MULTILPLE CHOICE

THEORY

1. Below is the common equity section (in millions) of Timeless Technology's last two
year-end balance sheets:
 
  2014 2013
Common stock $2,000 $1,000
Retained earnings   2,000   2,340
Total common equity $4,000 $3,340

The firm has never paid a dividend to its common stockholders. Which of the following
statements is CORRECT?

  a. The company's net income in 2014 was higher than in 2013.

  b. The firm issued common stock in 2014.
  c. The market price of the firm's stock doubled in 2014.
  d. The firm had positive net income in both 2013 and 2014, but its net income in 2014 was lower
than it was in 2013.
  e. The company has more equity than debt on its balance sheet.

2. Which of the following statements is CORRECT?

a. The more depreciation a firm reports, the higher its tax bill, other things held constant.
b. People sometimes talk about the firm's cash flow, which is shown as the lowest entry on
the income statement, hence it is often called "the bottom line."
c. Depreciation reduces a firm's cash balance, so an increase in depreciation would
normally lead to a reduction in the firm's cash flow.
d. Operating income is derived from the firm's regular core business. Operating income is
calculated as Revenues less Operating costs. Operating costs do not include interest or
taxes.
e. Depreciation is not a cash charge, so it does not have an effect on a firm's reported
profits.

3. Which of the following factors could explain why Michigan Energy's cash balance
increased even though it had a negative cash flow last year?

  a. The company sold a new issue of bonds.

  b. The company made a large investment in new plant and equipment.
  c. The company paid a large dividend.
  d. The company had high depreciation expenses.
  e. The company repurchased 20% of its common stock.
4. Which of the following statements is CORRECT?

  a. Actions that increase reported net income will always increase cash flow.
  b. One way to increase EVA is to generate the same level of operating income but with less
total invested capital.
  c. One drawback of EVA as a performance measure is that it mistakenly assumes that equity
capital is free.
  d. One way to increase EVA is to achieve the same level of operating income but with more
total invested capital obtained at a higher cost of capital.
  e. If a firm reports positive net income, its EVA must also be positive.

5. Last year, Delip Industries had (1) negative cash flow from operations, (2) a negative free
cash flow, and (3) an increase in cash as reported on its balance sheet. Which of the
following factors could explain this situation?

  a. The company had a sharp increase in its inventories.

  b. The company had a sharp increase in its accrued liabilities.
  c. The company sold a new issue of common stock.
  d. The company made a large capital investment early in the year.
  e. The company had a sharp increase in depreciation expenses.

6. Amram Company's current ratio is 2.0. Considered alone, which of the following actions
would lower the current ratio?

  a. Borrow using short-term notes payable and use the proceeds to reduce accruals.
  b. Borrow using short-term notes payable and use the proceeds to reduce long-term debt.
  c. Use cash to reduce accruals.
  d. Use cash to reduce short-term notes payable.
  e. Use cash to reduce accounts payable.

7. Which of the following statements is CORRECT?

  a. If one firm has a higher total debt to total capital ratio than another, we can be certain that the
firm with the higher total debt to total capital ratio will have the lower TIE ratio, as that ratio
depends entirely on the amount of debt a firm uses.
  b. A firm's use of debt will have no effect on its profit margin.
  c. If two firms differ only in their use of debt—i.e., they have identical assets, identical total
invested capital, sales, operating costs, interest rates on their debt, and tax rates—but one firm
has a higher total debt to total capital ratio, the firm that uses more debt will have a lower profit
margin on sales and a lower return on assets.
  d. The total debt to total capital ratio as it is generally calculated makes an adjustment for the use
of assets leased under operating leases, so the debt ratios of firms that lease different
percentages of their assets are still comparable.
   e. If two firms differ only in their use of debt—i.e., they have identical assets, identical total
invested capital, operating costs, and tax rates—but one firm has a higher total debt to total
capital ratio, the firm that uses more debt will have a higher operating margin and return on
assets.

8. You observe that a firm's ROE is above the industry average, but both its profit margin
and equity multiplier are below the industry average. Which of the following statements
is CORRECT?

  a. Its total assets turnover must be above the industry average.

  b. Its return on assets must equal the industry average.
  c. Its TIE ratio must be below the industry average.
  d. Its total assets turnover must be below the industry average.
  e. Its total assets turnover must equal the industry average.

