Fin 384 Quiz 1
ISC 388 Investments Quiz 1
Name:______________________________
1) A firm has a higher quick (or acid test) ratio than the industry average, which implies A. the firm has a higher P/E ratio than other firms in the industry.
B.
the firm is more likely to avoid insolvency in the short run than other firms in the industry.
C.
the firm may be less profitable than other firms in the industry.
D.
the firm has a higher P/E ratio than other firms in the industry and the firm is more likely to avoid insolvency in the short run than other firms in the industry.
E.
the firm is more likely to avoid insolvency in the short run than other firms in the industry and the firm may be less profitable than other firms in the industry. …show more content…
Current assets earn less than fixed assets; thus, a firm with a relatively high level of current assets may be less profitable than other firms. However, its high level of current assets makes it more liquid.
2) A firm has a higher asset turnover ratio than the industry average, which implies A. the firm has a higher P/E ratio than other firms in the industry.
B.
the firm is more likely to avoid insolvency in the short run than other firms in the industry.
C.
the firm is more profitable than other firms in the industry.
D.
the firm is utilizing assets more efficiently than other firms in the industry.
E.
the firm has higher spending on new fixed assets than other firms in the industry.
The higher the asset turnover ratio, the more efficiently the firm is using assets.
3) If the interest rate on debt is higher than ROA, a firm will __________ by increasing the use of debt in the capital structure. A. increase the ROE
B.
not change the ROE
C.
decrease the ROE
D.
change the ROE in an indeterminable manner
If ROA is less than the interest rate, then ROE will decline by an amount that depends on the debt to equity ratio.
4) A firm has a P/E ratio of 12 and a ROE of 13% and a market-to-book value of A.
0.64.
B.
0.92.
C.
1.08.
D.
1.56.
E/P = ROE/(P/B); 1/12 = 0.13 P/B; 0.0833 = 0.13/(P/B); 0.0833(P/B) = 0.13; P/B = 1.56.
Use the financial statements of Black Barn Company given below answer questions 5 to 7.
5) The firm's current ratio for 2009 is A.
2.31.
B.
1.87.
C.
2.22.
D.
2.46.
$3,240,000/$1,400,000 = 2.31.
6) The firm's average collection period for 2009 is A.
59.31.
B.
55.05.
C.
61.31.
D.
49.05.
E.
None of the options
AR turnover = $8,000,000/[($1,200,000 + $950,000)/2] = 7.44; ACP = 365/7.44 = 49.05 days.
7) The firm's P/E ratio for 2009 is A.
8.88.
B.
7.63.
C.
7.88.
D.
7.32.
EPS = $660,000/130,000 = $5.08; $40/$5.08 = 7.88.
8) A firm has a net profit/pretax profit ratio of 0.625, a leverage ratio of 1.2, a pretax profit/EBIT of 0.9, an ROE of 17.82%, a current ratio of 8, and a return on sales ratio of 8%. The firm's asset turnover is A.
0.3.
B.
1.3.
C.
2.3.
D.
3.3.
17.82% = 0.625 × 0.9 × 8% × asset turnover × 1.2; asset turnover = 3.3.
9) A firm has an ROA of 14%, a debt/equity ratio of 0.8, a tax rate of 35%, and the interest rate on the debt is 10%. The firm's ROE is A.
11.18%.
B.
8.97%.
C.
11.54%.
D.
12.62%.
ROE = (1 - 0.35)[14% + (14% - 10%)0.8] = 11.18%.
10) A firm has a (net profit/pretax profit) ratio of 0.6, a leverage ratio of 2, a (pretax profit/EBIT) of 0.6, an asset turnover ratio of 2.5, a current ratio of 1.5, and a return on sales ratio of 4%. The firm's ROE is
A.
4.2%.
B.
5.2%.
C.
6.2%.
D.
7.2%.
E.
None of the options
ROE = 0.6 × 0.6 × 4% × 2.5 × 2 = 7.2%.
11) A measure of asset utilization is A. sales divided by working capital.
B.
return on total assets.
C.
return on equity capital.
D.
operating profit divided by sales.
E.
None of the options
The return on total assets measures how efficiently the firm is utilizing assets to generate returns.
