FIN 501 Sample Exam 1
FIN 501 Sample Exam 1
FIN 501 Sample Exam 1
Sample Exam #1
Chapters 1, 3, 4
____ 1. The primary operating goal of a publicly-owned firm interested in serving its stockholders
should be to
a. Maximize its expected total corporate income.
b. Maximize its expected EPS.
c. Minimize the chances of losses.
d. Maximize the stock price per share over the long run, which is the stock's
intrinsic value.
e. Maximize the stock price on a specific target date.
____ 4. The primary operating goal of a publicly-owned firm trying to best serve its stockholders
should be to
a. Maximize managers' own interests, which are by definition consistent with
maximizing shareholders' wealth.
b. Maximize the firm's expected EPS, which must also maximize the firm's
price per share.
c. Minimize the firm's risks because most stockholders dislike risk. In turn,
this will maximize the firm's stock price.
d. Use a well-structured managerial compensation package to reduce conflicts
that may exist between stockholders and managers.
e. Since it is impossible to measure a stock's intrinsic value, the text states
that it is better for managers to attempt to maximize the current stock
price than its intrinsic value.
____ 5. Which of the following actions would be likely to reduce potential conflicts of interest
between stockholders and managers?
a. Congress passes a law that severely restricts hostile takeovers.
b. A firm's compensation system is changed so that managers receive larger
cash salaries but fewer long-term options to buy stock.
c. The company changes the way executive stock options are handled, with all
options vesting after 2 years rather than having 20% of the options awarded
vest every 2 years over a 10-year period.
d. The company's outside auditing firm is given a lucrative year-by-year
consulting contract with the company.
e. The composition of the board of directors is changed from all inside
directors to all outside directors, and the directors are compensated with
stock rather than cash.
offers a price for the stock that is higher than the price before the
takeover action started.
d. The managers of established, stable companies sometimes attempt to get
their state legislatures to impose rules that make it more difficult for
raiders to succeed with hostile takeovers.
e. The managers of established, stable companies sometimes attempt to get
their state legislatures to remove rules that make it more difficult for
raiders to succeed with hostile takeovers.
____ 8. Assume that the corporate tax rate is 34% and the personal tax rate is 30%. The founders
of a newly formed business are debating between setting up the firm as a partnership versus
a corporation. The firm will not need to retain any earnings, so all of its after-tax income will
be paid out to its investors, who will have to pay personal taxes on whatever they receive.
What is the difference in the percentage of the firm's pre-tax income that investors actually
receive and can spend under the corporate and partnership forms of organization?
a. 26.42%
b. 23.8%
c. 23.09%
d. 25.70%
e. 18.56%
____ 10. Other things held constant, which of the following actions would increase the amount of cash
on a companys balance sheet?
a. The company repurchases common stock.
b. The company pays a dividend.
c. The company issues new common stock.
d. The company gives customers more time to pay their bills.
e. The company purchases a new piece of equipment.
____ 11. Which of the following items is NOT normally considered to be a current asset?
a. Accounts receivable.
b. Inventory.
c. Bonds.
d. Cash.
e. Short-term, highly-liquid, marketable securities.
____ 12. Which of the following items cannot be found on a firms balance sheet under current
liabilities?
a. Accounts payable.
b. Short-term notes payable to the bank.
c. Accrued wages.
d. Cost of goods sold.
e. Accrued payroll taxes.
____ 14. Below are the 2010 and 2011 year-end balance sheets for Tran Enterprises:
Assets:
Cash
Accounts receivable
Inventories
Total current assets
Net fixed assets
Total assets
Liabilities and equity:
Accounts payable
Notes payable
Total current liabilities
Long-term debt
Common stock
Retained earnings
Total common equity
Total liabilities and equity
2011
$ 200,000
864,000
2,000,000
$3,064,000
6,000,000
$9,064,000
2010
$ 170,000
700,000
1,400,000
$2,270,000
5,600,000
$7,870,000
$1,400,000
1,600,000
$3,000,000
2,400,000
3,000,000
664,000
$3,664,000
$9,064,000
$1,090,000
1,800,000
$2,890,000
2,400,000
2,000,000
580,000
$2,580,000
$7,870,000
The firm has never paid a dividend on its common stock, and it issued $2,400,000 of 10-year,
non-callable, long-term debt in 2010. As of the end of 2011, none of the principal on this debt
had been repaid. Assume that the companys sales in 2010 and 2011 were the same. Which of
the following statements must be CORRECT?
a.
b.
c.
d.
e.
