Corporate Finance Exam-1.docx

CORPORATION FINANCE EXAM Financial Analysis Questions The goal of a financial manager of a publicly traded corporation should be to: Maximize Profits. Maximize Cash Flow from Operating Activities. Maximize the wealth of the shareholders. Minimize the risk of investing in the firm. Maximize the salary of the firm’s managers. USE THE FOLLOWING FINANCIAL STATEMENTS TO ANSWER QUESTIONS 2 and 3 Balance Sheet Columbia Industries Inc. Years ending December 31 (in millions) Assets 2001 2002 Cash $ 24,000 $ 40,000 Accounts receivable 30,000 9,000 Inventory 62,000 73,000 Total Current Assets $116,000 $122,000 Net plant and equipment $285,000 $295,000 Total assets $401,000 $417,000 Liabilities and stockholders’ equity Notes payable 6,000 21,000 Accounts payable to suppliers 49,000 37,000 Accruals 16,000 2,000 Total current liabilities $ 71,000 $ 60,000 Long-term debt 150,000 156,000 Common stock ($2.00 par value) 25,000 30,000 Capital surplus 90,000 91,000 Retained earnings 65,000 80,000 Total Liabilities and Equity $401,000 $417,000 Income Statement Columbia Industries Inc. Year ending December 31, 2002 Sales $600,000 Cost of goods sold 390,000 Gross Profit $210,000 General and administrative 80,000 Depreciation 20,000 Operating income 110,000 Interest expense 38,000 Earnings before taxes 72,000 Taxes 24,000 Net income $ 48,000 NOTE: You must use the financial statements on the prior page to answers questions 2 and 3 below Net Cash Flows from Operating Activities for Columbia Industries Inc. is: $32,000 $52,000 $67,000 $84,000 None of the above is within $1,000 of the correct answer. Columbia Industries Inc. expects sales to grow by 40% in 2003. The company plans to pay out $11,000 in dividends in 2002, and expects that the Net Profit Margin in 2003 will be 6%. Compute the Outside Funds Needed in 2003 to support this projected growth in sales. $111,800 $167,160 $107,760 $78,300 None of the above is with $1,000 of the correct answer. Assume you are given the following for Stackelberg industries: Return on Assets (ROA) = 8% Debt Ratio = 60% The Return on Equity (ROE) for Stackelberg industries is: 20% 25% 80% 100% Insufficient information If cash decreases by $1,000 during the year, total liabilities decrease by $5,000, and shareholders’ equity increases by $5,000, what is the change in non-cash assets for the year? A decrease of $5,000 An increase of $1,000 A decrease of $1,000 An increase of $5,000 The correct answer cannot be determined from the information given. Time Value of Money Questions: Assume that all other factors are held constant and that the interest rate is greater than zero. Increasing the number of periods (i.e., n) will cause the present value of a lump sum to be received in the future to _________ and the present value of an annuity to _______. Increase; Increase Increase; Decrease Decrease; Decrease Decrease; Increase It depends on whether the annuity is an annuity due or an ordinary annuity Congratulations! You have just won a small lottery. It will pay you either 5 annual payments of $15,000 each (with the first payment to be received two years from today), or a single lump sum to be received today. If you can invest at a 6% annual rate of interest, what is the least you should accept as the lump sum payout amount? $75,000.00 $66,976.58 $63,185.46 $59,608.92 $89,629.78 Which of the following accounts would pay you the highest effective annual rate? Stated annual rate of 6.05%, compounded annually Stated annual rate of 6.01%, compounded semi-annually Stated annual rate of 5.95%, compounded quarterly Stated annual rate of 5.90%, compounded monthly Stated annual rate of 5.85%, compounded daily (assuming 365 days a year) You have financed the purchase of a used Mercedes with a $31,500 loan with a 5-year term, monthly payments, and an 8% stated annual rate. What is the amount of your monthly loan payment? $657.45 $583.33 $477.92 $638.71 $350.00 You have just invested $3,000 into an account that will earn a 9% annual interest rate. You want to have exactly $8,000 in the account at the end of 5 years. The account allows you to make one deposit at the end of the 3rd year. In order to have exactly $8,000 at the end of year 5, how much must you deposit at the end of the 3rd year? $2,848.35 $2,613.17 $2,397.40 $3,384.13 None of the above answers is within $50 of the correct amount Terry just celebrated her 20th birthday and she has decided to quit drinking Diet Coke. Terry currently drinks 2 cans of Diet Coke per day at an average cost of $0.75 per can. To reward herself for quitting, Terry plans to invest all that she will save each day (i.e., $1.50) into a savings account that currently pays 6% p.a. Assuming her first deposit into the account is made tomorrow, and assuming that there are 365 days per year, how much money will be in Terry’s savings account on her 65th birthday (i.e., 45 years or 16,425 days from today)? $27,629.13 $37,659.48 $49,906.76 $50,885.83 None of the above is within $1,000 of the correct answer. Stock and Bond Valuation Questions A security that pays a constant dividend every year forever is known as: A zero-coupon bond Preferred stock Class A Common stock A Reverse Perpetual Mortgage obligation security A callable bond A 10-year annual coupon bond was issued four years ago at par. Since then the bond’s yield to maturity (YTM) has decreased from 9% to 7%. Which of the following statements is true about the current market price of the bond? The bond is selling at a discount The bond is selling at par The bond is selling at a premium The bond is selling at book value Insufficient information What should be the price of a $1,000 par value, 10% annual coupon rate (coupon interest paid semi-annually) bond with 30 years remaining to maturity, assuming a discount rate of 9%? $1,101.88 $1,102.44 $1,103.19 $1,104.48 $1,105.72 You have just discovered a $1,000 par value corporate bond with a maturity of 10 years. The bond’s yield to maturity is 9% and the bond is currently selling for $743.29. What is the bond’s annual coupon rate (the bond pays coupon payments annually)? 