FINC12-200 : Fundamentals of Finance

Amongst corporations, sole proprietorships and partnerships, approximately what percentage of revenues are generated by corporations?

50%

42%

33%

82%

Question 2

What should be the financial goal of any firm?

attracting and acquiring capital and investing it

maximization of the owners’ wealth

offering quality products at fair prices

quality customer service

Question 3
4 pts
Which of the following statement(s) is \ are true regarding the corporate management team?

In a corporation, ownership and direct control are typically separate.

Board of Directors is elected by shareholders and has ultimate decision-making authority

The Chief Executive Officer (CEO) – the Board typically delegates day-to-day decision making to the CEO.

All of the above

Question 4
4 pts
When calculating the present value of either a future single sum or a future annuity, it involves a process called discounting. The applicable interest rate to perform the discounting function is usually called the

yield to maturity

compound interest rate

discount rate

none of the above

Question 5
4 pts
_________________ are used to present additional information about items included in the financial statements and to present additional financial information.

stock certificates

Notes to financial statements

Preferred stocks

Convertible securities
Question 6
4 pts
What should be the financial goal of any firm?

maximization of the owners’ wealth

attracting and acquiring capital and investing it

offering quality products at fair prices

quality customer service

Question 7
4 pts
A competitive market is one in which a _____ numbers of producers compete with each other to satisfy the wants and needs of a _____ number of consumers.

Large, small

Small, small

Large, large

Small, large

Question 8
4 pts
The Valuation Principle is an analysis between the value of the ______ of a financial alternative and the value of its ______.

revenues, income

benefits, costs

expenses, costs

Question 9
4 pts
The Net Present Value rule implies that we should compare a project’s net present value (NPV) to___________. (zero \ future value \ the past).

Zero

Future Value

The Past

An Estimate

Question 10
4 pts
The internal rate of return (IRR) rule will _______ agree with the Net Present Value rule on a given investment project.

always

never

sometimes

none of the above

Question 11
5 pts
The law of one price exists due to arbitrage opportunities. If the price of a security, commodity or asset is different in two different markets, then an arbitrageur will ______ the asset in the more expensive market and ________ it where prices are lower.

sell, purchase

purchase, sell

purchase, purchase

sell, sell

Question 12
5 pts
Approaching every problem using a timeline is a(n) ________ idea because timelines identify events in a transaction or investment which might otherwise be easily overlooked.

good

bad

indifferent

unrealistic

Question 13
5 pts
The present value (PV) of a stream of cash flows is the _______ the present values of each individual cash flow

difference between

product of

sum of

same as

Question 14
5 pts
As the number of periods increases, present value (increases\decreases\stays the same).

increases

decreases

stays the same

is unrelated

Question 15
5 pts
When a constant cash flow will occur at regular intervals for a finite number of periods of time, it is called a(n) __________.

annuity

perpetuity

interest payment

principle payment

Question 16
5 pts
When a constant cash flow will occur at regular intervals forever, it is called a(n) ___________.

annuity

perpetuity

interest payment

principle payment

Question 17
5 pts
The NPV measures the ______ change in shareholder wealth that arises from undertaking a project.

consistent

dollar

annual

semi-annual

Question 18
5 pts
When calculating the present value of either a future single sum or a future annuity, the applicable interest rate is usually called the _______ rate

compounding

inverted

market

discount

Question 19
5 pts
To endow a perpetuity is the same as calculating the present value (PV) of a perpetuity. Say you want to endow an annual graduation party at your alma mater. You want the event to be a memorable one, so you budget $30,000 per year forever for the party. If the university earns 8% per year on its investments, and if the first party is in one year’s time, how much will you need to donate to endow the party?
The formula for PV of a perpetuity = C\r; = $30,000 \ 0.08; =

$3,750

$37,500

$375,000

$3,750,000

Question 20
5 pts
With an Ordinary Annuity, payments are required at the ________ of each period. An example of this is bonds which usually pay coupon payments at the end of every six months until the bond's maturity date.

