Business Finance
PART I: MULTIPLE CHOICE / SHORT-ANSWER QUESTIONS
Shell Corp’s 2008 sales were $12 millions ($MM). Its 2003 sales were $6MM. At which rate have the sales been growing?
a). 15%
b). 16%
c). 17%
d). 16.5%
e). 14%
All of the following are operating performance ratios except:
Total asset turnover
Net profit margin
Fixed asset turnover
Return on Assets (ROA)
All above are operating performance ratios
A company has run a multiple regression analysis between units sold (Y), advertising spent (X1), and sale price (X2), obtaining the function: Y = 30,005 + 0.4(X1) – 0.5(X2) The company has decided to use this function to predict future sales. How much revenue would the company generate if it assigns an advertising budget of $200,000 and defines the sales price of its product at $10?
$1,000,000
$1,100,000
$1,200,000
$1,300,000
$1,400,000
EBITDA in a firm’s income statement stands for earnings before interest, taxes, depreciation, and amortization.
True
False
Typically, the statement of stockholders’ equity starts with retained earnings at the beginning of the year, adds net income, subtracts dividends paid, and ends up with retained earnings at the end of the year.
True
False
Use the following information for Italy’s Manor National Bank (MNB) at the year-end to calculate the performance measures:
Net income: $185,600,000
Cash dividends: $21,400,000
Shares of stock outstanding: 30,191,000
Market price of the stock: $84.87
Book value of the common stock: $63.67
The European Bank’s stock P/E ratio is:
9.8 x
12.4 x
11.0 x
13.8 x
15.2 x
Other things held constant, if a bond indenture contains a call provision, the yield to maturity that would exist with such a call provision will generally be _____ the YTM without a call provision.
A). Lower than.
B). Higher than.
C). The same as.
D). Either higher or lower (depending on the level of the call premium) than.
E). None of above
Alice Johnson has $500 now. How much would she have after 6 years if he leaves it invested at 5.5% with annual compounding?
$591.09
$622.20
$654.95
$689.42
$723.89
Which of the following statements is CORRECT?
The more depreciation a firm reports, the higher its tax bill, other things held constant.
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.”
Depreciation reduces a firm’s cash balance, so an increase in depreciation would normally lead to a reduction in the firm’s cash flow.
Gross profit margin is a financial metric used to assess a firm’s financial health by revealing the proportion of money left over from revenues after accounting for the cost of goods sold (COGs).
Depreciation is not a cash charge, so it does not have an effect on a firm’s reported profits.
Assume that you are considering the purchase of a 20-year, non-callable bond with an annual coupon rate of 9.5%. The bond has a face value of $1,000, and it makes semiannual interest payments. If you require an 8.4% nominal yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond?
$1,105.69
$1,133.34
$1,161.67
$1,190.71
$1,220.48
How much would $5,000 due in 25 years be worth today if the discount rate were 5.5%? Assume annual interest compounding.
$1,067.95
$1,124.16
$1,183.33
$1,245.61
$1,311.17
Suppose the U.S. Treasury offers to sell you a bond for $747.25. No payments will be made until the bond matures 5 years from now, at which time it will be redeemed for $1,000. What interest rate would you earn if you bought this bond at the offer price? Assume annual interest compounding.
4.37%
4.86%
5.40%
6.00%
6.60%
Which of the following statements is CORRECT, other things held constant?
If companies have fewer good investment opportunities, interest rates are likely to increase.
If expected inflation increases, interest rates are likely to increase.
Interest rates on all debt securities tend to rise during recessions because recessions increase the possibility of bankruptcy, hence the riskiness of all debt securities.
Interest rates on long-term bonds are less volatile than rates on short-term debt securities like T-bills.
A price-linked derivative security pays $300 if the oil price over the next year increases by more than 5%, an event that can happen with a 60% probability. Otherwise, it pays $50. If the expected return on the security is 15%, how much does the security cost?
