C214 Financial Management

Study Guide Problems

With Solutions
09/06/19

The following questions are for practicing both calculations and concepts for C214 – Financial Management. Some
of the questions have been used in Topic Reviews in the Financial Management e-text. This list of questions does
not cover everything you may encounter in an assessment. They are in the same order as the topics presented in
the e-text. For solutions, please see your Course Instructor.

Overview of Finance

1. Trading on the NYSE is executed without a specialist (i.e. a market maker).

True/False*

2. Stocks and bonds are two types of financial instruments

*True/False

3. When revenue is matched with cost of sales in an income statement it is called:

Matching Principle

4. A high-quality customer just purchased $500,000 worth of product from your

company. The contract calls for immediate delivery of the product with a cash payment
of $300,000 today and $200,000 to be paid 60 days. The expense associated with the
product is $300,000, of which $100,000 has not been paid to your supplier. Under
accrual based accounting system, you will most likely report:
Revenues of ________________ Expenses of ____________________
Revenues 500,000 Expenses 300,000

Income Statement/Balance Sheet

5. A firm reported retained earnings of $300 in 12/31/20x2. For 12/31/20x3, the firm
reports retained earnings of $400 and pays dividends of $25. What was net income in
20x3?
Beg RE = 300, NI = 125, Div = -25, End RE = 400

6. A basic equation for the balance sheet is:

Equity = Assets – Liabilities

7. Why is the Balance Sheet known as a permanent statement?

Because the other statements are reset at the end of the fiscal year

8. How do you calculate the change in Retained Earnings?

Net Income – Dividends
9. Sales minus Cost of Sales minus other expenses equals what?
Operating Income or EBIT

10.Name four accounts that are part of total assets?

Cash Accounts Receivable, Inventory, Long Term Assets

11. Name three accounts that are part of current assets?

Inventory, Cash, Accounts Receivable, Short Term Investments

12. Name four accounts that are part of Total Liabilities?

Bonds, Accounts Payable, Mortgage

Statement of Cash Flows

13. Intel reported the following for 2014:

Net Income 100,000
Depreciation 20,000
Change in A/R 10,000
What is the cash flow from operating activities?
100 + 20 – 10 = 110

14. Name three accounts that are only included in Cash Flow from Financing (CFF)?

Common Stock, Dividends Paid, Bonds Payable

15.Define the Statement of Cash Flows:

Calculated for the same period of time as the Income Statement
Is calculated based on the Income Statement and the changes in the Balance Sheet
Is one of the three basic accounting statements

16. Intel reported the following for 2014:

Gross Equipment (1/1/14) 50,000
Gross Equipment (12/31/14) 65,000
Net income 100,000
Depreciation 20,000
What is the cash flow from investing activities for 2014?
(15,000) Depreciation is not counted when using Gross PPE

17. What is the Cash Flow from Operations given the following information?
Net Income 450,000
Change in Accounts Receivable 120,000
Change in Inventory - 90,000
Change in PP&E 60,000
Depreciation Expense 110,000
Change in Accounts Payable 50,000
Change in Accrued Expenses - 75,000
 Change in Common Stock 300,000
450 + 110 Depn – 120 + 90 + 50 – 75 = 505,000

18. What is the Cash Flow from Investing?

Increase in Gross PP&E 125,000
Beginning Net PP&E 750,000
Ending Net PP&E 850,000
Depreciation Expense 25,000
Net End 850 less Net Beg 750 plus Depn 25 = 125 Outflow
(125,000)

19. What is the Cash Flow from Investing?

Beginning Net PP&E 250,000
Ending Net PP&E 300,000
Depreciation Expense 40,000
Change in Long Term Investments 100,000
Change in Short Term Investments 50,000
Net End 300 – Net Beg 250 + Depn 40 + LT Investments + 100 = 190 outflow
190,000 outflow

20. What is the Cash Flow from Financing?

Accounts Payable 100,000
Accrued Expenses 50,000
Increase in Mortgage Payable 300,000
Decrease in Bonds Payable 75,000
Dividends Paid 80,000
Inc Mort 300 – Dec Bonds 75 – Div Paid 80 = 145,000

