# TUTORIAL EXAM 2 35819

Question

TUTORIAL EXAM 2

1. An increase in financial leverage generally results in a higher return on equity (ROE).

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True

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False

2. Leverage and liquidity generally rise or fall together.

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True

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False

3. It is possible for a company to grow faster than its sustainable growth rate.

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True

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False

4. Which of the following ratios uses sales in the denominator?

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Days in inventory

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Receivables turnover

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Cash ratio

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Average collection period

5. For a levered firm, EBIT is equivalent to:

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Net income

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Pro forma earnings

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Operating profit

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Net income before taxes

6. Common-size financial statements are constructed in order to:

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Adjust for inflation and risk

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Facilitate comparisons of different-sized companies

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To comply with SEC requirements

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All of the above

7. A firm has $100 of average inventory, operating profit of $500 and sales of $1,500. Its days in inventory is:

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36.5 days

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24.3 days

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73.0 days

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Not enough information

8. For which of the following generic businesses would you expect a combination of high asset turnover and low profit margins?

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Supermarkets

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Banks

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Software developers

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Airlines

**9. Analysis of a company’s financial statements:** Below are simplified versions of the balance sheet and income statement for *Toys by Tom, Inc.*Use this information to answer question 9.

*Toys by Tom, Inc.* has a current ratio of ____, suggesting ________.

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9.6; reasonable ability to cover interest expense

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0.57; potential illiquidity

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0.21; potential collection problems

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1.75; reasonable liquidity

**10. Analysis of a company’s financial statements:** Below are simplified versions of the balance sheet and income statement for *Toys by Tom, Inc.* Use this information to answer question 10.

What is *Toys by Tom, Inc.* return on assets (ROA)?

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6.9%

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0.86

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18%

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1.2

11. Operating cash flow is generated by a company’s daily operations related to production and sales of goods and/or services.

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True

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False

12. In general, the reduction of an asset is a source of funds.

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True

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False

13. The sustainable growth rate is the maximum growth rate achievable over an extended period of time.

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True

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False

14. The cash conversion cycle is calculated as:

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Days in Inventory + Collection Period

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Days in Inventory – Payables Period

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Days in Inventory + Collection Period – Payables Period

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None of the above

15. A company can shorten its cash cycle by:

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Reducing inventory turnover

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Reducing account payables

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Reducing days receivable

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None of the above

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16. A company has a retention rate of 50%, sales of $25,000, beginning equity of $50,000 and profit margins of 10%, an asset turnover ratio of .75 and debt of $10,000. What is its sustainable growth rate?

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2.5%

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1.7%

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3.75%

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Not enough information given

17. Scenario analysis is a way of testing forecasts by changing one assumption at a time.

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True

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False

18. Biases can and should always be eliminated in financial forecasts.

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True

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False

19. Which of the following is commonly used in preparing pro forma statements:

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Historical financial statements

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Projected sales

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Efficiency ratios

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All of the above

20. Pro forma statements are:

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Summaries of historical financial statements

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Government-mandated analyses of financial statements

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Projected statements used in financial planning

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Estimated tax liabilities

21. Which of the following liabilities form part of a company’s “real” activities?

I. Short-term debt

II. Accounts payable

III. Accrued operating expenses

IV. Long-term debt

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III only

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II and III

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I and IV

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I only

22. The cost of debt is generally lower than the cost of equity.

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True

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False

23. M&M’s Proposition I states that a company’s value is independent of its capital structure.

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True

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False

24. A higher level of leverage generally reduces managerial discretion.

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True

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False

25. The Pecking Order Theory of capital structure implies a unique optimum capital structure.

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True

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False

26. As EBIT drops, the return on equity (ROE) of a levered firm drops ______ the ROE of an otherwise identical unlevered firm.

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the same as

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relatively more than

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relatively less than

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more or less than (it cannot be determined)

27. The owner of Grandma’s Applesauce is planning to retire after the coming year. She has to repay a loan $50,000 plus 8 percent interest and must rely on cash flow from operations to do so. Cash flow from operations is uncertain; there is a 70% probability it will equal $65,000, and a 30% probability it will equal $45,000. Assuming a tax rate of 0%, what is the owner’s expected cash flow after debt service?

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$9,000

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$5,000

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$11,000

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$7,700

28. Shareholders prefer high risk projects when facing a high probability of bankruptcy because

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High risk projects usually bring high rewards.

