FIN 515 WEEK 8 FINAL EXAM
1. TCO A) In the United States, which of the following types of organization has the greatest revenue in total? (Points :
... [Show More] 5)
Sole proprietorship
Corporation
S corporation
Limited partnership
2. TCO A) A sole proprietorship is owned by (Points : 5)
one person.
one or two people, but if there are two owners, they must be married to each other.
up to 100 owners.
up to 64 owners.
3. TCO B) Which of the following would cause the present value of an annuity to increase? (Points : 5)
Reducing the number of payments.
Increasing the interest rate.
Decreasing the interest rate.
Decreasing the liquidity of the payments.
4. TCO B) Which of the following is an annuity due? (Points : 5)
A typical car loan.
A typical mortgage.
A typical apartment rental agreement.
A credit card balance.
5. TCO G) If you were a manager of a company, which of the three right side components of the DuPont Identity would you want to increase & which would you want to decrease, other things being equal? Give a specific example for how to do that for each of the three. (Points : 20)
The DuPont Identity measures the company’s ROE in terms of its profitability, asset efficiency, & leverage. The model helps investors compare similar companies like these with similar ratios. Investors can then apply perceived risks with each company's business model. Based on these three performances measures i.e. Profit Margin, Total Asset Turnover & Financial Leverage, the model concludes that a company can raise its ROE by maintaining a high profit margin, increasing asset turnover, or leveraging assets more effectively. In details, net profit margin can be used to margin a company's overall profitability. Besides, the firm’s asset turnover is used to identify how efficiently the firm is utilizing its assets to generate sales. The term equity multiplier indicates the value of assets held per dollar of shareholder equity.
The right side components of the DuPont Identity that can be increased are Net Income & Sales. The inventory & account receivable can be reduced which can help the current assets position & in turn reduces total assets, which then improves total asset turnover. Hence, decreasing the inefficiencies in asset utilization & inventory holding will improve the ROE. The management can use this formula to pinpoint the problem area whether it is a lower profit margin, asset turnover, or poor financial leveraging if investors are unsatisfied with a low ROE.
Source: http://www.myaccountingcourse.com/financial-ratios/dupont-analysis
6. TCO D) A stock has just paid a dividend & will pay a dividend of $3.00 in a year. The dividend will stay constant for the rest of time. The return on equity for similar stocks is 14%. What is P0? (Points : 20)
A stock has just paid a dividend & will pay a dividend of $3.00 in a year, so Dividend for Year 0 & coming years will be $3
=> D0 = 3
=> D1 = 3
The dividend will stay constant for the rest of time
=> Rate of Dividend growth = 0
=> g = 0
r = 14%
P0 = D1 / (r - g)
= 3 /(14% - 0)
= 21.43
7. TCO D) A stock has just paid a dividend & has declared an annual dividend of $2.00 to be paid one year from today. The dividend is expected to grow at a 5% annual rate. The return on equity for similar stocks is 12%. What is P0? (Points : 20)
Constant Dividend Growth Model:
P0 = Stock Price = 2.0 / (0.12 -0.05) = 2.0 /(0.07) = 200/7 = $28.57
8. (TCO D) A particular bond has 8 years to maturity. It has a face value of $1,000. It has a YTM of 7% & the coupons are paid semiannually at a 10% annual rate. What does the bond currently sell for? (Points : 10)
Face value (FV) = $1,000
Coupon rate = 10%,
YTM = 7% & has 8 years to maturity.
The compounding is semi-annual:
=> Semi-annual coupon payment = $1,000 * (10% / 2) = $50
Semi-annual YTM = 7% / 2 = 3.5%
Semi-annual years = 8 * 2 = 16
Using the excel to calculate current price of the bond:
PV = (Rate, Nper, PMT, FV)
= (3.5%, 16, -50, -1000)
= $1,181.41
9. (TCO D) A bond currently sells for $1,000 & has a par of $1,000. It was issued two years ago & had a maturity of 10 years. The coupon rate is 7% & the interest payments are made semiannually. What is its YTM? (Points : 10)
Yield to Maturity of Coupon Bond:
P = CPN x (1/y)(1-[1/(1+y)^n] + (FV / [1+y]^n)
=> 1000 = 35 * 1/y * (1 - 1/(1 + y)^16) + 1000 /(1+y)^16
Using Excel to compute the yield to maturity:
= Rate(16,-35,1000,-1000) = 3.5%
10. (TCO D) What is β & why is it important to investors & issuers of stock? Describe the behavior of stocks with βs of greater than one, less than one, & less than zero. (Points : 30)
The sensitivity of a stock to market movements is called Beta. It represents the most widely accepted masure of the extent to which the return on a stock fluctuates with the return on themarket portfoilio. Beta is the measure of volatility, more particularly known as sysematic risk. Investors uses beta to analyze the volatility of the stock in comparison of mrket & hence decides their required return. Issuers of the stock uses it to decide the cost of equity.
- A stock with beta ofgreater than one experiences greater fluctuations than the market portfolio. - A stock with beta of less than one has lesser return fluctuations that the market portflio & a stock with Beta 1 has the same fluctuation in return as that of the market portflio.
- Zero beta mens the stock is not correlated with market & it does not move any direction followig the market movement.