12) You wish to earn a return of 10% on each of two stocks, C and D. Each of the stocks is expected to pay a dividend of $2 in the upcoming year. The expected growth rate of dividends is 9% for stock C and 10% for stock D. The intrinsic value of stock C A. will be greater than the intrinsic value of stock D.
B.
will be the same as the intrinsic value of stock D.
C.
will be less than the intrinsic value of stock D.
D.
will be the same or greater than the intrinsic value of stock D.
E.
None of the options
PV0 = D1/(k - g); given that dividends are equal, the stock with the higher growth rate will have the higher value.
13) Low Tech Company has an expected ROE of 10%. The dividend growth rate will be ________ if the firm follows a policy of paying 40% of earnings in the form of dividends. A.
6.0%
B.
4.8%
C.
7.2%
D.
3.0%
10% × 0.60 = 6.0%.
14) You are considering acquiring a common stock that you would like to hold for one year. You expect to receive both $1.25 in dividends and $32 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 10% return. A.
$30.23
B.
$24.11
C.
$26.52
D.
$27.50
E.
None of the options
.10 = (32 - P + 1.25)/P; .10P = 32 - P + 1.25; 1.10P = 33.25; P = 30.23.
15) Sure Tool Company is expected to pay a dividend of $2 in the upcoming year. The risk-free rate of return is 4% and the expected return on the market portfolio is 14%. Analysts expect the price of Sure Tool Company shares to be $22 a year from now. The beta of Sure Tool Company's stock is 1.25.
The market's required rate of return on Sure's stock is A.
14.0%.
B.
17.5%.
C.
16.5%.
D.
15.25%.
E.
None of the options
4% + 1.25(14% - 4%) = 16.5%.
16) If Sure's intrinsic value is $21.00 today, what must be its growth rate? A.
0.0%
B.
10%
C.
4%
D.
6%
E.
7%
k = .04 + 1.25 (.14 - .04); k = .165; .165 = 2/21 + g; g = .07.
17) High Tech Chip Company paid a dividend last year of $2.50. The expected ROE for next year is 12.5%. An appropriate required return on the stock is 11%. If the firm has a plowback ratio of 60%, the dividend in the coming year should be A.
$1.00.
B.
$2.50.
C.
$2.69.
D.
$2.81.
E.
None of the options
g = .125 × .6 = 7.5%; $2.50(1.075) = $2.69.
18) JCPenney Company is expected to pay a dividend in year 1 of $1.65, a dividend in year 2 of $1.97, and a dividend in year 3 of $2.54. After year 3, dividends are expected to grow at the rate of 8% per year. An appropriate required return for the stock is 11%. The stock should be worth _______ today. A.
$33.00
B.
$40.67
C.
$71.80
D.
$66.00
E.
None of the options
Calculations are shown in the table below.
P3 = $2.54 (1.08)/(.11 - .08) = $91.44; PV of P3 = $91.44/(1.11)3 = $66.86; P0 = $4.94 + $66.86 = $71.80.
19) Consider the free cash flow approach to stock valuation. Utica Manufacturing Company is expected to have before-tax cash flow from operations of $500,000 in the coming year. The firm's corporate tax rate is 30%. It is expected that $200,000 of operating cash flow will be invested in new fixed assets. Depreciation for the year will be $100,000. After the coming year, cash flows are expected to grow at 6% per year. The appropriate market capitalization rate for unleveraged cash flow is 15% per year. The firm has no outstanding debt. The projected free cash flow of Utica Manufacturing Company for the coming year is A.
$150,000.
B.
$180,000.
C.
$300,000.
D.
$380,000.
Calculations are shown below.
20) Consider the free cash flow approach to stock valuation.
Utica Manufacturing Company is expected to have before-tax cash flow from operations of $500,000 in the coming year. The firm's corporate tax rate is 30%. It is expected that $200,000 of operating cash flow will be invested in new fixed assets. Depreciation for the year will be $100,000. After the coming year, cash flows are expected to grow at 6% per year. The appropriate market capitalization rate for unleveraged cash flow is 15% per year. The firm has no outstanding debt. The total value of the equity of Utica Manufacturing Company should be A.
$1,000,000.
B.
$2,000,000.
C.