21. When Fixed Assets increase what happens to Cash?

Cash decreases

22. Last year a firm recorded Net PP&E of $4,600 while this year the same firm
recorded Net PP&E of $4,500. If the depreciation expense for last year and this year are
$500 and $800 respectively, what is the CFI of the company? (assume no asset
disposals)
PPE End 4500 – PPE Beg 4600 + Curr Yr Depn 800 = 700 increase/outflow

23. Which is the purpose of the statement of cash flows?

Explains the change in cash over the course of the specified timeframe

24. Financial data for Intel is given below for 2014:

 EBIT 1,000,000
 Depreciation 30,000
 Change in working capital (10,000)
 Net capital expenditures 15,000
 Tax rate 40%
Compute the Free Cash Flow for 2014
 FCFF = EBIT (1-t) + Depn – Inc NWC – CapEx
1000 * (1-.4) + 30 + 10 – 15 = 625,000

Financial Ratios

25. Suppose the inventory turnover of a company is higher than the industry. Based on
this observation, what likely happened?
The firm has too little inventory resulting in lost sales or stock-outs.

26. Intel provides the following data for 2014:

 A/R 600
 Inventory 800
 Fixed Assets 1,000
 A/P 500
 Long term debt 900
 Common Stock 400
What is the current ratio?
600 + 800 / 500 = 2.8

27. If a company wishes to obtain a bank loan, will it want to have a higher current ratio or
a lower current ratio?
higher

28. A company has cash of 100, accounts receivable of 250, inventory of 300, and accounts
payable of 300. What is the quick ratio?
100 + 250 / 300 = 1.17

29. A company has cash sales of 200 and credit sales of 750. It’s average accounts
receivable is 90. What is the A/R turnover?
750 / 90 = 8.33

30. The OIROI (Operating Income Return on Investment) uses what elements on the
income statement?
EBIT, Total Assets

31. Why would a company be interested in the TAT (Total Asset Turnover) ratio?
How efficient assets are at producing sales

32. If a company has current assets of 80 and fixed assets of 120, if Sales are 150 and EBIT
is 35, what is the Fixed Asset Turnover?
150 / 120 = 1.25

33. If a company has current assets of 90 and fixed assets of 140, if it has debt of 125, what
is its debt ratio?
(debt) 125 / 140 + 90 (total assets) = .5435

34. A company has sales of 300, expenses of 200 and interest expense of 25, what is its
Times Interest Earned ratio?
EBIT / Int Exp (300 – 200) / 25 = 4

35. Suppose a firm has a financial leverage ratio of 2.50 which indicates the ratio that
the firm’s assets are financed by debt. What is percentage of the firm’s assets is
financed by equity?
The ratio is 2.5 to 1. The amount financed by equity is a ratio of 1 to 2.5 or the
inverse. 1 / 2.5 = .40

Time Value of Money – Perpetuities

36. What is the present value of a stream of cash flows of $125,000 at a discount rate of
7%?
125,000 / .07 = 1,785,714

37. What is the discount rate of a stream of cash flows of 50,000 that have a present value
of 450,000?
50,000 / 450,000 = 11.1%

38. What is the cash flow stream for a present value 1,000,000 at 5% paid in equal
installments in the future?
1,000,000 * .05 = 50,000

39. A woman has just found out that a rich great-aunt has bequeathed a trust fund that
pays $50,000 to her and to her descendants forever. If the trust fund earns 3.5% interest,
what is the amount of the trust fund?
$50,000 / .035 = PV or 1,428,571

Time Value of Money

40. A couple wants to save up for a down payment on a house. They think they need to
save 100,000 in five years. If the interest rate is 4% and they start at the end of the year
when they both get bonuses from their employers, what do they have to put aside
annually?
FV = 100,000, N = 5, I/Y = 4, PV = 0, Solve for PMT This is an END problem= $18,462.71

41. A person wants to put aside $500 at the beginning of each month for 10 years. If she
estimates an interest rate of 5.5%, what will she have in her savings account at the end?
Hint: Make the calculator inputs consistent.
PMT = 500, N = 120, I/Y = 0.4583 (5.5/12), PV = 0, Solve for FV This is a BEGIN problem
$80,119.33