11. TCO E) A company has 100 million shares outstanding trading for $8 per share. It also has $900 million in outstanding debt. If its equity cost f capital is 15%, & its debt cost of capital is 12%, & its effective corporat tax rate is 40%, what is its weighted average cost of capital? (Points : 30)
Weighted Average Cost of capital:
= [Equity / (Debt + Equity)]*Equity cost of capital + [ Debt / (Debt + equity)]*Debt Cost of capital*(1 - tax rate)
=[($100 / $1000) * 0.15] +[ ($900/$1000) * 0.12 *(1-0.40)
= 0.015 + 0.0648
= 0.0798
= 7.98%
12. TCO A) What is the difference between capital structure & capital budgeting? Explain & give an example of a capital structure decision & an example of a capital budgeting decision. (Points : 25)
Capital structure refers to the composition of the "Shareholder Equity & Liabilities" section of a corporation's balance sheet. Capital structure decisions related to capital structure of the company, which includes debt & equity. Besides, bank loans, preferred stock, retained earnings & working capital might also be part of the company's capital structure.
On the other hand, capital budgeting refers to the process of evaluating & managing a firm's long-tem investments. Capital budgeting decision involves three steps: recording th investment's cost, projecting the investment's cash flows & comparing the rojected earnings with inflation rates & the time value of the investment. Capital structure & capital budgeting must be aligned to ensure that the usiness has sufficient cash to undertake the investments necessary. For example:
Capital structure decision: How should we pay for our assets? Should we use debt orequity?
Capital bdgeting decision: What long-term investments or projects should the busines take on?
13. TCO H) What is the difference between the cash cycle & the perating cycle? Under what condition would they be the same? (Points : 0)
Cash conversion cycle is the number of days required for a ompany to convert resources to cash flows while an operating cycle is the average time period between the acquisition of inventory & the receipt of cash from the inventory's sale.
They would be the same as there is only inventory in the working capital of the company.
14. (TCO F) A company has the opportunity to do any of the projects for which the
net cash flows per year are shown below. The company has a cost of capital of 12%.
Which should the company do & why? You must use at least two capital budgeting
methods. Show your work
Year A B C
0 -300 -100 -300
1 100 -50 100
2 100 100 100
3 100 100 100
4 100 100 100
5 100 100 100
6 100 100 100
7 -100 -200 0 (Points : 40)
NPV Method: NPV = PV of cash inflow – PV of cash outflow
Profitable Index Method: PI= PV of Cash Inflow / PV of Cash Outflow
Company A:
PV of Cash Inflow = 100/1.12 + 100/1.12^2 + 100/1.12^3 + 100/1.12^4 + 100/1.12^5 +
100/1.12^6
= 411.14
PV of Cash Outflow = 300 + 100/1.12^7
= 345.23
NPV Method: NPV = PV of Cash Inflow - PV of Cash Outflow
= 411.14 - 345.23
= 65.91
Profitable Index Method: PI = PV of Cash Inflow / PV of Cash Outflow
= 411.14 / 345.23
= 1.19
Company B:
PV of Cash Inflow = 100/1.12^2 + 100/1.12^3 + 100/1.12^4 + 100/1.12^5 + 100/1.12^6
= 321.86
PV of Cash Outflow = 100 + 50/1.12 + 200/1.12^7
= 235.11
NPV Method: NPV = PV of Cash Inflow - PV of Cash Outflow
= 321.86 - 235.11
= 86.75
Profitable Index Method: PI = PV of Cash Inflow / PV of Cash Outflow
= 321.86 / 235.11
= 1.3690
Company C:
PV of Cash Inflow = 100/1.12 + 100/1.12^2 + 100/1.12^3 + 100/1.12^4 + 100/1.12^5
+ 100/1.12^6
= 411.14
PV of Cash Outflow = 300
NPV Method: NPV = PV of Cash Inflow - PV of Cash Outflow
= 411.14 - 300
= 111.14
Profitable Index Method: PI = PV of Cash Inflow / PV of Cash Outflow
= 411.14 / 300
= 1.3705
Regarding to NPV Method & Profitable Index Method, the best choice is project C as
its NPV is higher & also PI is higher though all of the three companies have Positive NPV
and PI is greater than 1.
In my business office, management is deciding whether to move or staff to a larger office or to remodel & add more cubicles to fit our growing staff. So in order to expand our space in the existing office I’m sure they are making capital budgeting decisions. In reading our lecture it is beneficial for companies to use more than one method to ensure the best decisions are made. The commonly used methods are:
1. Payback Period
2. Net Present Value
3. Internal Rate of Return
4. Discounted Payback Period
5. Accounting Rate of Return
6. Profitability Index
In my managements case they need to decide which project would be most cost effective & better for the company in the long run (which has long-term value). The costs for both projects will have to be estimated. They also need to determine the opportunity costs. The goal & objective should be to limit expenses while creating an efficient work space; while growing our internal operation. The Payback Period Method seems good for this type of project because it would help to monitor & control outflow costs. The other method is the Accounting Rate of Return.
Very true Professor. This is an easy way to determine calculations in small projects. It sometimes used as an start in determining the value of a project. The Payback rule can be used to weed out bad investments.Then they can use other methods like calculation of the NPV & IRR. However there are both advantages & disadvantages to using this method. They are:
Advantages:
1. Payback is easy to calculate
2. It can be used to measure inherent risk of project
3. When companies are faced with liquidity problems, it can provide a good ranking of projects that would return money early
Personally I would like to open a group home for unwanted children. I would need to purchase a home, with beds, & individual furniture like drawers & desks. Hypothetically I would need around 200,00 for a home in California, as well as another 50,000 to buy furniture & all other necessities that would allow me to be approved to open a home of that capacity. I would enjoy to run the home, until I'm unable to participate. I would say 30 years. [Show Less]