$3,000,000.
D.
$4,000,000.
Projected free cash flow = $180,000; V0 = 180,000/(.15 - .06) = $2,000,000.
21) The growth in dividends of Music Doctors, Inc. is expected to be 8% per year for the next two years, followed by a growth rate of 4% per year for three years; after this five-year period, the growth in dividends is expected to be 3% per year, indefinitely. The required rate of return on Music Doctors, Inc. is 11%. Last year's dividends per share were $2.75. What should the stock sell for today? A.
$8.99
B.
$25.21
C.
$39.71
D.
$110.00
E.
None of the options
Calculations are shown …show more content…
below
P5 = 3.7164/(.11 - .03) = $46.4544; PV of P5 = $46.4544/(1.11)5 = $27.5684; PO = $12.1449 + $27.5684 = $39.71.
22) If a firm has a required rate of return equal to the ROE A.
the firm can increase market price and P/E by retaining more earnings.
B.
the firm can increase market price and P/E by increasing the growth rate.
C.
the amount of earnings retained by the firm does not affect market price or the P/E.
D.
the firm can increase market price and P/E by retaining more earnings and increasing the growth rate.
E.
None of the options
If required return and ROE are equal, investors are indifferent as to whether the firm retains more earnings or increases dividends. Thus, retention rates and growth rates do not affect market price and P/E.
23) The present value of growth opportunities (PVGO) is equal to
I) the difference between a stock's price and its no-growth value per share.
II) the stock's price.
III) zero if its return on equity equals the discount rate.
IV) the net present value of favorable investment opportunities. A.
I and IV
B.
II and IV
C.
I, III, and IV
D.
II, III, and IV
E.
III and IV
All are correct except II—the stock's price equals the no-growth value per share plus the PVGO.
24) The most appropriate discount rate to use when applying a FCFE valuation model is the
A. required rate of return on equity.
B.
WACC.
C.
risk-free rate.
D.
None of the options
The most appropriate discount rate to use when applying a FCFE valuation model is the required rate of return on equity.
25) Fly Boy Corporation is expected have EBIT of $800k this year. Fly Boy Corporation is in the 30% tax bracket, will report $52,000 in depreciation, will make $86,000 in capital expenditures, and will have a $16,000 increase in net working capital this year. What is Fly Boy's FCFF? A.
510,000
B.
406,000
C.
542,000
D.
596,000
E.
682,000
FCFF = EBIT(1 - T) + depreciation - capital expenditures - increase in NWC or 800,000(.7) + 52,000 - 86,000 - 16,000 = 510,000.
26) Viking Insurance forecasts earnings next year of $4.50 per share. Viking has a dividend payout ratio of 40%. The required return is 15%. Return on equity is 8.33%. The present value of growth opportunities (PVGO) and the value of the stock based on the constant growth model are closets to:
A. PVGO = $4.00 Share value = $34.00
B. PVGO = $ –21.00 Share value = $9.00
C. PVGO = $ –12.00 Share value = $18.00
D. PVGO = $ 4.00 Share value = $12.00
27) Lisa Design pays a current annual dividend of $2.00 and is currently growing at a rate of 20%. The rate is expected to decline linearly to 10% over four years and remain at that level indefinitely. The required rate of return for an investment in Lisa Design is 18%. The current estimated value of Lisa Design is closest to:
A. $24.22
B. $29.78
C. $30.20
D. $32.50
28) Why is the NPAT margin a poor metric for performance evaluation across firms?
A. Differences in depreciation charges have too great an impact.
B. Differences in sales turnover have too great an impact.
C. Differences in operating leverage have too great an impact.
D. Differences in financing structure have too great an impact.
29) What are the major determinants of ROE (return of equity)?
A. Asset turnover, leverage, profit margin
B. Asset turnover, revenue, capital expenditure
C. Asset turnover, current ratio, EBIT
D. Enterprise value, profit margin, sales
30) Chamber Group is analyzing the potential takeover of Outmenu, Inc. Chamber has gathered the following data on Outmenu. The most appropriate model for valuing Outmenu is the:
A. Free cash flow to equity model
B. Dividend discount H-model
C. Free cash flow to the firm model
D. Constant dividend growth model
Name:______________________________
1) A firm has a higher quick (or acid test) ratio than the industry average, which implies A. the firm has a higher P/E ratio than other firms in the industry.
