FIN 534 Financial Management Class- Week 5 Midterm Exam (All Answered)

Question 1 4 out of 4 points Which of the following is a primary market transaction? Selected Answer: c. Johnson & Johnson issues 2,000,000 shares of new stock and sells them to the public through an investment banker.Correct Answer: c. Johnson & Johnson issues 2,000,000 shares of new stock and sells them to the public through an investment banker. Question 2 4 out of 4 points Which of the following statements is CORRECT? Selected Answer: d. It is usually easier to transfer ownership in a corporation than it is to transfer ownership in a sole proprietorship.Correct Answer: d. It is usually easier to transfer ownership in a corporation than it is to transfer ownership in a sole proprietorship.Response Feedback: Rationale: If ownership in a proprietorship or partnership is transferred, the basic documents under which the firm operates must be rewritten, whereas for a corporation the seller simply sells shares to a buyer, and the corporation records the transfer on its books. Question 3 0 out of 4 points Which of the following statements is CORRECT? Selected Answer: c. The limited partners in a limited partnership have voting control, while the general partner has operating control over the business. Also, the limited partners are individually responsible, on a pro rata basis, for the firm's debts in the event of bankruptcy.Correct Answer: a. Attracting large amounts of capital is more difficult for partnerships than for corporations because of such factors as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and selling) of partnership interests. Question 4 4 out of 4 points Which of the following statements is CORRECT? Selected Answer: e. One advantage of forming a corporation is that equity investors are usually exposed to less liability than in a regular partnership.Correct Answer: e. One advantage of forming a corporation is that equity investors are usually exposed to less liability than in a regular partnership.Response Feedback: Rationale: Corporations have limited liability; however, they face more regulations than the other forms of organization. Question 5 4 out of 4 points Which of the following statements is CORRECT? Selected Answer:a. If expected inflation increases, interest rates are likely to increase.Correct Answer: a. If expected inflation increases, interest rates are likely to increase. Question 6 4 out of 4 points Which of the following statements is CORRECT? Selected Answer: e. Free cash flow (FCF) is defined as follows: FCF = EBIT(1 − T) + Depreciation and Amortization − Capital expenditures required to sustain operations − Required changes in net operating working capital. Correct Answer: e. Free cash flow (FCF) is defined as follows: FCF = EBIT(1 − T) + Depreciation and Amortization − Capital expenditures required to sustain operations − Required changes in net operating working capital. Question 7 4 out of 4 points For managerial purposes, i.e., making decisions regarding the firm's operations, the standard financial statements as prepared by accountants under Generally Accepted Accounting Principles (GAAP) are often modified and used to create alternative data and metrics that provide a somewhat different picture of a firm's operations. Related to these modifications, which of the following statements is CORRECT? Selected Answer: e. The standard statements focus on accounting income for the entire corporation, not cash flows, and the two can be quite different during any given accounting period. However, for valuation purposes we need to discount cash flows, not accounting income. Moreover, since many firms have a number of separate divisions, and since division managers should be compensated on their divisions' performance, not that of the entire firm, information that focuses on the divisions is needed. These factors have led to the development of information that is focused on cash flows and the operations of individual units.Correct Answer: e. The standard statements focus on accounting income for the entire corporation, not cash flows, and the two can be quite different during any given accounting period. However, for valuation purposes we need to discount cash flows, not accounting income. Moreover, since many firms have a number of separate divisions, and since division managers should be compensated on their divisions' performance, not that of the entire firm, information that focuses on the divisions is needed. These factors have led to the development of information that is focused on cash flows and the operations of individual units. Question 8 0 out of 4 points Which of the following statements is CORRECT? Selected Answer: a. If a firm reports positive net income, its EVA must also be positive.Correct Answer: e. One way to increase EVA is to generate the same level of operating income but with less investor-supplied capital. Question 9 4 out of 4 points Pettijohn Inc. The balance sheet and income statement shown below are for Pettijohn Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over. Balance Sheet (Millions of $) Assets 2016 Cash and securities $ 1,554.0 Accounts receivable 9,660.0 Inventories 13,440.0 Total current assets $24,654.0 Net plant and equipment 17,346.0 Total assets $42,000.0 Liabilities and Equity Accounts payable $ 7,980.0 Notes payable 5,880.0 Accruals 4,620.0 Total current liabilities $18,480.0 Long-term bonds 10,920.0 Total debt $29,400.0 Common stock 3,360.0 Retained earnings 9,240.0 Total common equity $12,600.0 Total liabilities and equity $42,000.0 Income Statement (Millions of $) 2016 Net sales $58,800.0 Operating costs except depr'n $54,978.0 Depreciation $ 1,029.0 Earnings bef int and taxes (EBIT) $ 2,793.0 Less interest 1,050.0 Earnings before taxes (EBT) $ 1,743.0 Taxes $ 610.1 Net income $ 1,133.0 Other data: Shares outstanding (millions) 175.00 Common dividends $ 509.83 Int rate on notes payable & L-T bonds 6.25% Federal plus state income tax rate 35% Year-end stock price $77.69 Refer to the data for Pettijohn Inc. What is the firm's ROA? Selected Answer:d. 2.70%Correct Answer: d. 2.70% Response Feedback: Rationale: ROA = Net income/Total assets = 2.70% Question 10 4 out of 4 points Ziebart Corp.'s EBITDA last year was $390,000 ( = EBIT + depreciation + amortization), its interest charges were $9,500, it had to repay $26,000 of long-term debt, and it had to make a payment of $17,400 under a long-term lease. The firm had no amortization charges. What was the EBITDA coverage ratio? Selected Answer: a. 7.70 Correct Answer: a. 7.70 Response Feedback: Rationale: EBITDA $390,000 Interest charges $9,500 Repayment of principal $26,000 Lease payments $17,400 Total financial charges $52,900 Funds avail for fin charges (EBITDA + Lease pmts) $407,400 EBITDA coverage 7.70 Question 11 4 out of 4 points