9. Safeco's current assets total to $20 million versus $10 million of current liabilities,
while Risco's current assets are $10 million versus $20 million of current liabilities.
Both firms would like to "window dress" their end-of-year financial statements, and
to do so they tentatively plan to borrow $10 million on a short-term basis and to then
hold the borrowed funds in their cash accounts. Which of the statements below best
describes the results of these transactions?

  a. The transactions would improve Safeco's financial strength as measured by its current ratio
but lower Risco's current ratio.
  b. The transactions would lower Safeco's financial strength as measured by its current ratio
but raise Risco's current ratio.
  c. The transactions would have no effect on the firm' financial strength as measured by their
current ratios.
  d. The transactions would lower both firm' financial strength as measured by their current
ratios.
  e. The transactions would improve both firms' financial strength as measured by their current
ratios.

10. Companies HD and LD have the same total assets, sales, operating costs, and tax
rates, and they pay the same interest rate on their debt. Both firms finance using only
debt and common equity and total assets equal total invested capital. However,
company HD has a higher total debt to total capital ratio. Which of the following
statements is CORRECT?

  a. Given this information, LD must have the higher ROE.

  b. Company LD has a higher basic earning power ratio (BEP).
  c. Company HD has a higher basic earning power ratio (BEP).
  d. If the interest rate the companies pay on their debt is more than their basic earning power
 (BEP), then Company HD will have the higher ROE.
  e. If the interest rate the companies pay on their debt is less than their basic earning power
(BEP), then Company HD will have the higher ROE.
 

11. If in the opinion of a given investor a stock's expected return exceeds its required return,
this suggests that the investor thinks

  a. the stock is experiencing supernormal growth.

  b. the stock should be sold.
  c. the stock is a good buy.
  d. management is probably not trying to maximize the price per share.
  e. dividends are not likely to be declared.

12. Companies can issue different classes of common stock. Which of the following statements
concerning stock classes is CORRECT?

  a. All common stocks fall into one of three classes: A, B, and C.

  b. All common stocks, regardless of class, must have the same voting rights.
  c. All firms have several classes of common stock.
  d. All common stock, regardless of class, must pay the same dividend.
  e. Some class or classes of common stock are entitled to more votes per share than other classes.

13. Which of the following is NOT a capital component when calculating the weighted average cost
of capital (WACC) for use in capital budgeting?

  a. Long-term debt.
  b. Accounts payable.
  c. Retained earnings.
  d. Common stock.
  e. Preferred stock.

14. When working with the CAPM, which of the following factors can be determined with the most
precision?

  a.  The market risk premium (RPM).

  b. The beta coefficient, bi, of a relatively safe stock.
  c.  The most appropriate risk-free rate, rRF.
  d. The expected rate of return on the market, r M.
  e. The beta coefficient of "the market," which is the same as the beta of an average stock.

15. Which of the following statements is CORRECT?

   a. The regular payback method recognizes all cash flows over a project's life.
  b. The discounted payback method recognizes all cash flows over a project's life, and it also
adjusts these cash flows to account for the time value of money.
  c. The regular payback method was, years ago, widely used, but virtually no companies even
calculate the payback today.
  d. The regular payback is useful as an indicator of a project's liquidity because it gives managers
an idea of how long it will take to recover the funds invested in a project.
  e. The regular payback does not consider cash flows beyond the payback year, but the
discounted payback overcomes this defect.

16. Which of the following statements is CORRECT?

  a. The shorter a project's payback period, the less desirable the project is normally considered to
be by this criterion.
  b. One drawback of the payback criterion is that this method does not take account of cash flows
beyond the payback period.
  c. If a project's payback is positive, then the project should be accepted because it must have a
positive NPV.
  d. The regular payback ignores cash flows beyond the payback period, but the discounted
payback method overcomes this problem.
  e. One drawback of the discounted payback is that this method does not consider the time value
of money, while the regular payback overcomes this drawback.

17. Helena Furnishings wants to reduce its cash conversion cycle. Which of the following actions
should it take?

  a. Increases average inventory without increasing sales.

  b. Take steps to reduce the DSO.
  c. Start paying its bills sooner, which would reduce the average accounts payable but not affect
sales.
  d. Sell common stock to retire long-term bonds.
  e. Sell an issue of long-term bonds and use the proceeds to buy back some of its common stock.

