Financial Analysis and Decision Making

Financial Analysis and Decision Making

Make sure all work is legible and all work is shown for problems 16 – 27.

FOR MULTIPLE CHOICE, HIGHLIGHT OR BOLD YOUR RESPONSE

1. Moshen Corporation just announced that its net income was lower than last year. Nevertheless, analysts estimate that the company’s net cash flow increased. What factors could explain this inconsistency?

a. The company’s depreciation expense increased.

b. The company’s interest expense declined.

c. The company had an increase in its non-cash revenues.

d. Answers a and b are correct.

e. Answers b and c are correct.

2.  Rivers Edge Inc. has annual sales of $737,000. Earnings before interest and taxes is equal to 21 percent of sales. For the period, the firm paid $7,900 in interest. What is the profit margin if the tax rate is 35 percent?  a. 12.46 percent b. 12.95 percent c. 13.33 percent d. 15.29 percent e. 16.11 percent

3. Of the following activities, which will increase cash?

a. increasing inventory

b. repurchasing shares of stock

c. increasing accounts payable

d. buying new equipment

e. increasing prepaid taxes

4.  All else held constant, which will increase the present value of an annuity?

I. Increase in the number of payments

II. Increase in the interest rate

III. Decrease in the interest rate.

IV. Decrease in the payment amount  a. I and II only b. I and III only c. II and IV only d. I, II, and IV only e. I, III, and IV only

5. An investment will pay $3,500 five years from now. If the going interest rate on the 5-year security is 4.25%, how much is it worth today?

a. $1,928.78

b.$2,030.30

c. $2,131.81

d.$2,238.40

e. $2,842.42

6.  Standard deviation measures _____ risk while beta measures _____ risk.  a. systematic; unsystematic b. unsystematic; systematic c. total; unsystematic d. total; systematic e. asset-specific; market

7.  Forever Memories Corp. just paid an annual dividend of $2.80. The company has increased its dividend by 2.5 percent a year for the past ten years and expects to continue doing so. What will a share of this stock be worth six years from now if the required return is 16 percent?  a. $23.60 b. $24.65 c. $25.08 d. $25.50 e. $26.90

8. Main distinguishing differences between debt and equity capital consist of all of the following EXCEPT:

a. Debtholders have no voice in management so long as the issuer does not violate stated contractual obligations.

b. Claims on income and assets are as follows: bondholders, preferred shareholders, common shareholders.

c. Debt has a stated maturity, while equity does not.

d. In terms of tax treatment, common equity is entitled to a tax deduction.

e. Common stockholders have voting rights.

9. The payback period is the length of time it takes an investment to generate sufficient cash flows to enable the project to:  a. produce a positive annual cash flow. b. produce a positive cash flow from assets. c. offset its fixed expenses. d. offset its total expenses. e. recoup its initial cost.

10. Define the internal rate of return for a project: a. Discount rate that creates a zero cash flow from assets b. Discount rate which results in a zero net present value for the project c. Discount rate which results in a net present value equal to the project’s initial cost d. Rate of return required by the project’s investors e. The project’s current market rate of return

11. What is the net present value of a project that has an initial cost of $41,000 and produces cash inflows of $8,000 a year for 11 years if the discount rate is 15 percent?  a. $869.69 b. $1,240.23 c. $1,869.69 d. $2,111.41 e. $2,470.01

12. Consider the following two mutually exclusive projects:    Whichever project you choose, if any, you require a 14 percent return on your investment. If you apply the payback criterion, you will choose investment _____, if you apply the NPV criterion, you will choose investment _____; if you apply the IRR criterion, you will choose investment ____; if you choose the profitability index criterion, you will choose investment ____. Based on your first four answers, which project will you finally choose?  a. A; B; A; A; B b. A; A; B; B; A c. A; A; B; B; B d. B; A; B; A; A e. B; A; B; B; A

13. A 5.0 percent $1,000 bond matures in 7 years, pays interest semiannually, and has a yield to maturity of 6.23 percent. What is the current market price of the bond? a. $962.40 b. $931.07 c. $959.09 d. $967.60 e. $945.08

14. To help finance a major expansion, Castro Chemical Company sold a noncallable bond several years ago that now has 20 years to maturity. This bond has a 9.25% coupon, paid semiannually, sells at a price of $1,025, and has a par value of $1,000. If the firm’s tax rate is 40%, what is the component cost of debt for use in the WACC calculation?

a. 4.35%

b. 4.58%

c. 4.83%

d. 5.08%

e. 5.39%

15. Sorensen Systems Inc. is expected to pay a $2.50 dividend at year end (D1 = $2.50), the dividend is expected to grow at a constant rate of 5.50% a year, and the common stock currently sells for $52.50 a share. The before-tax cost of debt is 6.50%, and the tax rate is 40%. The target capital structure consists of 45% debt and 55% common equity. What is the company’s WACC if all the equity used is from retained earnings?

a. 7.07%

b. 7.40%

c. 7.67%

d. 7.98%

e. 8.29%

Section II – Problems (51 pts. available on problems– 48pts. count)

FOR PROBLEMS, SHOW YOUR WORK WHEN ABLE AND HIGHLIGHT OR BOLD YOUR ANSWER

Use the financial statements of the XYZ Corporation (found on last page of exam) to answer problems #17 & #18:

16. What is:

a) (2pts) the Operating Cash Flow for 2013?

b) (2 pts) the change in Net Working Capital for 2013?

c) (2 pts) Capital Spending for 2013?

d) (2 pts) the Free Cash Flow (or Cash Flow from Assets) for 2013?