42. A ten-year-old girl can put aside $45 at the end of each month for her college
education. If she has eight years before she starts higher education, how much will she
have in her savings if she can get 5% interest?
N = 96 (monthly pmts), I/Y = .4167 (5/12), PMT = 45, PV = 0, Solve for FV (END problem)
$5298.32
43. A mother wants to help her child’s higher education fund. She wishes to have $15,000
available each year for six years. Her child starts college in 15 years and she can save 6%
before school starts if she puts her end-of-year bonus into a trust fund and figures that the
fund will earn 4% after her child begins her college education. What does she have to put
aside annually if the money is withdrawn for college at the beginning of each year
attending college? Hint: Two-Step problem.
Step 1: PMT = 15,000, I/Y = 4, N = 6, FV = 0, Solve for PV Begin mode PV = 81,777.34
Step 2: Take PV in Step 1 and use it as FV in Step 2. N = 15, I/Y = 6, PV = 0, Solve for PMT
End problem = $3,513.38

44. A man has just inherited $250,000. If he invests the money at 4.5%, what can he
expect to have at the end of 15 years when he retires?
PV = 250,000, I/Y = 4.5, N = 15, PMT = 0, Solve for FV No PMT, so it doesn’t matter what
mode. = $483,820.61

Debt Valuation

45. What annual interest will be paid for a zero coupon bond?
0%

46. What is the most significant characteristic of subordinated debt?

Senior debt is paid off first

47. If a company wants to increase its debt capital, how will they raise the funds?
sell bonds

48. What is the lowest level of investment- grade bonds?

BBB

49. A company wishes to issue 10 year bonds with a face value of $1,000 and a coupon
rate of 5.5%. The market has shifted before the issuance and the bonds will sell at 94% of
face value. What is the YTM of the bonds when they are sold?
N = 10 , I/Y = ? , PMT = 55 , PV = - 940 , FV = 1,000 I/Yr = 6.33%

50. You want to buy a semiannual bond that has 4 years left before maturity. It has a 6%
coupon rate and the market yield is currently 5.2%. What is the price you are willing to
pay?
N = 8 , I/Y = 2.6 , PMT = 30 , PV = ? , FV = 1,000 PV = -1028.56

51. What is the price of a 1- year $1,000 bond with a 3% coupon rate if the YTM is 5.2%?
N = 1, I/Y = 5.2, PMT = 30, FV = 1,000 = 979.09

52. A 5% semiannual $1,000 bond matures in 4 years. What is the YTM if the price is
$1,069?
N = 8 , I/Y = ? , PMT = 25 , PV = - 1069 , FV = 1,000 I/Y = 1.5752 x 2 = 3.15%

53. What can cause the bond price to fluctuate?

 A change in the bond rating, a change in the financial condition, general change in interest
rates

54. You want to sell a bond for over $1,000. Can you do that if the coupon rate is 6.5% and
the bond yield is 6.8%?
No. If the coupon rate is higher than the yield, the price will be above $1,000. If the
coupon rate is lower than the yield (as in this case) the price will be below $1,000

55. A $1000 3% bond with a yield of 2.4% matures in 6 years. What is the price if the
interest payments are made semiannually?
N = 12 , I/Y = 1.2 , PMT = 15 , PV = ? , FV = 1,000 PV = 1033.34

56. What is the price of a six-year $1,000 bond with a coupon rate of 7.4% and a YTM of
6.2%?
N = 6 , I/Y = 6.2 , PMT = 74.00 , PV = ? , FV = 1,000 PV = 1059.37

57. What does a company use as security for a bond?

Credit worthiness

58. A bond issued with a face value of $1,000 pays a 3% coupon rate and matures in seven
years. If an investor wants a yield of 4%, what is the investor willing to pay for the bond?
N = 7, I/Y = 4, PMT = 30, FV = 1,000, PV = 939.98

59. An investor wants to know what the yield to maturity is for a $1,000 bond with a 5.5%
coupon rate that matures in 5 years if the current market price is $955?
N = 5, PV = -955, PMT = 55, FV = 1,000, I/Y = 6.59
a.
Debt Valuation – APR vs. APY

60. Which of the following gives the largest effective rate (APY)
18.6% compounded monthly, or 18.6% compounded daily, or 18.6% compounded
weekly or 18.6% compounded yearly?
18.6% compounded daily

61. Suppose that an investment will pay 24% APR for a year and the interest will be
compounded monthly. What is the expected APY for the investment?
(1 + .24/12)^12 – 1 = 26.82%