beginning

middle

end

payments are not required

Question 21
5 pts
Sales of securities that the seller does not own is called a:

stop-loss order

short sale

limit order

maintenance margin

Question 22
5 pts
What is the name of the market where money market securities, bonds, and mortgages are originated and traded?

debt securities market

foreign exchange market

derivative securities market

equity securities market

Question 23
5 pts
If an investor feels the price of a stock will decline in the future, which trade should the investor undertake?

market order

buy on margin

limit order

short sale

Question 24
5 pts
For risk averse investors, how much return is expected for taking on more risk?

lower

equal

zero

higher

Question 25
5 pts
A ___________________ is a highly regulated document which details the issuers operations and finances and must be provided to each buyer of a newly issued security.

Prospectus

An underwriting agreement

A best efforts agreement

none of the above

Question 26
5 pts
Which of the following statements about liquidity ratios is true?

The lower the quick ratio relative to the current ratio, the safer a firm is in terms of liquidity.

The higher the current ratio, the more likely a firm is able to pay its short-term obligations.

The quick ratio is always between 0 and 1.

All the above statements are true.

Question 27
5 pts
The ability of a firm to meet its short-term debt obligations as they come due is indicated by which of the following ratios:

liquidity ratios

asset utilization ratios

financial leverage ratios

profitability ratios

Question 28
5 pts
Which one of the following financial statements reports a firm’s assets and the claims on assets?

balance sheet

income statement

statement of changes in financial position

cash flow statement

Question 29
5 pts
The extent to which assets are used to support sales is indicated by which of the following ratios:

liquidity ratios

asset utilization ratios

financial leverage ratios

profitability ratios

Question 30
5 pts
The extent to which assets are financed by borrowed funds and other liabilities is indicated by:

liquidity ratios

asset utilization ratios

financial leverage ratios

profitability ratios

Question 31
5 pts
The basic price that equates the demand for and supply of loanable funds in the financial markets is the __________:

interest rate

yield curve

term structure

cash price

none of the above

Question 32
5 pts
Federal obligations usually issued for maturities of two to ten years are called:

Treasury bonds

Treasury notes

Treasury bills

Agency issues

Question 33
5 pts
An increase in the demand for loan-able funds, holding supply constant, will cause interest rates to:

increase

decrease

stay the same

none of the above

Question 34
5 pts
As interest rates rise, the prices of existing bonds will:

rise

stay the same

fall

either a or b

Question 35
5 pts
In an inflationary period, interest rates have a tendency to:

rise

fall

stay the same

act erratically

The goal of the firm is to ____ because _____. Answer maximize shareholders' wealth; it considers all risks invest funds in real estate; the return is longer maximize shareholders' profit; it is a short term outlook closely matching management goals Mike is paying $8,000 a year on his mortgage at 6% nominal annual interest. He has 15 more years to make payments. He wants to sell his house today. The lowest [minimum] price he can sell the house without losing any money on the house would be about ___. Answer $120,000 $ 50,000 $77,698 $ 186,208 A firm's net income before tax, EBT [NIBT] (on the income statement) is affected by _____. Answer taxes interest dividends Common Stock as listed on the Balance Sheet could include which of the following? Answer A) retained earnings B) additional paid in capital over par value C) preferred capital Both A) and B) If an asset is sold for ___ than its basis, the tax effect would be ____. Answer A) more; capital gain and depreciation recapture B) less; depreciation recapture C) more; capital loss Both A) and B) The main reason for a firm to have assets is to _______. Answer generate revenue match the liabilities and equity both of the above be able to borrow money and pay its debts none of the above The only risk you would NOT have in loaning money to the United States Government (Uncle Sugar) is _____ risk. Answer liquidity maturity default A(n) ____ shows _____. Answer balance sheet; sources and uses of funds income statement; net income as of a specific date cash flow statement; how well the firm is doing relative to its competition You can compare dollars _____ because ______. Answer computed using equations; any math is always correct at any point in time; time is never a factor if they are at nominal value; that is when decisions are made only at the same point in time; dollars can be invested to earn interest There ___ a tax benefit to the company with paying preferred dividends because _______. Answer is; investors can write them off is not; investors declare them as income is; the company can use the payments as an expense is not; the company cannot use the payments as an expense XYZ issued a 6% coupon, $1,000 par, 30 year to maturity bond. It is now 6 years to maturity. What is the price of the bond if the yield to maturity [market interest rate] is 10%? Answer $1,000 $659.46 $825.79 $705.33 The valuation process can be described as ______. Answer calculating the present value of an expected future cash flow using the investor's required rate of return as the discount rate calculating the future value of an expected future cash flow using the investor's required rate of return as the discount rate amortizing the value of the asset over its holding period The ______ is the minimum required rate of return a firm must earn on its investments. Answer net present value opportunity cost of capital or weighted average cost of capital. internal rate of return gross profit margin The value of an asset is the _____ dollar price someone is willing to pay for it. Answer usual maximum minimum Companies use ____ in capital budgeting project analysis because ________. Answer accounting profit; that is the total net income after tax cash flow; that is what the owners would receive from the project and reinvest accounting profit; that is what the owners would receive from the project and reinvest after tax cash flow; that is the result of prudent accounting When borrowing money, you want to know the ____ interest rate because ____. Answer nominal; it is the easiest to find. effective; it is the true cost of borrowing risk free; that is what the government pays Fed funds; that is what you would pay the bank Cash available to pay out to the investors after the firm pays for new investments or additions to working capital is _____. Answer a statement of cash flows operating after tax cash flow free cash flow net income An organization that raises money from investors and provides financing for individuals and businesses is a ___. Answer factor federal government regulatory unit state government taxing authority financial intermediary Negatives/cons of the Net Present Value (NPV) technique include: Answer least conservative reinvestment assumption multiple rates of return for non-conventional cash flows all of the above none of the above A fixed exchange rate means a country _____. Answer can only use gold coins as money is limited in the amount of paper money it can print can print money as the economy demands Your company is considering an investment with the following expected cash flows: Initial Investment = $407,596 Operating Cash Flows = $73,428 per year Terminal Cash Flow = $11,872. The company's WACC is 11% for similar risk projects. The proposed project would have an expected life of 9 years. Your boss asks you to do the analysis. You would tell your boss this proposed project ___ because ____. Answer is acceptable; NPV is about $3,620 is acceptable; NPV is zero should be rejected; NPV is about -$5,660 [negative $5,660]. should be rejected; NPV is zero All ratios are ___ and a reason to analyze ratios is ____. Answer good; to continue to look productive good and bad; because seemingly good ratios can be masking something bad bad; to try to rework the numbers to have them look good basically irrelevant; there really is no need to analyze financial statements When analyzing financial statements, ratio analysis gives ____ and provides insight into ____. Answer very little useful information; practically nothing good practice in logical thinking; what has occurred and the logic behind it financiers something to do during slow periods; how the financier spends his time accountants a reason to provide financial statements; why accountants do what they do while at work Given: Economic State[i]: Good Average Expected Return[i]: 10% 8% Probability[i]: 30% 70% What is the Standard Deviation? Answer 3% 8.4% 0.92% 5.6% Chapter 9: XYZ has a projected project to install a new press. The expected cash revenue is $175,000 per year. Expected yearly expenses are: Operatinf costs of $50,000; Rental of $17,000; Utilities of $20,500; and Depreciation of $10,000. The tax rate is 35%. What is the expected After-Tax Operating Cash Flow for the first year? Answer $65,500 $60,375 $77,500 $97,500 A stock just paid a dividend of $1.60 per year. The dividend is expected to grow at 3% per year indefinately. Equally risky stocks offer expected rates of return of 8%. What should be the stock price? Answer 53.33 $16.00 $32.96 None of the above. A plot of the CAPM is the _____. Answer wrong thing to do Security Market Line a function showing how to calculate TVM All of the above. Derivatives are used to ___. Answer divide one number by another find old ways to do things hedge risk none of the above With the end of the Gold Standard in the 1970's, what new risk did business face in the international market? Answer Comjpetition Exchange rate Worker compensation Property taxes One of the positive aspects [pros] of a Floating Exchange Rate System is ____. Answer money can be printed as needed to support financial/economic growth no/reduced inflation economic growth is reduced as a result of reduced liquidity [lower money supply] business planning is more difficult A(n) ____ contract obligates the seller to execute the contract and the contract is executed. Answer backwards forward future option What policies did countries institute after the Great War that help lead to the Great Depression? Answer A. Mandatory military service B. Trade restrictions C. High tariffs D. Isolationism Only B., C. and D. All of the above

