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(1) Because a firm that uses debt can be as profitable as a firmthat does not, some financial ratios are calculated with NOPAT (NetOperating Profit After Tax) rather than with net income.

(2) Free Cash Flow to the Firm measures the cash available toequity investors, after all debt payments (including interest andprincipal), have been made.

(3) For Company T during 2017, the change in accounts receivablewas positive, the change in inventories was positive, and there wasno change in accounts payable. Therefore the change in workingcapital was a cash inflow. Is this last statement true orfalse?

(4) The Price-to-earnings ratio (PE ratio) is useful as anindicator of liquidity because it relates the earnings of a companyto its stock price.

(5) In consolidated accounts, when the parent company pays morefor the shares of a subsidiary than book value, the difference ispositive goodwill

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Keith Leannon
Keith LeannonLv2
28 Sep 2019

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TRUE OR FALSE

  1. For Company T during 2017, the change in accounts receivablewas positive, the change in inventories was positive, and there wasno change in accounts payable. Therefore the change in workingcapital was a cash outflow.
  1. In ROC the debt and equity values from the balance sheet aretaken from the same year as the income statement.
  1. ROA can be estimated by multiplying the operating profit marginby the asset turnover ratio.
  1. Classify the following changes in each of the accounts as either an outflow or an inflow of cash. (1 Mark – 0.2 each)

 

a. Is a decrease in land and buildings an inflow or an outflow of​ cash?

b. Is an increase in accounts payable an inflow or an outflow of​ cash?

c. Is a decrease in vehicles an inflow or an outflow of​cash?

d. Is an increase in accounts receivable an inflow or an outflow of​cash?

e) Is the payment of dividends an inflow or an outflow of​cash?

 

  1. Robert Arias recently inherited a stock portfolio from his uncle. Wishing to learn more about the companies in which he is now​invested, Robert performs a ratio analysis on each one and decides to compare them to each other. Some of his ratios are listed here:

 

 

Island

Burger

Fink

Roland

 

Ratio

Electric Utility

Heaven

Software

Motors

Current ratio

1.06

1.35

6.79

4.55

Quick ratio

0.92

0.87

5.23

3.73

Debt ratio

0.69

0.45

0.04

0.34

Net profit margin

6.25%

14.33%

28.46%

8.43%

 

Assuming that his uncle was a wise investor who assembled the portfolio with​ care, Robert finds the wide differences in these ratios confusing. Help him out.

a. What problems might Robert encounter in comparing these companies to one another on the basis of their​ratios? (Select all the answers that​) (0.25 Marks)

 

  1. The four companies are in very different industries.
  2. The operating characteristics of firms across different industries vary significantly resulting in very different ratio values.
  3. Financial ratios from software companies are never very reliable.
  4. Caution must be exercised when comparing older to newer​firms,g., utility company vs. software'

 

b. Why might the current and quick ratios for the electric utility and the​fast-food stock be so much lower than the same ratios for the other​ companies? (Select all the answers that​) (0.25 Marks)

 

  1. Their inventory balances are going to be very close to zero because it is impossible to stockpile electricity and burgers.
  2. The explanation for the lower current and quick ratios most likely relates to poor management performance.
  3. Their accounts receivable balances are going to be much lower than for the other two companies.
  4. The explanation for the lower current and quick ratios most likely rests on the fact that these two industries operate primarily on a cash basis.

 c. Why might it be all right for the electric utility to carry a large amount of​debt, but not the software​ company? (Select all the answers that​) (0.25 Marks)

 

  1. A high level of debt can be maintained if the firm has a​large, predictable, and steady cash flow.
  2. The software firm will have very uncertain and changing cash flow.
  3. Utilities tend to have steady cash flow requirements.
  4. The software industry is subject to greater competition resulting in more volatile cash flow.

 

d. Why​ wouldn't investors invest all of their money in software companies instead of in less profitable​ companies? (Focus on risk and​) (Select all the answers that​ apply.) (0.25 Marks)

 

1. Software companies tend to carry large debt which represents senior claims on the​companies'

2.Investors​wouldn't invest all of their money in software companies because their average collection period is usually very high.

