FIN EXAM 1

All else equal, in which of the following forms of business would the possibility of an agency problem be the greatest?

A U.S. corporation in which individual stockholders own extremely small proportions of the company

Which of the following statements is correct?

The potential for agency problems is greatest when individual stockholders own extremely small proportions of the companies and managers have little, if any, of their own wealth tied up in these companies.

Institutional investors can ensure that a corporation pursues goals that are in their best interest by _____.

monitoring its financial performance to ensure that managers pursue the goal of wealth maximization

The treasurer of a company is a key subordinate of the _____.

financial vice president

Which of the following statements is true of earnings per share?

Earnings per share is often used as an indication of the firm's potential for generating future cash flows.

It is possible to limit the liability faced by some of the partners in a partnership form of business by establishing a _____

limited liability partnership (LLP)

Using the information below for WAM Inc., the market value per share is: Earnings after interest and taxes = $200,000 Earnings per share = $2.00 Stockholders' equity = $2,000,000 Market/Book ratio = 0.20

$4.00.

If a company has a quick ratio of 1.0 and a current ratio of 2.0, then:

the value of current liabilities is equal to the value of inventory.

Other things held constant, which of the following will not affect the current ratio, assuming an initial current ratio greater than 1.0?

accounts receivable are collected

Pearl Automotive Ltd. has a current ratio of 2. The company wants to window dress its financial statements. Which of the following transactions will increase the current ratio of Pearl Automotive, assuming all other variables remain constant?

Repayment of short-term loan

Bicksler Corporation has a current ratio of 2.0 on July 21 of the current year. On July 22, Bicksler purchased (and received) raw materials on credit from its supplier. Assuming all other things are equal, how will this transaction affect the current ratio of Bicksler?

The value of the current ratio will decrease.

Which of the following transactions will not affect the quick ratio of a company?

accounts receivable are collected

Emerald Corporation's current ratio is 0.5, while Ruby (Emerald's competitor) Company's current ratio is 1.5. Both firms want to "window dress" their coming end-of-year financial statements. As part of their window dressing strategy, each firm will double its current liabilities by adding short-term debt and placing the funds obtained in the cash account. Which of the statements below best describes the actual results of these transactions?

Only Emerald Corporation's current ratio will be increased.

Alumbat Corporation has $800,000 in debt outstanding, and pays an interest rate of 10 percent annually on its bank loan. Alumbat's annual sales are $3,200,000, its average tax rate is 40 percent, and its net profit margin on sales is 6 percent. If the company does not maintain a TIE ratio of at least 4 times, its bank will refuse to renew its loan, and bankruptcy will result. Alumbat's current times interest earned ratio is:

5.0 times.

Selzer Inc. sells all of its merchandise on credit. It has a profit margin of 4 percent, days sales outstanding equal to 60 days, receivables of $150,000, total assets of $3 million, and a debt ratio of 0.64. The firm's return on equity (ROE) is:

3.3%.

An inventory turnover ratio of 8.5 times indicates that:

the firm will restock its inventory every 42.35 days

If a firm's existing quick ratio is 1.2, and all other variables remain unchanged, the quick ratio can be increased by

receiving interest income.

Suppose a firm has a growth rate equal to 8 percent, return on assets (ROA) of 10 percent, a debt ratio of 20 percent, and a current stock price of $36. The firm's return on equity (ROE) is:

12.5%.

Determine the increase or decrease in cash for Rinky Supply Company for last year, given the following information. (Assume no other changes occurred during the past year.) ​ Dividend payment $25 Increase in accounts receivables $50 Increase in notes payable $30 Decrease in accounts payable $20 Increase in accrued wages and taxes $15 Increase in inventories $35 Addition to retained earnings $5

-$80

A firm has total interest charges of $10,000 per year, sales of $1 million, a tax rate of 40 percent, and a net profit margin of 6 percent. The firm's times interest earned ratio is:

11 times

Which of the following statements is true regarding debt ratios?

Firms with relatively high debt ratios have higher expected returns when business is good.

Helium Brands Ltd. has a beginning balance of retained earnings of $185 million. Helium has a net income of $48 million and has paid a dividend of $15 million in the current year. The ending balance of retained earnings is:

$218 million.

Which of the following mathematical expressions calculates a firm's retained earnings at the end of a year?

Retained earnings = Beginning balance of retained earnings + Net income in the current year − Dividends paid in the current year

The statement of retained earnings for Redwood Systems Ltd. shows a retained earnings balance of $300 million on December 31. During the year, Redwood generated net income of $60 million and paid dividends of $20 million to its stockholders. What was the beginning balance of retained earnings at the start of this year?

