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4 Jun 2018

1) A company can improve its liquidity by increasing its accounts payable, while holding all else constant. Is this true or False?

2) The higher the times interest earned ratio, the more comfortable are a firm’s creditors in the ability of the firm to meet its interest obligations. Is this True or False?

3) A firm’s management analyzes financial statement’s so that:

a)they can get feedback on their investing, financing, and working capital decisions by identifying trends in the various accounts that are reported in the financial statements.

b) similar to shareholders, they can focus on profitability, dividend, capital appreciation, and return on investment.

c) they can get more stock options.

d) a and b.

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Sixta Kovacek
Sixta KovacekLv2
5 Jun 2018

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Related questions

Please answer if True/False and give a valid explanation.

1. When considering an institution’s capital plan, the Federal Reserve considers only quantitative factors. The only factor that matters is a firm’s capital ratios under severe economic and financial market stress. After the Federal Reserve objects to a capital plan, the institution may only make capital distributions that are equal to the distributions made in the previous year.

a. True/False

2. A bank that funds a portfolio of assets with higher credit risk than another bank has to have more equity capital if creditors are to be indifferent between lending to either bank.

a. True/False

3. Bank holding companies can issue common stock to raise equity capital.

a. True/False

4. The interest rate spread between 3 month financial commercial paper and 3 month constant maturity treasury securities declined from 160 basis points on June 15th, 2007 to 58 basis points on August 24, 2007. This is because the Fed was active in adding reserves to the banking system.

a. True/False

QUESTION 1

In the lease versus buy decision, leasing is often preferable

A.

because the lessee owns the property at the end of the least term.

B.

because lease obligations do not affect the firm's risk as seen by investors.

C.

because, generally, no down payment is required, and there are no indirect interest costs.

D.

because it has no effect on the firm's ability to borrow to make other investments.

E.

because the lessee may have greater flexibility in abandoning the project in which the leased property is used than if the lessee bought and owned the asset.

2 points

QUESTION 2

The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.

True

False

2 points

QUESTION 3

Ratio analysis involves analyzing financial statements in order to appraise a firm's financial position and strength.

True

False

2 points

QUESTION 4

Which of the following statements is CORRECT?

A.

If the returns on two stocks are perfectly positively correlated (i.e., the correlation coefficient is +1.0) and these stocks have identical standard deviations, an equally weighted portfolio of the two stocks will have a standard deviation that is less than that of the individual stocks.

B.

If a stock has a negative beta, its expected return must be negative.

C.

A portfolio with a large number of randomly selected stocks would have less market risk than a single stock that has a beta of 0.5.

D.

According to the CAPM, stocks with higher standard deviations of returns must also have higher expected returns.

E.

A portfolio with a large number of randomly selected stocks would have more market risk than a single stock that has a beta of 0.5, assuming that the stock's beta was correctly calculated and is stable.

2 points

QUESTION 5

Many leases written today combine the features of operating and financial leases. Such leases are often called "combination leases."

True

False

2 points

QUESTION 6

The owner of a convertible bond owns, in effect, both a bond and a call option.

True

False

2 points

QUESTION 7

If a firm raises capital by selling new bonds, it is called the "issuing firm," and the coupon rate is generally set equal to the required rate on bonds of equal risk.

True

False

2 points

QUESTION 8

Which of the following statements is most CORRECT?

A.

Warrants can sometimes be detached and traded separately from the debt with which they were issued, but this is unusual.

B.

One important difference between warrants and convertibles is that convertibles bring in additional funds when they are converted, but exercising warrants does not bring in any additional funds.

C.

The coupon rate on convertible debt is normally set below the coupon rate that would be set on otherwise similar straight debt even though investing in convertibles is more risky than investing in straight debt.

D.

Warrants have an option feature but convertibles do not.

E.

The value of a warrant to buy a safe, stable stock should exceed the value of a warrant to buy a risky, volatile stock, other things held constant.

2 points

QUESTION 9

Because of improvements in forecasting techniques, estimating the cash flows associated with a project has become the easiest step in the capital budgeting process.

True

False

2 points

QUESTION 10

The form of organization for a business is not an important issue, as this decision has very little effect on the income and wealth of the firm's owners.