B.
the firm is more likely to avoid insolvency in the short run than other firms in the industry.
C.
the firm may be less profitable than other firms in the industry.
D.
the firm has a higher P/E ratio than other firms in the industry and the firm is more likely to avoid insolvency in the short run than other firms in the industry.
E.
the firm is more likely to avoid insolvency in the short run than other firms in the industry and the firm may be less profitable than other firms in the industry. …show more content…
Current assets earn less than fixed assets; thus, a firm with a relatively high level of current assets may be less profitable than other firms. However, its high level of current assets makes it more liquid.
2) A firm has a higher asset turnover ratio than the industry average, which implies A. the firm has a higher P/E ratio than other firms in the industry.
B.
the firm is more likely to avoid insolvency in the short run than other firms in the industry.
C.
the firm is more profitable than other firms in the industry.
D.
the firm is utilizing assets more efficiently than other firms in the industry.
E.
the firm has higher spending on new fixed assets than other firms in the industry.
The higher the asset turnover ratio, the more efficiently the firm is using assets.
3) If the interest rate on debt is higher than ROA, a firm will __________ by increasing the use of debt in the capital structure. A. increase the ROE
B.
not change the ROE
C.
decrease the ROE
D.
change the ROE in an indeterminable manner
If ROA is less than the interest rate, then ROE will decline by an amount that depends on the debt to equity ratio.
4) A firm has a P/E ratio of 12 and a ROE of 13% and a market-to-book value of A.
0.64.
B.
0.92.
C.
1.08.
D.
1.56.
E/P = ROE/(P/B); 1/12 = 0.13 P/B; 0.0833 = 0.13/(P/B); 0.0833(P/B) = 0.13; P/B = 1.56.
Use the financial statements of Black Barn Company given below answer questions 5 to 7.
5) The firm's current ratio for 2009 is A.
2.31.
B.
1.87.
C.
2.22.
D.
2.46.
$3,240,000/$1,400,000 = 2.31.
6) The firm's average collection period for 2009 is A.
59.31.
B.
55.05.
C.
61.31.
D.
49.05.
E.
None of the options
AR turnover = $8,000,000/[($1,200,000 + $950,000)/2] = 7.44; ACP = 365/7.44 = 49.05 days.
7) The firm's P/E ratio for 2009 is A.
8.88.
B.
7.63.
C.
7.88.
D.
7.32.
EPS = $660,000/130,000 = $5.08; $40/$5.08 = 7.88.
8) A firm has a net profit/pretax profit ratio of 0.625, a leverage ratio of 1.2, a pretax profit/EBIT of 0.9, an ROE of 17.82%, a current ratio of 8, and a return on sales ratio of 8%. The firm's asset turnover is A.
0.3.
B.
1.3.
C.
2.3.
D.
3.3.
17.82% = 0.625 × 0.9 × 8% × asset turnover × 1.2; asset turnover = 3.3.
9) A firm has an ROA of 14%, a debt/equity ratio of 0.8, a tax rate of 35%, and the interest rate on the debt is 10%. The firm's ROE is A.
11.18%.
B.
8.97%.
C.
11.54%.
D.
12.62%.
ROE = (1 - 0.35)[14% + (14% - 10%)0.8] = 11.18%.
10) A firm has a (net profit/pretax profit) ratio of 0.6, a leverage ratio of 2, a (pretax profit/EBIT) of 0.6, an asset turnover ratio of 2.5, a current ratio of 1.5, and a return on sales ratio of 4%. The firm's ROE is
A.
4.2%.
B.
5.2%.
C.
6.2%.
D.
7.2%.
E.
None of the options
ROE = 0.6 × 0.6 × 4% × 2.5 × 2 = 7.2%.
11) A measure of asset utilization is A. sales divided by working capital.
B.
return on total assets.
C.
return on equity capital.
D.
operating profit divided by sales.
E.
None of the options
The return on total assets measures how efficiently the firm is utilizing assets to generate returns.
