FINA 061 Practice problem exam 1 questions and answers solution

FINA 061 Practice problem exam 1 questions and answers solution Optional Problem Set 1 (Solution is provided at the bottom for reference. No additional answer or explanation will be given) This problem set is to help you review for the first midterm exam and the answers are provided at the bottom of this document for your reference. However, students should note that there is no guarantee that the actual exam will be similar to this problem set in length, format, or level of difficulty. To be fully prepared, you need to review the lecture materials, previous homework, and end-of-chapter problems. Select and circle one correct answer for each question (3 points for each correct answer) i. The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to a. Maximize its expected total corporate income. b. Maximize its expected EPS. c. Minimize the chances of losses. d. Maximize the stock price per share over the long run, which is the stock’s intrinsic value. e. Maximize the stock price on a specific target date. ii. Which of the following mechanisms would be most likely to help motivate managers to act in the best interests of shareholders? a. Decrease the use of restrictive covenants in bond agreements. b. Take actions that reduce the possibility of a hostile takeover. c. Elect a board of directors that allows managers greater freedom of action. d. Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries. e. Eliminate a requirement that members of the board of directors have a substantial investment in the firm’s stock. iii. River Hawks Construction recently reported $20.50 million of sales, $12.60 million of operating costs other than depreciation, and $3.00 million of depreciation. It had $8.50 million of bonds outstanding that carry a 7.0% interest rate, and its federal-plus-state income tax rate was 40%. What was River Hawks’ operating income, or EBIT, in millions? a. $3.21 b. $3.57 c. $3.97 d. $4.41 e. $4.90 iv. Brown Office Supplies recently reported $15,500 of sales, $8,250 of operating costs other than depreciation, and $1,750 of depreciation. It had $9,000 of bonds outstanding that carry a 7.0% interest rate, and its federal-plus-state income tax rate was 40%. How much was the firm's earnings before taxes (EBT)? 2 a. $4,627 b. $4,870 c. $5,114 d. $5,369 e. $5,638 v. Lowell Sun Systems has the following balance sheet. How much net operating working capital does the firm have? Cash $ 100 Accounts payable $ 200 Accounts receivable 650 Accruals 350 Inventory 550 Notes payable 350 Current assets $1,300 Current liabilities $ 900 Net fixed assets 1,000 Long-term debt 600 Common equity 300 Retained earnings 500 Total assets $2,300 Total liab. & equity $2,300 a. $675 b. $750 c. $825 d. $908 e. $998 vi. Watson Oil recently reported (in millions) $8,250 of sales, $5,750 of operating costs other than depreciation, and $650 of depreciation. The company had $3,200 of outstanding bonds that carry a 5% interest rate, and its federal-plus-state income tax rate was 35%. In order to sustain its operations and thus generate future sales and cash flows, the firm was required to make $1,250 of capital expenditures on new fixed assets and to invest $300 in net operating working capital. By how much did the firm's net income exceed its free cash flow? a. $718 b. $756 c. $796 d. $836 e. $878 vii. Andover Corp's sales last year were $315,000, and its year-end total assets were $355,000. The average firm in the industry has a total assets turnover ratio (TATO) of 2.4. The firm's new CFO believes the firm has excess assets that can be sold so as to bring the TATO down to the industry average without affecting sales. By how much must the assets be reduced to bring the TATO to the industry average, holding sales constant? a. $201,934 b. $212,563 c. $223,750 d. $234,938 e. $246,684 3 viii. Last year Chelmsford Corp had $155,000 of assets, $305,000 of sales, $20,000 of net income, and a debt-to-total-assets ratio of 37.5%. The new CFO believes a new computer program will enable it to reduce costs and thus raise net income to $33,000. Assets, sales, and the debt ratio would not be affected. By how much would the cost reduction improve the ROE? a. 11.51% b. 12.11% c. 12.75% d. 13.42% e. 14.09% ix. Last year Jandik Corp. had $295,000 of assets, $18,750 of net income, and a debt-to-total-assets ratio of 37%. Now suppose the new CFO convinces the president