Equity Valuation – Single Holding Period

62. A stock sells for 87.00 one year from now giving a total return of 8%. What is the
dividend if the stock was originally purchased for 82.00.
D = Vo * (1+r) – V1 Dividend step by step: 82.00 * 1.08 = 88.56, 88.56 -87.00 = 1.56
dividend
63. What does a stock have to sell for one year in the future, if it currently sells for $75,
has a planned dividend of $1.87 a share and an expected return of 14%?
V1 = Vo * (1+r) – D where Vo = stock price today, V1 = stock price in 1 yr, r = rate of
return, D = dividend. Stock in the future step by step: 75 * .14 = 10.50 10.50 – 1.87 =
8.63 75 + 8.63 = 83.63 stock price in one year

64. What would a dividend have to be if the investor buys a stock for $110, expects to sell
the stock in a year for $120 and expects an annual return of 13%?
D = Vo * (1+r) – V1 Dividend step by step: 110 * 1.13 = 124.30 124.30 – 120.00 = 4.30

65. What would an investor be willing to pay for a stock today, if the value in a year would
be $55 with a dividend of $2.24 per share and the investor wants to make 9% on the
investment?
Vo = V1 + D / (1 + r)
Stock Price Today step by step: 55.00 + 2.24 = 57.24 57.24 / 1.09 = 52.51

66. What is the rate of return for a stock purchased for $89, sold in a year for $100, paying
a dividend during that time period of $2.75?
R = (V1 + D) / Vo
Rate of return step by step: 100.00 + 2.75 = 102.75 / 89.00 = 1.1545 Less 1 = 15.45 %

Equity Valuation – Gordon Growth Model

67. A company just paid a dividend of 2.30 to its shareholder. It estimates that future
growth will be at 2%. What is the value of the stock if you are looking for an 8% return on
your investment?
(2.30 * 1.02) / (.08 - .02) = 39.10

68. If you are looking for a return of at least 10%, what would you invest in a company
given that it just paid a dividend of 1.80, and estimates a growth rate of 3%?
Vo = ((1.80 * 1.03) /(.10 - .03) = 26.49

69. You are interested in buying a preferred stock and want to know what the rate of
return is. The stock is selling for $85.00 and pays a dividend today of $2.25. What is the
rate of return?
2.25 / 85.00 = .0265 or 2.65% (preferred stock has no growth)

70. The company expected to pay a dividend of $13.85 at the end of the year.
Management has estimated growth at 2.75% and the stock is currently selling for $290.00.
What is the expected rate of the return for this investment?
(13.85 / 290) + .0275 = .0753 or 7.53%

71. One of your friends is recommending a stock if it sells for more than $165.00 per share.
The growth rate is 4% and the latest dividend was $6.00. You are expecting an 11% return.
Why is the calculated value of the stock?
(6.00 * 1.04) / (.110 - .040) = $89.14
72. An investor wishes to know what the value of a common stock is if it pays a dividend of
$6.00 today. The company’s growth rate is 4.5% and the investor wants expects the stock
to earn 7%. What is the value?
(6 * 1.045) / (.07 - .045) = 250.80

73. If a common stock is worth $75 and the growth rate is 5% with a dividend expected to
pay $2.00 in a year’s time, what is the expected rate of return?
(2.00 / 75.00) + .05 = .0767

74. An investor wishes to know what the value of preferred stock, when the dividend is
$3.00 per share and the expected rate of return is 6.5%?
3.00 / .065 = 46.15

CAPM – Expected Rate of Return in different Economic States

75. What is the expected rate of return for a stock where there is a 60% chance of a
recession and a 40% chance of an expansion? The stock would return 2% during a
recession and 8% in an expansionary period.
Cycle Prob Stock
Recession 60% .02 .012
Expansion 40% .08 .032
.044

76. There are two economic states, expansion and recession. The probability of an
expansion is 70%, the probability of a recession is 30%. What is the expected return of
Alpha Company’s stock, if it has an expected return of 2% in a recession and 10% in an
expansion?
Cycle Prob Stock
Recession 30% .02 .0060
Expansion 70% .10 .0700
.0760

Capital Asset Pricing Model and Risk

77. Under the Efficient Market Hypothesis, what will companies endeavor to do?
Maximize profits for a given level of risk

