# BA350 Financial Management: Week 8 Final Exam (25 Review Problems)

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BA350 Financial Management

Week 8 Final Exam

Chapter 2: Problem 2-4, 2-7

Chapter 3: Problem 3-8, 3-10

Chapter 12: Problem 12-1, 12-4

Chapter 13: Problem 13-6, 13-7, 13-8

Chapter 4: Problem 4-4, 4-5, 4-20, 4-22

Chapter 5: Problem 5-15, 5-21

Chapter 6: Problem 6-4, 6-10

Chapter 7: Problem 7-4, 7-10

Chapter 8: Problem 8-4, 8-5, 8-6

Chapter 9: Problem 9-3, 9-8, 9-13

2-4 Income Statement

Pearson Brothers recently reported an EBITDA of $7.5 million and net income of $1.8 million. It had $2.0 million of interest expense, and its corporate tax rate was 40%. What was its charge for depreciation and amortization?

2-7 Corporate Tax Liability

The Talley Corporation had a taxable income of $365,000 from operations after all operating costs but before (1) interest charges of $50,000, (2) dividends received of $15,000, (3) dividends paid of $25,000, and (4) income taxes.

What are the firm’s income tax liability and its after-tax income?

What are the company’s marginal and average tax rates on taxable income?

3-8 Profit Margin and Debt Ratio

Assume you are given the following relationships for the Clayton Corporation:

Sales/total assets 1.5

Return on assets (ROA) 3%

Return on equity (ROE) 5%

Calculate Clayton’s profit margin and debt ratio.

3-10 Times-Interest-Earned Ratio

The Manor Corporation has $500,000 of debt outstanding, and it pays an interest rate of 10% annually: Manor’s annual sales are $2 million, its average tax rate is 30%, and its net profit margin on sales is 5%. If the company does not maintain a TIE ratio of at least 5 to 1, then its bank will refuse to renew the loan and bankruptcy will result. What is Manor’s TIE ratio?

12-1 AFN Equation

Baxter Video Products’s sales are expected to increase by 20% from $5 million in2010 to $6 million in 2011. Its assets totaled $3 million at the end of 2010. Baxter is already at full capacity, so its assets must grow at the same rate as projected sales. At the end of 2010, current liabilities were $1 million, consisting of $250,000 of accounts payable, $500,000 of notes payable, and $250,000 of accruals. The after-tax profit margin is forecasted to be 5%, and the forecasted payout ratio is 70%.

Use the AFN equation to forecast Baxter’s additional funds needed for the coming year.

12-4 Sales Increase

Bannister Legal Services generated $2,000,000 in sales during 2010, and its year-end total assets were $1,500,000. Also, at year-end 2010, current liabilities were $500,000, consisting of $200,000 of notes payable, $200,000 of accounts payable, and $100,000 of accruals. Looking ahead to 2011, the company estimates that its assets must increase at the same rate as sales, its spontaneous liabilities will increase at the same rate as sales, its profit margin will be 5%, and its payout ratio will be 60%. How large a sales increase can the company achieve without having to raise funds externally; that is, what is its self-supporting growth rate?

13-6 Value of Operations

Brooks Enterprises has never paid a dividend. Free cash flow is projected to be $80,000 and $100,000 for the next 2 years, respectively; after the second year, FCF is expected to grow at a constant rate of 8%. The company’s weighted average cost of capital is 12%.

a. What is the terminal, or horizon, value of operations? (Hint: Find the value of all free cash flows beyond Year 2 discounted back to Year 2.)

b. Calculate the value of Brooks’s operations.

13-7 Corporate Valuation

Dozier Corporation is a fast-growing supplier of office products. Analysts project the following free cash flows (FCFs) during the next 3 years, after which FCF is expected to grow at a constant 7% rate. Dozier’s weighted average cost of capital is WACC = 13%.

Year

1 2 3

Free cash flow ($ millions) $(20) $30 $40

a. What is Dozier’s terminal, or horizon, value? (Hint: Find the value of all free cash flows beyond Year 3 discounted back to Year 3.)

b. What is the current value of operations for Dozier?

c. Suppose Dozier has $10 million in marketable securities, $100 million in debt, and 10 million shares of stock. What is the intrinsic price per share?

