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<strong>FIN</strong> <strong>650</strong> <strong>GC</strong> <strong>WEEK</strong> 6 <strong>EXAM</strong> 2 <strong>LATEST</strong><br />
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<strong>FIN</strong> <strong>650</strong> <strong>GC</strong> Week 6 Exam 2 Latest<br />
<strong>FIN</strong><strong>650</strong><br />
<strong>FIN</strong> <strong>650</strong> <strong>GC</strong> Week 6 Exam 2 Latest<br />
Question 1. Your consultant firm has been hired by Eco Brothers Inc. to help them estimate the cost of<br />
common equity. The yield on the firm’s bonds is 8.75%, and your firm’s economists believe that the cost<br />
of common can be estimated using a risk premium of 3.85% over a firm’s own cost of debt. What is an<br />
estimate of the firm’s cost of common from reinvested earnings?<br />
12.60%<br />
13.10%<br />
13.63%<br />
14.17%<br />
14.74%<br />
Question 2. Which of the following statements best describes the optimal capital structure?<br />
The optimal capital structure is the mix of debt, equity, and preferred stock that maximizes the company’s<br />
____.<br />
stock price<br />
cost of equity<br />
cost of debt<br />
earnings per share (EPS)<br />
preferred stock.
Other things held constant, which of the following events is most likely to encourage a firm to increase the<br />
amount of debt in its capital structure?<br />
Its sales become less stable over time.<br />
The costs that would be incurred in the event of bankruptcy increase.<br />
Management believes that the firm’s stock has become overvalued.<br />
Its degree of operating leverage increases.<br />
The corporate tax rate increases.<br />
Question 3. Reynolds Paper Products Corporation follows a strict residual dividend policy. All else equal,<br />
which of the following factors would be most likely to lead to an increase in the firm’s dividend per share?<br />
The firm’s net income increases.<br />
The company increases the percentage of equity in its target capital structure.<br />
The number of profitable potential projects increases.<br />
Congress lowers the tax rate on capital gains. The remainder of the tax code is not changed.<br />
Earnings are unchanged, but the firm issues new shares of common stock.<br />
Question 4. Burnham Brothers Inc. has no retained earnings since it has always paid out all of its<br />
earnings as dividends. This same situation is expected to persist in the future. The company uses the<br />
CAPM to calculate its cost of equity, and its target capital structure consists of common stock, preferred<br />
stock, and debt. Which of the following events would REDUCE its WACC?<br />
The flotation costs associated with issuing new common stock increase.<br />
The company’s beta increases.<br />
Expected inflation increases.<br />
The flotation costs associated with issuing preferred stock increase.<br />
The market risk premium declines.<br />
Question 5. Based on the corporate valuation model, the value of Weidner Co.’s operations is $1,200<br />
million. The company’s balance sheet shows $80 million in accounts receivable, $60 million in inventory,<br />
and $100 million in short-term investments that are unrelated to operations. The balance sheet also
shows $90 million in accounts payable, $120 million in notes payable, $300 million in long-term debt, $50<br />
million in preferred stock, $180 million in retained earnings, and $800 million in total common equity. If<br />
Weidner has 30 million shares of stock outstanding, what is the best estimate of the stock’s price per<br />
share?<br />
$24.90<br />
$27.67<br />
$30.43<br />
$33.48<br />
$36.82<br />
Question 6. The world-famous discounter, Fernwood Booksellers, specializes in selling paperbacks for<br />
$7 each. The variable cost per book is $5. At current annual sales of 200,000 books, the publisher is just<br />
breaking even. It is estimated that if the authors’ royalties are reduced, the variable cost per book will<br />
drop by $1. Assume authors’ royalties are reduced and sales remain constant; how much more money<br />
can the publisher put into advertising (a fixed cost) and still break even?<br />
$600,000<br />
$466,667<br />
$333,333<br />
$200,000<br />
Question 7. The term “additional funds needed (AFN)” is generally defined as follows:<br />
Funds that are obtained automatically from routine business transactions.<br />
Funds that a firm must raise externally from non-spontaneous sources, i.e., by borrowing or by selling<br />
new stock to support operations.<br />
The amount of assets required per dollar of sales. The amount of internally generated cash in a given<br />
year minus the amount of cash needed to acquire the new assets needed to support growth.<br />
A forecasting approach in which the forecasted percentage of sales for each balance sheet account is<br />
held constant.
