Professional Documents
Culture Documents
savannahstate.edu/misc/dowlingw/3155/Practice%20Exams/make-up_review_-_spring_2008.htm
1.
A brokerage firm that offers to buy and sell a stock at specified bid and ask prices is "making a market."
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2.
Only large commercial banks are subject to the regulation of the Federal Reserve.
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3.
Since the reserves of commercial banks earn interest, there is an incentive to hold excess reserves.
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4.
The present value of an annuity is worth more if interest rates are 5% instead of 10%.
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5.
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6.
The expected return on an investment includes both the expected of income plus expected price
appreciation.
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7.
The larger an investment's standard deviation, the smaller is the element of risk.
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8.
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9.
Depreciation expense produces a cash outflow of funds, because it reduces the firm's earnings.
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10.
Pre-emptive rights mean that current stockholders have the right to maintain their proportionate ownership
before new shares may be sold to the general public.
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11.
Federal income taxes favor the retention of earnings over the distribution of earnings.
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12.
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13.
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14.
The dividend-growth model cannot be adjusted for changes in growth rates or changes in risk.
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15.
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16.
Many bonds have a call feature, which permits the firm to retire the bonds prior to maturity.
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17.
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18.
One of the major advantages associated with investing in mutual funds is potential diversification.
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19.
If a corporation operates at a loss, the loss is initially carried forward to offset future income.
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20.
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21.
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22.
As a firm increases its use of debt, it becomes more financially leveraged and riskier.
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23.
The optimal capital structure is the firm's best combination of debt and equity funds.
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24.
If the marginal cost of capital rises, that suggests the cost of some component of the firm's capital structure
has risen.
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25.
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Multiple Choice
Identify the choice that best completes the statement or answers the question.
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26.
b.
c.
d.
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27.
Money serves as
a.
b.
c.
a medium of exchange
d.
a risk-free liability
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28.
b.
marketed
c.
d.
sold
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29.
An investment banker
1.
2.
3.
serves as a middleman between financial intermediaries and firms issuing new securities
a.
1 and 2
b.
1 and 3
c.
2 and 3
d.
only 3
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30.
b.
c.
d.
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31.
2.
3.
4.
a.
1 and 3
b.
1 and 4
c.
2 and 3
d.
2 and 4
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32.
2.
3.
4.
a.
1 and 3
b.
1 and 4
c.
2 and 3
d.
2 and 4
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33.
b.
c.
d.
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34.
Nasdaq
b.
SEC
c.
SIPC
d.
FDIC
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35.
selling securities
2.
buying securities
3.
4.
a.
1 and 3
b.
1 and 4
c.
2 and 3
d.
2 and 4
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36.
b.
c.
d.
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37.
lending
b.
borrowing
c.
retiring debt
d.
saving
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38.
2.
3.
4.
a.
1 and 3
b.
1 and 4
c.
2 and 3
d.
2 and 4
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39.
2.
3.
4.
a.
1 and 3
b.
1 and 4
c.
2 and 3
d.
2 and 4
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40.
b.
c.
d.
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41.
b.
c.
d.
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42.
b.
c.
d.
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43.
Discounting is
1.
2.
3.
4.
a.
1 and 3
b.
1 and 4
c.
2 and 3
d.
2 and 4
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44.
b.
c.
d.
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45.
b.
equal to 1.0
c.
d.
negative
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46.
b.
c.
d.
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47.
stock
b.
bonds
c.
accounts receivable
d.
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48.
b.
c.
d.
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49.
b.
c.
an increase in plant
d.
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50.
b.
accrued interest
c.
accounts payable
d.
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51.
Performance is measured by
a.
liquidity ratios
b.
leverage ratios
c.
profitability ratios
d.
turnover ratios
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52.
Times-interest-earned uses
a.
gross earnings
b.
operating earnings
c.
net earnings
d.
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53.
b.
c.
d.
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54.
investments
2.
3.
retained earnings
a.
1 and 2
b.
1 and 3
c.
2 and 3
d.
1, 2, and 3
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55.
b.
c.
d.