13-8 Value of Equity

The balance sheet of Hutter Amalgamated is shown below. If the 12/31/2010 value of operations is $756 million, what is the 12/31/2010 intrinsic market value of equity?

Balance Sheet, December 31, 2010 (Millions of Dollars)

Assets Liabilities and Equity

Cash 20.0 Accounts payable 19.0

Marketable securities 77.0 Notes payable 151.0

Accounts receivable 100.0 Accruals 51.0

Inventories 200.0 Total current liabilities 221.0

Total current assets 397.0 Long-term bonds 190.0

Net plant and equipment 279.0 Preferred stock 76.0

Common stock， (par plus PIC) 100.0

Retained earnings 89.0

Common equity 189.0

Total assets $676.0 Total liabilities and equity $ 676.0 $676.0

4-4 Number of Periods of a Single Payment

If you deposit money today in an account that pays 6.5% annual interest, how long will it take to double your money?

4-5 Number of Periods for an Annuity

You have $42,180.53 in a brokerage account, and you plan to deposit an additional $5,000 at the end of every future year until your account totals $250,000. You expect to earn 12% annually on the account. How many years will it take to reach your goal?

4-20 Amortization

a. Set up an amortization schedule for a $25,000 loan to be repaid in equal installments at the end of each of the next 5 years. The interest rate is 10%.

b. How large must each annual payment be if the loan is for $50,000? Assume that the interest rate remains at 10% and that the loan is still paid off over 5 years.

c. How large must each payment be if the loan is for $50,000, the interest rate is 10%, and the loan is paid off in equal installments at the end of each of the next 10 years? This loan is for the same amount as the loan in part b, but the payments are spread out over twice as many periods. Why are these payments not half as large as the payments on the loan in part b?

4-22 Expected Rate of Return

Washington-Pacific invested $4 million to buy a tract of land and plant some young pine trees. The trees can be harvested in 10 years, at which time W-P plans to sell the forest at an expected price of $8 million. What is W-P’s expected rate of return?

5-15 Yield to Call, Yield to Maturity, and Market Rates

Absalom Motors’s 14% coupon rate, semiannual payment, $1,000 par value bonds that mature in 30 years are callable 5 years from now at a price of $1,050. The bonds sell at a price of $1,353.54, and the yield curve is flat. Assuming that interest rates in the economy are expected to remain at their current level, what is the best estimate of the nominal interest rate on new bonds?

5-21 Bond Valuation and Changes in Maturity and Required Returns

Suppose Hillard Manufacturing sold an issue of bonds with a 10-year maturity, a $1,000 par value, a 10% coupon rate, and semiannual interest payments.

a. Two years after the bonds were issued, the going rate of interest on bonds such as these fell to 6%. At what price would the bonds sell?

b. Suppose that, 2 years after the initial offering, the going interest rate had risen to 12%. At what price would the bonds sell?

c. Suppose, as in part a, that interest rates fell to 6%, 2 years after the issue date. Suppose further that the interest rate remained at 6% for the next 8 years. What would happen to the price of the bonds over time?

6-4 Expected Returns

A stock's returns have the following distribution:

Demand for Company's Products Probability of this Demand Occuring Rate of return if this demand Occurs

Weak 0.10 -50%

Below average 0.20 -5%

Average 0.40 16%

Above average 0.20 25%

Strong 0.10 60%

1.00

Calculate the stock's expected return, standard deviation, and coefficient of variation.

6-10 Portfolio Beta

You have a $2 million portfolio consisting of a $100,000 investment in each of 20 different stocks. The portfolio has a beta of 1.1. You are considering selling $100,000 worth of one stock with a beta of 0.9 and using the proceeds to purchase another stock with a beta of 1.4. What will the portfolio’s new beta be after these transactions?

7-4 Preferred Stock Valuation

Nick’s Enchiladas Incorporated has preferred stock outstanding that pays a dividend of $5 at the end of each year. The preferred sells for $50 a share. What is the stock’s required rate of return?