A). $133.9
B). $143.9
C). $153.9
D). $163.9
E). $173.9
ABC Inc.’s bond currently sells for $1,180 and has a par value of $1,000. The coupon rate is 10.5% and it has a 15-year maturity, but they can be called in 5 years at $1,100. What is their yield to call (YTC)?
6.63%
6.98%
7.35%
7.74%
8.12%
Flagship Company is located in Paris, France. The firm had the following Statement of Cash Flows data as of 12/31/2019:
| Cash payments for interest | 12 |
| Retirement of common stock | 32 |
| Cash payments to merchandise suppliers | 85 |
| Purchase of building | 8 |
| Sale of equipment | 30 |
| Payments of dividends | 37 |
| Cash payment for expenses | 35 |
| Cash collection from customers | 260 |
| Purchase of equipment | 40 |
Using the data above, cash flows from investing activities are?
A). ($49).
B). ($10).
C). ($81).
D). ($18).
E). None of above
An investment analyst estimates the following regression between the return on a stock (R) and the return on S&P 500 index (RSP): R = 5% + 1.2 RSP + error term. Assuming error term is zero (“0”), Estimate the change in the return on the stock when the return on the S&P 500 index changes from 11% to 14%.
A). 4.5%
B). 3.6%
C). 5.3%
D). 6.8%
E). 3.4%
A corporate bond currently yields 8.5 percent. Municipal bonds with the same risk, maturity, and liquidity currently yield 5.5 percent. At what tax rate would investors be indifferent between the two bonds?
35.29%
40.00%
24.67%
64.71%
30.04%
Suppose that you have generated the estimates listed below from a pro forma analysis for a company that had requested a three year loan. The loan is a $1.5 million term loan with the equal annual payments of principals. The P&I payments are due at the end of each year with the annual interest rate = Prime rate + 2%.
| Yr.1 | Yr. 2 | Yr. 3 | |||
| Capital expenditure | 250,000 | 125,000 | 75,000 | ||
| Cash dividends | 140,000 | 140,000 | 140,000 | ||
| Cash flow from operations before interest expense | 750,000 | 780,000 | 800,000 |
Assuming the Prime rate = 8% each year. What will be the interest payment at year 2?
$60,000
$70,000
$80,000
$90,000
$100,000
What’s the future value of $1,500 after 5 years if the appropriate interest rate is 6%, compounded semiannually?
$1,819
$1,915
$2,016
$2,117
$2,223
21. A real estate investment has the following expected cash flows:
Year Cash Flows
1 $10,000
2 25,000
3 50,000
4 35,000
The initial cost is $85,000. The discount rate is 8.25 percent. What is the investment’s present value?
a). $10,479
b). $13,479
c.) $16,479
d). $14,479
$15,479
New Jersey Utility reported $2.3 million of retained earnings on its 2012 balance sheet. In 2013, the company lost money-—its net income was -$500,000 (negative $500,000). Despite the loss, the company still paid a $1.00 per share dividend. The company’s earnings per share for 2013 were -$2.50 (negative $2.50). What was the level of retained earnings on the company’s 2013 balance sheet?
a). 1,500,000
b). 1,600,000
c). 1,700,000
d). 1,775,000
e). 1,800,000
You sold a car 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%?
Years: 0 1 2 3 4
| | | | |
CFs: $0 $1,000 $2,000 $2,000 $2,000
$5,987
$6,286
$6,600
$6,930
$7,277
At a rate of 6.5%, what is the future value of the following cash flow stream?
Years: 0 1 2 3 4
| | | | |
CFs: $0 $75 $225 $0 $300
$526.01
$553.69
$582.83
$613.51
$645.80
Question 25-27
A bond security has a $1000 par value, 10 years to maturity, 7% coupon payments (annual compounding), and currently sells for $985.
What’s the yield to maturity (YTM)?
a). 7.22%
b). 7.75%
c). 8.5%
d). 6.75%
e). 5.75%
Briefly explain the business meaning of YTM, assuming that you are providing an investment seminar to an audience with little or no financial background.
a). Same as the current yield
b). Same as the bond price appreciation
c). Same as the bond capital appreciation
d). same as the dividend yield
e). total return if you hold the bond until it matures.
