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Date Posted: 10:40:37 07/05/00 Wed
Author: Richard Fendler
Subject: FENDLER SAMPLE MID TERM EXAM

This is the exam that I gave last Spring. This semester's exam will be similar. I DO NOT have an answer key for the exam. You
are free to post possible answers/solutions and share with one another.

R. Fendler


BA 8622 - CORPORATION FINANCE
Spring 1999
EXAM ONE


Name _________________________________________________________

Part I: Multiple Choice Questions/Short Problems (2.5 pts each) - Circle the letter corresponding with the best correct answer to
each multiple choice question (there is only one best answer per multiple choice question).

1. In order to accurately estimate cash flow from operations, depreciation must be added back to net income. The reason for this
is that even though depreciation is deducted from revenue it is really a non-cash charge.

a. True
b. False

2. One of the problems of ratio analysis is that account relationships can be manipulated. For example, we know that if we use
some of our cash to pay off some of our current liabilities, the current ratio will always increase, especially if the current ratio is
low initially, for example, below 1.0.

a. True
b. False

3. Pro forma financial statements, as discussed in the text, are used primarily to assess a firm's historical performance.

a. True
b. False

4. When the present financial ratios of a firm are compared with similar ratios for another firm in the same industry it is called
trend analysis.

a. True
b. False

5. Firms today are more likely to rely on cash than on reserve borrowing power or marketable securities for speculative purposes.

a. True
b. False

6. The central goal of inventory management is to provide sufficient incentives to ensure that the firm never suffers a stock-out
(i.e., runs out of an inventory item).

a. True
b. False

7. Which of the following statements is most correct?

a. One of the ways in which firms can mitigate or reduce agency problems between bondholders and stockholders is by increasing
the amount of debt in the capital structure.
b. The threat of takeover is one way in which the agency problem between stockholders and managers can be alleviated.
c. Managerial compensation can be structured to reduce agency problems between stockholders and managers
d. Both statements b and c are correct.
e. All of the statements above are correct.



8. A seven-year municipal bond yields 4.8 percent. Your marginal tax rate is 28 percent. What interest rate on a seven-year
corporate bond of equal risk would provide you with the same after-tax return?

a. 3.46%
b. 4.80%
c. 6.14%
d. 6.67%
e. 17.14%



9. Swann Systems is forecasting the following income statement for the upcoming year:

Sales $5,000,000
Operating costs (excluding depreciation) 3,000,000
Gross margin $2,000,000
Depreciation 500,000
EBIT $1,500,000
Interest 500,000
EBT $1,000,000
Taxes (40%) 400,000
Net income $ 600,000

The company's president is disappointed with the forecast and would like to see Swann generate higher sales and a forecasted net
income of $2,000,000.

Assume that operating costs (excluding depreciation) are always 60 percent of sales. Also, assume that depreciation, interest
expense, and the company's tax rate, which is 40 percent, will remain the same even if sales change. What level of sales would
Swann have to obtain to generate $2,000,000 in net income?

a. $ 5,800,000
b. $ 6,000,000
c. $ 7,200,000
d. $ 8,300,000
e. $10,833,333

10. Which of the following actions will cause an increase in the quick ratio in the short run?

a. $1,000 worth of inventory is sold, and an account receivable is created. The receivable exceeds the inventory by the amount of
profit on the sale, which is added to retained earnings.
b. A small subsidiary which was acquired for $100,000 two years ago and which was generating profits at the rate of 10 percent is
sold for $100,000 cash. (Average company profits are 15 percent of assets.)
c. Marketable securities are sold at cost.
d. All of the answers above.
e. Answers a and b above.

11. Kansas Office Supply had $24,000,000 in sales last year. The company's net income was $400,000. Its total assets turnover
was 6.0. The company's ROE was 15 percent. The company is financed entirely with debt and common equity. What is the
company's debt ratio?

a. 0.20
b. 0.30
c. 0.33
d. 0.60
e. 0.66

12. Which of the following factors are likely to increase market interest rates?

a. Corporations increase their demand for capital.
b. Households become less willing to save.
c. Expected inflation increases.
d. Statements a and c are correct.
e. Statements a, b, and c are correct.