7-10 Rates of Return and Equilibrium

The beta coefficient for Stock C is bC = 0.4 and that for Stock D is bD = -0.5. (Stock D’s beta is negative, indicating that its rate of return rises whenever returns on most other stocks fall. There are very few negative-beta stocks, although collection agency and gold mining stocks are sometimes cited as examples.)

a. If the risk-free rate is 9% and the expected rate of return on an average stock is 13%, what are the required rates of return on Stocks C and D?

b. For Stock C, suppose the current price, P0, is $25; the next expected dividend,D1, is $1.50; and the stock’s expected constant growth rate is 4%. Is the stock in equilibrium? Explain, and describe what would happen if the stock were not in equilibrium.

8-4 Put-Call Parity

The current price of a stock is $33, and the annual risk-free rate is 6%. A call option with a strike price of $32 and with 1 year until expiration has a current value of $6.56. What is the value of a put option written on the stock with the same exercise price and expiration date as the call option?

8-5 Black-Scholes Model

Use the Black-Scholes Model to find the price for a call option with the following inputs: (1) current stock price is $30, (2) strike price is $35, (3) time to expiration is 4 months, (4) annualized risk-free rate is 5%, and (5) variance of stock return is 0.25.

8-6 Binomial Model

The current price of a stock is $20. In 1 year, the price will be either $26 or $16. The annual risk-free rate is 5%. Find the price of a call option on the stock that has a strike price of $21 and that expires in 1 year. (Hint: Use daily compounding.)

9-3 Cost of Preferred Stock

Duggins Veterinary Supplies can issue perpetual preferred stock at a price of $50 a share with an annual dividend of $4.50 a share. Ignoring flotation costs, what is the company’s cost of preferred stock, rps?

9-8 WACC

David Ortiz Motors has a target capital structure of 40% debt and 60% equity. The yield to maturity on the company’s outstanding bonds is 9%, and the company’s tax rate is 40%. Ortiz’s CFO has calculated the company’s WACC as 9.96%. What is the company’s cost of equity capital?

9-13 The Cost of Equity and Flotation Costs

Messman Manufacturing will issue common stock to the public for $30. The expected dividend and the growth in dividends are $3.00 per share and 5%, respectively. If the flotation cost is 10% of the issue’s gross proceeds, what is the cost of external equity, re?

BA350 Financial Management

Week 8 Final Exam

Chapter 2: Problem 2-4, 2-7

Chapter 3: Problem 3-8, 3-10

Chapter 12: Problem 12-1, 12-4

Chapter 13: Problem 13-6, 13-7, 13-8

Chapter 4: Problem 4-4, 4-5, 4-20, 4-22

Chapter 5: Problem 5-15, 5-21

Chapter 6: Problem 6-4, 6-10

Chapter 7: Problem 7-4, 7-10

Chapter 8: Problem 8-4, 8-5, 8-6

Chapter 9: Problem 9-3, 9-8, 9-13

2-4 Income Statement

Pearson Brothers recently reported an EBITDA of $7.5 million and net income of $1.8 million. It had $2.0 million of interest expense, and its corporate tax rate was 40%. What was its charge for depreciation and amortization?

2-7 Corporate Tax Liability

The Talley Corporation had a taxable income of $365,000 from operations after all operating costs but before (1) interest charges of $50,000, (2) dividends received of $15,000, (3) dividends paid of $25,000, and (4) income taxes.

What are the firm’s income tax liability and its after-tax income?

What are the company’s marginal and average tax rates on taxable income?

3-8 Profit Margin and Debt Ratio

Assume you are given the following relationships for the Clayton Corporation:

Sales/total assets 1.5

Return on assets (ROA) 3%

Return on equity (ROE) 5%

Calculate Clayton’s profit margin and debt ratio.

3-10 Times-Interest-Earned Ratio

The Manor Corporation has $500,000 of debt outstanding, and it pays an interest rate of 10% annually: Manor’s annual sales are $2 million, its average tax rate is 30%, and its net profit margin on sales is 5%. If the company does not maintain a TIE ratio of at least 5 to 1, then its bank will refuse to renew the loan and bankruptcy will result. What is Manor’s TIE ratio?