$260 million

Assume that Meyer Corporation is 100 percent equity financed, and has the following information: (1) Earnings before taxes = $1,500; (2) Sales = $5,000; (3) Dividend payout ratio = 60%; (4) Total assets turnover = 2.0; (5) Applicable tax rate = 30% The firm's return on equity is:

42%.

Ruby Enterprises Ltd. has long-term bonds worth $20 million, retained earnings of $45 million, accounts payable of $10 million, notes payable of $12 million, and inventory worth $18 million. What is the value of total liabilities of Ruby Enterprises?

$42 million

Ship Shape Marine (SSM) needs $92 million to support future growth. If SSM issues bonds to raise funds, flotation (issuance) costs will be 8 percent. Each bond will be sold for $1,000; fractions of bonds cannot be issued. How many bonds must be issued so that SSM has $92 million after flotation costs to use for its planned growth?

100,000

The process by which commercial banks transform funds provided by savers into funds used by borrowers is called _____

financial intermediation

If William earns a 10 percent return and Kate earns a 7 percent return on investments with the same risk, the additional 3 percent return on William's investment is a(n) _____

abnormal return

What is the primary reason an investment banking firm often forms an underwriting syndicate to sell new securities?

-

Which of the following plans is administered primarily by the trust departments of commercial banks or by life insurance companies?

Pension plans

When issuing new securities, which of the following decisions does the firm make by itself?

Deciding whether to go for a competitive bid or a negotiated deal with an investment banker

Financial intermediaries spread their risk by providing funds to a large number and variety of borrowers by offering many different types of loans. Due to this, the loan portfolios of intermediaries are said to be _____.

well diversified

Welsh Corporation wants to issue debt of $525,000 to invest in a new project. Welsh is required to pay its investment banker 5 percent of the issue's total value. There are no other floatation costs. Compute the amount of debt that the firm must issue to net $525,000 after flotation costs.

$552,632

Treasury bills are issued by the U.S. government. In which type of financial market do already issued treasury bills trade?

Money market

Investment companies that use the money provided by savers to invest in various types of financial assets, including stocks and bonds, are called _____.

mutual funds

Mutual funds _____.

are investment companies that use funds provided by savers to buy various types of financial assets, including stocks and bonds, in the financial markets

Devine Linens (DL) must raise $14,000,000 to support future growth. If it raises the funds by issuing stock, DL must pay an investment banker 5 percent of the total amount issued plus $250,000 in other costs associated with the issue. What is the amount of stock that DL must issue to net $14,000,000 after flotation costs?

$15,000,000

When issuing new securities, which of the following decisions is made jointly by a corporation and its investment banker?

Deciding whether to go for a best-efforts or underwritten issue

Zinc Corporation, a large, well-known public company that frequently issues securities, filed a master registration statement with the Securities and Exchange Commission (SEC). This master statement is updated with a short-form statement just prior to each individual security offering. What is this arrangement called?

Shelf registration

Persian Rugs needs $600 million to support growth next year. If it issues new common stock to raise the funds, the flotation (issuance) costs will be 4 percent. If Persian can issue stock at $125 per share, how many shares of common stock must be issued so that it has $600 million after flotation costs to use for its planned growth?

5,000,000

Which of the following financial intermediaries operates as a not-for-profit organization?

Credit union

Which of the following financial intermediaries is also known as a savings and loan association?

Thrift institution

The difference between the issuing price of a debt or equity issue and the net proceeds of the issue received by the issuing firm is known as the _____.

underwriter's spread

Credit unions, mutual funds, and thrift institutions are all examples of _____.

financial intermediaries

Which of the following statements is true of a term life insurance?

a term life insurance is a relatively short term contract that provides financial protection for Temporary period

Following are the yields on selected Treasury securities: ​ Maturity Yield 2 years 1.6% 3 years 2.2 4 years 2.4 ​ Using the expectations theory, compute the expected one-year interest rate in Year 3. That is, compute the rate that is expected to exist only during Year 3. (Base your answer on an arithmetic average rather than a geometric average.)

3.4%

Your uncle would like to restrict his interest rate risk and his default risk, but he would still like to invest in corporate bonds. Which of the bonds listed below best satisfies your uncle's criteria?

An AAA bond with 5 years to maturity

Which of the following bonds has the greatest default risk?

A CCC corporate bond with a 10-year maturity

Following is information about three bonds: ​ ​ Issuer Yield Time to Maturity Treasury 2.0% 6 months Company A 5.0 5 years Company B 5.3 8 years ​ Although none of the bonds has a liquidity premium, any bond with a maturity equal to one year or greater has a maturity risk premium (MRP). Except for their terms to maturity, the characteristics of the Company A and Company B bonds are the same (including their default risk). The average inflation rate is expected to remain constant during the next 10 years. What is the default risk premium (DRP) associated with the bonds issued by Company A and Company B?