Assuming that YTM is constant for the next 3 years, what will be the price three years from today?
a). $880
b). $780
c). $857
d). $950
e). $988
Suppose your father has just retired and has a retirement nest egg currently worth $1,100,000. If he plans to take out $95,000 at the end of each of the next 20 years beginning one year from today so that his nest egg is worth $100,000 after making the 20th withdrawal, what interest rate must his nest egg earn? Assuming annual interest rate compounding.
8.0%
8.5%
7.5%
5.5%
6.8%
29-30. Assume a Discount Rate of 11%
| 0 | 1 | 2 | 3 | 4 | 5 | 6 | |
|
|
| | | | | | | | | | | | |
| 0 | 150 | 150 | 150 | 250 | 300 | 500 | |
|
PV = ? |
FV = ? |
||||||
What’s the PV of the above cash flow streams?
956.6
946.6
986.6
996.6
976.6
What’s the FV of the above cash flow streams?
1,526.86
1,626.86
1,726.86
1,826.86
1,926.86
PART II: ESSAY QUESTIONS / BONUS QUESTIONS
Note: A bonus question carry the same weight as an individual question (#1-30). For example, a simple True / False question from Part 1 (e.g.) #3 is weighted the same as more time-consuming bonus question such as Question #34.
Suppose someone makes the following statement: “Sales doubled in 5 years. This represents a growth of 100% in 5 years; so dividing 100% by 5, we conclude the growth rate to be 20% per year”. Is this statement correct and what is the actual annual growth rate?
No; actual annualized growth rate is around 12%
No; actual annualized growth rate is around 13%
No; actual annualized growth rate is around 14%
No; actual annualized growth rate is around 15%
No; actual annualized growth rate is around 16%
Julie Smith has collected the following data about the firm
EBITDA = $3.5 million
Tax rate = 38%
Debt outstanding = $2.5 million
Cost of debt = 10.5%
Cost of common equity = 14%
Shares of stock outstanding = 800,000
BV of the stock per share = $12
The firm’s product market is considered stable, and the firm expects no growth, and all earnings are paid out as dividends. Calculate the firm’s net income and EPS, assuming depreciation & amortization costs of $500,000 per year.
$2.12
$2.62
$2.92
$3.42
$5.21
Excel Technology is considering seller-finance for an existing customer with the following information. The net income is $120MM. The depreciation cost is $10MM. What is the subject firm’s cash flow from operations (CFO)?
$113
$123
$134
$143
$153
| Decrease in accounts receivable | $30 MM |
| Issuance of new stocks | 17 |
| Proceeds from the sale of fixed assets | 5 |
| Increase in inventory | 17 |
| Increase in accounts payable | 15 |
| Dividends paid out | 35 |
| Decrease in wages payable | 15 |
Horizon Corporation has $500,000 of debt outstanding, and it pays an interest rate of 8% annually. The company’s annual sales are $2 millions, and its average tax rate is 30%, and its net profit margin on sales is 5%. What’s the TIE ratio?
$4.47
$4.57
$4.67
$4.77
$4.87
ABC Systems is forecasting the following income statement for the upcoming year:
Sales $5,000,000
Operating costs (excluding depreciation) $3,000,000
Gross margin $2,000,000
Depreciation $500,000
EBIT $1,500,000
Interest $500,000
EBT $1,000,000
Taxes (40%) $400,000
Net income $ 600,000
The company’s president is disappointed with the forecast and would like to see ABC firm generate higher sales and a forecasted net income of $2,000,000. Assume that operating costs (excluding depreciation) are always 60 percent of sales. Also, assume that depreciation ($500,000), interest expense ($500,000), and the company’s tax rate (which is 40 percent) will remain the same even if sales change. What level of sales would ABC Firm have to obtain to generate $2,000,000 in net income?
$10,833,333
$11,833,333
$12,833,333
$13,833,333
$14,833,333
