## Friday, February 18, 2011

### Final Exam Part 1 and Part 2

Solution is available here for U\$60

Include your calculations for Part 1 on the Excel spreadsheet that you create for Part 2, as these calculations can be worth more points.
Part 2 – Short Answer – Calculations – create your own Excel file (this file may be used for showing your calculations in Part 1 as well)
PART 1:
Multiple choices. 20 questions; 20 points – 1 point each – Select the best answer. In some instances (i.e., a series of calculations), partial credit is possible – but you must give your instructor insight into your thought process via Excel, Word, etc.
Note that you may not get the “exact” answer due to rounding. For that reason, you should round out to at least three digits, and then choose the answer that is closest.

1. Consider the following equally likely project outcomes:
Profit
X                 Y
Pessimistic prediction                                          \$ 0              \$500
Expected outcome                                               \$ 500           \$500
Optimistic prediction                                            \$1000          \$500
a. Project Y has less uncertainty than Project X.
b. Project X has more variability than Project Y.
c. Since Projects X and Y have the same expected outcomes of \$500, investors will view them as identical in value.
d. Answers (a) and (b) above are true

2.  Which of the following is NOT included in the calculation of free cash flows?
a. Interest expense
b. Operating income
c. Depreciation
d. Net operating working capital

3. Hi Sky Enterprises has total assets of \$3 million, a debt ratio of 30%, and an after-tax profit margin of 11.04% and sales of \$2.5 million. What is Hi Sky’s return on equity?
a. 15%
b. 35%
c. 27%
d. 13%
4.   4.  Edward Johnson decided to open up a Roth IRA. He will invest \$1,800 per year for the next 35 years. Deposits to the Roth IRA will be made via a \$150 payroll deduction at the end of each month. Assume that Edward will earn 8.75% over the life of the IRA. How much will he have at the end of 35 years?
a. \$125,250
b. \$250,321
c. \$363,000
d. \$414,405
5. As the cost of capital is increased, the:
a. IRR remains constant.
b. payback period remains the same.
c. discounted payback period increases.
d. both b and c.
e. all of the above.

6. SpaceTech is considering a new project with the following projections for year 2

Year 2 Projections
EBIT                      \$400,000
Interest Expense         \$20,000

Depreciation Expense     \$40,000
Tax Rate 40%
Net Working Capital Needs \$200,000
If the projected net working capital needs for Year 1 was \$150,000, calculate the free cash flow for Year 2.
a. \$130,000
b. \$180,000
c. \$230,000
d. \$280,000

7. Famous Danish Corp. is replacing an old cookie cutter with a new one. The cookie cutter is being sold for \$25,000 and it has a net book value of \$75,000. Assume that Famous Danish is in the 34% income tax bracket. How much will Famous Danish net from the sale?

a. \$61,000
b. \$55,000
c. \$75,000
d. \$42,000
8. ABC will purchase a machine that will cost \$2,575,000. Required modifications will cost \$375,000. ABC will need to invest \$75,000 for additional inventory. The machine has an IRS approved useful life of 7 years; it is presumed to have no salvage value. ABC plans to depreciate the machine by using the straight-line method. The machine is expected to increase ABC’s sales revenues by \$1,890,000 per year; operating costs excluding depreciation are estimated at \$454,600 per year. Assume that the firm’s tax rate is 40%. What is the annual operating cash flow?

a. \$922,464
b. \$1,126,287
c. \$813,563
d. \$1,029,811
9. Knoko Systems is considering a capital budgeting project with a life of five years that requires an outlay of \$90,000. It has Free Cash Flows (FCF) each period as shown in the following distribution:

P (FCF)             FCF
0.10                  \$ 0
0.20                 12,500

0.40                  37,500
0.20                 43,750
0.10                 50,000
Assuming a risk-adjusted required rate of return of 0.20 is appropriate for projects of this level of risk, the risk-adjusted net present value of the project is \$_________, and therefore the project ___________ [should] or [should not] be accepted.

a. \$ (3,469); should not be accepted
b. \$ (4,963); should not be accepted
c. \$ 4,963; should be accepted
d. \$ 3,469; should be accepted
10. East Man Kodiac plans to maintain its optimal capital structure of 30% debt, 20% preferred stock, and 50% common stock. Bondholders require a return on East Man’s bonds of 10%; preferred shareholders require 11%; and common stockholders require 16%. Assuming that the firm has a marginal tax rate of 40%, what after-tax rate of return must East Man Kodiac earn on its investments if the value of the firm is to remain unchanged?

a. 10%
b. 12%
c. 14%
d. 16%
Use the following information to answer questions #11 - #14:
A friend of yours is trying to determine whether to open a sandwich stand at the local mall based on the following data. She expects total fixed costs per year of \$24,000, a sale price per sandwich of \$3.00, and variable costs per sandwich of \$1.80.
1.      The break-even level of output for this endeavor is:

a. 12,000.
b. 16,000.
c. 20,000.
d. 24,000.
2. What percentage of every sales dollar will contribute to covering fixed costs?

a.       30%
b. 40%
c. 50%
d. 60%
3. The break-even point in sales dollars is:

a. \$60,000.
b. \$54,000.
c. \$46,000.
d. \$30,000.
4. If your friend expects to sell no more than 15,000 sandwiches per year, then:

a. she should not undertake the endeavor given the current cost/volume/profit expectations.
b. she should undertake the endeavor given the current cost/volume/profit expectations.
c. she should assess the effect of lowering the sales price of sandwiches if she wishes to pursue this endeavor.
d. none of the above.
5. A firm has a degree of combined leverage of 1.25. Sale price per unit is \$15 and the quantity output is equal to 200,000 units. Interest expense is \$10,000 and fixed costs are \$270,000. Calculate the variable cost per unit.

a. \$5
b. \$6
c. \$7
d. \$8
6. As a general rule, the capital structure:

a. maximizes expected EPS and also maximizes the price per share of common stock.
b. minimizes the interest rate on debt and also maximizes the expected EPS.
c. minimizes the required rate on equity and also maximizes the stock price.
d. maximizes the price per share of common stock and also minimizes the weighted average cost of capital.
7. What is the central feature of the moderate view (theory) of capital structure?