2.5%

Assume that the expectations theory holds and that liquidity and maturity risk premiums are zero. The annual rate of interest on a two-year Treasury bond is 10.5 percent and the rate on a one-year Treasury bond is 12 percent. What is the expected one-year interest rate during the second year?

9.0%

If the Federal Reserve loosens the money supply to control growth in the economy, _____.

interest rates will decrease

Assume that real risk-free rate (r*) = 1.00%; the maturity risk premium is found as MRP = 0.20% × (t - 1), where t = years to maturity; the default risk premium for AT&T bonds is found as DRP = 0.07% × (t - 1); the liquidity premium (LP) is 0.50 percent for AT&T bonds but zero for Treasury bonds; and inflation is expected to be 7 percent, 6 percent, and 5 percent during the next three years and then 4 percent thereafter. What is the difference in interest rates between 10-year AT&T bonds and 10-year Treasury bonds? (Round answer to two decimal places.)

1.13%

Assume that a three-year Treasury note (T-note) has no maturity premium, and that the real risk-free rate of interest is 3 percent. If the T-note carries a nominal risk-free rate of return of 13 percent and if the expected average inflation rate over the next two years is 9 percent, what is the implied expected inflation rate during Year 3?

12%

When the economy is expanding too quickly and the Federal Reserve (Fed) wants to control future growth in the economy, the Fed will:

decrease the money supply

Following is information about three bonds: ​ ​ Issuer Yield Time to Maturity Treasury 2.0% 6 months Company A 5.0 5 years Company B 5.3 8 years ​ Although none of the bonds has a liquidity premium, any bond with a maturity equal to one year or greater has a maturity risk premium (MRP). Except for their terms to maturity, the characteristics of the Company A and Company B bonds are the same (including their default risk). The average inflation rate is expected to remain constant during the next 10 years. What is the annual MRP?

0.1%

Which of the following statements is true?

Treasury bonds have zero default risk.

Which of the following statements is correct?

Other things held constant, the "liquidity preference theory" would generally lead to an upward sloping yield curve

The yield on a one-year Treasury bond is 5 percent, and the yield on a two-year Treasury bond is 6 percent. Assume that the pure expectations theory holds and that the market is in equilibrium. Which of the following statements is correct?

The market expects one-year interest rate during the second year to be 7 percent.

Treasury securities that mature in 6 years currently have an interest rate of 8.50 percent. Inflation is expected to be 5 percent in each of the next three years and 6 percent each year thereafter. The maturity risk premium is estimated to be 0.10% × (t - 1), where t is equal to the maturity of the bond (i.e., the maturity risk premium of a one-year bond is zero). The real risk-free rate is assumed to be constant over time. What is the real risk-free rate of interest?

2.50%

Assume that the current interest rate on a one-year bond is 8 percent, the current rate on a two-year bond is 10 percent, and the current rate on a three-year bond is 12 percent. If the expectations theory of the term structure is correct, what is the one-year interest rate expected during Year 3? (Base your answer on an arithmetic average rather than a geometric average.)

16%

Assume that the real risk-free rate is 4 percent, and that inflation is expected to be 9 percent in Year 1, 6 percent in Year 2, and 4 percent thereafter. Also, assume that all Treasury bonds are highly liquid and free of default risk. If 2-year and 5-year Treasury bonds both yield 12 percent, what is the difference in the maturity risk premiums (MRPs) on the two bonds, i.e., what is MRP5 - MRP2? (Round answer to one decimal place.)

2.1%

Which of the following statements is correct?

Reinvestment rate risk is lower, other things held constant, on long-term than on short-term bonds.

Everything else the same, if the yield curve is downward sloping, what is the yield to maturity on a 10-year Treasury coupon bond, relative to that on a one-year Treasury bond (T-bond)?

The yield on the 10-year bond is less than the yield on a one-year bond.

Open market operations occur when _____.

the Federal Reserve buys or sells Treasury securities to expand or contract the U.S. money supply.

You are given the following data:

r* = real risk-free rate 4% Constant inflation premium (IP) 7% Maturity risk premium (MRP) 1% Default risk premium for AAA bonds (DRP) 3% Liquidity premium for long-term Treasury bonds (T-bonds) (LP) 2% ​ Assume that a highly liquid market does not exist for long-term T-bonds, and the expected rate of inflation is a constant. Given these conditions, the rate on long-term Treasury bonds is _____.

14 percent