78. What does the beta coefficient represent?

It is a statistically-derived measure of volatility

79. A stock has a beta of 2.1, a market premium of .14 where the market rate is .17. What
is the expected rate of return?
E(r) = Rf + B (Rm – Rf) .17-.14 + 2.1 * .14 = .324

80. The market rate is .14, Treasury bonds are returning .025. A stock has a beta of .75.
What is that stock’s expected return?
.025 + ( .75 * (.14 - .025) = .1113
81. A stock has a beta of 1.42. The stock market is returning .11 and treasury bills are
trading at a rate of .014. What is the expected return?
.014 + 1.42 (.11 - .014) = .1503

82. The market rate is .09 and the risk-free rate is .015. If a stock has a beta of 1.92, what
is the expected rate of return?
.015 + 1.92 (.09 - .015) = .1590

83. What is the Expected Rate of Return for a stock where treasury bills are returning 2.5%
and the market as a whole, is returning 15%. The stock has a beta of 1.25?
E(R) = .025 + (1.25(.15 - .025)) = .18125

84. If an investor knows the idiosyncratic risk, the investor knows the:
Beta Coefficient

Weighted Average Cost of Capital

85. Common stock is valued at 400,000, Long-term debt is valued at 250,000, and
preferred stock is valued at 50,000. What is the WACC where common stock costs .16,
long-term debt costs .08, and preferred stock costs .07? The tax rate is 40%.
(400/700 * .16) + (250/700 *.08 * .6) + (50/700 * .07 ) = .0914 + .0171 + .0050 = .1135

86. Common stock is valued at 1,000,000 and costs .20. Bonds are valued at 850,000 and
costs .04, Preferred stock is valued at 500,000 and costs .06. The tax rate is 40%. What is
the pre-tax WACC?
(1000/2350 * .2) + (850/2350 * .04) + (500/2350 * .06) = .0851 + .0145 + .0128 = .1124

87. Capital is valued at 3,000,000 consisting of 1,600,000 of common stock, 1,000,000 of

bonds, 400,000 of short-term debt. Cost of common stock is .135. Bonds before tax
are .045. Short term debt costs .065. What is the after- tax WACC if the tax rate is 35%?
(1600/3000 * .135) + (1,000/3,000 * .045 * .65) + (400/3,000 * .065 * .65) = .0720 + .0098 + .0056 = .0874

88. If a company has a capital structure of $100,000 common stock, $50,000 bonds and
$10,000 preferred stock and the respective rates are 15% common stock, 3% bonds and
4% preferred stock, what is the Weighted Average Cost of Capital if the tax rate is 30%?
(.625 * .15) + (.3125 * .03*.7) + (.0625 * .04) = .0938 + .0066 + .0025 = .1029

89. If a company has a capital structure of $5 million common stock with a cost of 17%, $2
million bonds at 4%, $1 million of Short Term Debt with a cost of 7%, and $2 million
preferred stock with a cost of 3%, what is the Weighted Average Cost of Capital? The
company has a 40% tax rate.
(.50 * .17) +( .20 * .04 * (1-t) or .6) + (.10 * .07 * .6) + (.2 * .03) = .0850 + .0048 + .0042 + .0060 = .1000

Capital Budgeting

90. What is the initial outlay given the following information:

  Equipment Price 375,000
 Installation 10,000
 Power Survey 30,000
 Shipping 8,000
 Working Capital 100,000
 Project Marketing Report 15,000
493,000

91. What is the initial outlay given the following when a new piece of equipment replaces
an old one:
 Old equipment sells for 125,000
 Book value of old equipment 22,000
 Tax rate 40%
 New equipment cost 800,000
 Site survey 18,000
 Installation cost 20,000
125,000 – 22000 = 103,000 * .4 = 41,200
125,000 – 41,200 = 83,800 deducted from new equipment
800,000 + 20,000 - 83,800 = 736,200

92. What is the initial outlay from the following information?

 Old equipment sells for (net of taxes) 55,000
 New equipment at cost 190,000
 Installation and shipping 18,000
 Working Capital 62,000
190 + 18 – 55 + 62 = 215

93. A project has sales of 300,000, general expenses of 195,000 and depreciation expense
of 25,000. The tax rate is 35%. What is the differential cash flow?
(300 – 195 – 25) * (1 - .35) + 25 = 77

94. Why is depreciation expense taken out of the net income calculation, yet added back
at the end?
Because depreciation expense is tax deductible