Question 8. Which of the following events is likely to encourage a company to raise its target debt ratio,<br />
other things held constant?<br />
An increase in the corporate tax rate.<br />
An increase in the personal tax rate.<br />
An increase in the company’s operating leverage.<br />
The Federal Reserve tightens interest rates in an effort to fight inflation.<br />
The company’s stock price hits a new high.<br />
Question 9. Poff Industries’ stock currently sells for $120 a share. You own 100 shares of the stock. The<br />
company is contemplating a 2-for-1 stock split. Which of the following best describes what your position<br />
will be after such a split takes place?<br />
You will have 200 shares of stock, and the stock will trade at or near $120 a share.<br />
You will have 200 shares of stock, and the stock will trade at or near $60 a share.<br />
You will have 100 shares of stock, and the stock will trade at or near $60 a share.<br />
You will have 50 shares of stock, and the stock will trade at or near $120 a share.<br />
You will have 50 shares of stock, and the stock will trade at or near $60 a share<br />
Question 10. Which of the following would be most likely to lead to a decrease in a firm’s dividend payout<br />
ratio?<br />
Its earnings become more stable.<br />
Its access to the capital markets increases.<br />
Its R&D efforts pay off, and it now has more high-return investment opportunities.<br />
Its accounts receivable decrease due to a change in its credit policy.<br />
Its stock price has increased over the last year by a greater percentage than the increase in the broad<br />
stock market averages.<br />
Question 11. F. Marston, Inc. has developed a forecasting model to estimate its AFN for the upcoming<br />
year. All else being equal, which of the following factors is most likely to lead to an increase of the<br />
additional funds needed (AFN)?
A sharp increase in its forecasted sales.<br />
A switch to a just-in-time inventory system and outsourcing production.<br />
The company reduces its dividend payout ratio.<br />
The company switches its materials purchases to a supplier that sells on terms of 1/5, net 90, from a<br />
supplier whose terms are 3/15, net 35.<br />
The company discovers that it has excess capacity in its fixed assets.<br />
Question 12. Which of the following assumptions is embodied in the AFN equation?<br />
None of the firm’s ratios will change.<br />
Accounts payable and accruals are tied directly to sales.<br />
Common stock and long-term debt are tied directly to sales.<br />
Fixed assets, but not current assets, are tied directly to sales.<br />
Last year’s total assets were not optimal for last year’s sales.<br />
Question 13. Perpetual preferred stock from Franklin Inc. sells for $97.50 per share, and it pays an $8.50<br />
annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 4.00%<br />
of the price paid by investors. What is the company’s cost of preferred stock for use in calculating the<br />
WACC?<br />
8.72%<br />
9.08%<br />
9.44%<br />
9.82%<br />
10.22%<br />
Question 14. Myron Gordon and John Lintner believe that the required return on equity increases as the<br />
dividend payout ratio is decreased. Their argument is based on the assumption that<br />
investors are indifferent between dividends and capital gains.<br />
investors require that the dividend yield and capital gains yield equal a constant.
capital gains are taxed at a higher rate than dividends.<br />
investors view dividends as being less risky than potential future capital gains.<br />
investors value a dollar of expected capital gains more highly than a dollar of expected dividends because<br />
of the lower tax rate on capital gains.<br />
Question 15. Krackle Korn Inc. had credit sales of $3,500,000 last year and its days sales outstanding<br />
was DSO = 35 days. What was its average receivables balance, based on a 365-day year?<br />
$335,616<br />
$352,397<br />
$370,017<br />
$388,518<br />
$407,944<br />
Question 16. Trahern Baking Co. common stock sells for $32.50 per share. It expects to earn $3.50 per<br />
share during the current year, its expected dividend payout ratio is 65%, and its expected constant<br />
dividend growth rate is 6.0%. New stock can be sold to the public at the current price, but a flotation cost<br />
of 5% would be incurred. What would be the cost of equity from new common stock?<br />
12.70%<br />
13.37%<br />
14.04%<br />
14.74%<br />
15.48%<br />
Question 17. The capital intensity ratio is generally defined as follows:<br />
Sales divided by total assets, i.e., the total assets turnover ratio.<br />
The percentage of liabilities that increase spontaneously as a percentage of sales.<br />
The ratio of sales to current assets.<br />
The ratio of current assets to sales.