Sabrina Gupta, an investment advisor with a major brokerage firm, was examining Wal-Mart Stores, Inc. (Wal-Mart) stock and its valuation. Gupta wondered whether to recommend the stock to any of her new clients or to existing clients who did not currently have Wal-Mart in their portfolios.

Her key task was to use an intrinsic value approach to price the shares and to then compare the resulting price with the price at which the stock was traded in the market. Gupta wanted to use alternative valuation methods and assumptions to produce intrinsic value estimates for Wal-Mart stock.

She was interested in seeing if the alternative methods would point to a consensus regarding the valuation of the stock and to see if the valuations suggested an investment opportunity given the current market price. Methods she contemplated to use were:

Multi-stage growth model

Price Earnings Multiple

Most valuation methods Gupta considered required a common set of inputs:

Future Cash Flows to Wal-Mart Investors

Growth rate of future cash flows

Discount factor or required rate of return by Wal-Mart investors

Gupta gathered data to determine each of the above.

Gupta thought that Dividends to Wal-Mart shareholders would adequately capture the cash flows to Wal-Mart shareholders; she also thought that this approach would simplify her task and she would revisit more complex valuation models if she felt the need.

Gupta thought that CAPM would provide her a relatively reliable estimate of the required rate of return. CAPM based required rate of return can be estimated by using a risk free rate, systematic risk of the firm and equity market risk premium. Gupta thought that in a valuation exercise that involve long term cash flows, 10-year government bond yield would be an appropriate risk free rate of return estimate. She checked the 10 year note rate and found out that it was about 3.68%. Gupta searched for Wal-Mart beta in Bloomberg. Bloomberg estimates betas by regressing the S&P 500 returns on the firm returns over the past two years and arrives at a “raw” beta estimate. Bloomberg makes an adjustment in raw beta based on some academic research. Gupta is confident that Bloomberg adjustment is justified and she uses Wal-Mart beta estimate of 0.66 in her analysis.

While Gupta is aware of the importance of EMRP assumption, she thinks that Bloomberg’s historical estimate of 5.05% is a safe assumption. She is aware of the fact that some studies suggest a larger risk premium of approximately six per cent, while others suggest a much lower forward-looking premium of less than four per cent. She is mindful of the arbitrariness of her assumption, and she takes a note to revisit this issue if her valuations produce unreasonable estimates.

Anticipated dividend growth (g) is often estimated in a variety of ways.

First, observed historical dividend growth can be assumed to continue in a perpetual fashion.

Second, future dividend growth can be estimated on the basis of recent estimates of analysts.

Gupta noted that the consensus annual Wal-Mart dividend for fiscal year 2011 was $1.21, and one respected analyst had estimated the expected constant dividend growth (in perpetuity) at approximately 3%.

As the chart suggests, both earnings and dividend growth rates are declining but they seem to be higher than the “respected analyst’s” estimates. Gupta decides to use several alternative perpetual growth assumptions to see the impact on price. Since Gupta decided to use variants of dividend discount model (DDM), she checked the anticipated earnings for 2011. Analyst’s estimates suggested $4.10 earnings per share. Gupta decided to use 10% growth rate from 2011 to 2012 and assumed a steady decline to 3% in 13 years (until 2024) where the perpetual growth rate of 3% resumes. She also assumed that WalMart will increase its dividend payout ratio from 30% to 55% from years 2012 to 2024. You are asked to reproduce Gupta’s analysis of multi-stage growth model and double check her valuation by using an earnings multiple. You have all the data you need to conduct the multi stage discounted growth model analysis, but you will need to do some research about the multiples valuation.