Exam II

Name
FINANCE 5023
Summer 2008

Multiple Choice -- Circle the letter of the BEST answer (3 points each)
1. The primary goal of accounts receivable management should be
a.
b.
c.
d.
e.

maximizing market share

maximizing shareholder wealth
minimizing investment in receivables
minimizing bad debt
none of the above

2. Which of the following statements is FALSE?

a. In addition to sales price, product quality, and advertising, credit policy is a major
controllable variable which can affect product demand.
b. Sharp seasonal swings in sales and fast growth are two reasons why a firm's aging
schedule and average collection period (days' sales outstanding) may show high
variability.
c. Changes in a firm's collection policy can affect sales and working capital but will
not affect the firm's cash balances.
d. Cash discounts can be used to influence a firm's sales volume and its average collection
period (days' sales outstanding).
e. Firms which offer credit terms with a cash discount usually seek two benefits: (1) to
attract more customers, and (2) to reduce their average collection period (days' sales
outstanding).
3. Which of the following statements concerning commercial paper is FALSE?
a. Commercial paper is generally written for terms less than 270 days.
b. Commercial paper generally carries an interest rate BELOW the prime rate.
c. Commercial paper is sold to money market mutual funds, as well as to other financial
institutions and nonfinancial corporations.
d. Commercial paper can be issued by any firm so long as it is willing to pay the going
rate of interest.
e. All of the above statements are true.
4. According to the residual theory of dividends
a.
b.

dividends are a residual after financing needs have been met

earnings remaining after payment of preferred stock dividends should be paid to
common stockholders
c. dividend payments are a constant percentage of earnings per share
d. a dividend is the residual above the payout ratio
e. none of the above

5. Most investment banking firms do business in the

a. primary market
b. secondary market
c. money market
d. capital market
e. all of the above
6. Which of the following would NOT be expected to result in a dilution of stock price?
a.
b.
c.
d.

stock split
stock dividend
stock repurchase
sale of stock through an offering to existing shareholders at a 20% discount from the
market price
e. all of the above would result in a dilution of stock price
7. Which of the following is NOT a typical attribute of an operating lease?
a. lease period equals the economic life of the asset
b. lease payments under the initial lease contract are insufficient to recover the full cost of
the asset for the lessor
c. maintenance and insurance are the responsibility of the lessor
d. lessor retains the depreciation expense deduction
e. all of the above are attributes of an operating lease
8. The objective of offering a cash discount is to
a.
b.
c.
d.
e.

reduce the number of bad checks received from customers

encourage customers to place their orders prior to the peak selling period
reduce the firm's level of receivables investment
reduce the firm's inventory carrying costs
none of the above

9. On 1/3/08, George instructed his broker to buy 100 shares of Company XYZ stock at $80 per
share. On 3/20/08, the broker called George and informed him that unless he added some
more money to his account with the broker, the broker would have to sell 100 shares of XYZ
stock at a price of $60 per share. George told the broker to go ahead and sell the 100
shares of stock. The transactions that George has just participated in is a
a.
b.
c.
d.
e.

margin purchase
call option exercise
put option exercise
short sale
none of the above

10. Which of the following factors does NOT influence a firm's financial structure?

a.
b.
c.
d.
e.

The stability of sales

LIFO versus FIFO inventory valuation
The growth rate of sales
Attitudes of management and shareholders toward risk
All of the above influence financial structure

11. What is the agency problem? Briefly describe the pros and cons of employee stock options
and stock grants. (10 points)

12. You have just taken out a four-year term loan for $500,000 at an 8% rate of interest.
Construct a loan amortization table that includes a breakdown of the interest and principal
payments. (10 points)
Year

Payment

Interest

Principal

Balance

0
1
2
3
4

-0150,960
150,960
150,960
150,960

-040,000
31,123
21,536
11,182

-0110,960
119,837
129,424
139,778

500,000
389,040
269,203
139,779
1

13. What is the effective annual rate of interest on a $500,000 placement of 90-day commercial
paper with a stated rate of interest of 10% if the interest is deducted in advance and a $2,000
placement fee is paid? (10 points)

11.96%

14. You have $20,000 that you have just received from a customer and are considering investing
it in a new refrigerated trailer for your long-haul trucking company. The trailer costs $80,000
but you can generate an additional $30,000 by selling your current trailer to a competitor. If
you do not buy the new trailer, you feel that the old trailer will be worth only $12,000 four
years from now when you would need to upgrade it anyway. The old trailer cost $60,000
when you purchased it three years ago and is being depreciated using the MACRS
depreciation schedule for 5-year assets (20%, 32%, 19.2%, 11.52%, 11.52%, 5.76%). The
new trailer will be depreciated using the same MACRS depreciation schedule. You anticipate
that the new truck will have a resale value of $35,000 at the end of four years when you plan
to replace it. Because the trailer is refrigerated, you estimate that the larger variety of
products you can transport will increase revenues by $120,000 per year. Your costs,
however, will also go up by $75,000 per year due to increased usage. Working capital
requirements of $15,000 will accompany the acquisition of the new equipment, all of which
will be recovered at the end of the fourth year. Your marginal tax bracket is 40%. Calculate
the incremental cash flows of this investment project for each year. (20 points)

Net Cash Flows

Year 0

Year 1

Year 2

Year 3

Year 4

( 70,088)

30,635

34,475

31,762

65,016

15.

The Binder Company has the following balance sheet:

Total Assets

$ 6,000

L-T Debt (8%)

Common Stock ($1 par)
Retained Earnings

$ 3,000
400
2,600

Tot. Liab. & Equity

$ 6,000

No dividend is paid on the common stock. The stock is currently selling for $12 per share
and its historical beta is estimated to be 1.2 using daily price data. The current market
rate of interest on the debt is 9% and the current debt will mature in 10 years. Binder has
a 40% tax rate. The expected return on the market is 10% and the risk-free rate is 4%.
A. What is the market value of the debt? What is the market value of the Equity?
(5 points)
Value of Debt = $ 2,807
Value of Equity = $ 4,800

B. What is the WACC for Binder? (5 points)

Cost of Debt (after-tax) = 5.4%
Cost of Equity = 11.2%
WACC = 9.06%

16. Regina invested $6,000 in 2003 in a stock portfolio. The value of the portfolio during the
years 2003-2008 was as follows:
Year

Value

2003
2004
2005
2006
2007
2008

$ 6,000
7,200
7,920
6,732
10,771
9,644

What annual rate of return did Gina's portfolio earn during the 1995-2000 period? (5 points)
9.96%

17. Gardner's Supply Co. has calculated its marginal cost of capital at various levels and found
them to be as follows:
Amount of Funds Raised

Marginal Cost

Up to $1 million
From $1 million to $3 million
From $3 million to $5 million
From $5 million to $8 million
From $8 million to $10 million
Over $10 million

8%
9%
10%
11%
13%
15%

The investment opportunities available to the firm are shown below:

Project
A
B
C
D
E
F
G

Rate of Return
16%
14%
13%
12%
10%
9%
8%

Cost
$1.5 million
0.5 million
1.0 million
2.0 million
1.5 million
1.0 million
0.5 million

What should be the size of the capital budget for Gardner's Supply Company? (5 points)
$ 5 million