The amount of assets required per dollar of sales, or A0*/S0.<br />
Question 18. Suppose Acme Industries correctly estimates its WACC at a given point in time and then<br />
uses that same cost of capital to evaluate all projects for the next 10 years, then the firm will most likely<br />
become riskier over time, but its intrinsic value will be maximized.<br />
become less risky over time, and this will maximize its intrinsic value.<br />
accept too many low-risk projects and too few high-risk projects.<br />
become more risky and also have an increasing WACC.<br />
Its intrinsic value will not be maximized.<br />
continue as before, because there is no reason to expect its risk position or value to change over time as<br />
a result of its use of a single cost of capital.<br />
Question 19. A lockbox plan is most beneficial to firms that<br />
have suppliers who operate in many different parts of the country.<br />
have widely dispersed manufacturing facilities.<br />
have a large marketable securities portfolio and cash to protect.<br />
receive payments in the form of currency, such as fast food restaurants, rather than in the form of checks.<br />
have customers who operate in many different parts of the country.<br />
Question 20. The value of Broadway-Brooks Inc.’s operations is $900 million, based on the corporate<br />
valuation model. Its balance sheet shows $70 million in accounts receivable, $50 million in inventory, $30<br />
million in short-term investments that are unrelated to operations, $20 million in accounts payable, $110<br />
million in notes payable, $90 million in long-term debt, $20 million in preferred stock, $140 million in<br />
retained earnings, and $280 million in total common equity. If the company has 25 million shares of stock<br />
outstanding, what is the best estimate of the stock’s price per share?<br />
$23.00<br />
$25.56<br />
$28.40<br />
$31.24
$34.36<br />
Question 21. If a firm adheres strictly to the residual dividend policy, the issuance of new common stock<br />
would suggest that<br />
the dividend payout ratio has remained constant.<br />
the dividend payout ratio is increasing.<br />
no dividends were paid during the year.<br />
the dividend payout ratio is decreasing.<br />
the dollar amount of investments has decreased.<br />
Question 22. Which of these items will not generally be affected by an increase in the debt ratio?<br />
Business risk.<br />
Total risk.<br />
Financial risk.<br />
Market risk.<br />
The firm’s beta.<br />
Question 23. Last year National Aeronautics had a FA/Sales ratio of 40%, comprised of $250 million of<br />
sales and $100 million of fixed assets. However, its fixed assets were used at only 75% of capacity. Now<br />
the company is developing its financial forecast for the coming year. As part of that process, the company<br />
wants to set its target Fixed Assets/Sales ratio at the level it would have had had it been operating at full<br />
capacity. What target FA/Sales ratio should the company set?<br />
28.5%<br />
30.0%<br />
31.5%<br />
33.1%<br />
34.7%<br />
Question 24. Spontaneous funds are generally defined as follows:
Assets required per dollar of sales.<br />
A forecasting approach in which the forecasted percentage of sales for each item is held constant.<br />
Funds that a firm must raise externally through short-term or long-term borrowing and/or by selling new<br />
common or preferred stock.<br />
Funds that arise out of normal business operations from its suppliers, employees, and the government,<br />
and they include immediate increases in accounts payable, accrued wages, and accrued taxes.<br />
The amount of cash raised in a given year minus the amount of cash needed to finance the additional<br />
capital expenditures and working capital needed to support the firm’s growth.<br />
Question 25. Mark’s Manufacturing’s average age of accounts receivable is 45 days, the average age of<br />
accounts payable is 40 days, and the average age of inventory is 69 days. Assuming a 365-day year,<br />
what is the length of its cash conversion cycle?<br />
63 days<br />
67 days<br />
70 days<br />
74 days<br />
78 days<br />
Question 26. The Besnier Company had $250 million of sales last year, and it had $75 million of fixed<br />
assets that were being operated at 80% of capacity. In millions, how large could sales have been if the<br />
company had operated at full capacity?<br />
$312.5<br />
$328.1<br />
$344.5<br />
$361.8<br />
$379.8<br />
Question 27. Which of the following statements is NOT CORRECT?<br />
The corporate valuation model discounts free cash flows by the required return on equity.
The corporate valuation model can be used to find the value of a division.<br />
An important step in applying the corporate valuation model is forecasting the firm’s pro forma financial<br />
statements.<br />
Free cash flows are assumed to grow at a constant rate beyond a specified date in order to find the<br />
horizon, or terminal, value.<br />
The corporate valuation model can be used both for companies that pay dividends and those that do not<br />
pay dividends.<br />
Question 28. Last year Baron Enterprises had $350 million of sales, and it had $270 million of fixed<br />
assets that were used at 65% of capacity last year. In millions, by how much could Baron’s sales increase<br />
before it is required to increase its fixed assets?<br />
$170.09<br />
$179.04<br />
$188.46<br />
$197.88<br />
$207.78