95. A project has net income of 750,000 including depreciation expense of 42,000. What is
the differential cash flow?
750 + 42 = 792

96. A piece of equipment is to be sold at the end of the project. Its appraised value is
420,000. A company makes an offer for 350,000. The equipment has a book value of
75,000. The tax rate is 40%. What is the salvage value if the company accepts the offer?
350,000 - ((350,000 – 75,000) * .4) = 240,000

97. A piece of equipment was sold at the end of the project. The project received 85,000
for the equipment that carried a book value of 75,000. The tax rate is 35%. What is the
salvage value?
85,000 – ((85,000-75,000)*.35) = 81,500

98. A project is closing. Equipment is sold for 50,000 even though the book value was
75,000. The tax rate is 30%. The project started with 100,000 in working capital. What is
the terminal cash flow?
50,000 – ((50,000-75,000)*.3) + 100,000 = 157,500

99. Equipment is scrapped at the end of the project and has a book value of 20,000. The
tax rate is 35%. The projected started with 75,000 of working capital. What is the terminal
cash flow?
(20,000 * .35) + 75,000 = 82,000

100. Equipment is sold for 30,000 at the end of a project. The working capital return is
50,000. The tax rate is 40%. What is the terminal cash flow?
30,000 – (30,000 * .4) + 50,000 = 68,000

101. Why would we reject project based on NPV?

The NPV is a negative number

102. Why would we reject this project based on the IRR?

The discount rate is higher than the IRR

103. What are two key elements of differential cash flow:

Depreciation expense
Net Income

104. From the following information, calculate the terminal cash flow.
 Proceeds from sale of equipment 100,000
 Book Value of equipment sold 50,000
 Year 3 Diff Cash Flow 225,000
 Tax rate 40%
 Depreciation Yrs 1 to 5 125,000
 Working Capital Return 75,000
100,000 – 50,000 = 50,000 Net Realizable Value * tax rate of .4 = 20,000 to be paid in taxes. 100,000 from
buyer – taxes paid of 20,000 = 80,000 total salvage value + 75,000 in Working Capital Return = 155,000
Terminal Cash Flow

105. If the Investment is 140,000, then what is the Net Present Value, given a Total Present
Value of 154,606?
154,606 – 140,000 = 14,606

106. Why is the NPV preferred over the IRR? Two answers
It measures the dollar value
It is more reliable

107. What is the IRR given the following: Investment is $250,000, Yr 1: 50,000, Yr 2 is
60,000, Yr 3 is 80,000, Yr 4 is 100,000, Yr 5 is 90,000, the terminal cash flow is 45,000?
Make sure to add the TCF to Yr5 for 135,000
17.213%

108. If a WACC of 15.00% is used to compute the NPV, what does the IRR computed in
previous question above tell us about the project?
The project is acceptable

Financial Forecasting - Discretionary Financing Needed

109. If Sales are $1,000,000, then what are the total current assets given the following:
 Cash 25% of Sales
 Accounts Receivable 13% of Sales
 Accounts Payable 10% of Sales
 Accrued Payroll 5% of Sales
 Cost of Goods Sold 50% of Sales
 Inventory 15% of Cost of Goods Sold
Cash 250,000 + A/R 130,000 + Inventory (.15 * COST OF GOODS SOLD of 500,000) = 250 + 130 + 75 = 455

110. Mountain Inc. forecasts sales of 450 million. It has established the following
percentages of spontaneous accounts: 5% of Cash, 17% of A/R, 11% of Inventory, 48% of
PP&E, 18% of A/P. A mortgage of 30 million, bonds of 50 million, equity of 150 million and
earnings of 35 million. What is the DFN?
Assets Liabilities & Equity
Cash 22.5 million Accounts Payable 81.0 million
Acct Rec 76.5 million Mortgage 30.0 milion
Inventory 49.5 million Bonds 50.0 million
PP&E 216.0 million Equity 150.0 million
Earnings 35.0 million
Total Assets 364.5 million Total Liab & Equity 346.0 million
DFN 364.5 – 346.0 = 18.5 million