3. By placing all of the money in one​stock, the benefits of reduced risk associated with diversification are lost.

4. Although the software industry has potentially high profits and investment return​performance, it also has a large amount of uncertainty associated with the profits.

 

3.You have $5,100 to invest today at 11​% interest compounded annually. Find how much you will have accumulated in the account at the end of​: (0.5 Marks each)

(1)4years,

(2) 8 years, and​ 

(3) 12 years.

4.Using the values​ below, answer the questions that follow:

Amount of annuity

Interest rate

Deposit period​ (years)

 

​$500

9​%

10

 

  1. Calculate the future value of the​annuity, assuming that it is
    • ​An ordinary annuity. (0.5 marks)
    • ​An annuity due. (0.5 marks)

 

  1. Compare your findings in parts a​(1) and a​(2). All else being​identical, which type of annuity—ordinary or annuity due—is preferable as an​ investment? Explain why. (0.5 Marks)

 

 

1. Which of the following is true of the change in the weighted average cost of capital of a firm? a. A decrease in the weighted average cost of the capital increases the value of the firm. b. An increase in the weighted average cost of the capital increases the value of the firm. c. A decrease in the weighted average cost of the capital decreases the value of the firm. d. A decrease in the weighted average cost of the capital increases the cash flow generated by the investments. e. Any change in the weighted average cost of capital results in no change in the value of the firm.

2. The cost of debt to the firm is adjusted for _____. a. marginal revenue generated b. taxes c. interest rate d. internal rate of return e. return to investors

3. The firm's cost of external equity capital is the same as the required rate of return on the firm's outstanding common stock. a. True b. False

4. The target capital structure of a firm is the capital structure that: a. minimizes the operating risk of the firm's assets. b. maximizes the tax shield created by debt. c. minimizes the default risk of long-term debt. d. maximizes the price of the firm's stock. e. minimizes the risk premium paid on long-term debt.

5. The correct discount rate for a firm to use in capital budgeting, assuming that new investments are as risky as the firm's existing assets, is its marginal cost of capital. a. True b. False

6. The component costs of capital are market-determined variables in as much as they are based on investors' required returns. a. True b. False

7. The rates of return, or costs, that a firm must pay to raise funds to invest in capital budgeting projects are determined by: a. the marginal revenue generated by investment in the new projects. b. the investors who purchase the firm's stocks and bonds. c. the internal rate of return of the firm. d. the cash flow generated by the investment in the additional projects. e. the dividend payout ratio fixed by the firm.

8. The marginal cost of capital _____ as more capital is raised during a given period. a. remains the same b. decreases c. increases d. changes in an unpredictable way e. approaches zero 10. The firm's cost of capital represents the maximum rate of return that a firm can earn from its capital budgeting projects to ensure that the value of the firm increases. a. True b. False

12. Omega Inc. has a history of abnormally high growth due to general economic fluctuations. Estimating the cost of common equity using the discounted cash flow approach is difficult because: a. the dividend yield is extremely difficult to estimate. b. the proper growth rate is difficult to establish. c. the market price of the common equity is very volatile. d. the firm grows at a constant rate in perpetuity. e. the firm's historical data of dividend yield is unavailable.

13. The cost of debt is equal to one minus the marginal tax rate multiplied by the coupon rate on outstanding debt. a. True b. False

14. Bouchard Company's stock sells for $20 per share, its last dividend (D0) was $1.00, its growth rate is a constant 6 percent, and the company would incur a flotation cost of 20 percent if it sold new common stock. Which of the following is the cost of issuing new common stock? (Round off the answer to two decimal places.) a. 11.96 percent b. 12.25 percent c. 12.63 percent d. 10.24 percent e. 11.42 percent

15. Which of the following is a capital component for the purpose of calculating the weighted average cost of capital in capital budgeting? a. The after-tax cost of long-term debt b. The after-tax cost of common stock c. The after-tax cost of preferred stock d. The after-tax cost of retained earnings e. The after-tax cost of new equity

16. Which of the following statements is true of the impact of tax on the cost of capital of a firm? a. All else being equal, an increase in the corporate tax rate results in a decrease in the weighted average cost of capital. b. The before-tax cost of debt is the cheapest component of the cost of capital since the tax paid is a deductible expense. c. The before-tax cost of debt is always less than the after-tax cost of debt of a firm. d. The tax paid on dividends of preferred stock reduces the amount of funds that the firm can use for financing capital budgeting projects. e. All else being equal, an increase in the equity capital that a firm raises by retaining earnings results in in the increase in the tax rate applicable to the firm.