A.    A high debt ratio will result in a maximum price of a firm’s common stock.
b. A firm’s common stock price will not be affected by the amount of debt a firm uses.
c. A low debt ratio will result in a maximum price for a firm’s common stock.
d. Modest levels of debt have a more favorable impact on a firm’s average cost of capital and stock price than no debt.
8. An optimal capital structure is achieved:

a. when a firm’s expected profits are maximized.
b. when a firm’s expected EPS are maximized.
c. when a firm’s expected stock price is maximized.
d. when a firm’s break-even point is achieved.
10. The Goreman Corporation has a debt ratio of 33.33% and it needs to raise \$100,000 to expand. Management feels that an optimal debt ratio is 16.67%. Sales are currently \$750,000, and the total assets turnover is 7.5. How should the expansion be financed so as to produce the desired debt ratio?

a. Finance it all with debt.
b. Finance it all with equity.
c. Finance 20% with debt and 80% with equity.
d. Finance 40% with debt and 60% with equity.
e. Finance 50% with debt and 50% with equity.

11. The moderate position of capital structure theory indicates that:

a. the tax shield on debt positively affects firm value, indicating that there is some benefit to financial leverage as opposed to an all-equity capitalization.
b. the higher the firm’s financial leverage, the higher the probability the firm will be unable to meet the financial obligations included in its debt contracts, which could ultimately lead to firm failure.
c. there is a range of capital structures, rather than a single capital structure, that is optimal.
D. all of the above.

PART 2:
Create an Excel spreadsheet to show your work. There are 7 problems, totaling 30 points – points assigned per problem as noted.

1.      From the scrambled list of items presented in Table 4, prepare an income statement and a balance sheet for Dooley Sportswear Company. (4 points)

Table 4
Financial Data for Dooley Sportswear, December 31, 1996
Inventory        \$206,250
Long-term debt           300,000
Interest expense          5,000
Accumulated depreciation      442,500
Cash    180,000
Net sales (all credit)    1,500,000
Common stock            800,000
Accounts receivable    225,000
Operating expenses     525,000
Notes payable-current             187,500
Cost of goods sold      937,500
Plant and equipment   1,312,500
Accounts payable        168,750
Marketable securities  95,000
Prepaid insurance        80,000
Accrued wages                                             65,000
Retained earnings-current-year                        ?
Federal income taxes                                      5,750

2. Frank Zanca is considering three different investments that his broker has offered to him. The different cash flows are as follows: (4 points)

End of Year            A                  B                     C

1                              300                                         400

2                              300

3                              300

4                              300               300                    600

5                                                   300

6                                                   300

7                                                   300

8                                                   300                    600

Because Frank has enough savings for only one investment, his broker has proposed the third alternative to be, according to his expertise, the best in town. However, Frank questions his broker and wants to estimate the present value of each investment. Assuming a 15% discount rate, what is Frank's best alternative?
2.                 If provided the nominal rate of interest (r) of 14.2% and the anticipated rate of inflation (i) of         5.5%, what is the real rate of interest (R)? (2 point)

3.                 AA & Co. has a beta of .656. If the expected market return is 13.2% and the risk-free rate is 5.7%, what is the appropriate required return of AA & Co. using the CAPM model? (2 point)

5. Bull Gator Industries is considering a new assembly line costing \$6,000,000. The assembly line will be fully depreciated by the simplified straight line method over its 5 year depreciable life. Operating costs of the new machine are expected to be \$1,100,000 per year. The existing assembly line has 5 years remaining before it will be fully depreciated and has a net book value of \$3,000,000. If sold today the company would receive \$2,400,000 for the existing machine. Annual operating costs on the existing machine are \$2,100,000 per year. Bull Gator is in the 46 percent marginal tax bracket and has a required rate of return of 12 percent. (10 points)

Required: Calculate the net present value of replacing the existing machine.
6. The terms of sale given by a company were 3/10 net 60.
a. Their customers would get a discount if they paid within how many days?
b. The discount would be __________.
c. If they do not take advantage of the discount, when must the account be paid?
d. What is the annualized opportunity cost of foregoing the discount?
(Hint: use a 360-day year in calculations.) (3 points)
7. The treasurer for Brook dale Clothing must decide how much money the company needs to borrow          in July. The balance sheet for June 30, 2004 is presented below:
Brook dale Clothing Balance Sheet
June 30, 2004
Cash                   \$75,000                                                          Accounts payable \$ 400,000
Marketable securities 100,000                                              Long-term debt 300,000
Accounts receivable    300,000                                             Common stock 100,000
Inventory                      250,000                                             Retained earnings 200,000
Total current assets    725,000                                             Total liabilities and
Fixed assets                  275,000                                             stockholder’s equity \$1,000,000

Total assets \$1,000,000
The company expects sales of \$250,000 for July. The company has observed that 25% of its sales is for cash and that the remaining 75% is collected in the following month. The company plans to purchase \$400,000 of new clothing. Usually 40% of purchases is for cash and the remaining 60% of purchases is paid in the following month. Salaries are \$100,000 per month, lease payments are \$50,000 per month, and depreciation charges are \$20,000 per month. The company plans to purchase a new building for \$200,000 in July and sell its marketable securities for \$100,000. If the company must maintain a minimum cash balance of \$50,000, how much money must the company borrow in July? (5 points)