5% 6% 7% 8% 9% What is the yield to maturity of a $1,000 par value bond with a coupon rate of 10% (semi-annual coupon payments) that matures in 30 years assuming the bond is currently selling for $838.13? 6.0% 6.2% 10.0% 12.0% 12.4% XYZ, Inc. just paid a dividend of $3 per share. The industry analysts predict that XYZ’s dividends will grow at a constant rate of 4% forever. If the stock is currently trading at $25 per share, what is the required rate of return on this stock? 8.48% 12.00% 12.48% 16.00% 16.48% Unitongue Talk, Inc. just paid a $2.00 annual dividend. Investors believe that the dividends will grow at a rate of 20% per year for each of the next two years and 5% per year thereafter. Assuming a discount rate of 10%, what should the current price of the stock be? $60.50 $57.60 $54.55 $49.87 $43.56 Capital Budgeting Questions Consider the following mutually exclusive projects with equal lives: Project Payback Period IRR PI NPV A 3.2 years 18% 1.50 $ 10,000 B 2.7 years 22% 1.72 $ 37,000 C 4.1 years 23% 1.90 $ 70,000 D 5.6 years 16% 1.32 $150,000 Assuming that the appropriate discount rate is 12%, which project(s) would you choose? Project A Project B Project C Project D All of these projects should be accepted. Consider a project with an initial outflow at time 0 and positive cash flows in all subsequent years. As the discount rate is increased the _____________. IRR remains constant while the NPV increases. IRR decreases while the NPV remains constant. IRR increases while the NPV remains constant. IRR remains constant while the NPV decreases. IRR decreases while the NPV decreases. Which of the following statements is most correct? Since depreciation is not a cash expense, it does not affect operating cash flows Corporations should include sunk costs when making investment decisions. Corporations should include opportunity costs when making investment decisions. All of the answers above are correct. Answers (a) and (c) are correct. Milson Company is considering the purchase of MiHe Company at a price of $190,000. If Milson makes the acquisition, its after-tax net cash flows will increase by $30,000 per year and remain at this new level forever. If the appropriate cost of capital is 15 percent, should Milson buy MiHe? Yes, because the NPV = $30,000 Yes, because the NPV = $200,000 Yes, because the NPV = $10,000 No, because NPV < 0. There is not enough information given to answer this question. USE THE FOLLOWING INFORMATION TO ANSWER QUESTIONS 23 THROUGH 25 Philburn Files manufactures a variety of saws and tools for the commercial building industry. The company is considering the construction of a new facility to update its manufacturing process. The company's CFO has collected the following information about the proposed new facility project. (Note: You may or may not need to use all of this information, use only the information that is relevant.) The project has an anticipated economic life of 10 years. The new facility will be constructed on a piece of land that Philburn currently owns. The land has a current market value of $5 million. If Philburn does not use the land for this project, the land will instead be sold. Last year Philburn spend $500,000 to grade the land and to put in sewer and water lines. The company has capitalized these costs and is recording them on their income statement at $100,000 per year over the next 5 years. Construction of the new production facility will require an immediate outlay (at t=0) of $15 million. The production facility will be depreciated on a straight-line basis over 10 years to a $5 million salvage value. Philburn plans to sell the production facility to a competitor at the end of the 10-year period for $5 million. If the company accepts the project, the land will be sold with the production facility in 10 years for its current book value, which is $2 million. If the company goes ahead with the proposed project, it will require an immediate increase in inventory of $1,800,000, but will also result in an immediate increase of $800,000 in accounts payable. Each of these positions will be reversed at the completion of the project (that is, any change in net working capital that occurs at the beginning of the project will be recovered at the end of the project). The new facility is expected to reduce annual operating expenses, excluding management salaries, by $8 million per year for each of the next 10 years. No change in annual revenue is expected. The accounting department plans to allocate the annual salaries of 5 managers