Download Midterm 1 - Quantos Analytics

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BUS 438 (Durham). Fall 2016. Exam 1.
Multiple choice (3 pts each)
1. If shareholders are unhappy with a CEO’s performance, they are most likely to:
(a) buy more shares in an effort to gain control of the firm.
(b) file a shareholder resolution.
(c) replace the CEO through a grassroots shareholder uprising.
(d) Solution: sell their shares.
2. An investment is said to be liquid if the investment:
(a) has large day to day fluctuations in price.
(b) has a large bid-ask spread.
(c) Solution: can easily be converted into cash.
(d) is traded on a stock exchange.
3. If you buy shares of Coca-Cola on the secondary market:
(a) Coca-Cola receives the money because the company has issued new shares.
(b) Solution: you buy the shares from another investor who decided to sell the shares.
(c) you buy the shares from the New York Stock Exchange.
(d) you buy the shares from the Federal Reserve.
4. Accounts payable is a:
(a) long-term liability.
(b) current asset.
(c) long-term asset.
(d) Solution: current liability.
5. Financial leverage refers to the:
(a) Solution: use of debt in a firm’s capital structure.
(b) ratio of retained earnings to shareholders’ equity.
(c) ratio of paid-in surplus to shareholders’ equity.
(d) ratio of sales to total assets.
(e) ratio of current assets to long-term assets.
6. Which of the following best describes free cash flow?
(a) Solution: Free cash flow is the amount of cash flow available for distribution to all investors
after all necessary investments in operating capital have been made.
(b) Free cash flow is the amount of cash flow available for distribution to shareholders after all necessary
investments in operating capital have been made.
(c) Free cash flow is the net change in the cash account on the balance sheet.
(d) Free cash flow is equal to net income plus depreciation.
(e) Free cash flow is equal to the cash flow from non-taxable transactions.
7. Company J and Company K each recently reported the same earnings per share (EPS). Company J’s stock,
however, trades at a higher price. Which of the following statements is most correct?
(a)
(b)
(c)
(d)
(e)
Solution: Company J must have a higher P/E ratio.
Company J must have a higher market to book ratio.
Company J must be riskier.
Company J must have fewer growth opportunities.
All of the statements above are correct.
8. Project A has an internal rate of return (IRR) of 15 percent. Project B has an IRR of 14 percent. For
both projects, the cash flows are conventional (i.e., all positive except for the initial cost) and the appropriate
discount rate is 12 percent. Which of the following statements is most correct?
(a)
(b)
(c)
(d)
(e)
Solution: Both projects have a positive net present value (NPV).
Project A must have a higher NPV than Project B.
If the cost of capital were less than 12 percent, Project B would have a higher IRR than Project A.
Statements a and b are correct.
Statements a, b, and c are correct.
9. Your _____ tax rate is the amount of tax payable on the next taxable dollar you earn.
(a)
(b)
(c)
(d)
(e)
mean
residual
total
average
Solution: marginal
10. The CFO of Mulroney Brothers has suggested that the company should issue $300 million worth of common
stock and use the proceeds to reduce some of the company’s outstanding debt. Assume that the company
adopts this policy, and that total assets and operating income (EBIT) remain the same. The company’s tax
rate will also remain the same. Which of the following will occur:
(a)
(b)
(c)
(d)
(e)
Solution: The company’s net income will increase.
The company’s taxable income will fall.
The company will pay less in taxes.
All of the answers above are correct.
Answers b and c are correct.
11. Net capital spending:
(a) is equal to ending fixed assets minus beginning fixed assets.
(b) Solution: is equal to zero if the decrease in the fixed assets account is equal to the depreciation expense.
(c) reflects the net changes in total assets over a stated period of time.
(d) is equivalent to the cash flow from assets minus the operating cash flow minus the change in net working
capital.
(e) is equal to the change in the inventory balance for the period.
12. The annual annuity stream of payments with the same present value as a project’s costs is called the project’s
_______ cost.
(a)
(b)
(c)
(d)
(e)
incremental
sunk
opportunity
erosion
Solution: equivalent annual
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Problems
1. (12 points) Use the financial statements below to answer the following questions.