The firm
The firm
The firm
The firm
The firm
d. Congress recently changed the tax laws to make dividend income received by
individuals exempt from income taxes. Prior to the enactment of that law,
corporate income was subject to double taxation, where the firm was first
taxed on the corporation's income and stockholders were taxed again on this
income when it was paid to them as dividends.
e. All corporations other than non-profits are subject to corporate income
taxes, which are 15% for the lowest amounts of income and 38% for the
highest amounts.
____ 19. Last year, Delip Industries had (1) negative cash flow from operations, (2) a negative free
cash flow, and (3) an increase in cash as reported on its balance sheet. Which of the following
factors could explain this situation?
a. The company had a sharp increase in its inventories.
b. The company had a sharp increase in its accrued liabilities.
c. The company sold a new issue of common stock.
d. The company made a large capital investment early in the year.
e. The company had a sharp increase in depreciation expenses.
____ 20. The Nantell Corporation just purchased an expensive piece of equipment. Assume that the
firm planned to depreciate the equipment over 5 years on a straight-line basis, but Congress
then passed a provision that requires the company to depreciate the equipment on a straightline basis over 7 years. Other things held constant, which of the following will occur as a
result of this Congressional action? Assume that the company uses the same depreciation
method for tax and stockholder reporting purposes.
a. Nantells taxable income will be lower.
b. Nantells operating income (EBIT) will increase.
c. Nantells cash position will improve (increase).
____ 21. Assume that Besley Golf Equipment commenced operations on January 1, 2011, and it was
granted permission to use the same depreciation calculations for shareholder reporting and
income tax purposes. The company planned to depreciate its fixed assets over 15 years, but in
December 2011 management realized that the assets would last for only 10 years. The firm's
accountants plan to report the 2011 financial statements based on this new information. How
would the new depreciation assumption affect the companys financial statements?
a. The firms reported net fixed assets would increase.
b. The firms EBIT would increase.
c. The firms reported 2011 earnings per share would increase.
d. The firms cash position in 2011 and 2012 would increase.
e. The provision will increase the company's tax payments.
____ 22. The CFO of Daves Industries plans to have the company issue $300 million of new common
stock and use the proceeds to pay off some of its outstanding bonds that carry a 7% interest
rate. Assume that the company, which does not pay any dividends, takes this action, and that
total assets, operating income (EBIT), and its tax rate all remain constant. Which of the
following would occur?
a. The companys taxable income would fall.
b. The companys interest expense would remain constant.
c. The company would have less common equity than before.
d. The companys net income would increase.
e. The company would have to pay less taxes.
____ 23. Brown Fashions Inc.'s December 31, 2011 balance sheet showed total common equity of
$4,050,000 and 295,000 shares of stock outstanding. During 2011, the firm had $450,000 of
net income, and it paid out $100,000 as dividends. What was the book value per share at
12/31/11, assuming no common stock was either issued or retired during 2011?
a. $11.34
b. $13.87
c. $16.56
d. $12.38
e. $14.92
____ 24. On 12/31/11, Hite Industries reported retained earnings of $502,500 on its balance sheet,
and it reported that it had $135,000 of net income during the year. On its previous balance
sheet, at 12/31/10, the company had reported $445,000 of retained earnings. No shares were
repurchased during 2011. How much in dividends did the firm pay during 2011?
a. $78,275
b. $89,125
c. $83,700
d. $96,100
e. $77,500
____ 25. Your corporation has the following cash flows: If the applicable income tax rate is 40%
(federal and state combined), and if 70% of dividends received are exempt from taxes, what
is the corporation's tax liability?
Operating income
Interest received
Interest paid
Dividends received
Dividends paid
a.
b.
c.
d.
e.
$250,000
$10,000
$45,000
$15,000
$50,000
$71,118
$87,800
$86,044
$102,726
$98,336
____ 26. Wu Systems has the following balance sheet. How much net operating working capital does the
firm have?