111. Dishwasher Heaven, Inc. forecasts sales of 750,000. Their financial department has
developed the following forecast percentages based on historical averages: Cash 11%, A/R
8%, 13% for inventory and accounts payable of 14%. Property Plant and Equipment is
210,000. The company has long term debt of 120,000 and equity of 85,000. It estimates
profits at 55,000. What is the DFN?
Assets Liabilities & Equity
Cash 82,500 A/P 105,000
A/R 60,000 Long Term Debt 120,000
Inventory 97,500 Equity 85,000
PP&E 210,000 Profits 55,000
Total Assets 450,000 Total Liab & Equity 365,000
DFN 450,000 – 365,000 = 85,000
85,000

Financial Forecasting – Sustainable Growth Rate

112. Dinosaur Chicken Co. had sales of 70,000,000, expenses of 50,000,000 and paid 40%
in taxes. It has equity of 42,000,000. The board approved dividends totaling 4,500,000.
What is the company’s Sustainable Growth Rate?
Net Income = 70 million – 50 million = 20 million * (1-.40) = 12 million Net Income
ROE = 12 million / 42 million = .2857
Dividend payout ratio = 4.5 million / 12 million = .375
SGR = .2857 ( 1 - .375) = .1786

113. UltraGrunge, Inc. earned 25 million after tax in the last year. The company has 100
million in assets and 85 million in equity. It has a policy of paying 12% of earnings as
dividends. What is the SGR of UltraGrunge?
ROE 25 million / 85 million = .2941 SGR = .2941 (1 - .12) = .2588

114. What is the increase in Retained Earnings given the following:

 Sales are $10 million
 Net Earnings pre-tax are $1 million
 Dividend payout ratio is .12
 Tax rate is 40%
1,000,000 – 400,000 in taxes = 600,000 .12 * 600,000 = 72,000 600,000 – 72,000 = 528,000
Increase in Retained Earnings doesn’t need Beg RE or End RE, since it is only the increase between
the years.

115. What is the Sustained Growth Rate given the following:

 Sales are 2.5 million
 Total Expenses (including cost of goods sold through taxes) 2.0 million
 Total Assets are 3.0 million
 Equity is 1.3 million
 Dividend payout ratio is .25
ROE = NI / Equity 2.5 – 2.0 = .5 in income divided by 1.3 in Equity for .3846 1 – Dividend
Payout Ratio is 1 - .25 = .75 .3846 * .75 = .2885

Capital Structure

116. When a company uses more leverage as evidenced by a higher degree of either
financial or operating leverage, what effect does it have on changes in profitability?
Higher leverage leads to higher profitability for a given sales level

117. A company has an EBIT of 700,000 and interest expense of 30,000. B company has
EBIT of 1,500,000 and interest expense of 30,000. Which company has a higher degree of
financial leverage?
Company A Co A: 700,000/670,000 = 1.04 Co B: 1,500,000/1,470,000 = 1.02

118. What is the operating leverage of the Company Y? How will that affect profits
compared with Company Z that has an operating leverage of 5.25? Company Y has an EBIT
of 3,000,000, Sales of 25,000,000 and variable expenses of 18,000,000
As sales increases, Y’s profits will rise slower than Z’s (25-18) / 3 = 2.33
 119. What is the financial leverage of Company A? How will that leverage affect profits
compared to Company B if sales decrease? For Company A, EBIT is 500,000, interest
expense is 50,000, Sales are 4,500,000, and variable costs are 3,000,000.
Profits decrease more as leverage increases 500/(500 - 50) = 1.11

120. What is the degree of combined leverage when EBIT is 700,000, interest expense is
100,000, Sales is 3,500,000 and variable costs are 1,200,000?
(3,500-1,200) / (700-100) = 3.833

121. What is the Degree of Operating Leverage given Sales of 100,000. Variable Costs of
75,000 and EBIT of 10,000?
100,000 – 75,000 / 10,000 = 2.50

122. What does the Degree of Financial Leverage indicate?

a. The reliance on debt

123. If a company has a high degree of financial leverage, what does that tell us about the
firm’s risk profile?
Financial leverage also means more financing is done through debt, not equity.
a. Higher profits to shareholders

Working Capital Management

124. What is the cash cycle?

The amount of time to regenerate cash

125. Why is float important to understand?

To time cash expenditures

126. What should a company do to manage its working capital?

Collect quickly and pay slowly

127. Company A wishes to keep 20% of its assets as cash. Company B keeps its cash
balance at 5% of assets. Which of the following statements apply?
Company B invests in more working current assets