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56.
declaration date
b.
ex dividend date
c.
date of record
d.
distribution date
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57.
total equity
2.
total assets
3.
corporate taxes
4.
total liabilities
a.
1 and 2
b.
1 and 3
c.
2 and 3
d.
3 and 4
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58.
cash
2.
stock
3.
retained earnings
a.
1 and 2
b.
1 and 3
c.
2 and 3
d.
1, 2, and 3
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59.
b.
c.
d.
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60.
2.
3.
a.
1 and 2
b.
1 and 3
c.
2 and 3
d.
all three
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61.
calling it
2.
repurchasing it
3.
a.
1 and 2
b.
1 and 3
c.
2 and 3
d.
only 2
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62.
paid-in capital
b.
retained earnings
c.
preferred stock
d.
debentures
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63.
b.
c.
d.
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64.
management fees
2.
3.
4.
load charges
a.
1 and 3
b.
1 and 4
c.
2 and 3
d.
2 and 4
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65.
b.
c.
d.
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66.
b.
c.
d.
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67.
Variable costs
a.
b.
c.
d.
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68.
2.
per unit variable cost may initially fall but start to increase with further increases in output
3.
a.
1 and 2
b.
1 and 3
c.
2 and 3
d.
only 3
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69.
b.
c.
d.
rank investments
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70.
b.
c.
d.
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71.
bonds
2.
preferred stock
3.
common stock
a.
1 and 2
b.
1 and 3
c.
2 and 3
d.
only 1
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72.
Debt financing
1.
increases stockholders' return more than an equal dollar amount of preferred stock
2.
increases stockholders' return less than an equal dollar amount of preferred stock
3.
4.
a.
1 and 3
b.
1 and 4
c.
2 and 3
d.
2 and 4
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73.
Debt financing is more risky for firms than preferred stock financing because
a.
b.
c.
d.
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74.
b.
c.
d.
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75.
b.
c.
d.
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Problem
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76.
You bought an asset for $10,000 and sold it for $20,000 after 10 years. What was the annual rate of return
on this investment?
RESPONSE:
ANSWER:
$10,000(1 + g) 10 = $20,000
(1 + g) 10 = $20,000/$10,000 = 2
The rate of return or growth rate (g) is approximately 7%.
(PV = -10000; N = 10; I = ?; PMT = 0, and FV = 20,000. I = 7.18.)
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77.
An investment is expected to generate $1,000,000 each year for 4 years. If the firm's cost of funds is 10%,
what is the maximum amount the firm should pay for the investment?
RESPONSE:
ANSWER:
X = $1,000,000(3.170) = $3,170,000
3.170 is the interest factor for the present value of an annuity at 10% for four years.
(PV = ?; N = 4; I = 10; PMT = 1000000, and FV = 0. PV = -3169865.)
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78.
You bought a Picasso for $50,000 and sold it after 5 years for $88,000. What was the annual return on the
investment?
RESPONSE:
ANSWER:
(1 + x) 5 = $88,000/$50,000 = 1.760
x = 12%
Look up 1.760 in the interest table for the future value of $1 for 5 years, and determine
the annual growth rate. (PV = -50000; N = 5; I = ?; PMT = 0, and FV = 88000. I =
11.97.)
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79.
If an annuity costs $200,000 and yields 7 percent annually for 5 years, how much cash can an individual
withdraw each year such that the principal is consumed at the end of the time period?
RESPONSE:
ANSWER:
This illustrates the present value of an annuity of $1.00. The interest factor at 7
percent for 5 years is 4.10.
(FVAIF)(X) = $200,000
4.1X = $200,000
X = $200,000/4.1 = $48,780
The person may withdraw over $48,778 annually for five years. (PV = -200000; N = 5;
FV = 0; I = 7; PMT = ? PMT = 48778.14.)
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80.
You bought a stock with a beta of 1.4 and earned a return of 8.3%. Did you outperform the market if, during
the same period, the market rose by 7.4% and you could have earned 5.4% by investing in a Treasury bill?