12-1 AFN Equation

Baxter Video Products’s sales are expected to increase by 20% from $5 million in2010 to $6 million in 2011. Its assets totaled $3 million at the end of 2010. Baxter is already at full capacity, so its assets must grow at the same rate as projected sales. At the end of 2010, current liabilities were $1 million, consisting of $250,000 of accounts payable, $500,000 of notes payable, and $250,000 of accruals. The after-tax profit margin is forecasted to be 5%, and the forecasted payout ratio is 70%.

Use the AFN equation to forecast Baxter’s additional funds needed for the coming year.

12-4 Sales Increase

Bannister Legal Services generated $2,000,000 in sales during 2010, and its year-end total assets were $1,500,000. Also, at year-end 2010, current liabilities were $500,000, consisting of $200,000 of notes payable, $200,000 of accounts payable, and $100,000 of accruals. Looking ahead to 2011, the company estimates that its assets must increase at the same rate as sales, its spontaneous liabilities will increase at the same rate as sales, its profit margin will be 5%, and its payout ratio will be 60%. How large a sales increase can the company achieve without having to raise funds externally; that is, what is its self-supporting growth rate?

13-6 Value of Operations

Brooks Enterprises has never paid a dividend. Free cash flow is projected to be $80,000 and $100,000 for the next 2 years, respectively; after the second year, FCF is expected to grow at a constant rate of 8%. The company’s weighted average cost of capital is 12%.

a. What is the terminal, or horizon, value of operations? (Hint: Find the value of all free cash flows beyond Year 2 discounted back to Year 2.)

b. Calculate the value of Brooks’s operations.

13-7 Corporate Valuation

Dozier Corporation is a fast-growing supplier of office products. Analysts project the following free cash flows (FCFs) during the next 3 years, after which FCF is expected to grow at a constant 7% rate. Dozier’s weighted average cost of capital is WACC = 13%.

Year

1 2 3

Free cash flow ($ millions) $(20) $30 $40

a. What is Dozier’s terminal, or horizon, value? (Hint: Find the value of all free cash flows beyond Year 3 discounted back to Year 3.)

b. What is the current value of operations for Dozier?

c. Suppose Dozier has $10 million in marketable securities, $100 million in debt, and 10 million shares of stock. What is the intrinsic price per share?

13-8 Value of Equity

The balance sheet of Hutter Amalgamated is shown below. If the 12/31/2010 value of operations is $756 million, what is the 12/31/2010 intrinsic market value of equity?

Balance Sheet, December 31, 2010 (Millions of Dollars)

Assets Liabilities and Equity

Cash 20.0 Accounts payable 19.0

Marketable securities 77.0 Notes payable 151.0

Accounts receivable 100.0 Accruals 51.0

Inventories 200.0 Total current liabilities 221.0

Total current assets 397.0 Long-term bonds 190.0

Net plant and equipment 279.0 Preferred stock 76.0

Common stock， (par plus PIC) 100.0

Retained earnings 89.0

Common equity 189.0

Total assets $676.0 Total liabilities and equity $ 676.0 $676.0

4-4 Number of Periods of a Single Payment

If you deposit money today in an account that pays 6.5% annual interest, how long will it take to double your money?

4-5 Number of Periods for an Annuity

You have $42,180.53 in a brokerage account, and you plan to deposit an additional $5,000 at the end of every future year until your account totals $250,000. You expect to earn 12% annually on the account. How many years will it take to reach your goal?

4-20 Amortization

a. Set up an amortization schedule for a $25,000 loan to be repaid in equal installments at the end of each of the next 5 years. The interest rate is 10%.

b. How large must each annual payment be if the loan is for $50,000? Assume that the interest rate remains at 10% and that the loan is still paid off over 5 years.

c. How large must each payment be if the loan is for $50,000, the interest rate is 10%, and the loan is paid off in equal installments at the end of each of the next 10 years? This loan is for the same amount as the loan in part b, but the payments are spread out over twice as many periods. Why are these payments not half as large as the payments on the loan in part b?

4-22 Expected Rate of Return

Washington-Pacific invested $4 million to buy a tract of land and plant some young pine trees. The trees can be harvested in 10 years, at which time W-P plans to sell the forest at an expected price of $8 million. What is W-P’s expected rate of return?