17. Calculate the financial ratio for XYZ Corp. for ’13. The industry standard is provided in brackets. Comment on results as to how XYZ Corp. fairs to the industry average.

a) (2 pts) Quick Ratio (Acid Test) {Industry average 1.3}

b) (2 pts) Day Sales in Receivables (also known as Average Collection Period) {Industry average 42}

c) (2 pts) Profit Margin {Industry average 5%}

d) (2 pts) Return on Common Equity (ROE) {Industry average 17%}

18. (3 points) You find a home that you can purchase for $250,000. You make a 20 percent down-payment on the home. You find a savings bank that will write a loan for 30 years at a 6 percent annual rate with monthly payments that include interest and principal. Calculate the monthly payment.

19. (3 pts.) Assume you are to receive a 25-year annuity with annual payments of $50. The first payment will be received at the end of Year 1, and the last payment will be received at the end of year 25. You will invest each payment in an account that pays 10 percent. What will be the value in your account at the end of Year 30?

20. (3 points) Over the past 4 years, a stock produced returns of 15 percent, 6 percent, 11 percent, and 22 percent. Based on these 4 years, what range of returns would you expect to see 68 percent of the time? 

21. (3 points) Due to a number of lawsuits related to toxic wastes, a major chemical manufacturer has recently experienced a market reevaluation. The firm has a bond issue outstanding with 15 years to maturity and a coupon rate of 9 percent, with interest paid semi-annually. The required nominal rate on this debt has now risen to 16 percent. Face value of the bonds is $1000. What is the current value of this bond?

22. (3 points) Excite Inc. is expected to maintain a constant 5.8 percent growth rate in its dividends, indefinitely. If the company has a dividend yield of 4.7 percent, what is the required return on the company’s stock?

23. (3 points) Eastern Seed Supply is considering a project that has the following cash flow and WACC data. What is the project’s NPV?

WACC: 10.00%

Year 0 1 2 3

Cash flows -$950 $500 $400 $300

24. (3 points) Stern Associates is considering a project that has the following cash flow data. What is the project’s IRR? (Note that a project’s projected IRR can be less than the WACC (and even negative), in which case it will be rejected.)

Year 0 1 2 3 4 5

Cash flows -$9,500 $2,000 $2,025 $2,050 $2,075 $2,100

25. (3 points) Lloyd Systems is considering a project that has the following cash flow data. What is the project’s payback?

Year 0 1 2 3 4 5

Cash flows -$1,100 $300 $310 $320 $330 $340

26. (3 points) Last month, Anderson Co. analyzed the project whose cash flows are shown below. However, before the decision to accept or reject the project, the Federal Reserve took actions that changed interest rates and therefore the firm’s WACC. The Fed’s action did not affect the forecasted cash flows. By how much did the change in the WACC affect the project’s forecasted NPV?

Old WACC: 10.00% New WACC: 11.25%

Year 0 1 2 3

Cash flows -$1,000 $410 $410 $410

Problem 27 (each part is worth 2 points)

You have been hired as a consultant by to estimate XYZ firm’s weighted average cost of capital. Its target capital structure is 20% debt, 20% preferred stock, and 60% common equity. Its bonds have a 12% coupon, paid semi-annually, a current maturity of 20 years, and sell for $929.30. The firm could sell, at par, $1,000 preferred stock which pays a 12% annual dividend (cost of preferred stock). XYZ’s beta is 1.2, the yield on a 10-year Treasury bond is 10% and the required return on the stock market is 14%. XYZ is a constant growth firm which just paid a dividend of $2.00, sell for $27.00 per share, and has a growth rate of 8%. The firm’s marginal tax rate is 40%.

a) What is XYZ’s after-tax cost of Debt?

b) What is XYZ’s cost of common stock using the Capital Asset Pricing Model approach?

c) What is the firm’s cost of common stock using the Dividend Discount Model approach?

d) What is XYZ’s Weighted Average Cost of Capital (WACC)?

Section III – Short Answer Essays

28. (5 pts.) In one sentence or two: What should be the primary goal of a financial manager?

29. (5pts.) Pick one of the following topics covered: 1) Financial Statement Analysis, 2) Working Capital Management, 3) Time Value of Money, 4) Risk and Reward Tradeoff, 5) Securities Valuation, 6) Capital Budgeting

Explain its relevance to that of a financial manager in 5 sentences or less:

XYZ Corporation Income Statements for year ending December 31
	(thousands of dollars)
	2013	2012
Sales	1,500.0	1,200.0
Operating costs excluding depreciation	1,275.0	1,020.0
Depreciation	36.0	30.0
Earnings before interest & taxes (EBIT)	189.0	150.0
Less Interest	23.3	21.7
Earnings before taxes	165.7	128.3
Taxes (40%)	66.3	51.3
Net Income available to common stockholders	99.4	77.0
Common dividends	69.0	5.5
XYZ Corporation Balance Sheets as of December 31
	(thousands of dollars)
	2013	2012
Assets
Cash and equivalents	14.4	12.0
Short-term investments	0.0	0.0
Accounts receivable	225.0	180.0
Inventories	225.0	240.0
Total current assets	464.4	432.0
Net plant and equipment	360.0	300.0
Total Assets	824.4	732.0
Liabilities and Equity
Accounts payable	135.0	108.0
Notes payable	84.0	67.0
Accruals	90.0	72.0
Total current liabilities	309.0	247.0
Long-term bonds	180.0	180.0
Total liabilities	489.0	427.0
Common stock	55.0	55.0
Retained earnings	280.4	250.0
Common equity	335.4	305.0
Total liabilities and equity	824.4	732.0

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