True

False

2 points

QUESTION 11

Two important issues in corporate governance are (1) the rules that cover the board's ability to fire the CEO and (2) the rules that cover the CEO's ability to remove members of the board.

True

False

2 points

QUESTION 12

The "preferred" feature of preferred stock means that it normally will provide a higher expected return than will common stock.

True

False

2 points

QUESTION 13

If an investment project would make use of land which the firm currently owns, the project should be charged with the opportunity cost of the land.

True

False

2 points

QUESTION 14

Operating leases help to shift the risk of obsolescence from the user to the lessor.

True

False

2 points

QUESTION 15

Starting to invest early for retirement increases the benefits of compound interest.

True

False

2 points

QUESTION 16

Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock, and its beta will be greater than 1.0.

True

False

2 points

QUESTION 17

Other things held constant, an increase in the cost of capital will result in a decrease in a project's IRR.

True

False

2 points

QUESTION 18

An option is a contract that gives its holder the right to buy or sell an asset at a predetermined price within a specified period of time.

True

False

2 points

QUESTION 19

The optimal distribution policy strikes that balance between current dividends and capital gains that maximizes the firm's stock price.

True

False

2 points

QUESTION 20

If the current price of a stock is below the strike price, then an option to buy the stock is worthless and will have a zero value.

True

False

2 points

QUESTION 21

The desire for floating-rate bonds, and consequently their increased usage, arose out of the experience of the early 1980s, when inflation pushed interest rates up to very high levels and thus caused sharp declines in the prices of outstanding bonds.

True

False

2 points

QUESTION 22

Taylor Inc. estimates that its average-risk projects have a WACC of 10%, its below-average risk projects have a WACC of 8%, and its above-average risk projects have a WACC of 12%. Which of the following projects (A, B, and C) should the company accept?

A.

Project C, which is of above-average risk and has a return of 11%.

B.

Project A, which is of average risk and has a return of 9%.

C.

None of the projects should be accepted.

D.

All of the projects should be accepted.

E.

Project B, which is of below-average risk and has a return of 8.5%.

2 points

QUESTION 23

To finance the construction of a new plant, Pietersen Corporation must raise an additional $10,000,000 of equity capital through the sale of common stock. The firm currently has an EPS of $5.40 and a P/E ratio of 10, with 1,200,000 shares outstanding. If the firm wants its ex-rights price to be $50, what subscription price must it set on the new shares?

A.

$39.28

B.

$50.00

C.

$29.55

D.

$41.80

E.

$33.78

2 points

QUESTION 24

Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant?

A.

A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage.

B.

A bank loan's nominal interest rate will always be equal to or less than its effective annual rate.

C.

The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity.

D.

If an investment pays 10% interest, compounded annually, its effective annual rate will be less than 10%.

E.

Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays semiannually. Deposits in Bank B will provide the higher future value if you leave your funds on deposit.

2 points

QUESTION 25

Which of the following statements is CORRECT?

A.

In the statement of cash flows, a decrease in inventories is reported as a use of cash.

B.

In the statement of cash flows, a decrease in accounts receivable is reported as a use of cash.

C.

In the statement of cash flows, depreciation charges are reported as a use of cash.

D.

In the statement of cash flows, a decrease in accounts payable is reported as a use of cash.

E.

Dividends do not show up in the statement of cash flows because dividends are considered to be a financing activity, not an operating activity.

2 points

QUESTION 26

The term "additional funds needed (AFN)" is generally defined as follows:

A.

A forecasting approach in which the forecasted percentage of sales for each balance sheet account is held constant.

B.

Funds that are obtained automatically from routine business transactions.

C.

Funds that a firm must raise externally from non-spontaneous sources, i.e., by borrowing or by selling new stock to support operations.

D.

The amount of internally generated cash in a given year minus the amount of cash needed to acquire the new assets needed to support growth.

E.

The amount of assets required per dollar of sales.

2 points

QUESTION 27

The cash flows associated with common stock are more difficult to estimate than those related to bonds because stock has a residual claim against the company versus a contractual obligation for a bond.