18. A firm's weighted average cost of capital (WACC) is: a. set by the board of directors of the firm because it is the benchmark they use to evaluate upper management. b. regulated by the Internal Revenue Service (IRS) because tax-deductible debt is included in the computation. c. determined by the financial markets because investors provide the funds used by firms and these funds have costs, which are the returns demanded by investors. d. the same as the firm's internal rate of return (IRR). e. the total net present value (NPV) of all the capital budgeting projects in which the firm invests in any year.

19. Everything else equal, an asset's value is directly related to: a. the cost of raising additional capital. b. the rate of return investors require to invest in that asset. c. the risk associated with the investment in that asset. d. the cash flow the asset is expected to generate. e. the rate of return that the firm must earn to satisfy investors' demands.

24. If a project's _____ exceeds the firm's cost of capital, its NPV will be positive. a. marginal cost of capital b. cash flow c. rate of return expected by investors d. internal rate of return (IRR) e. discount rate

25. The cost of equity raised by retaining earnings can be less than, equal to, or greater than the cost of equity raised by selling new issues of common stock, depending on tax rates, flotation costs, the attitude of investors, and other factors. a. True b. False

26. The before-tax cost of debt, rd, is the same as the: a. average yield to maturity (YTM) associated with the firm's bonds. b. dividend yield associated with the firm's common stock. c. average coupon rate of the firm's bonds. d. return on equity if the firm has no preferred stock. e. the firm's marginal tax rate.

29. As per the Bond-Yield-Plus-Risk-Premium Approach, analysts estimate the cost of common equity by adding a risk premium of 3 to 5 percentage points to: a. the cost of preferred stock of the firm. b. the risk free rate of the common equity of the firm. c. the interest rate on the long term debt of the firm. d. the return on the firm's investment in municipal bonds. e. the growth rate of the firm.

30. The marginal cost of capital (MCC) is the cost of the last dollar of new capital that the firm raises, and the marginal cost declines as more and more of a specific type of capital is raised during a given period. a. True b. False

31. Which of the following statements is true of flotation costs? a. Flotation costs decrease the cost of preferred stock to the issuing firm. b. Flotation costs are added to the issue price of preferred stock to compute the cost of preferred stock. c. Floatation costs are added to the cost of debt to compute the weighted average cost of capital of a firm. d. Floatation costs result in higher funds available from the issue of preferred stock to the firm. e. Floatation costs increase the rate the issuing firm must earn to pay the preferred dividend.

34. Under normal circumstances, the weighted average cost of capital is used as the firm's required rate of return because: a. as long as the firm's investments earn returns greater than the cost of capital, the value of the firm will not decrease. b. returns below the cost of capital will cover all the fixed costs associated with the capital and provide excess returns to the firm's stockholders. c. it is comparable to the average of all the interest rates on debt that currently prevail in the financial markets. d. it is an indication of the return the firm is expecting to earn in future from all of its expansion plans. e. the weighted average cost of capital remains unchanged if the components costs of capital changes.

36. The cost of issuing preferred stock by a corporation must be adjusted to an after-tax figure because of the 70 percent dividend exclusion provision for corporations holding other corporations' preferred stock. a. True b. False

38. The after-tax cost of debt is used to calculate the weighted average cost of capital since we are concerned with the after-tax cash flows of the firm. a. True b. False

39. Beige Inc. plans to issue preferred stock that pays an $11.50 dividend per share and sells for $120 per share in the market. It will cost 4 percent, or $4.80 per share, to issue the new preferred stock, so Beige will net $115.20 per share. Which of the following is Beige's cost of preferred stock? (Round off the answer to two decimal places.) a. 8.89 percent b. 12.25 percent c. 11.50 percent d. 15.20 percent e. 9.98 percent