to this new facility, however, only 2 new managers will actually be hired by the company. Each of these managers will earn $200,000 per year for the next 10 years. The company's interest expense each year will be $300,000. The company's cost of capital (i.e., the required rate of return on this project) is 12 percent. The company's tax rate is 40 percent. Record your final numerical answer to each of the following questions on the answer sheet. Show your work on the back of the answer sheet for possible partial credit. What is the initial investment for the project? What is the fourth year expected incremental operating cash flow? What is the 10th year incremental non-operating cash flow? Corporation Finance Answer Key to Exam C B A A B D D B D A E B C C A D E C D D C C $21m $4.96M $8M Details of solution for #23: Construction of new facility ($15M) Land Opportunity cost ($ 5M) Change in net working capital ($ 1M) Initial Investment ($21M) Details of solution for #24: NCF = (Incremental revenue – Incremental Cost – Incremental Depreciation)(1-T) + Incremental Depreciation. NCF = (0 - -8M - .4M – 1M)(.6) + 1M = 4.96M Notes: Depreciation = (15M – 5M)/10 = 1M The incremental part of management salaries = .4M (2 managers at 200,000/yr) Details of solution for #25: Sell new facility $5M Sell Land $2M Recover net working capital $1M 10th Year non-operating cash flow $8M While calculating a project's annual cash flows, which of the following is not directly included? The reduction in taxes attributable to sale of an asset for less than its book value The tax incurred when the trade-in value of the old asset exceeds its book value The reduction in taxes attributable to depreciation charges Depreciation expense The basic characteristics of relevant project flows include all of the following except After-tax flows. Cash flows. Incremental flows. Financing flows. Project GROW will require $250,000 to purchase new machinery. Capitalized expenditures total $40,000. The new machine will require that the firm purchase some additional inventory which will result in an increase in net working capital of $50,000. What is the initial cash outflow? $300,000 $350,000 $270,000 None of the given option In analyzing a long-term investment proposal, Include opportunity costs. Include before-tax interest payments. Include after-tax interest payments. Include sunk costs. The Pink Pussycat Lounge is considering replacing its lighting system. The new lights will cost $16,000 and can be installed for $2,500. The old light fixtures were depreciated to zero but can be sold to Secondhand Sam for $1,000. If the Pink Pussycat has a 35 percent tax rate, the initial cash outflow for the new lighting system is $18,500. $16,000. $17,500. $17,850. A company is considering a project costing $50,000. The hurdle rate is 9 percent and the project is expected to yield an ordinary annuity for 10 years. The annual annuity must be at least ________ for the project to be accepted. $9,231 $8,321 $8,667 $7,791 Your firm is considering two mutually exclusive projects, code-named A and B, that would each require an initial cash outflow of $10,000. They would generate the following incremental, after-tax, operating cash flows: Project A Project B Year 1 $5,000 $3,000 Year 2 4,000 4,000 Year 3 3,000 6,000 If the firm's required rate of return is 14 percent, which would you select? Neither project because neither adds value to the firm. Project A because it has the higher net present value. Project B because it has the higher internal rate of return. Project A because it has the shorter payback period. A proposed investment project requires an initial cash outflow of $82,650 and has an economic life of three years, with no salvage value. It is expected to generate before tax cash flows of $45,000 for each of the three years. The firm's tax rate is 30 percent. Which of the following is closest to the project's internal rate of return? 30 percent 7 percent 40 percent 12 percent The initial cost of a conventional project is $14,000. The present value of the project's cash inflows, discounted at 12 percent, is $12,500. The internal rate of return is Less than 12 percent. Greater than 12 percent. Equal to 12 percent. Cannot tell without additional information Hi Lighter, Inc., is considering a project with an initial investment of $25,000 that generates cash-inflows of $10,000 per year for 8 years starting today. What is the net present value of this project if the firm requires a 15% rate of return on this project? (Choose the nearest figure.) $22,854 $19,873 $1,152 $55,000 ESSAY QUESTIONS. Describe the characteristics of a Multinational Corporation, any advantages/drawbacks, and give examples. What reasons does the author of your text give for becoming a multinational corporation? Give some examples of Market Imperfections, and discuss how they interfere with the optimality of free trade. Also discuss how multi-national corporations can get around these imperfections, or use them to their advantage in competing against domestically oriented firms. What is a VAT? Why is it driving jobs and manufacturing out of the United States to countries overseas? What does the US have to do to correct the problem, and why are we not doing that? Also, what international agreement is giving the VAT this effect, what