True

False

2 points

QUESTION 28

Which of the following statements is CORRECT?

A.

The NPV method automatically deals correctly with externalities, even if the externalities are not specifically identified, but the IRR method does not. This is another reason to favor the NPV.

B.

Identifying an externality can never lead to an increase in the calculated NPV.

C.

Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not specifically identified. However, the payback method does not.

D.

An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank's other offices to increase.

E.

An externality is a situation where a project would have an adverse effect on some other part of the firm's overall operations. If the project would have a favorable effect on other operations, then this is not an externality.

2 points

QUESTION 29

Time lines can be constructed in situations where some of the cash flows occur annually but others occur quarterly.

True

False

2 points

QUESTION 30

A warrant is an option, and as such it cannot be used as a "sweetener."

True

False

2 points

QUESTION 31

BLW Corporation is considering the terms to be set on the options it plans to issue to its executives. Which of the following actions would decrease the value of the options, other things held constant?

A.

The life of the option is increased, i.e., the time until it expires is lengthened.

B.

The exercise price of the option is increased.

C.

The Federal Reserve takes actions that increase the risk-free rate.

D.

BLW's stock price becomes more risky (higher variance).

E.

BLW's stock price suddenly increases.

2 points

QUESTION 32

Convertible debentures for Kulik Corporation were issued at their $1,000 par value in 2012. At any time prior to maturity on February 1, 2032, a debenture holder can exchange a bond for 25 shares of common stock. What is the conversion price, Pc?

A.

$48.62

B.

$40.00

C.

$42.00

D.

$46.31

E.

$44.10

2 points

QUESTION 33

A stock is expected to pay a dividend of $0.75 at the end of the year. The required rate of return is rs = 10.5%, and the expected constant growth rate is g = 6.4%. What is the stock's current price?

A.

$18.29

B.

$17.39

C.

$19.22

D.

$18.75

E.

$17.84

2 points

QUESTION 34

If a firm's goal is to maximize its earnings per share, this is the best way to maximize the price of the common stock and thus shareholders' wealth.

True

False

2 points

QUESTION 35

The common stock of Southern Airlines currently sells for $33, and its 8% convertible debentures (issued at par, or $1,000) sell for $850. Each debenture can be converted into 25 shares of common stock at any time before 2025. What is the conversion value of the bond?

A.

$783.75

B.

$744.56

C.

$825.00

D.

$866.25

E.

$707.33

2 points

QUESTION 36

Which of the following statements is CORRECT?

A.

If interest rates increase, the price of a 10-year coupon bond will decline by a greater percentage than the price of a 10-year zero coupon bond.

B.

If a bond's yield to maturity exceeds its annual coupon, then the bond will trade at a premium.

C.

If a coupon bond is selling at par, its current yield equals its yield to maturity.

D.

If a coupon bond is selling at a premium, its current yield equals its yield to maturity.

E.

If a coupon bond is selling at a discount, its price will continue to decline until it reaches its par value at maturity.

2 points

QUESTION 37

A proxy is a document giving one party the authority to act for another party, including the power to vote shares of common stock. Proxies can be important tools relating to control of firms.

True

False

2 points

QUESTION 38

Projects S and L are equally risky, mutually exclusive, and have normal cash flows. Project S has an IRR of 15%, while Project L's IRR is 12%. The two projects have the same NPV when the WACC is 7%. Which of the following statements is CORRECT?

A.

Project S's NPV is more sensitive to changes in WACC than Project L's.

B.

If the WACC is 13%, Project S will have the lower NPV.

C.

If the WACC is 6%, Project S will have the higher NPV.

D.

If the WACC is 10%, both projects will have positive NPVs.

E.

If the WACC is 10%, both projects will have a negative NPV.

2 points

QUESTION 39

A firm's AFN must come from external sources. Typical sources include short-term bank loans, long-term bonds, preferred stock, and common stock.

True

False

2 points

QUESTION 40

Which of the following could explain why a business might choose to operate as a corporation rather than as a sole proprietorship or a partnership?

A.

Less of a corporation's income is generally subjected to taxes than would be true if the firm were a partnership.

B.

