Managerial Finance Final Exam Review

1
Managerial Finance Final Exam Review

• May 2, 2007

2
What is the goal of the financial manager?

• To maximize shareholders wealth.

3
You purchase a machine for 10,000, depreciated
straight-line to a salvage value of 2,000 over
its 4 year life. If the machine is sold at the
end of the third year for 6,000, what are the
after-tax proceeds from the sale, assuming your
tax rate is 34.
4
What is a pure discount loan?

• A loan where the borrower receives money today
  and repays a single lump sum at some time in the
  future.

5
In reference to bonds, what are protective
covenants?

• Parts of the indenture limiting certain actions
  that might be taken during the term of the loan
  (usually to protect the interests of the
  borrower).

6
What is the difference between a call and a put
option on a bond?

• A call gives the seller the right but not the
  obligation to purchase the bond from the
  investor.
• A put gives the purchaser (investor) the right
  but not the obligation to sell the bond to the
  issuer.

7
What is a consol?

• A bond that pays only coupons and does not mature.

8
How much would you pay for a 7 coupon bond if
the MIR is 7?

• Par value.

9
What name is given to a loan that requires that
you repay the total principal and interest over 5
years?

• Fully Amortized loan.

10
Taylor Systems has just issued preferred stock.
The stock has a 12 annual dividend and a 100
par value and was sold at 97.50 per share. In
addition, floatation costs of 2.50 per share
must be paid. Calculate the cost of the preferred
stock.

• kp (.12 100) / (97.50 - 2.50) 12.63

11
Why is debt generally a cheaper source of
financing than equity?

• Interest is tax deductible, so it lowers the
  effective cost of borrowing.

12
What is the bond indenture?

• The legal document that spells out the rights and
  responsibilities of the bond issuer and the bond
  holder.

13
Suppose you purchase a zero coupon bond with face
value 1,000, maturing in twenty-five years, for
350. What is the implicit interest, in dollars,
in the first year of the bond's life?
14
Define the risk premium.

• The difference between the return on a risky
  investment and that on a risk-free investment.

15
Suppose Jones, Inc. has just paid a dividend of
1.20 per share. Sales and profits for Jones Inc.
are expected to grow at a rate of 6 per year.
Its dividend is expected to grow by the same
amount. If the required return is 9, what is the
value of a share of Jones Inc.?

• 1.20 (1.06) / (.09-.03) 42.4

16
According to the Dupont Analysis what are the
three components of a firms ROE?

• Operating Efficiency (measured by profit margin)
• Asset Use Efficiency (Measured by total asset
  turnover)
• Financial Leverage (measured by equity
  multiplier)

17
How much would you yield on a stock if the risk
free rate is 3, the beta is 1.1 and the market
risk premium is 4?

• Rs Rf B(Rm Rf)
• Rs 3 (1.1 4) 7.4

18
Suppose Exhale, Inc. has just paid a dividend of
1.25 per share. Sales and profits for Exhale are
expected to grow at a rate of 5 per year. Its
dividend is expected to grow by the same amount.
If the required return is 10, what is the value
of a share of Exhale Inc?
19
A firm is considering a project which would
increase accounts receivable by 55,000, accounts
payable by 15,000, and inventory by 30,000.
What can you deduce about working capital?

• Net working capital has increased.

20
Consider a project with an initial investment and
positive future cash flows. As the discount rate
increases, what happens to the NPV?

• The NPV falls.

21
The rate of return required by investors in the
market for owning a bond is called the

• yield to maturity

22
What is the basic difference between the payback
rule and the NPV rule in capital budgeting
decision?

• The payback rule uses time to determine if a
  project is acceptable and the NPV uses cash flows
  to determine acceptability.

23
Preemptive right refers to

• The right of shareholders to share
  proportionately in any new stock issues sold.

24
The principal amount of a bond that is repaid at
the end of the loan term is called the bond's

• Face value.

25
A project costs 475 and has cash flows of 150
for the first three years and 85 in each of the
project's last five years. If the discount rate
is 10, what is the discounted payback period?
26
You are considering purchasing a bond that will
start paying a coupon of 75 per year five years
from now and the coupon payments will continue
forever. If the discount rate is 6, what is the
maximum price you will pay?

• 990.12

27
True or false Interest payments are legally
binding while dividend payments generally are
not.

• True

28
True or false The payment of dividends by a
corporation is a tax-deductible business expense.

• False, dividends are NOT tax deductible

29
List four ways that Preferred stock is much like
debt.

• both frequently carry credit ratings
• both can be repaid using a sinking fund
• both receive a stated payment from the
  corporation during the year
• the holders of both get a stated payment in the
  event of a liquidation

30
The changes in the firm's future cash flows that
are a direct consequence of accepting a project
are called

• Incremental cash flows.