Which of the following statements is CORRECT? Selected Answer: a. If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their P/E ratios must also be the same.Correct Answer: a. If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their P/E ratios must also be the same. Response Rationale: Feedback: No reason for a to be true. No reason for b to be true. c must be true, as EPS and P will be the same. No reason for d to be true. e is wrong, because high risk and low growth lead to low P/Es. Question 12 4 out of 4 points Which of the following statements regarding a 20-year monthly payment amortized mortgage with a nominal interest rate of 10% is CORRECT? Selected Answer: a. A larger proportion of the first monthly payment will be interest, and a smaller proportion will be principal, than for the last monthly payment.Correct Answer: a. A larger proportion of the first monthly payment will be interest, and a smaller proportion will be principal, than for the last monthly payment.Response Feedback: Rationale: c is correct. b is clearly wrong, as are d and e. It is not obvious whether a is correct or not, but we could set up an example to see: Loan 100000 Term 20 Rate 10% Periods/Year 12 Periodic rate 0.00833333 Total periods 240 Payment −$965.02 Interest Month 1 $833.33 Interest as % of total payment: 86%, which is much larger than 10%.Question 13 0 out of 4 points You sold your motorcycle and accepted a note with the following cash flow stream as your payment. What was the effective price you received for the car assuming an interest rate of 6.0%? Selected Answer: b. $7,277 Correct Answer: c. $5,987 Response Rationale: Feedback: I/YR = 6.0% 0 1 2 3 4 CFs: $0 $1,000 $2,000 $2,000 $2,000 PV of CFs: $0 $943 $1,780 $1,679 $1,584 PV = $5,987 Found using the Excel NPV function. PV = $5,987 Found by summing individual PVs. PV = $5,987 Found using the calculator NPV key. Question 14 4 out of 4 points Assume that you own an annuity that will pay you $15,000 per year for 12 years, with the first payment being made today. You need money today to open a new restaurant, and your uncle offers to give you $120,000 for the annuity. If you sell it, what rate of return would your uncle earn on his investment? Selected Answer: c. 8.41% Correct Answer: c. 8.41% Response Feedback: Rationale: BEGIN Mode N 12 PV $120,000 PMT $15,000 FV $0.00 I/YR 8.41% Question 15 4 out of 4 points Jerome Corporation's bonds have 15 years to maturity, an 8.75% coupon paid semiannually, and a $1,000 par value. The bond has a 6.50% nominal yield to maturity, but it can be called in 6 years at a price of $1,050. What is the bond's nominal yield to call? Selected Answer:d. 5.27%Correct Answer: d. 5.27%Response Feedback: Rationale: First, use the given data to find the bond's current price. Then use that price to find the YTC. Coupon rate 8.75% Yrs to call 6 YTM 6.50% Call price $1,050.00 Maturity 15 Par value $1,000 Periods/year2Determine the bond's YTC Determine the bond's price N12PMT/period$43.75PV$1,213.55N30PMT$43.75I/YR3.25%FV$1,050.00FV$1,000.00I/YR2.64%PV = Price Question 16 0 out of 4 points Which of the following statements is CORRECT? Selected Answer: c. $1,213.55Nom. YTC5.27%If a bond's yield to maturity exceeds its coupon rate, the bond will sell at par. Correct Answer: d. All else equal, if a bond's yield to maturity increases, its price will fall. Question 17 0 out of 4 points Curtis Corporation's noncallable bonds currently sell for $1,165. They have a 15-year maturity, an annual coupon of $95, and a par value of $1,000. What is their yield to maturity? Selected Answer:a. 7.24%Correct Answer: b. 7.62% Response Feedback: Rationale: N 15 PV $1,165 PMT $95 FV $1,000 I/YR 7.62% Question 18 4 out of 4 points Which of the following statements is CORRECT? Selected Answer: c. Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of −0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period.Correct Answer: c. Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of −0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period. Question 19 4 out of 4 points Stock A has a beta of 0.8, Stock B has a beta of 1.0, and Stock C has a beta of 1.2. Portfolio P has 1/3 of its value invested in each stock. Each stock has a standard deviation of 25%, and their returns are independent of one another, i.e., the correlation coefficients between each pair of stocks is zero. Assuming the market is in equilibrium, which of the following statements is CORRECT? Selected Answer: e. Portfolio P's expected return is equal to the expected return on Stock B. Correct Answer: e. Portfolio P's expected return is equal to the expected return on Stock B.