Corporate shareholders escape liability for the firm's debts, but this factor may be offset by the tax disadvantages of the corporate form of organization.

C.

Corporations generally find it relatively difficult to raise large amounts of capital.

D.

Corporations generally face relatively few regulations.

E.

Corporate investors are exposed to unlimited liability.

2 points

QUESTION 41

The cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on all outstanding debt.

True

False

2 points

QUESTION 42

Amram Company's current ratio is 1.9. Considered alone, which of the following actions would reduce the company's current ratio?

A.

Use cash to reduce accruals.

B.

Borrow using short-term notes payable and use the proceeds to reduce long-term debt.

C.

Use cash to reduce accounts payable.

D.

Borrow using short-term notes payable and use the proceeds to reduce accruals.

E.

Use cash to reduce short-term notes payable.

2 points

QUESTION 43

ESOPs were originally designed to help improve worker productivity, but today they are also used to help prevent hostile takeovers.

True

False

2 points

QUESTION 44

High current and quick ratios always indicate that a firm is managing its liquidity position well.

True

False

2 points

QUESTION 45

A firm should never accept a project if its acceptance would lead to an increase in the firm's cost of capital (its WACC).

True

False

2 points

QUESTION 46

"Capital" is sometimes defined as funds supplied to a firm by investors.

True

False

2 points

QUESTION 47

Heavy use of off-balance sheet lease financing will tend to

A.

affect a company's cash flows but not its degree of risk.

B.

make a company appear less risky than it actually is because its stated debt ratio will appear lower.

C.

make a company appear more risky than it actually is because its stated debt ratio will be increased.

D.

affect the lessee's cash flows but only due to tax effects.

E.

have no effect on either cash flows or risk because the cash flows are already reflected in the income statement.

2 points

QUESTION 48

As a firm's sales grow, its current assets also tend to increase. For instance, as sales increase, the firm's inventories generally increase, and purchases of inventories result in more accounts payable. Thus, spontaneous liabilities that reduce AFN arise from transactions brought on by sales increases.

True

False

2 points

QUESTION 49

On the balance sheet, total assets must always equal total liabilities and equity.

True

False

2 points

QUESTION 50

The annual report contains four basic financial statements: the income statement, balance sheet, statement of cash flows, and statement of stockholders' equity.

True

False

Roger McDonald, 55 years old and single, is a dental surgeon and owns a dental practice. Roger has accumulated a SGD2,000,000 investment portfolio with a large concentration in small-cap Singapore equities. Over the last 5 years the portfolio has averaged 15 percent annual total return on investment. Roger does not expect to retire before he is 70 years old. His current income is more than sufficient to meet his expenses. Upon retirement, he plans to sell his medical practice and use the proceeds to purchase an annuity to cover his retirement cash flow needs. He has no additional long term goals or needs.
In consultation with Roger, his investment advisor, Justin Teo has drawn up an investment policy statement with the following elements (Justin’s notes justifying each item are included):
Risk tolerance: Roger has above average risk tolerance.
Justin’s notes:
- Roger’s present investment portfolio and his desire for larger returns indicate a high willingness to take risk.
- His financial situation (largely current asset base, has ample income to cover expenses, lack of need for liquidity or cashflow, and long time horizon) indicates a high ability to assume risk.
Return Objective: The return objective is an average total return of 10 per cent or more with a focus on long-term capital appreciation.
Justin’s notes:
- Roger’s circumstances warrant an above-average return objective that emphasizes capital appreciation for the following reasons:
- Roger has a sizable assert base and ample income to cover his current spending; therefore, the focus should be on growing the portfolio.
- Roger’s low liquidity needs and long time horizon support an emphasis on a long term capital appreciation approach.
- Roger does not rely on the portfolio to meet living expenses.
-The numerical objective of 10 per cent represents an estimate of a target Roger can aim for rather than a minimum return required to meet a specific financial goal.