Cash
Accounts receivable
Inventory
Current assets
Net fixed assets
$ 100
650
550
$ 1,300
$ 1,000
Total assets
$ 2,300
a. $1,025
Accounts payable
Accruals
Notes payable
Current liabilities
Long-term debt
Common equity
Retained earnings
Total liab. & equity
$ 200
75
625
$ 900
600
300
500
$ 2,300
b.
c.
d.
e.
$1,138
$1,179
$933
$1,169
____ 27. Hartzell Inc. had the following data for 2010, in millions: Net income = $600; after-tax
operating income [EBIT (1-T)] = $700; and Total assets = $2,000. Information for 2011 is as
follows: Net income = $825; after-tax operating income [EBIT (1-T)] = $1,125; and Total
assets = $2,500. How much free cash flow did the firm generate during 2011?
a. $644
b. $494
c. $481
d. $675
e. $625
$67,200
$82,600
$64,400
$70,000
$83,300
____ 29. Garner Grocers began operations in 2008. Garner has reported the following levels of taxable
income (EBT) over the past several years. The corporate tax rate was 34% each year. Assume
that the company has taken full advantage of the Tax Codes carry-back, carry-forward
provisions, and assume that the current provisions were applicable in 2008. What is the
amount of taxes the company paid in 2011?
Year
Taxable Income
2008
2009
2010
2011
a.
b.
c.
d.
e.
-$2,750,000
$200,000
$500,000
$2,800,000
$295,800
$272,850
$288,150
$255,000
$201,450
____ 30. A 7-year municipal bond yields 4.8%. Your marginal tax rate (including state and federal
taxes) is 28%. What interest rate on a 7-year corporate bond of equal risk would provide you
with the same after-tax return?
a. 5.20%
b. 6.20%
c. 5.40%
d. 5.80%
e. 6.67%
____ 31. Allen Corporation can (1) build a new plant that should generate a before-tax return of 11%, or
(2) invest the same funds in the preferred stock of Florida Power & Light (FPL), which should
provide Allen with a before-tax return of 9%, all in the form of dividends. Assume that Allens
marginal tax rate is 25%, and that 70% of dividends received are excluded from taxable
income. If the plant project is divisible into small increments, and if the two investments are
equally risky, what combination of these two possibilities will maximize Allens effective
return on the money invested?
a. All in FPL preferred stock.
b. 60% in FPL; 40% in the project.
c. All in the plant project.
d. 60% in the project; 40% in FPL.
e. 50% in each.
____ 32. West Corporation has $50,000 that it plans to invest in marketable securities. The
corporation is choosing between the following three equally risky securities: Alachua County
tax-free municipal bonds yielding 8.5%; Exxon Mobil bonds yielding 10.5%; and GM preferred
stock with a dividend yield of 9.25%. Wests corporate tax rate is 15%. What is the after-tax
return on the best investment alternative? Assume a 70% dividend exclusion for Tax on
Dividends. (Assume the company chooses on the basis of after-tax returns.)
a.
b.
c.
d.
e.
8.747%
9.461%
8.657%
8.925%
7.765%
____ 33. Uniontown Books began operating in 2007. The company lost money its first three years of
operations, but has had an operating profit during the past two years. The companys
operating income (EBIT) for its first five years was as follows:
Year
2007
2008
2009
2010
2011
EBIT
-$5,000,000
-$2,000,000
-$1,000,000
$1,200,000
$7,000,000
The company has no debt, and therefore, pays no interest expense. Its corporate tax rate has
remained at 34% during this 5-year period. What was Uniontowns tax liability for 2011?
(Assume that the company has taken full advantage of the carry-back and carry-forward
provisions, and assume that the current provisions were applicable in 2007.)
a. $85,000
b. $77,520
c. $65,960
d. $68,000
e. $78,200
____ 34. Mays Industries was established in 2006. Since its inception, the company has generated the
following levels of taxable income (EBT):
Year
2006
2007
2008
2009
2010
2011
Taxable Income
$50,000
$40,000
$30,000
$20,000
-$92,500
$60,000
Assume that each year the company has faced a 40% income tax rate. Also, assume that the
company has taken full advantage of the Tax Codes carry-back, carry-forward provisions, and
assume that the current provisions were applicable in 2006. What is the companys tax
liability for 2011?
a. $5,810
b. $6,790
c. $7,000
d. $7,420
e. $5,740
____ 35. Last year, Martyn Company had $140,000 in taxable income from its operations, $50,000 in
interest income, and $100,000 in dividend income. Using the corporate tax rate table given
below, what was the companys tax liability for the year?