12) You wish to earn a return of 10% on each of two stocks, C and D. Each of the stocks is expected to pay a dividend of $2 in the upcoming year. The expected growth rate of dividends is 9% for stock C and 10% for stock D. The intrinsic value of stock C A. will be greater than the intrinsic value of stock D.
B.
will be the same as the intrinsic value of stock D.
C.
will be less than the intrinsic value of stock D.
D.
will be the same or greater than the intrinsic value of stock D.
E.
None of the options
PV0 = D1/(k - g); given that dividends are equal, the stock with the higher growth rate will have the higher value.
13) Low Tech Company has an expected ROE of 10%. The dividend growth rate will be ________ if the firm follows a policy of paying 40% of earnings in the form of dividends. A.
6.0%
B.
4.8%
C.
7.2%
D.
3.0%
10% × 0.60 = 6.0%.
14) You are considering acquiring a common stock that you would like to hold for one year. You expect to receive both $1.25 in dividends and $32 from the sale of the stock at the end of the year. The maximum price you would pay for the stock today is _____ if you wanted to earn a 10% return. A.
$30.23
B.
$24.11
C.
$26.52
D.
$27.50
E.
None of the options
.10 = (32 - P + 1.25)/P; .10P = 32 - P + 1.25; 1.10P = 33.25; P = 30.23.
15) Sure Tool Company is expected to pay a dividend of $2 in the upcoming year. The risk-free rate of return is 4% and the expected return on the market portfolio is 14%. Analysts expect the price of Sure Tool Company shares to be $22 a year from now. The beta of Sure Tool Company's stock is 1.25.
The market's required rate of return on Sure's stock is A.
14.0%.
B.
17.5%.
C.
16.5%.
D.
15.25%.
E.
None of the options
4% + 1.25(14% - 4%) = 16.5%.
16) If Sure's intrinsic value is $21.00 today, what must be its growth rate? A.
0.0%
B.
10%
C.
4%
D.
6%
E.
7%
k = .04 + 1.25 (.14 - .04); k = .165; .165 = 2/21 + g; g = .07.
17) High Tech Chip Company paid a dividend last year of $2.50. The expected ROE for next year is 12.5%. An appropriate required return on the stock is 11%. If the firm has a plowback ratio of 60%, the dividend in the coming year should be A.
$1.00.
B.
$2.50.
C.
$2.69.
D.
$2.81.
E.
None of the options
g = .125 × .6 = 7.5%; $2.50(1.075) = $2.69.
18) JCPenney Company is expected to pay a dividend in year 1 of $1.65, a dividend in year 2 of $1.97, and a dividend in year 3 of $2.54. After year 3, dividends are expected to grow at the rate of 8% per year. An appropriate required return for the stock is 11%. The stock should be worth _______ today. A.
$33.00
B.
$40.67
C.
$71.80
D.
$66.00
E.
None of the options
Calculations are shown in the table below.
P3 = $2.54 (1.08)/(.11 - .08) = $91.44; PV of P3 = $91.44/(1.11)3 = $66.86; P0 = $4.94 + $66.86 = $71.80.
19) Consider the free cash flow approach to stock valuation. Utica Manufacturing Company is expected to have before-tax cash flow from operations of $500,000 in the coming year. The firm's corporate tax rate is 30%. It is expected that $200,000 of operating cash flow will be invested in new fixed assets. Depreciation for the year will be $100,000. After the coming year, cash flows are expected to grow at 6% per year. The appropriate market capitalization rate for unleveraged cash flow is 15% per year. The firm has no outstanding debt. The projected free cash flow of Utica Manufacturing Company for the coming year is A.
$150,000.
B.
$180,000.
C.
$300,000.
D.
$380,000.
Calculations are shown below.
20) Consider the free cash flow approach to stock valuation.
Utica Manufacturing Company is expected to have before-tax cash flow from operations of $500,000 in the coming year. The firm's corporate tax rate is 30%. It is expected that $200,000 of operating cash flow will be invested in new fixed assets. Depreciation for the year will be $100,000. After the coming year, cash flows are expected to grow at 6% per year. The appropriate market capitalization rate for unleveraged cash flow is 15% per year. The firm has no outstanding debt. The total value of the equity of Utica Manufacturing Company should be A.
$1,000,000.
B.
$2,000,000.