RESPONSE:
ANSWER:
The material in this problem was not explicitly covered in the chapter. You may use the
problem to set up the question, "What return should you have earned during a
particular investment horizon?" The answer uses the capital asset model to evaluate
performance. Thus, the return that should have been realized is
Rf + (R m - Rf) beta = 5.4% + (8.3 - 5.4)1.4 = 9.46%.
The actual return (8.3% return) is less than the return that would be expected given
the beta and the market performance. The stock under-performed the market on a
risk-adjusted basis.
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81.
4,000
Accumulated depreciation
30,000
10,000
Retained earnings
86,000
Accrued wages
11,000
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Work in process
5,000
Finished goods
30,000
100,000
10,000
Land
10,000
Accounts receivable
32,000
2,000
15,000
Long-term debt
15,000
Raw materials
7,000
Investments
10,000
Taxes due
1,000
20,000
RESPONSE:
ANSWER:
Firm XYZ
Balance Sheet for the Period Ending December 31, 20XX
Assets
Current assets
Cash and marketable securities
Accounts receivable
$10,000
$32,000
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accounts
(2,000)
30,000
Inventory
Finished goods
30,000
Work in process
5,000
Raw materials
7,000
42,000
$82,000
Long-term assets
Plant and equipment
$100,000
Less accumulated
depreciation
Land
(30,000)
70,000
10,000
$80,000
Investments
$ 10,000
Total assets
$172,000
$10,000
Accrued wages
11,000
Bank notes
15,000
4,000
Accrued taxes
1,000
$41,000
Long-term debt
$15,000
Total liabilities
$56,000
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Stockholders' equity
Common stock ($1 par value; 20,000
shares authorized; 10,000 shares
outstanding)
$ 10,000
Paid-in capital
20,000
Retained earnings
Total stockholders' equity
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86,000
$116,000
$172,000
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82.
The inventory turnover for an industry is 6 (every two months) but Slow Corp. turns over its inventory 4
times a years (every three months). If annual sales are $1,000,000 and the interest cost to carry inventory
is 12 percent, what is the potential savings in interest expense if the firm achieves the industry for the
turnover of its inventory?
RESPONSE:
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ANSWER:
The current level of inventory is
Inventory turnover: Sales/Average inventory
1,000,000/X = 4
X = $250,000.
The potential savings in interest expense (if the firm can achieve the industry
average for the turnover of its inventory):
$83,888 0.12 = $10,000.
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83.
What is the debt/net worth ratio and the debt to total assets ratio for a firm with total debt of $600,000 and
equity of $400,000?
RESPONSE:
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84.
If the industry days sales outstanding is 65 days and a firm with sales of $1,034,550 has receivables of
$268,700, how much in interest expense could the firm save if the receivables turn over as quickly as the
industry average and the cost of carrying the receivables is 9%?
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85.
Construct a new balance sheet showing the impact of a 5 percent stock dividend. What will be the new
price of the stock?
RESPONSE:
ANSWER:
Cash
$ 10,000,000
Accounts payable
$ 20,000,000
Accounts
250,000,000
Long-term debt
400,000,000
10,500,000
receivable
Inventory
120,000,000
1,050,000 shares
outstanding)
Plant and
325,000,000
equipment
Retained earnings
$705,000,000
92,400,000
182,100,000
$705,000,000
The firm issues (.05)(1,000,000) = 50,000 shares with a $10 par value. The common
stock entry is increased by $500,000 to $10,500,000.
The market value of the stock is $58 50,000 = $2,900,000.
Retained earnings are reduced by $2,900,000 to $182,100,000.
Since retained earnings are reduced by $2,900,000 and common stock is increased
only by $500,000, $2,400,000 is unaccounted for. In order to balance the balance
sheet, additional paid-in capital is increased by $2,400,000.
The new price of the stock is $58 /1.05 = $55.24. This price adjustment is necessary to
adjust for the dilution of the old stock that results from the stock dividend.
Be certain to point out that in both the stock split and the stock dividend (1) assets are
not changed, (2) liabilities are not changed, and (3) total equity is not changed. All that
occurs is (1) a reduction in the price of the stock resulting from the increase in the
number of shares, and (2) some changes in the individual entries in the equity section
of the balance sheet.