13. Churchill Corporation just issued bonds that will mature in 10 years. George Corporation just issued bonds that will mature in
12 years. Both bonds are standard coupon bonds that cannot be retired early. The two bonds are equally liquid. Which of the
following statements is most correct?

a. If the yield curve for Treasury securities is flat, Churchill's bond will have the same yield as George's bonds.
b. If the yield curve for Treasury securities is upward sloping, George's bonds will have a higher yield than Churchill's bonds.
c. If the two bonds have the same level of default risk, their yields will also be the same.
d. If the Treasury yield curve is upward sloping and Churchill has less default risk than George, then Churchill's bonds will have a
lower yield.
e. If the Treasury yield curve is downward sloping, George's bonds will have a lower yield.

14. Three-year Treasury bills currently yield 6 percent. Four-year Treasury bills currently yield 6.5 percent. Assume that the
expectations theory holds. What does the market believe the rate will be on one-year Treasury securities three years from now?

a. 8.0%
b. 8.5%
c. 9.0%
d. 9.5%
e. 10.0%
15. You have developed data which give (1) the average annual returns on the market for the past five years, and (2) similar
information on Stocks A and B. If these data are as follows, which of the possible answers best describes the historical betas
(denoted as b) for A and B?

Year Market Stock A Stock B
1 0.03 0.16 0.05
2 -0.05 0.20 0.05
3 0.01 0.18 0.05
4 -0.10 0.25 0.05
5 0.06 0.14 0.05

a. bA > 0; bB = 1
b. bA > +1; bB = 0
c. bA = 0; bB = -1
d. bA < 0; bB = 0
e. bA < -1; bB = 1

16. Which of the following is not a difficulty concerning beta and its estimation?

a. Sometimes a security or project does not have a past history which can be used as a basis for calculating beta.
b. Sometimes, during a period when the company is undergoing a change such as toward more leverage or riskier assets, the
calculated beta will be drastically different than the "true" or "expected future" beta.
c. The beta of an "average stock," or "the market," can change over time, sometimes drastically.
d. Sometimes the past data used to calculate beta do not reflect the likely risk of the firm for the future because conditions have
changed.
e. All of the above are difficulties concerning beta and its estimation.

17. A stock has an expected return of 12.25 percent. The beta of the stock is 1.15 and the risk-free rate is 5 percent. What is the
market risk premium?

a. 1.30%
b. 6.50%
c. 15.00%
d. 6.30%

18. Which of the following statements is most correct?

a. If a firm's volume of credit sales declines then its DSO will also decline.
b. If a firm changes its credit terms from 1/20, net 40 days, to 2/10, net 60 days, the impact on sales can't be determined because
the increase in the discount is offset by the longer net terms which tends to reduce sales.
c. The DSO of a firm with seasonal sales can vary because while the sales per day figure is usually based on the total annual
sales, the accounts receivable balance will be high or low depending on the season.
d. An aging schedule is used to determine what portion of customers pay cash and what portion buy on credit.
e. Aging schedules can be constructed from the summary data provided in the firm's financial statements.
Part II: Short Problems (6 pts each) - fill in answer on the line provided.

1. XYZ's balance sheet and income statement are given below:

Balance Sheet
Cash $ 50 Accounts payable $ 100
A/R 150 Notes payable 0
Inventories 300 Long-term debt (10%) 700
Fixed assets 500 Common equity (20 shares) 200
Total assets $1,000 Total claims $1,000

Income Statement
Sales $1,000
Cost of goods sold 855
EBIT $ 145
Interest 70
EBT $ 75
Taxes (33.333%) 25
Net income $ 50

The industry average inventory turnover is 5, the interest rate on the firm's long-term debt is 10 percent, 20 shares are outstanding,
and the stock sells at a P/E of 8.0. If XYZ changed its inventory methods so as to operate at the industry average inventory
turnover, if it used the funds generated by this change to buy back common stock at the current market price and thus to reduce
common equity, and if sales, the cost of goods sold, and the P/E ratio remained constant, by what dollar amount would its stock
price increase?


Stock Price increase = $_______________.