31
Ceteris paribus, what happens to the price of
stocks and bonds when market interest rate falls?

• Prices rise

32
The increase in current assets over current
liabilities over a period of time is called
_____________.

• additions to net working capital

33
Suppose Jones, Inc. has just paid a dividend of
1.20 per share. Sales and profits for Jones Inc.
are expected to grow at a rate of 6 per year.
Its dividend is expected to grow by the same
amount. If the required return is 9, what is the
value of a share of Jones Inc.?

• 1.20 (1.06) / (.09-.03) 42.4

34
Assume that you can borrow 1,000 and pay back
the principal and interest three years later. The
lender charges 12 interest per year on the
outstanding balance at the end of each year, all
due and payable at the end of 3 years. How much
would have to be repaid at the end of three
years?

• 1,000 (1.12)3 1,404.93

35
How much would you have put to put in the bank at
the end of each month to accumulate 1million if
you could earn 6 on your deposits and you make
no withdrawal for 30 years?

• 1,000,000 CF (1.005)360 1/.005
• 995.51

36
If the nominal interest rate is 9 and expected
inflation is 3, then the real interest rate is

• (1 R) (1 r) (1 h)
• (1 .09) (1 r) (1 .03)
• R (1.09/1.03) 1 5.825

37
Assume Treasury bills currently have a return of
4.5 and the market risk premium is 7. If a firm
has a beta of 1.7, what is its cost of equity?
38
Jackos Used Cars will sell you a 1976 Plymouth
Voyager for 1,500 with no money down. You agree
to make weekly payments for 2 years, beginning
one week after you buy the car. The stated rate
on the loan is 26. How much is each payment?

• 18.53

39
You are currently in the market for a new house.
The mortgage company gives you two alternatives
to finance the 150,000 mortgage a 15-year loan
_at_ 6.5 or a 30-year loan at 6. Which loan would
have the larger interest payment over the life of
the loan and how much more?
40
Treasury bills currently have a return of 3.5
and the market risk premium is 8. If a firm has
a beta of 1.6, what is its cost of equity?

• 16.3 3.5 (1.6 8)

41
The preferred stock of Cars-A-Lot currently sells
for 48.55 per share. The annual dividend of
2.00 is fixed. Assuming a constant dividend
forever, what is the rate of return on this
stock?

• R 2.00 / 48.55 4.12

42
The preferred stock of Jones Inc. currently sells
for 50 per share. The annual dividend of 2.50
is fixed. Assuming a constant dividend forever,
what is the rate of return on this stock?
43
The net present value (NPV) rule can be best
stated as

• An investment should be accepted if the NPV is
  positive and rejected if it is negative.

44
What is the balance sheet identity?

• Total Assets Total Liabilities Equity (i.e.,
  the balance sheet MUST balance).

45
Mary just purchased a zero coupon bond with face
value 1,000, maturing in twenty-five years, for
250.00. What is the implicit interest, in
dollars, she will earn in the first year of the
bond's life?
46
The annual coupon payment of a bond divided by
its market price is called the

• Current yield

47
Parts of the indenture limiting certain actions
that might be taken during the term of the loan
(usually to protect the interests of the lender)
are called

• Protective covenants

48
A bond with a face value of 1,000 has annual
coupon payments of 100 and was issued 5 years
ago. The bond currently sells for 1,000 and has
10 years remaining to maturity. This bond's
_______, _______, and _______ must be 10.
49
The length of time required for an investment to
generate cash flows sufficient to recover its
initial cost is the

• Payback period.

50
The preferred stock of Cars-A-Lot currently sells
for 48.55 per share. The annual dividend of
2.00 is fixed. Assuming a constant dividend
forever, what is the rate of return on this
stock?

• R 2.00 / 48.55 4.12

51
The interest rate used to calculate the present
value of future cash flows is called the
____________ rate.

• discount

52
The weighted average of the firm's costs of
equity, preferred stock, and after-tax debt is
the

• Weighted average cost of capital (WACC).

53
You are considering two mortgages. One for 15
years, at 6.5 and the other for 30years at 6.
Both require monthly payments. Which mortgage
will have the higher total interest payment and
by how much?
54
What is the payback period for the following
investment if the market interest rate is
5?Year 0 1 2 3 4Cash Flow
75,000 30,000 20,000 15,000 25,000

• 3.75 years

55
Suppose your company needs to raise 7.5 million
and you want to issue bonds for this purpose. You
could issue a consol, a 15-year zero-coupon, or a
15-year 8 coupon bond. Assuming that the market
rate is 8 and the face value is 1,000 for each
type of bond a) How many of each type of bond
would you have to issue to raise the 7.5
million? b) In year 15, what will your companys
repayment be for each type of bond?
56
The End

• Forget the parties this weekend and prepare
  well.Thats a sure way to ace the test!!