Taxable Income
$0-$50,000
$50,000-$75,000
$75,000-$100,000
$100,000-$335,000
$335,000$10,000,000
$10,000,000$15,000,000
$15,000,000$18,333,333
Over $18,333,333
a.
b.
c.
d.
e.
$69,050
$75,265
$64,907
$70,431
$80,098
Tax on Base of
Bracket
$0
7,500
13,750
22,250
113,900
3,400,000
35
5,150,000
38
6,416,667
35
____ 36. Last year, Stewart-Stern Inc. reported $11,250 of sales, $4,500 of operating costs other
than depreciation, and $1,250 of depreciation. The company had $3,500 of bonds outstanding
that carry a 6.5% interest rate, and its federal-plus-state income tax rate was 35%. During
last year, the firm had expenditures on fixed assets and net operating working capital that
totaled $2,000. These expenditures were necessary for it to sustain operations and generate
future sales and cash flows. This year's data are expected to remain unchanged except for
one item, depreciation, which is expected to increase by $1,350. By how much will the
depreciation change cause (1) the firm's net income and (2) its free cash flow to change?
Note that the company uses the same depreciation for tax and stockholder reporting
purposes.
Net Income
a.
b.
c.
d.
e.
-$877.50
-$1,044.23
-$1,070.55
-$693.23
-$658.13
____ 37. Companies E and P each reported the same earnings per share (EPS), but Company Es stock
trades at a higher price. Which of the following statements is CORRECT?
a. Company E probably has fewer growth opportunities.
b. Company E is probably judged by investors to be riskier.
c. Company E must have a higher market-to-book ratio.
d. Company E must pay a lower dividend.
e. Company E trades at a higher P/E ratio.
____ 38. You observe that a firms ROE is above the industry average, but its profit margin and debt
ratio are both below the industry average. Which of the following statements is CORRECT?
a. Its total assets turnover must be above the industry average.
b. Its return on assets must equal the industry average.
c. Its TIE ratio must be below the industry average.
d. Its total assets turnover must be below the industry average.
e. Its total assets turnover must equal the industry average.
____ 39. Companies HD and LD have the same tax rate, sales, total assets, and basic earning power.
Both companies have positive net incomes. Company HD has a higher debt ratio and,
therefore, a higher interest expense. Which of the following statements is CORRECT?
a. Company HD has a lower equity multiplier.
b.
c.
d.
e.
Company
Company
Company
Company
____ 42. Walter Industries current ratio is 0.5. Considered alone, which of the following actions would
INCREASE the companys current ratio?
a. Borrow using short-term notes payable and use the cash to increase
inventories.
b.
c.
d.
e.
Use cash
Use cash
Use cash
Use cash
to reduce accruals.
to reduce accounts payable.
to reduce short-term notes payable.
to reduce long-term bonds outstanding.
____ 43. Meyer Inc's assets are $745,000, and its total debt outstanding is $185,000. The new CFO
wants to establish a debt/assets ratio of 55%. The size of the firm does not change. How
much debt must the company add or subtract to achieve the target debt ratio?
a. $168,563
b. $224,750
c. $191,038
d. $211,265
e. $271,948
____ 44. Last year Ann Arbor Corp had $110,000 of assets, $305,000 of sales, $20,000 of net income,
and a debt-to-total-assets ratio of 37.5%. The new CFO believes a new computer program will
enable it to reduce costs and thus raise net income to $33,000. Assets, sales, and the debt
ratio would not be affected. By how much would the cost reduction improve the ROE?
a. 22.12%
b. 23.26%
c. 19.67%
d. 21.18%
e. 18.91%
____ 45. Last year Kruse Corp had $420,000 of assets, $403,000 of sales, $28,250 of net income, and
a debt-to-total-assets ratio of 39%. The new CFO believes the firm has excessive fixed
assets and inventory that could be sold, enabling it to reduce its total assets to $252,500.