18. A lockbox plan is

  a. used to protect cash, i.e., to keep it from being stolen.
  b. used to identify inventory safety stocks.
  c. used to slow down the collection of checks our firm writes.
  d. used to speed up the collection of checks received.
  e. used primarily by firms where currency is used frequently in transactions, such as fast food
restaurants, and less frequently by firms that receive payments as checks.

19. Which of the following is NOT commonly regarded as being a credit policy variable?
   a. Credit period.
  b. Collection policy.
  c. Credit standards.
  d. Cash discounts.
  e. Payments deferral period.

20. Other things held constant, which of the following would tend to reduce the cash conversion
cycle?

  a. Carry a constant amount of receivables as sales decline.

  b. Place larger orders for raw materials to take advantage of price breaks.
  c. Take all discounts that are offered.
  d. Continue to take all discounts that are offered and pay on the net date.
  e. Offer longer payment terms to customers.

PROBLEMS

BONDS

21. Morin Company's bonds mature in 8 years, have a par value of $1,000, and make an annual
coupon interest payment of $65. The market requires an interest rate of 8.2% on these bonds.
What is the bond's price?

a.  $903.04 b. $925.62 c. $948.76 d. $972.48 e. $996.79

22. Dyl Inc.'s bonds currently sell for $1,040 and have a par value of $1,000. They pay a $65 annual
coupon and have a 15-year maturity, but they can be called in 5 years at $1,100. What is their
yield to maturity (YTM)?

 a. 5.78%   b. 6.09%   c. 6.39% d. 6.71% e. 7.05%

STOCKS
23. The Francis Company is expected to pay a dividend of D 1 = $1.25 per share at the end of the year,
and that dividend is expected to grow at a constant rate of 6.00% per year in the future. The
company's beta is 1.15, the market risk premium is 5.50%, and the risk-free rate is 4.00%. What is
the company's current stock price?

a. $28.90 b. $29.62 c. $30.36 d. $31.12   e. $31.90

24. Porter Inc's stock has an expected return of 12.25%, a beta of 1.25, and is in equilibrium. If the
risk-free rate is 5.00%, what is the market risk premium?

a. 5.80% b. 5.95% c. 6.09% d. 6.25% e. 6.40%

25. You hold a diversified $100,000 portfolio consisting of 20 stocks with $5,000 invested in each.
The portfolio's beta is 1.12. You plan to sell a stock with b = 0.90 and use the proceeds to buy a
new stock with b = 1.80. What will the portfolio's new beta be?

a. 1.286 b. 1.255 c. 1.224 d. 1.194 e. 1.165

COST OF CAPITAL
26. A company's perpetual preferred stock currently sells for $92.50 per share, and it pays an $8.00
annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost
of 5.00% of the issue price. What is the firm's cost of preferred stock?

a. 7.81% b. 8.22% c. 8.65% d. 9.10% e. 9.56%

27. Scanlon Inc.'s CFO hired you as a consultant to help her estimate the cost of capital. You have
been provided with the following data: r RF = 4.10%; RPM = 5.25%; and b = 1.30. Based on the
CAPM approach, what is the cost of equity from retained earnings?

  a. 9.67% b. 9.97% c. 10.28% d. 10.60% e.  10.93%

CAPITAL BUDGETING
28. Anderson Systems is considering a project that has the following cash flow and WACC data.
What is the project's NPV? Note that if a project's projected NPV is negative, it should be
rejected.
 
WACC: 9.00%      
Year 0   1  2  3 
Cash flows −$1,000 $500 $500 $500

a. $265.65 b. $278.93 c. $292.88 d. $307.52 e. $322.90

29. Warr Company is considering a project that has the following cash flow data. What is the
project's IRR? Note that a project's projected IRR can be less than the WACC or negative, in both
cases it will be rejected.
 
Year 0   1  2  3  4 
 Cash flows −$1,050 $400 $400 $400 $400

a. 14.05% b. 15.61% c. 17.34% d. 19.27% e. 21.20%

30. Taggart Inc. is considering a project that has the following cash flow data. What is the project's
payback?
 
Year 0   1  2  3 
Cash flows −$1,150 $500 $500 $500

a. 1.86 years b. 2.07 years c. 2.30 years d. 2.53 years e. 2.78 years

31.  Cornell Enterprises is considering a project that has the following cash flow and WACC data.
What is the project's NPV? Note that a project's projected NPV can be negative, in which case it
will be rejected.
 