C.
$3,000,000.
D.
$4,000,000.
Projected free cash flow = $180,000; V0 = 180,000/(.15 - .06) = $2,000,000.
21) The growth in dividends of Music Doctors, Inc. is expected to be 8% per year for the next two years, followed by a growth rate of 4% per year for three years; after this five-year period, the growth in dividends is expected to be 3% per year, indefinitely. The required rate of return on Music Doctors, Inc. is 11%. Last year's dividends per share were $2.75. What should the stock sell for today? A.
$8.99
B.
$25.21
C.
$39.71
D.
$110.00
E.
None of the options
Calculations are shown …show more content…
below
P5 = 3.7164/(.11 - .03) = $46.4544; PV of P5 = $46.4544/(1.11)5 = $27.5684; PO = $12.1449 + $27.5684 = $39.71.
22) If a firm has a required rate of return equal to the ROE A.
the firm can increase market price and P/E by retaining more earnings.
B.
the firm can increase market price and P/E by increasing the growth rate.
C.
the amount of earnings retained by the firm does not affect market price or the P/E.
D.
the firm can increase market price and P/E by retaining more earnings and increasing the growth rate.
E.
None of the options
If required return and ROE are equal, investors are indifferent as to whether the firm retains more earnings or increases dividends. Thus, retention rates and growth rates do not affect market price and P/E.
23) The present value of growth opportunities (PVGO) is equal to
I) the difference between a stock's price and its no-growth value per share.
II) the stock's price.
III) zero if its return on equity equals the discount rate.
IV) the net present value of favorable investment opportunities. A.
I and IV
B.
II and IV
C.
I, III, and IV
D.
II, III, and IV
E.
III and IV
All are correct except II—the stock's price equals the no-growth value per share plus the PVGO.
24) The most appropriate discount rate to use when applying a FCFE valuation model is the
A. required rate of return on equity.
B.
WACC.
C.
risk-free rate.
D.
None of the options
The most appropriate discount rate to use when applying a FCFE valuation model is the required rate of return on equity.
25) Fly Boy Corporation is expected have EBIT of $800k this year. Fly Boy Corporation is in the 30% tax bracket, will report $52,000 in depreciation, will make $86,000 in capital expenditures, and will have a $16,000 increase in net working capital this year. What is Fly Boy's FCFF? A.
510,000
B.
406,000
C.
542,000
D.
596,000
E.
682,000
FCFF = EBIT(1 - T) + depreciation - capital expenditures - increase in NWC or 800,000(.7) + 52,000 - 86,000 - 16,000 = 510,000.
26) Viking Insurance forecasts earnings next year of $4.50 per share. Viking has a dividend payout ratio of 40%. The required return is 15%. Return on equity is 8.33%. The present value of growth opportunities (PVGO) and the value of the stock based on the constant growth model are closets to:
A. PVGO = $4.00 Share value = $34.00
B. PVGO = $ –21.00 Share value = $9.00
C. PVGO = $ –12.00 Share value = $18.00
D. PVGO = $ 4.00 Share value = $12.00
27) Lisa Design pays a current annual dividend of $2.00 and is currently growing at a rate of 20%. The rate is expected to decline linearly to 10% over four years and remain at that level indefinitely. The required rate of return for an investment in Lisa Design is 18%. The current estimated value of Lisa Design is closest to:
A. $24.22
B. $29.78
C. $30.20
D. $32.50
28) Why is the NPAT margin a poor metric for performance evaluation across firms?
A. Differences in depreciation charges have too great an impact.
B. Differences in sales turnover have too great an impact.
C. Differences in operating leverage have too great an impact.
D. Differences in financing structure have too great an impact.
29) What are the major determinants of ROE (return of equity)?
A. Asset turnover, leverage, profit margin
B. Asset turnover, revenue, capital expenditure
C. Asset turnover, current ratio, EBIT
D. Enterprise value, profit margin, sales
30) Chamber Group is analyzing the potential takeover of Outmenu, Inc. Chamber has gathered the following data on Outmenu. The most appropriate model for valuing Outmenu is the:
A. Free cash flow to equity model
B. Dividend discount H-model
C. Free cash flow to the firm model
D. Constant dividend growth model