Sales, costs, and net income would not be affected, and the firm would maintain the same
debt ratio (but with less total debt). By how much would the reduction in assets improve the
ROE?
a. 7.31%
b. 7.46%
c. 7.17%
d. 5.78%
e. 6.00%
The balance sheet and income statement shown below are for Koski Inc. Note that the firm
has no amortization charges, it does not lease any assets, none of its debt must be retired
during the next 5 years, and the notes payable will be rolled over.
Balance Sheet (Millions of $)
Assets
Cash and securities
Accounts receivable
Inventories
Total current assets
Net plant and
equipment
Total assets
Liabilities and Equity
Accounts payable
Notes payable
Accruals
Total current
liabilities
Long-term bonds
Total debt
Common stock
Retained earnings
Total common equity
Total liabilities and equity
2010
$1,290
9,890
13,760
$24,940
$18,060
$43,000
$8,170
6,020
4,730
$18,920
$8,815
$27,735
$5,805
9,460
$15,265
$43,000
500.00
$346.67
6.25%
35%
$23.77
1.
2.
3.
4.
5.
6.
7.
8.
D
A
C
D
E
D
D
B
Corporate tax rate
(TC):
Personal tax rate
(TP):
Corporate
net
Investors'
net
34%
30%
46.2%
The business pays no tax, but investors pay tax on business income.
Investors'
net
Difference
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
B
C
C
D
B
C
E
E
C
C
C
B
(1 -
(1 -
70%
23.8%
21. D
22. D
23. E
12/31/11 common equity
2011 net income
2011 dividends
2011 addition to retained earnings
12/31/11 common equity
Shares outstanding
12/31/11 BVPS $14.92
$4,050,000
$450,000
$100,000
$350,000
$4,400,000
295,000
24. E
12/31/11 RE
$502,500
12/31/10 RE
$445,000
Change in RE
$57,500
Net income for 2011
$135,000
Dividends = Net income - Change $77,500
25. B
Operating income
$250,000
Interest received
$10,000
Interest paid
$45,000
Dividends received
$15,000
Divdend exclusion %
70%
Dividends paid
$50,000
Tax rate (T)
40%
Taxable income = Oper. income + Interest received Interest paid + Taxable dividends
received
Taxable income = Oper. income + Interest received Interest paid + dividends received
(1 Div exclusion %)
Taxable income = $219,500
Taxes paid = Taxable income Tax rate
Taxes paid = $87,800
26. A
Cash
Accounts receivable
Inventory
Current assets
Net fixed assets
$100
650
550
$1,300
1,000
Accounts payable
Accruals
Notes payable
Current liabilities
Long-term debt
Common equity
$200
75
625
$ 900
600
300
Total assets
Retained earnings
Total liab. & equity
$ 2,300
2010
$2,000
2011
$2,500
2011 FCF =
EBIT(1 - T)
2011 FCF =
$1,125
2011 FCF = $625
EBT
$1,616,667
Interest
EVA
EBIT(1
T)
$970,000
(WACC
EVA
$850,000
$200,000
$9,000,000
40%
10%
Net income / (1 T)
$1,416,667
EBIT
EBIT
EVA
28. D
Net income
Interest expense
Investor-supplied operating capital
Tax rate
After-tax cost of capital
EBT
EBT
500
$2,300
$900,000
Total investor-supplied
capital)
$70,000
29. D
Tax rate
34%
CarryForward
EBT After
Forward
Unused
Carryable
Year
2008
2009
2010
2011
2011
2011
Tax. Income
Used
-$2,750,000
$0
$200,000
$200,000
$500,000
$500,000
$2,800,000 $2,050,000
Tax liability =
Tax liability =
30. E
Municipal bond yield
Tax rate
Municipal yield
4.80%
4.80%
BT yield
31. A
BT project return
BT preferred return
Tax rate
Dividend exclusion %
Applied
$0
$0
$0
$750,000
Amount
$2,750,000
$2,550,000
$2,050,000
$0