to increase the debt ratio to 48%. Sales and total assets will not be affected, but interest expenses would increase. However, the CFO believes that better cost controls would be sufficient to offset the higher interest expense and thus keep net income unchanged. By how much would the change in the capital structure improve the ROE? a. 2.13% b. 2.35% c. 2.58% d. 2.84% e. 3.12% x. Suppose you have $2,000 and plan to purchase a 3-year certificate of deposit (CD) that pays 4% interest, compounded annually. How much will you have when the CD matures? a. $2,324.89 b. $2,591.45 c. $2,249.73 d. $2,011.87 e. $2,854.13 xi. The U.S. Treasury offers to sell you a bond for $613.81. No payments will be made until the bond matures 10 years from now, at which time it will be redeemed for $1,000. What interest rate would you earn if you bought this bond at the offer price? a. 5.91% b. 6.71% c. 7.10% d. 5.59% e. 5.00% xii. Your father has $500,000 and wants to retire. He expects to live for another 20 years, and to be able to earn 8% on his invested funds. How much could he withdraw at the end of each of the next 20 years (nothing will be left in his account after that)? a. $55,119.76 b. $53,431.83 4 c. $54,764.40 d. $47,843.15 e. $50,926.10 xiii. What’s the present value of a 5-year ordinary annuity of $2,000 per year plus an additional $1,000 at the end of Year 5 if the interest rate is 5%? a. $8,324.89 b. $8,591.45 c. $8,974.77 d. $9,211.87 e. $9,442.48 xiv. An investment promises the following cash flow stream: $1,000 at Time 0; $2,000 at the end of Year 1 (or at T=1); $3,000 at the end of Year 2; and $5,000 at the end of Year 3. At an interest rate of 5%, what is the future value (at the end of Year 3) of the cash flow stream? a. $11,512.63 b. $11,691.45 c. $11,945.04 d. $11,011.87 e. $11,854.13 xv. You are buying your first house for $220,000, and are paying $30,000 as a down payment. You have arranged to finance the remaining $190,000 30-year mortgage with a 7% nominal interest rate and monthly payments. What are the equal monthly payments you must make? a. $1,513 b. $1,110 c. $1,264 d. $1,976 e. $1,349 xvi. Bank A offers to lend you $10,000 at a nominal rate of 7%, compounded monthly. The loan (principal plus interest) must be repaid at the end of the year. Bank B also offers to lend you the $10,000, but it will charge 8%, with interest due at the end of the year. What is the difference in the effective annual rates charged by the two banks? a. 0.77% b. 1.71% c. 1.10% d. 1.59% e. 0.91% xvii. You recently purchased a 20-year investment that pays you $100 at t = 1, $500 at t = 2, $750 at t = 3, and some fixed cash flow, X, at the end of each of the remaining 17 years. You purchased the investment for $5,544.87. Alternative investments of equal risk have a required return of 9%. What is the annual cash flow received at the end of each of the final 17 years, that is, what is X? a. $600 b. $625 c. $650 d. $675 5 e. $700 xviii. Johnson Battery Systems Metals recently reported $9,000 of sales, $6,000 of operating costs other than depreciation, and $1,500 of depreciation. The company had no amortization charges, it had $4,000 of bonds that carry a 7% interest rate, and its federal-plus-state income tax rate was 40%. In order to sustain its operations and thus generate sales and cash flows in the future, the firm was required to make $800 of capital expenditures on new fixed assets and to invest $500 in net operating working capital. What was its free cash flow? a. $1,000 b. $1,100 c. $1,200 d. $1,300 e. $1,400 xix. During the latest year Ruth Corp. had sales of $300,000 and a net income of $20,000, and its yearend assets were $200,000. The firm's total debt to total assets ratio was 40%. Based on the Du Pont equation, what was the firm's ROE? a. 15.33% b. 15.67% c. 16.00% d. 16.33% e. 16.67% xx. Your sister turned 30 today, and she is planning to save $3,000 per year for retirement, with the first deposit to be made one year from today. She will invest in a mutual fund, which she expects to provide a return of 10% per year. She plans to retire 35 years from today, when she turns 65, and she expects to live for 30 years after retirement, to age 95. Under these assumptions, how much can she spend in each year after she retires? Her first withdrawal will be made at the end of her first retirement year and there is nothing left after she turns 95. a. $86,250 b. $85,510 c. $87,310 d. $85,980 e. $86,560