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Shareholders have the residual claim on a company.

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Creditors have the residual claim on a company, and therefore bear the risk.

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There is a good chance the government will rescue them in bankruptcy.

29. The _________ states that the value of the firm is determined solely by the value of its assets.

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Static Tradeoff Model

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M&M proposition I

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The Pecking Order Model

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Agency Theory

30. Which of the following expresses the value of a levered firm (V_{L}) in the Static Tradeoff model of optimal capital structure? [Note: V_{U} denotes the value of the unlevered firm; CFD denotes expected costs of financial distress; and PV denotes present value.]

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V_{L} = PV(Tax Shield) – PV(CFD)

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V_{L} = V_{U} + PV(Tax Shield) / PV(CFD)

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V_{L} = V_{U} + PV(Tax Shield) – PV(CFD)

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V_{L} = V_{U} + PV(Tax Shield)

31. A example of indirect costs of bankruptcy is

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Court costs

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Attorney and advisor fees

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Lost sales due to costumers and suppliers lost trust

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All of the above

32. Which of the following are equivalent under M&M proposition I?

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Maximizing firm value and maximizing firm profit

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Maximizing firm value and minimizing the cost of capital

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Minimizing firm’s cost of capital and minimizing firm’s debt burden

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Maximizing profit and minimizing taxes

33. Which of the following is not an assumption underlying M&M proposition I?

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No arbitrage

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No taxes

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Corporate investments are risk-free

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Symmetric information

34. Which trait is commonly found in debt contracts?

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Seniority

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Covenants

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Callability

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All of the above

35. Selecting investment projects according to rules based either on project NPV or IRR results in maximizing firm value.

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True

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False

36. A dollar today is worth more than a dollar tomorrow.

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True

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False

37. The NPV rule, which says companies should invest in projects for which NPV is greater than 0, depends on the assumption of value maximization.

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True

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False

38. If you invest $2,000 today for three years at 5% interest paid annually, you will earn a total of $______ in interest. Assume you re-invest all interest.

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205.00

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300.00

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315.25

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500.00

39. The amount by which a project increases the value of the firm is given by which of the following?

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The project’s accounting rate of return

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The project’s net present value (NPV).

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The project’s internal rate of return (IRR).

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The project’s present value.

40.Which items are necessary in calculating the net present value of a project?

I. Investment outlays

II. Discount rate

III. Incremental cash flow

IV. Time period for the project

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I, II and IV

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I, II and III

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II, III and IV

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All of the above

41. Compute the net present value of an investment with 5 years of annual cash inflows of $100 and two cash outflows, one today of $100 and one at the beginning of the second year of $50. Use a discount rate of 10 percent.

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$229.08

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$287.60

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$233.62

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$271.53

42. Suppose a riskless project requires an initial investment of $10 and will generate a one-time cash inflow of $30 two years later. Assuming a risk-free interest rate of 5%, which of the following statements about the project is NOT true?

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The net present value of the project is positive

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The IRR is greater than 50 percent.

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The accounting rate of return on the project is positive.

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The payback period is less than 2 years.

43. What is the present value of a perpetuity of $100 given a discount rate of 5%?

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$ 2,000

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$ 3,000

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$ 1,500

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$ 500

44. All else equal, when a company’s debt ratio rises, its beta falls.

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True

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False

45. If you borrow capital to start a business and the money is provided interest-free, then your cost of capital is zero.

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True

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False

46. Increasing a company’s leverage has no effect on its cost of equity.

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True

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False

47. Which of the following assumptions regarding investor behavior are required by the CAPM?

I. Investors try to maximize their wealth

II. Investors consider only risk when making investments

III. Investors are risk averse

IV. Investors adopt a long-term perspective

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I and III

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I, II and III

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I and IV

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All of the above

48. For a firm with an optimal capital structure, the weighted average cost of capital (WACC) is:

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higher than the cost of equity

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lower than the cost of debt

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lower than the cost of unlevered equity

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independent of the capital structure

49. Which is NOT required information when calculating the weighted average cost of capital for a company with debt?

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its capital structure ratios

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its cost of debt

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its current ratio

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its tax rate

50. In the CAPM, the parameter beta measures:

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non-systematic (diversifiable) risk

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systematic (non-diversifiable) risk

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total risk

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risk-adjusted stock returns

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