Question 20 4 out of 4 points Selected c. Answer: A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable. Correct c. Answer: A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable. Question 21 4 out of 4 points Response Feedback: Rationale: Expected dividend (D1)$1.25Stock price$32.50Required return10.5%Dividend yield3.85%Growth rate = rs − D1/P0 =6.65%Which of the following statements is CORRECT? Question 22 4 out of 4 points The value of Broadway-Brooks Inc.'s operations is $900 million, based on the free cash flow valuation model. Its balance sheet shows $70 million in accounts receivable, $50 million in inventory, $30 million in short-term investments that are unrelated to operations, $20 million in accounts payable, $110 million in notes payable, $90 million in long-term debt, $20 million in preferred stock, $140 million in retained earnings, and $280 million in total common equity. If the company has 25 million shares of stock outstanding, what is the best estimate of the stock's price per share? Selected Answer: d. $28.40 Correct Answer: d. $28.40Response Feedback: Rationale: Value of operations: $900 Short-term investments: $30 Notes payable: $110 Long-term debt: $90 Preferred stock $20 Shares outstanding: 25 Assuming that the book value of debt is close to its market value, the total market value of the company is: Total market value = Value of operations + Value of non-operating assets = $900 + $30 = $930. Value of Equity = Total MV − Long- and Short-term debt and preferred = $710 Stock price = Value of Equity/Shares outstanding = $28.40The book value of equity figures are irrelevant for this problem. Also, the working capital account numbers are not relevant because they were netted out when the FCF was calculated. Question 23 4 out of 4 points Which of the following statements is CORRECT? Selected Answer: e. Preferred stock is normally expected to provide steadier, more reliable income to investors than the same firm's common stock, and, as a result, the expected after-tax yield on the preferred is lower than the after-tax expected return on the common stock.Correct Answer: e. Preferred stock is normally expected to provide steadier, more reliable income to investors than the same firm's common stock, and, as a result, the expected after-tax yield on the preferred is lower than the after-tax expected return on the common stock. Question 24 4 out of 4 points Which of the following statements is CORRECT? Selected Answer: e. The stock valuation model, P0 = D1/(rs − g), can be used to value firms whose dividends are expected to decline at a constant rate, i.e., to grow at a negative rate.Correct Answer: e. The stock valuation model, P0 = D1/(rs − g), can be used to value firms whose dividends are expected to decline at a constant rate, i.e., to grow at a negative rate. Question 25 4 out of 4 points McGaha Enterprises expects earnings and dividends to grow at a rate of 25% for the next 4 years, after the growth rate in earnings and dividends will fall to zero, i.e., g = 0. The company's last dividend, D0, was $1.25, its beta is 1.20, the market risk premium is 5.50%, and the risk-free rate is

3.00%. What is the current price of the common stock?

Selected Answer: d.

$29.05

Correct Answer: d.

$29.05

Response

Feedback:

Rationale:

Last dividend (D0)

$1.25

Short-run growth rate

25%

Long-run growth rate

0%

Beta

1.20

Market risk premium

5.50%

Risk-free rate

3.00%

Required return = rs = rRF + b(RPM) =

9.60%

Year

0

1

2

3

4

25%

25%

25%

25%

Dividend

$1.2500

$1.5625

$1.9531

$2.4414

$3.0518

Horizon value = D5/(rs − g5) =

31.7891

Total CFs

$1.5625

$1.9531

$2.4414

$34.8409

PV of the CFs

Price = Sum of PVs = $29.05

$1.4256

$1.6260

$1.8544

$24.1461

Thursday, May 4, 2017 5:30:54 PM EDT