Arrow Corporation
Consolidated Balance Sheet
December 31, 2014 (in $ millions)
Liabilities and
Assets
Stockholders’ Equity
Current Assets
Current Liabilities
Cash
63.6
Accounts payable
Accounts receivable
55.5
Notes payable
Inventories
45.9
Current maturities of
long-term debt
Other current assets
6.0
Other current liabilities
Total current assets
171.0
Total current liabilities
Long-Term Assets
Long-Term Liabilities
Land
66.6
Long-term debt
Buildings
109.5
Equipment
119.1
Less accumulated
depreciation
(56.1)
Deferred taxes
Net property, plant,
and equipment
239.1
Other long-term liabilities
Goodwill
60.0
Total long-term liabilities
Other long-term assets
63.0
Total liabilities
Total long-term assets
362.1
Stockholders’ Equity
Total Assets
533.1
Total liabilities and
Stockholders’ Equity
Arrow Corporation
Consolidated Income Statement
Year ended December 31 (in $ millions)
Total sales
610.1
Cost of sales
(500.2)
Gross profit
109.9
Selling, general, and
administrative expenses
(40.5)
Research and development
(24.6)
Depreciation and amortization
(3.6)
Operating income
41.2
Other income
0.0
EBIT
41.2
Interest income (expense)
(25.1)
Pre-tax income
16.1
Taxes
(5.5)
Net income
10.6
Dividends Paid
5.1
Price per Share
Shares outstanding (millions)
Stock options outstanding (millions)
Stockholders’ Equity (Book)
Total Liabilities and Stockholders’ Equity (Book)
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$16
10.2
0.3
126.6
533.1
87.6
10.5
39.9
6.0
144.0
239.7
22.8
0.0
262.5
406.5
126.6
533.1
What is Arrow’s:
(a) EPS (earnings per share)
(b) Enterprise value
(c) Market-to-book
(d) Total asset turnover
(e) ROE (return on equity)
(f) ROA (return on assets)
Solution:
(a) EPS (earnings per share)
NI / # shares outstanding = 10.6 / 10.2 = $1.039
(b) Enterprise value
Market cap + LTD + Current maturities of LTD + NP cash
= 163.2 + 239.7 + 39.9 + 10.5 63.6 = $389.7 M
(c) Market-to-book
163.2 / 126.6 = 1.289
(d) Total asset turnover
Sales / assets = 610.1 / 533.1 = 1.14
(e) ROE (return on equity)
NI / Equity = 10.6 / 126.6 = 8.37%
(f) ROA (return on assets)
(NI + Interest) / assets = (10.6 + 25.1) / 533.1 = 6.70%
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2. (8 points) Use the annual cash flows below to answer following questions.
Year Cash flow Year Cash flow
0
-8000
10
400
1
200
11
400
2
200
12
400
3
200
13
400
4
300
14
400
5
300
15
500
6
300
16
500
7
300
17
500
8
300
18
500
9
300
19
-1000
(a) What is the NPV (using a discount rate of 10%)?
Solution:
-5624
(b) What is the IRR?
Solution:
IRR is not useful because of nonconventional cash flows.
(c) What is the MIRR (using a discount rate of 10%)?
Solution:
CF(17) = 500 + 500/1.10 - 1000/1.10^2 = 128
MIRR = -3.54%
(d) What is the profitability index?
Solution:
-5624 / 8000 = -70.3%
3. (8 points) Dave will receive cash flows of $100 per month beginning five years from today and continuing every
year thereafter forever. Using a discount rate of 6%, what is the present value of those cash flows?
Solution:
P(59) = 100/0.005 = 20,000
P(0) = P(59) / 1.0005^59 = 14,902
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4. (8 points) NJH Corp. is evaluating a new piece of machinery. The machine has an initial cost of $1000 and
operating costs of $300 per year. It is to be depreciated over 7 years using the straight-line method. The
machine has a useful life of 5 years. At the end of that time it has no salvage value. The tax rate is 35% and
the appropriate discount rate is 12%. What is the machines equivalent annual cost (EAC)?
Solution:
OCF = -300 * 0.65 + 1000/7*0.35 = -145
ATSV = 2/7*1000*0.35 = 100
0
1
2
3
4
5
OCF
-145 -145 -145 -145 -145
ChNWC
NCS
-1000
100
============================================
-1000 -145 -145 -145 -145 -45
NPV = -1465.95
For EAC, use PV=-1465.95, n=5, FV=0, i=12, and solve for PMT.
You should get 406.67.
5. (8 points) You have decided to refinance your mortgage. You plan to borrow whatever is outstanding on your
current mortgage. The current monthly payment is $2356 and you have made every payment on time. The
original term of the mortgage was 30 years and the mortgage is exactly four years and eight months old. You
have just made your monthly payment. The mortgage interest rate is 6.375%. How much do you owe on the
mortgage today?
Solution:
n=304, FV=0, PMT=2356, R=6.375/12, solve to get PV=354,900
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6. (12 points) JRM Inc. is evaluating a new project to produce filing cabinets. The machinery required for this
project will cost $2.5 million and be depreciated using the straight-line method over 10 years. The filing
cabinets will sell for $120 each and JRM expects to sell 8000 per year. Variable costs will be $40 per unit and
fixed costs will be $200,000 per year. JRM has spent $300,000 in consulting fees to assess the market demand
for this product. The project will run for 6 years. At the end of year 6, JRM expects to be able to sell the
machinery required for this project for $300,000. The project will require an increase of $100,000 in NWC at
the start of the project. This NWC will be recovered at the end of year 6. The cost of capital for this project
is 12% and JRM’s tax rate is 40%.
(a) What is the NPV of this project?
(b) What is the IRR?
Solution:
All values in $1000’s
EndBV = 1000
BTSV = 300
ATSV = BTSV*(1-T) + EndBV*T
= 300 * .6 + 1,000 * .4
= 580
Depr = 2500/10 = 250
OCF = (Q*(P-VC) - FC) * (1-T) + Depr*T
= (8000*(120-40) - 200)*0.6 + 250*0.4
= 364
0
1 ...
6
OCF
364 ... 364
ChNWC
-100
100
NCS
-2500
580
==================================
FCF
-2600
364 ... 1044
NPV(R=.12) = -$758,938
IRR = 2.41%
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