIS STATE UNIVERSITY
FIL 440 - Ahlgrim
NOTE: For all bond questions, always assume semiannual coupons unless stated
otherwise in the question.
MULTIPLE CHOICE – Circle the BEST response for each of the following
questions. 4 points each
1. What is the decision that determines which assets a company should
a. Capital structure
b. Corporate form
c. Asset substitution
d. Capital budgeting
e. Risk/return tradeoff
2. You are given the following cash flows. What is the present value (t = 0)
if the discount rate is 8 percent, rounded to a whole dollar?
3. What is the standard deviation of the following investment?
Scenario Probability Return
Boom 0.10 18%
Normal 0.50 12%
Recession 0.40 -6%
4. You deposit $10,000 in a bank each year for 10 years. If you earn 6% on
your deposits, what is the future value of your deposits?
5. When compared to sole proprietorships, which of the following is NOT an
advantage of the corporate form of ownership?
a. Limited liability of owners
b. Ease of raising large amounts of capital
c. Ease of transfer of ownership
d. Reduced taxation
e. All of the above
6. Suppose you buy a $40,000 car with no money down. You finance the car
over 5 years at a fixed interest rate of 9%. What is the amount of principal
repayment that is contained in the first monthly payment?
7. Garfield Industries is expanding its operations. Garfield anticipates that
the expansion will increase sales by $1,000,000 and the costs of goods sold
by $700,000. Depreciation expenses will rise by $50,000 and interest expense
will increase by $150,000. The company's tax rate is 40%. How much will net
income increase or decrease, as a result of the expansion?
a. No change.
b. $40,000 increase.
c. $60,000 increase.
d. $100,000 increase.
e. $180,000 increase.
8. Coolidge Cola is forecasting the following income statement:
Operating costs excluding 20,000,000
Operating income (EBIT) $ 5,000,000
Interest expense 2,000,000
Taxable income (EBT) $ 3,000,000
Taxes (40%) 1,200,000
Net income $ 1,800,000
With the exception of depreciation, all other non-cash revenues and expenses
sum to zero. Congress is considering a proposal which will allow companies
to depreciate their equipment at a faster rate. If this provision were put in
place, Coolidge's depreciation expense would be $8,000,000 (instead of
$5,000,000). If this proposal were to be implemented, what would be the
company's net cash flow?
9. A share of common stock has just paid a dividend of $3.00. If the expected
long-run growth rate for this stock is 5 percent, and if investors require an
11 percent rate of return, what is the price of the stock?
10. On January 1, you charge $1,000 on your credit card which has an APR of
19.9%, compounded daily. Suppose your credit card company allows you the
opportunity to defer any payments until December 31. What is the balance on
your account on December 31?
11. Harmeling Enterprises had a decline in net operating profit after taxes
(NOPAT). Which of the following definitely cannot help explain this decline?
a. Sales revenues decreased.
b. Costs of goods sold increased.
c. Depreciation increased.
d. Interest expense increased.
e. Taxes increased.
12. Assume that you wish to purchase a bond with 30 years to maturity, a
coupon of 10%, and a face value of $1,000. If you require a 9 percent yield
to maturity on this investment, what is the price of the bond?
WRITTEN ANSWER – Answer the following questions on separate paper (put your
name on each sheet of paper and number the questions). SHOW ALL WORK AND
NUMERICAL QUESTIONS. Choose any FOUR of questions 13-17. 7 Points Each
13. You are given that the beta of a stock is 0.6, the risk free rate is 7%,
and the market risk premium is 5%. Draw the security market line for this
situation. A stock analyst estimates that, based on the future prospects of
the company, the stock is expected to earn 9%. Evaluate the attractiveness
of this stock.
14. The last dividend paid by Jay Bee Company was $1.00. The company's
growth rate is expected to be 25% next year, 15% in the 2nd year, and then
dividends are expected to grow at a rate of 8% forever. Jay Bee's required
rate of return on equity (rs) is 11 percent. What is the current price of Jay
Bee's common stock?
15. Suppose a 2-year bond has a coupon of 10% and a face value of $1,000.
The bond sells for $932.26.
a. Write out the equation that can be solved to determine the yield-to-
maturity of this bond.
b. Is the yield-to-maturity equal to 14%? Why or why not?
c. If the bond is callable at $1,120 in one year, without performing any
calculations, which is larger, the YTC or the YTM? Why?
16. Calculate free cash flow for 2005 based on the following data.
Income Statement 2005
Interest expense 25
Tax rate 30%
Balance Sheet 2005 2004
Cash 25 5
Other Current Assets 125 95
Net fixed Assets 200 100
Total assets 350 200
Current liabilities 75 50
Long-term debt 75 0
Shareholder equity 200 150
Total Liab & Equity 350 200
17. Compare the following two companies’ financial statements and use DuPont
Analysis to determine why one company’s ROE is higher than the other’s.
Income Statement Blackjack Co. Poker Inc.
Revenue 75,000 50,000
Operating Costs 65,000 40,000
EBIT 10,000 10,000
Interest 3,000 3,000
EBT 7,000 7,000
Taxes (40%) 2,800 2,800
Net Income 4,200 4,200
Balance Sheet Blackjack Co. Poker Inc.
Current Assets 10,000 5,000
Net Fixed Assets 90,000 75,000
Total Assets 100,000 80,000
Current Liab 20,000 10,000
Long-term debt 40,000 40,000
Total Liab 60,000 50,000
Common Stock 15,000 10,000
Retained Earnings 25,000 20,000
Total Liab and Equity 100,000 80,000
CONCEPTUAL QUESTIONS. Choose any THREE of questions 18-21. 8 Points Each
18. What is the market-to-book ratio of a company? What does it indicate?
Explain why the market-to-book ratio of Pfizer would likely be significantly
higher than a generic drug manufacturer’s.
19. Explain why the interest rate on 5-year bonds issued by Microsoft would
be much lower than the interest rate on 20-year bonds issued by General
Motors. What are the risks of these two bonds?
20. What is the goal of corporations? Does this goal benefit society or does
it lead to problems? Explain your response.
21. Suppose you are a loan officer for a bank. Explain how you would use a
company’s financial statements to evaluate a company’s request for a loan.
Looking only at the financial statements, what information would be most
useful to you?