WACC: 10.00%      
Year 0   1  2  3 
Cash flows −$1,050 $450 $460 $470

a. $ 92.37 b. $ 96.99 c. $101.84 d. $106.93 e. $112.28

CASH FLOW ESTIMATION

32. As assistant to the CFO of Boulder Inc., you must estimate the Year 1 cash flow for a project with
the following data. What is the Year 1 cash flow?
 

Sales revenues $13,000

Depreciation $4,000
Other operating costs $6,000
Tax rate 35.0%

a. $5,950 b. $6,099 c. $6,251 d. $6,407 e. $6,568

33. As a member of UA Corporation's financial staff, you must estimate the Year 1 cash flow for a
proposed project with the following data. What is the Year 1 cash flow?
 
Sales revenues, each year $42,500
Depreciation $10,000
Other operating costs $17,000
Interest expense $4,000
Tax rate 35.0%
 a. $16,351 b. $17,212 c. $18,118 d. $19,071 e. $20,075

34. You work for Whittenerg Inc., which is considering a new project whose data are shown below.
What is the project's Year 1 cash flow?
 
Sales revenues, each year $62,500
Depreciation $8,000
Other operating costs $25,000
Interest expense $8,000
Tax rate 35.0%

a. $25,816 b. $27,175 c. $28,534 d. $29,960 e. $31,458

35. Fool Proof Software is considering a new project whose data are shown below. The equipment
that would be used has a 3-year tax life, and the allowed depreciation rates for such property are
33%, 45%, 15%, and 7% for Years 1 through 4. Revenues and other operating costs are expected
to be constant over the project's 10-year expected life. What is the Year 1 cash flow?
 
Equipment cost (depreciable basis) $65,000
Sales revenues, each year $60,000
Operating costs (excl. depreciation) $25,000
Tax rate 35.0%

a. $30,258 b. $31,770 c. $33,359 d. $35,027 e. $36,778

WORKING CAPITAL MANAGEMENT

36. Romano Inc. has the following data. What is the firm's cash conversion cycle?

Inventory conversion period = 38 days

Receivables collection period = 19 days
Payables deferral period = 20 days
   
a. 33 days b. 37 days c. 41 days d. 45 days e. 49 days

37. Inmoo Company's average age of accounts receivable is 45 days, the average age of accounts
payable is 40 days, and the average age of inventory is 69 days. Assuming a 365-day year, what is
the length of its cash conversion cycle?
 
a. 63 days b. 67 days c. 70 days d. 74 days e. 78 days
 38. Data on Shick Inc. for 2013 are shown below, along with the days sales outstanding of the firms
against which it benchmarks. The firm's new CFO believes that the company could reduce its
receivables enough to reduce its DSO to the benchmarks' average. If this were done, by how
much would receivables decline? Use a 365-day year.

  Sales $110,000
Accounts receivable $16,000
Days sales outstanding (DSO) 53.09
a. $ 8,078
Benchmarks'b. $ 8,975
days c. $ 9,973
sales outstanding (DSO) d. $10,970 e. $12,067
20.00
   

39. Data on Shin Inc for last year are shown below, along with the inventory conversion period
(ICP) of the firms against which it benchmarks. The firm's new CFO believes that the company
could reduce its inventory enough to reduce its ICP to the benchmarks' average. If this were
done, by how much would inventories decline? Use a 365-day year.
  Cost of goods sold = $85,000
Inventory = $20,000
Inventory conversion period (ICP) = 85.88
a. $ 7,316 b. $ 8,129 c. $ 9,032 d. $10,036 e. $11,151
Benchmark inventory conversion period (ICP) = 38.00
   

40. Assume that you and your brother plan to open a business that will make and sell a newly
designed type of sandal. Two robotic machines are available to make the sandals, Machine A and
Machine B. The price per pair will be $20.00 regardless of which machine is used. The fixed and
variable costs associated with the two machines are shown below. What is the difference between
the break-even points for Machines A and B? (Hint: Find BE B − BEA)

  Machine A Machine B
Price per pair (P) $20.00 $20.00
Fixed costs (F) $25,000 $100,000
Variable cost/unit (V) $7.00 $4.00
     
a. 3,154 b. 3,505 c. 3,894 d. 4,327 e. 4,760