Liquidity: Roger’s liquidity needs are low.
Justin’s notes:
- Roger has no regular cash flow needs from the portfolio, because the income from his medical practice meets all current spending needs.
- No large, one-time cash needs are stated. However, it could be considered appropriate to keep a small cash reserve for emergencies.
Time Horizon: Roger’s time horizon is long term and consists of 2 stages:
(1) The first stage consists of the time until his retirement, which he expects to be 15 years.
(2) The second consists of his lifetime following retirement, which could range
from 10 to 20 years. Justin has also summarised Roger’s current portfolio in Exhibit 1 below:
Value Total Return Deviation
Short-term Bonds $200,000 10% 4.6% 1.6%
Domestic Large-Cap Equities $600,000 30% 12.4% 19.5%
Domestic Small-Cap $1,200,000 60% 16.0% 29.9%
Total Portfolio $2,000,000 100% 13.8% 23.1%
Exhibit 1: Roger’s Current Investment Portfolio


Roger expects to receive an inheritance of SGD2,000,000 soon. Roger and Justin sit down to discuss its investment in one of the four index funds. Given Roger’s already above average risk tolerance and level of portfolio risk, Roger and Justin have concluded that the risk tolerance description in the current IPS remains valid; they do not want to contemplate further increase in portfolio risk. On the other hand, they do not wish to reduce expected return. Justin is evaluating the four index funds shown in Exhibit 2 below for their ability to produce a portfolio that will meet the following two criteria relative to the current portfolio:
- Maintain or enhance expected return, and
- Maintain or reduce volatility.

Each Fund in Exhibit 2 is invested in an asset class that is not substantially represented in the current portfolio shown in Exhibit 1. Exhibit 2 presents statistics on those index
funds.
Expected Expected Correlation of
Index Annual Annual Standard Returns with Current
Fund Return Deviation Portfolio’s Return
Fund A 15% 25% +0.80
Fund B 11% 22% +0.60
Fund C 16% 25% +0.90
Fund D 14% 22% +0.65
Exhibit 2: Expected Risk, Return and Correlation of 4 Index Funds under Consideration

Question 1
(a) Recommend the most appropriate index fund to add to Roger’s portfolio. Justify your recommendations by describing how your chosen fund best meets both of the stated criteria. (No calculations are required.)

(b) Twenty years later, Roger is meeting with you, his new financial advisor. You are evaluating if Roger’s investment policy remains appropriate for his changed circumstances.
- Roger is now 75 years old and retired. His spending requirements are expected to increase with the rate of general inflation, which is expected to average 3.0 per cent annually.
- Roger estimates his current living expenses at SGD150,000 annually. An annuity, purchased with the proceeds from the sale of his medical practice, provides SGD20,000 of this amount. The annuity is adjusted for inflation annually using a national price index.
- Because of poor investment performance and a high level of spending, Roger’s asset base has declined to SGD1,200,000 exclusive of the value of the annuity.
- Roger sold all of his small-cap investment last year and invested the proceeds in domestic bonds.
- Because his international equity investments have performed poorly, Roger has become markedly uncomfortable holding international equities.
-Roger plans to donate SGD60,000 to a charity in three months.

Discuss how each of the following components of Roger’s investment policy statement should now reflect the changes in his (note that the observations should focus on but not limited to the direction and magnitude of change in each component rather than on a specific numeric change):
(i) Risk tolerance
(ii) Return requirement
(iii) Liquidity needs
(iv) Time horizon

(c) Roger’s investment portfolio at 75 years old is summarised in Exhibit 3 below:
Current Expected Expected
Allocation Return Standard Deviation
Cash equivalents 2% 5% 3%
Fixed Income 75% 7% 8%
Domestic Equities 10% 10% 16%
International Equities 3% 12% 22%
Domestic Real Estate 10% 10% 17%
_______________________________________________________________
Exhibit 3: Roger’s Investment Portfolio at Age 75 Years Old


Given Roger’s changed circumstances, state whether the current allocation to each asset class should be lower, the same, or higher. Justify your response with one reason for each asset class. No calculations are required and responses should be based only on Roger’s changed circumstances and the information in
Exhibit 3.
(i) Cash Equivalents
(ii) Fixed Income
(iii) Domestic Equities
(iv) International Equities
(v) Domestic Real Estate

(d) Explain one (1) way in which Roger might seek to reduce the tension between his current return requirement and his current risk tolerance.

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