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86.
Your broker recommends that you purchase Good Mills at $30. The stock pays a $2.20 annual dividend,
which (like its per share earnings) is expected to grow annually at 8 percent. If you want to earn 15 percent
on your funds, is this stock a good buy?
RESPONSE:
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87.
the firm's earnings and dividends are growing annually at 10 percent, the current dividend is
$1.32, and investors require a 15 percent return on investments in common stock?
b.
What is the value of this stock if you add risk to the analysis and the firm's beta coefficient is 0.8,
the risk-free rate is 9 percent, and the return on the market is 15 percent?
c.
If the price of the stock is $35, what is the rate of return offered by the stock? Should the investor
acquire this stock?
RESPONSE:
ANSWER:
a.
b.
c.
The rate of return is less than the required rate (14.15% versus 15%) until the risk
adjustment is made. After this adjustment, the expected rate of return exceeds the
required rate of return (14.15% versus 13.8%); therefore, buy the stock.
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88.
You bought a stock for $20 and sold it for $59.72 after six years. What was the annual rate of return?
RESPONSE:
ANSWER:
$20(1 + g) 6 = $59.72
(1 + g) 6 = $59.72/$20 = 2.986
Use the future value of a dollar table to find 2.986; the return is 20%. (PV = -20; N = 6;
PMT = 0; FV = 59.72; I = ? = 20.)
The answer may also be derived as follows:
(1 + g) 6 = $59.72/$20 = 2.986
g = 2.986 .1667 - 1 = 20%
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89.
If an investor buys shares in a closed-end investment company for $46 and the net asset value is $53,
what is the discount? If the company distributes $1, the net asset value rises to $58, and the investor sells
the shares for a premium of 5 percent over the net asset value, what is the percentage earned on the
investment?
RESPONSE:
ANSWER:
The discount is $53 - 46 = $7 (The shares initially sell for a discount of $7/53 = 13.2
percent from net asset value.)
The percentage return is ($1 + 1.05(58) - 46)/$46 = 34.6%.
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90.
Using the corporate tax rates given in the text (p. 345), what is the corporate income tax paid on earnings
of (a) $1,000, (b) $10,000, (c) $100,000, (d) 1,000,000, and (e) 10,000,000?
RESPONSE:
ANSWER:
a.
b.
c.
d.
for $1,000,000:
($50,000).15 + (25,000).25 + 25,000(.34) +
(235,000).39 + (665,000).34 = $340,000
e.
for $10,000,000:
($50,000).15 + (25,000).25 + 25,000(.34) +
(335,000).39 + (665,000).34 + (9,000,000)x.34 =
$3,400,000
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91.
b.
If the firm sells 1,300 units, what are its earnings or losses?
c.
If sales rise to 2,000 units, what are the firm's earnings or losses?
d.
RESPONSE:
ANSWER:
a.
b.
Earnings
c.
Earnings
d.
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92.
(This is a simple problem that replicates the example in the chapter.) A firm needs $100 to start and
expects
Sales
$200
Expenses
$185
Tax rate
33% of earnings
a.
b.
If the firm borrows $40 of the $100 at any interest rate of 10%, what are the firm's net earnings?
c.
What is the return on the owners' investment in each case? Why do the returns differ?
d.
e.
f.
RESPONSE:
ANSWER:
a.
and b.
Sales
Expenses
no financial
with financial
leverage
leverage
$200
$200
185
185
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EBIT
15
15
Interest
EBT
15
11
Taxes
c.
3.63
Net earnings
10
Return on equity
$10/$100 = 10%
7.37
$7.37/$60 = 12.28%
The return for b is higher because of the successful use of financial leverage.
(Point out that operating income is 15% of assets versus the 10% interest rate
and the reduction in taxes that results from the interest expense.)
d.
Sales
no financial
with financial
leverage
leverage
$200
$200
194
194
Expenses
e.
EBIT
Interest
EBT
Taxes
0.66
Net earnings
Return on equity
$4/$100 = 4%
1.34
$1.34/$60 = 2.23%
The return on equity fell more for the firm that was financially leveraged.