2. Gemini Beverage has the following historical balance sheet:

Cash $ 20 Accounts payable $ 200
Accounts receivable 240 Notes payable 130
Inventory 320 Accruals 30
Total current assets $ 580 Current liabilities $ 360
Net plant & equipment $ 420 Long-term bonds $ 260
Common stock 270
Retained earnings 110
Total assets $1,000 Total liab. & equity $1,000

Over the next year Gemini's current assets, accounts payable, and accruals will grow in proportion to sales. Last year's sales were
$800 and this year's sales are expected to increase by 40 percent. The firm will retain $58 in earnings to fund current asset
growth, and the rest of the increase will be funded entirely with notes payable. The net plant and equipment account will increase
to $500 and will be funded directly by a new equity issue. What will Gemini's new current ratio be after the changes in the firm's
financial picture are complete?


New Current ratio = ______________ times.
3. For each event listed below, determine the effect on the listed ratios (C.R. = Current ratio, Q.R. = Quick ratio, and NWC = Net
working capital). Write D (decrease), N (no effect), or I (increase) on the line next to each ratio.

a. Borrow $10,000 from bank on short-term note (i.e., notes payable) and deposit proceeds into checking account.

C.R. _____; Q.R. _____; NWC _____; Debt ratio _____


b. Issue $25,000 in new common stock and deposit proceeds into checking account.

C.R. _____; Q.R. _____; NWC _____; Debt ratio _____


c. Purchase $5,000 in inventory on credit (i.e., accounts receivable).

C.R. _____; Q.R. _____; NWC _____; Debt ratio _____


4. The Wilson Corporation has the following relationships:

Sales/Total assets = 2.0; Return on assets (ROA) = 4%; Return on equity (ROE) = 6%.


What is Wilson's net profit margin? _________________


What is Wilson's debt ratio? _________________


5. C. Stern, chief financial officer of R-M Corp., has just reviewed the current year's third-quarter financial results with company
president R. Macon. R-M Corp., sets an annual target for earnings growth of 12%. It now appears likely that the company will fall
short of that goal and achieve only a 9% increase in earnings. This would have a potentially detrimental impact on the firm's stock
price. President Macon has directed C. Stern to develop alternative plans to stimulate earnings during the last quarter in order to
reach the 12% target. C. Stern has approached you, a recent finance graduate of a well-known southeastern business school, to
make recommendations for meeting the firm's earnings growth objective during the coming year. List three different techniques
which could be used to increase earnings but which would lower the quality of reported earnings.

a.



b.



c.
PART IV: Problems (12.5 pts each)

1. The Balance Sheet for the Sharkton Company for the year ending December 31, 1996 is shown below:
Proforma
1996 1997

Cash $ 200,000 ____________
Accounts receivable 1,400,000 ____________
Inventory 3,600,000 ____________
Net Property & Plant 8,000,000 ____________
Total Assets $13,200,000 ____________

Notes payable $ 900,000 ____________
Accounts payable $ 600,000 ____________
Long term debt 6,500,000 ____________
Common Stock 4,800,000 ____________
Retained earnings 400,000 ____________
Total Liabilities and Net Worth $13,200,000 ____________

Additional Information:
Projected sales for 1997 = $19,200,000.
The 1997 dividend payout ratio will be 70 percent.
The 1997 Net profit margin is projected to be 4.0 percent
Sales for 1996 = $16,000,000.

a. Fill in the proforma balance sheet for 1997 (lines in chart above). Assume that all asset accounts and all spontaneous liability
accounts increase as a percent of sales. Assume no change in the 1996 financing variable values.







b. Compute Sharkton's outside funds needed to support the projected sales level for 1997.



Outside funds needed = _______________



2. You are holding a stock with a beta of 3.0. The required return on the stock is 24%, and the return on a risk free asset is 6%.
What should the return on the stock be if the stock's beta decreases to 2.5 while the risk free rate and market return remains
unchanged?














Compute the expected return and the standard deviation of the following stock?

Economy Return Probability
Boom 30% 10%
High growth 20% 20%
Moderate growth 12% 40%
No growth 5% 20%
Recession -10% 10%


Expected return = _______________; Standard deviation = _______________.











What is the required rate of return for the following portfolio of stocks if the risk free rate of return is 5% and the market return is
13%?

Stock $ Invested Beta
Red 10,000 2.5
Blue 50,000 2.2
Green 25,000 1.3
Yellow 15,000 0.5


Required return = _______________.

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