4.80%
28.00%
=
=
=
=
(1 T)
72.00%
11.00%
9.00%
25.00%
70.00%
(1 T)
8.50%
10.50%
9.25%
15.00%
70.00%
Since municipal bonds are exempt from federal taxes, its BT return = AT return
AT municipal bond yield 8.500%
AT bond yield =
BT bond yield
AT bond yield = 8.925%
(1 T)
34%
Year
Tax. Income
2007 -$5,000,000
2008 -$2,000,000
2009 -$1,000,000
2010
$1,200,000
2011
$7,000,000
CarryForward
Used
$0
$0
$0
$1,200,000
$6,800,000
EBT After
Forward
Applied
$0
$0
$0
$0
$200,000
Unused
Carryable
Amount
$5,000,000
$7,000,000
$8,000,000
$6,800,000
$0
34. C
Tax rate
40%
Year
Tax. Income
2006
$50,000
2007
$40,000
2008
$30,000
2009
$20,000
2010
-$92,500
2011
$60,000
2011 Tax liability = EBT
2011 Tax liability = $7,000
35. A
Operating income
Interest income
Dividend income
Carry-Forward
Used
$0
$0
$0
$0
$0
$92,500
Tax rate
$140,000
$50,000
$100,000
EBT After
Unused
Forward
Carryable
Applied
Amount
$50,000
$0
$40,000
$0
$30,000
$0
$20,000
$0
$0
$92,500
$17,500
$0
Dividend exclusion %
70%
$22,250
$46,800
$69,050
36. A
This problem can be worked very easily--just multiply the increase in depreciation by (1-T) to
get the decrease in net income, and then subtract this value from the change in depreciation
to get the change in free cash flow:
Change in depreciation
Tax rate
Reduction in net income = Change in Depr'n (1 - Tax rate)
Increase in free cash flow = Change in Depr'n - Reduction
in NI
$1,350
35.00%
-$877.50
$472.50
You can also get the answer the long way, which explains things in more detail:
Old
New
Change
Bonds
$3,500 $3,500
$0.00
Interest rate
6.50% 6.50%
0.00
Tax rate
35%
35%
0.00
Capex + NOWC
$2,000 $2,000
$0.00
Sales
$11,250 $11,250
$0.00
Operating costs excluding depreciation
$4,500 $4,500
$0.00
Depreciation
Operating income (EBIT)
Taxes
Net income
Interest charges
Taxable income
Tax
$472.50
I like this problem because it illustrates that an increase in depreciation will decrease
the firm's net income yet increase its free cash flow, and cash is king.
37. E
38. A
39. E
HD has higher interest charges. Basic earning power equals EBIT/Assets, and since assets
and BEP are equal, EBIT must also be equal. TIE = EBIT/Interest. Therefore, HD's higher
interest charges means that its TIE must be lower.
40.
41.
42.
43.
E
C
A
B
Total assets
Old debt
Target debt ratio
Target amount of debt = Target debt% Total
assets =
Change in amount of debt outstanding = Target debt - Old
debt =
44. E
Assets
Debt ratio
Debt = Assets Debt% =
Equity = Assets - Debt =
$745,000
$185,000
55%
$409,750
$224,750
$110,000
37.5%
$41,250
$68,750
Sales
Old net income
New net income
New ROE = New NI / Equity =
Old ROE = Old NI / Equity =
Increase in ROE = New ROE Old ROE
=
$305,000
$20,000
$33,000
48.00%
29.09%
18.91%
45. A
Original
New
$420,000 $252,500
$403,000 $403,000
$28,250 $28,250
39.00% 39.00%
$163,800 $98,475
$256,200 $154,025
11.03%
18.34%
7.31%
Assets
Sales
Net income
Debt ratio
Debt = Assets debt% =
Equity = Assets - Debt =
ROE = NI / Equity =
Increase in ROE
46. A
Inventory turnover ratio = Sales/Inventory =
47. E
Debt ratio = Total debt/Total assets
=
3.75
64.5%
48. A
ROA = Net income/Total assets =
2.30%
49. B
ROE = Net income/Common equity =
6.49%
50. A
P/E ratio = Price per share/Earnings per share
=
12.0