40. The Jackson Company has just paid a dividend of $3.00 per share on its common stock, and it expects this dividend to grow by 10 percent per year, indefinitely. The firm has a beta of 1.50; the risk-free rate is 10 percent; and the expected return on the market is 14 percent. Which of the following is the required rate of return as per the capital asset pricing model (CAPM) approach? a. 9 percent b. 12 percent c. 7 percent d. 16 percent e. 18 percent

41. J. Ross and Sons Inc. has a target capital structure that calls for 40 percent debt, 10 percent preferred stock, and 50 percent common equity. Ross' common stock currently sells for $40 per share. The firm recently paid a dividend of $2 per share on its common stock, and investors expect the dividend to grow indefinitely at a constant rate of 10 percent per year. Which of the following is the firm's cost of retained earnings? (Round off the answer to two decimal places.) a. 16.34 percent b. 10.42 percent c. 15.50 percent d. 12.20 percent e. 13.25 percent

42. Omega Inc.'s net income is expected to be $600,000 and the firm's payout ratio is 60 percent. The firm's common stock ratio is 30 percent and it has no preferred stock outstanding. Which of the following is the retained earnings break point for Omega Inc.? a. $400,000 b. $250,000 c. $375,000 d. $100,000 e. $800,000

43. Marigold Inc.'s common stock currently sells for $40 per share, but the firm will net only $34 per share from the sale of new common stock. The firm recently paid a dividend of $2 per share on its common stock, and investors expect the dividend to grow indefinitely at a constant rate of 10 percent per year. Which of the following is the cost of newly issued common stock? (Round off the answer to two decimal places.) a. 12.24 percent b. 13.56 percent c. 14.12 percent d. 16.47 percent e. 17.53 percent

44. Super Solutions Inc. is a constant growth firm, which just paid a dividend of $3.00, sells for $33.00 per share, and has a growth rate of 6 percent. Which of the following is the cost of retained earnings using the discounted cash flow (DCF) approach? (Round off the answer to two decimal places.) a. 12.55 percent b. 15.64 percent c. 16.25 percent d. 13.35 percent e. 12.40 percent

45. The _____ is equal to the average rate of return that investors require to provide funds to the firm in the form of debt. a. Coupon rate b. Yield to maturity (YTM) c. Maturity value d. Discount rate e. Internal rate of return

46. Oval Inc. has just paid a dividend of $1.50 per share on its common stock, and it expects this dividend to grow by 4 percent per year, indefinitely. The firm plans to issue common stock at $16. The firm's investment bankers believe that new issues of common stock would have a flotation cost equal to 4 percent of the current market price. Which of the following is the cost of newly issued common stock? (Round off the answer to two decimal places.) a. 14.16 percent b. 10.15 percent c. 15.36 percent d. 13.80 percent e. 16.92 percent

47. Diggin Tools just issued new preferred stock, which sold for $85 in the stock markets. Holders of the stock will receive an annual dividend equal to $9.35. The flotation costs associated with the new issue were 6 percent and Diggin's marginal tax rate is 30 percent. Which of the following is the component cost of preferred stock, rps? (Round off the answer to two decimal places.) a. 10.75 percent b. 10.52 percent c. 12.25 percent d. 11.70 percent e. 11.05 percent

48. Rollins Corporation is constructing its MCC schedule. Its target capital structure is 20 percent debt, 20 percent preferred stock, and 60 percent common equity. Its bonds have a 12 percent coupon, paid semiannually, a current maturity of 20 years, and sell for $1,000. The firm's marginal tax rate is 40 percent. Which of the following is Rollins' component cost of debt? (Round off the answer to one decimal place.) a. 8.4 percent b. 7.2 percent c. 6.8 percent d. 5.3 percent e. 9.5 percent

50. Coral Inc.'s preferred stock currently sells for $90 a share and pays a dividend of $10 per share; however, the firm will net only $80 per share from the sale of new preferred stock. What is the firm's cost of newly issued preferred stock? (Round off the answer to two decimal places.) a. 11.15 percent b. 12.50 percent c. 16.45 percent d. 10.52 percent e. 13.46 percent

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