is the purpose of that agreement? Discuss the Exchange Rate, Market, and Legal/Political risks that foreign investors confront. Explain the theory of Comparative Advantage, and its implication for production and trade. Are there some countries that have no comparative advantage? What happens if two countries have exactly the same skill, technology, and labor costs? How could comparative advantage explain the overseas shift of manufacturing and the outsourcing of labor? Does it provide the sole explanation, or are there other causes? (If so, discuss.) Discuss key events leading to globalization of our markets, and why they are significant. (Particularly rely on the book and external sources beyond the notes for this.) Discuss the formation of the European Union, and the introduction of the Euro. Discuss the key legal and financial steps did they take to achieve the EU and enter into a common currency, and the challenges they faced (include a timeline). What are the advantages to being in the EU and adopting the Euro (two separate issues)? What are the chief drawbacks (EU and Euro, economic and political)? Why hasn’t England, Norway, Sweden, or Switzerland adopted the Euro? Which are EU members, and why did the others not join the EU? What would be the advantages and disadvantages to the US entering into a similar union with Mexico and Canada? (This is known as the North American Trade Union, this you may have to Google. A book, titled “The Late Great USA” by Corsi, discusses some of the issues in detail.) Who are the principle beneficiaries of NATU (e.g. countries/categories—workers, so on), who can it hurt? Why? What is the traditional gold standard, how does it differ from our current monetary system, and how does it work to resolve trade imbalances? Give an example. What are the advantages to being on a gold standard and what are the drawbacks? What is the implication for exchange rates (or the exchange rate system), when two nations are on a gold standard? What was the difference between the traditional gold standard and the Bretton Woods (BW) system? Why did BW fail and when? When was BW put in place, and why was it created? What were the attempt(s) to revive the BW, what finally happened to exchange rates when it did fail? Why did they want BW to succeed, and what problems resulted after its failure? List and explain the eight (or so) exchange rate arrangements. How do central banks enforce them (explain the mechanics of buying and selling)? In what two basic types can we classify each of these arrangements? What are the benefits and draw backs between these two types (explain the tradeoffs)? What is the Balance of Payments (BOP), and what does it mean to have a surplus or deficit? Can you BOP deficit/surplus under fixed exchange rates? Floating rates? Explain how. What two primary accounts is the BOP composed of? What account does the book specify that I’ve left out, and why am I ignoring it? Explain what the two primary accounts are, and what having a surplus or deficit in these accounts implies. In which account will a deficit most likely lead to a depreciation of our currency if it is sustained over a long period of time? Why? Explain using graphs and words the long-run effects of an increase in government spending (e.g. what it does to inflation, the rate of economic growth, and the amount of GDP/productivity that government consumes. Explain how this is similar to the public increasing its consumption (without increasing productivity) using graphs. Be sure to discuss what happens to Net Exports (NX). Using those same graphs, explain why we grew so rapidly in the 90’s, and the problems we now confront. Also explain why our currency has devalued since 2001. Explain what would happen (using graphs) if we were to suddenly find large new oil supplies in Alaska. Likewise, explain what would happen if terrorist attack destroy several of our oil terminals. Discuss what would happen to the US dollar visa vi other currencies following the attack. Discuss the 2008 financial crisis, and chief contributing factors. What is the “Credit Crunch” the book discusses, explain exactly how it might lead to a recession, and why it does not fully explain the crisis. If we had not entered into a war, or had we cut other spending to offset its cost, would we be in a better position to handle the real estate crisis? Explain why. Explain how consumer spending has contributed to the crisis. Discuss the Peso Crisis and Asian Crisis. What did they have in common, and how did they differ? Why did the Peso collapse? What two unique elements of the Peso Crisis are not normal to most currency crises? Discuss the common components of most crises (four), and what would be expected to occur under floating exchange rates given similar circumstances. What is the Forex or FX market, how is that market organized (e.g. exchange etc.), who are the major participants, when and where does it operate, how is it managed, and in what major cities is it located and what regions do these hubs control? What is the trading volume of this market, and how is trading conducted? Where are currency derivatives traded, and what financial entities predominate in their creation? If you wanted to find a job as a currency derivatives hedger working with major firms, where should you look?