128. Company A offers trade credit of 2% 10 / net 30 and Company B offers trade credit at
net 30. What can be said about the relative credit policies of each company?
Company A can attract more customers

129. Which of the following characterizes increased collection float

Increased float indicates slower processing time

130. Company A’s inventory is larger than Company B. Both companies are competitors
and are about the same size. What does this difference mean from a working capital
management standpoint?
 Company B might have higher inventory turnover

131. In regards to Accounts Payable balances, what is a good policy:

Paying off A/P on the last day due is good policy

Firm Valuation

132. Ajax, Inc. is seeking to sell the company, but it is a private company with no sales of
stock to determine its market value. It has Earnings of $1,200,000 on 350,000 shares.
Epsilon Manufacturing is a direct competitor and of equal size and profitability. Its stock
sells for $21 per share and has earnings per share of $3.80. What is value of Ajax?
1,200,000/350,000 = 3.4286 earnings per share 21 / 3.80 = 5.5263 mulitple
$3.4286 * 5.5263 * 350,000 = $6,631,615

133. Ham Corp. is seeking to buy Eggs, Inc. Eggs is a private company. Eggs had an EPS of
2.80 last year and has 125,000 shares outstanding. Ham Corp. stock sells for $43.00 and
has an EPS of 5.00. Ham is larger than Eggs, but sees both companies as operating in
similar markets. What is the value of Eggs?
43.00 * 5.00 = 8.60 PE Ratio 8.6 PE * 2.8 EPS * 125,000 Shares O/S = 3,010,000

134. What would be a source of information to determine Replacement Cost?

Building Appraisal

135. What is the company valuation given the following:

Cash Flows: Yr 1 $80,000, Yr 2 $100,000, Yr 3 $95,000, Yr 4 $80,000 Discount Rate 7%
N FV I/Y PV
1 80000 7 74,766
2 100000 7 87,344
3 95000 7 77,548
4 80000 7 61,032
300,690

136. What is the Discounted Cash Flow of the company with the following Cash Flows:
Cash Flows: Yr 1 $100,000, Yr 2 $150,000, Yr 3 $150,000, Future Forecasted Annual Cash
Flows $100,000. Discount Rate 5% Hint: the forecasted annual cash flows is a perpetuity.
N FV I/Y PV
1 100,000 5 95,238
2 150000 5 136,054
3 150000 5 129,576
Infin 100000 -- Perpetuity: 100,000 / .05 = 2,000,000
3 2,000,00 5 1,727,675 Find PV using same int rate and last yr of annual values
2,088,543

137. If two companies have earnings of $2,000,000, and Company X has a multiple of 1.2
and Company Z has a multiple of 2.0, what can we estimate about the relative value of
Company Z?
The value of Company Z is higher

138. Calculate the Free Cash Flow given the following information:
  Net Working Capital increases by 20,000
 Tax Rate is .40
 EBIT is 250,000
 Capital Expenditures are 10,000
 Depreciation is 15,000
250,000 (1-.40) + 15,000 – 20,000 – 10,000 = 135,000

139. If a company has a constant growth rate estimated at 5% and a Free Cash Flow of
150,000, what is its estimated valuation (terminal value)?
150,000 / .05 = 3,000,000
* a. 3,000,000

Government Regulation

140. Dodd-Frank regulates which segment of the U.S. Economy?

Banking Industry

141. What is the regulatory body that oversees the systematic risk in banking?
Financial Stability Oversight Council

142. The SEC Securities & Exchange Commission requires companies to do the following:
(pick two)
Register all public offerings
Regulates stock sales
Ensures transparency through uniform reporting

143. What does the Sarbanes-Oxley Act require companies to do?

Have internal control audits, Sr Mgt signs off on statements, restrictions on auditors

144. FINRA (Financial Industry Regulatory Authority) does the following:

Licenses stock brokers, audits brokerage firms

Global Financing

145. If a product is made 100% domestically, what can affect its domestic market?
International competition

146. If a company makes its product in a foreign country where labor costs are much
lower, what happens?
Profits go up and domestic employment decreases.

147. If the value of a dollar increases, the price of imports:

Decreases

148. Why would a farmer buy a hedge when he signs a contract to sell produce overseas?
To reduce currency risk