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f.
POINTS:
The generalization is that the use of financial leverage to increase the return
on equity works both ways. If revenues fall and/or expenses rise, the use of
financial leverage will magnify the swing in the firm's return on equity.
-- / 1
REF:
93.
Case B
- firm uses 30% debt with a 10% interest rate and 70% equity
Case C
- firm uses 50% debt with a 12% interest rate and 50% equity
Debt outstanding
300
300
300
Stockholders' equity
Earnings before
interest and taxes
Interest expense
Earnings before taxes
Taxes (40% of earnings)
Net earnings
Return on stockholders'
investment
What happens to the rate of return on the stockholders' investment as the amount of debt increases? Why
did the rate of interest increase in case C?
RESPONSE:
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ANSWER:
A
0
$ 600
$1,000
Debt outstanding
Stockholders' equity
2,000
1,400
1,000
Earnings before
300
300
300
Interest expense
60
120
300
240
180
120
96
72
Net earnings
$ 180
$ 144
$ 108
Return on stockholders'
9%
10.3%
10.8%
investment
The rate of return to stockholders rises because the after tax cost of debt in B is .1(1 .4) = 6%. The after tax cost of debt in C is .12(1 - .4) = 7.2%. These costs are less
than the 9 percent the firm earns after taxes on its assets ($180/$2,000). The interest
rate increases because the firm becomes riskier when it uses more financial leverage.
POINTS:
-- / 1
REF:
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94.
A firm with the following investment opportunities has a capital budget of $10,000. According to the net
present value technique, which investment(s) should the firm make if the firm's cost of capital is 10%?
Investment
A
Cost
$10,000
$7,000
$3,000
Cash inflow
$12,000
$8,600
$4,000
RESPONSE:
ANSWER:
The firm should select that combination of investments which uses the available funds
and maximizes the combined net present value.
NPVA
NPVB
NPVC
NPVA is less than NPV B + NPV C. Therefore, select B + C over A even though A has
the highest individual NPV.
POINTS:
-- / 1
REF:
95.
A firm has three investment opportunities. Each costs $1,000, and the firm's cost of capital is 10 percent.
The cash inflow of each investment is as follows:
cash inflow
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year
1
$300
500
100
300
400
200
300
200
400
300
100
500
a.
If the net present value method is used, which investment(s) should the firm make?
b.
What is the internal rate of return of investment A? The internal rate of return of investment B is
10.22% and 6.15% for investment C. Which investment(s) should the firm make?
c.
RESPONSE:
ANSWER:
A.
Discount the cash inflows by the cost of capital. For each investment, that is
$300 .909
$272.70
$500 .909
$ 454.50
300 .826
247.80
400 .826
330.40
300 .751
225.30
200 .751
150.20
300 .683
100 .683
204.90
$950.70
68.30
$1,003.40
C
$100 .909
$ 90.90
200 .826
165.20
400 .751
300.40
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500 .683
341.50
$898.00.
Next subtract the cost from the present value to determine the net present
value:
A:
B:
C:
Since only B has a net present value that is positive, it is the only investment
that covers the firm's cost of capital and hence is the only one that should be
selected.
b.
Since investment A is an annuity, the annuity table for the present value of an
annuity may be used to solve the problem. Restated the equation is
$1,000 = $300X
X = $1,000/$300 = 3.33.
3.33 is the interest factor for the present value of an annuity for four years.
Find this interest factor in the table to determine the internal rate of return. In
this case the internal rate of return is approximately 8 percent, which is less
than the firm's cost of capital. (The IRR is 7.7 percent using a financial
calculator.) Therefore, the investment should not be made. (This answer is
consistent with the answer given by the net present value in the previous
question.) The internal rates of return for investments B and C were given.
Only the internal rate of return of B exceeds the cost of capital; thus it is the
only investment the firm should make.
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c.
Notice that in this case the payback method gives the same ranking of
investments as the net present value. However, the payback method does not
tell if any of the investments should be made.
POINTS:
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REF:
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