5-15 Yield to Call, Yield to Maturity, and Market Rates

Absalom Motors’s 14% coupon rate, semiannual payment, $1,000 par value bonds that mature in 30 years are callable 5 years from now at a price of $1,050. The bonds sell at a price of $1,353.54, and the yield curve is flat. Assuming that interest rates in the economy are expected to remain at their current level, what is the best estimate of the nominal interest rate on new bonds?

5-21 Bond Valuation and Changes in Maturity and Required Returns

Suppose Hillard Manufacturing sold an issue of bonds with a 10-year maturity, a $1,000 par value, a 10% coupon rate, and semiannual interest payments.

a. Two years after the bonds were issued, the going rate of interest on bonds such as these fell to 6%. At what price would the bonds sell?

b. Suppose that, 2 years after the initial offering, the going interest rate had risen to 12%. At what price would the bonds sell?

c. Suppose, as in part a, that interest rates fell to 6%, 2 years after the issue date. Suppose further that the interest rate remained at 6% for the next 8 years. What would happen to the price of the bonds over time?

6-4 Expected Returns

A stock's returns have the following distribution:

Demand for Company's Products Probability of this Demand Occuring Rate of return if this demand Occurs

Weak 0.10 -50%

Below average 0.20 -5%

Average 0.40 16%

Above average 0.20 25%

Strong 0.10 60%

1.00

Calculate the stock's expected return, standard deviation, and coefficient of variation.

6-10 Portfolio Beta

You have a $2 million portfolio consisting of a $100,000 investment in each of 20 different stocks. The portfolio has a beta of 1.1. You are considering selling $100,000 worth of one stock with a beta of 0.9 and using the proceeds to purchase another stock with a beta of 1.4. What will the portfolio’s new beta be after these transactions?

7-4 Preferred Stock Valuation

Nick’s Enchiladas Incorporated has preferred stock outstanding that pays a dividend of $5 at the end of each year. The preferred sells for $50 a share. What is the stock’s required rate of return?

7-10 Rates of Return and Equilibrium

The beta coefficient for Stock C is bC = 0.4 and that for Stock D is bD = -0.5. (Stock D’s beta is negative, indicating that its rate of return rises whenever returns on most other stocks fall. There are very few negative-beta stocks, although collection agency and gold mining stocks are sometimes cited as examples.)

a. If the risk-free rate is 9% and the expected rate of return on an average stock is 13%, what are the required rates of return on Stocks C and D?

b. For Stock C, suppose the current price, P0, is $25; the next expected dividend,D1, is $1.50; and the stock’s expected constant growth rate is 4%. Is the stock in equilibrium? Explain, and describe what would happen if the stock were not in equilibrium.

8-4 Put-Call Parity

The current price of a stock is $33, and the annual risk-free rate is 6%. A call option with a strike price of $32 and with 1 year until expiration has a current value of $6.56. What is the value of a put option written on the stock with the same exercise price and expiration date as the call option?

8-5 Black-Scholes Model

Use the Black-Scholes Model to find the price for a call option with the following inputs: (1) current stock price is $30, (2) strike price is $35, (3) time to expiration is 4 months, (4) annualized risk-free rate is 5%, and (5) variance of stock return is 0.25.

8-6 Binomial Model

The current price of a stock is $20. In 1 year, the price will be either $26 or $16. The annual risk-free rate is 5%. Find the price of a call option on the stock that has a strike price of $21 and that expires in 1 year. (Hint: Use daily compounding.)

9-3 Cost of Preferred Stock

Duggins Veterinary Supplies can issue perpetual preferred stock at a price of $50 a share with an annual dividend of $4.50 a share. Ignoring flotation costs, what is the company’s cost of preferred stock, rps?

9-8 WACC

David Ortiz Motors has a target capital structure of 40% debt and 60% equity. The yield to maturity on the company’s outstanding bonds is 9%, and the company’s tax rate is 40%. Ortiz’s CFO has calculated the company’s WACC as 9.96%. What is the company’s cost of equity capital?

9-13 The Cost of Equity and Flotation Costs

Messman Manufacturing will issue common stock to the public for $30. The expected dividend and the growth in dividends are $3.00 per share and 5%, respectively. If the flotation cost is 10% of the issue’s gross proceeds, what is the cost of external equity, re?

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