Tuesday, June 14, 2011

Questions Set 85: Solution

Matterhorn Company’s charter allows it to sell 250,000 shares of $2 par value common stock. To date, the firm has sold 100,000 shares for a total of $600,000. Matterhorn has reacquired 4,000 shares from shareholders at a price of $8 per share. Retained earnings equals $250,000. (10 points)
    • What total amount of contributed capital should Matterhorn report?
    • What amount should be reported for the Common Stock account?
    • What was the average selling price of each share of common stock?
    • How many shares of stock are outstanding?
    • What amount should be reported for stockholders’ equity?

Questions Set 84: Solution

How would you explain that, although the efficient market hypothesis applies to the stock market, you can’t successfully invest by randomly selecting stocks?
  1. The hypothesis fails to fully explain the real market environment.
  2. The hypothesis fails to consider these monopolies, which dominate certain segments of the market.
  3. Random selection of stocks would ignore an individual investor’s goals.
  4. New theories are needed to explain stock price behavior in the new economy
At what rate does $1,000 grow to $1,953 after three years? Use the formula for the future value of a lump sum, and assume annual compounding.
  1. 25 percent
  2. 75 percent
  3. 31.8 percent
  4. 95.3 percent
Given a choice between calculating returns using the holding period return (HPR) or the formula for the future value, you should select the future value formula because the
  1. HPR fails to consider the discounted value of the purchase price.
  2. future value formula incorporates the timing of cash flows.
  3. HPR overstates the internal rate of return in direct proportion to the discount rate.
  4. future value formula incorporates cash payments that are omitted in the HPR.
Which of the following statements most accurately explains the utility of the dividend growth model?
  1. Dividend growth increases the total return earned on equity investments.
  2. Projected dividend growth can be incorporated into calculation of the discounted value of cash flows.
  3. Stocks with rising dividends generally outperform stocks that don’t pay dividends or that pay relatively static dividends.
  4. Rising dividends, plotted as a function of time, appear as an exponential function with a positive slope.
ABC Corporation recently announced its plans to pay a 5 percent stock dividend in addition to its scheduled $0.32 quarterly dividend, which has been paid on its common stock in all of the previous 13 quarters. The ex-dividend date will be one month after the announcement. ABC Corporation hadn’t paid a stock dividend in the past nine years. You own 100 shares of ABC Corporation common stock valued at $68 per share. Which of the following explanations accurately projects the effect of these transactions?
  1. Dilution will effect a 5 percent decline in price per share. That will be offset by the 2 percent (annualized) dividend for a net decline of 3 percent in the stock price.
  2. The 5 percent stock dividend is equivalent to 1-for-20 stock split. Stock prices generally rise after stocks split, so the 5 percent dilution effect will be reduced to either a price rise or a decline that’s smaller than 5 percent.
  3. The stock price will drop about 5 percent if all other factors remain constant.
  4. The discounted value of the stock split and will render a price decline smaller than 5 percent.
In the absence of compelling empirical data to support technical analysis, which of these arguments supports its use?
  1. The Dow Theory has a long history of successful use and has earned respect in non-academic circles.
  2. Traders of odd lots tend to be smaller, less sophisticated investors who reliably make the wrong investment decisions.
  3. Emotions lead to irrational investment decisions that can be overcome by applying a strict set of technical methods.
  4. Several technical methods capitalize on empirical data supporting the contention that security prices move in the same direction.
Which of the following statements is correct?
  1. Security selection can be a complex process that’s aided by Internet financial information services.
  2. Security selection is most efficiently practiced by applying both technical and fundamental analysis.
  3. Security selection requires only the use of accounting ratios.
  4. Security selection simplifies investment decisions.
Which of the following reasons best explains why you would include inflation in a fundamental analysis of stock values?
  1. Inflation exerts broad influence on factors that underlie the economy.
  2. Inflation generally increases stock prices at a faster rate than other prices.
  3. Inflation generally increases stock prices prices because cash inflows increase.
  4. High inflation corresponds with high interest rates and low bond values.
In fundamental analysis, the value added by industry analysis is particularly apparent
  • When inflation rates are high and have a broad negative impact on business in general.
  • In industries where business levels significantly change in certain seasons or in relation to the business cycle.
  • During recessions when business levels are suppressed across most industries.
  • During the rapid growth stage of an economy.

Questions Set 83: Solution

  • You received $30,000 from your grandparents. You want to investment it to fund your mortgage down-payment in four years. You want to buy a house that is at least $200,000 but no more than $300,000. Normally, banks require home buyers to make 20% (of the house price) down-payment. What is the minimum and maximum interest rates that you need to earn on your investment?
  • You want to buy a Volvo in 4 years, after you graduate from college. The car is currently selling for $35,000, and the price will increase at a rate of 5% per year. Your friend, Bob, introduces to you a one-time chance to earn 14% per year over the next 4 years. And you want to grab this chance to plan for your purchase. How much do you need to invest today so that you are able to buy your dream car after graduation?
  • If inflation rate runs at 3% annually, how long does it take for prices to double?
  • Your current bank is paying a 6.25% annual simple interest rate with monthly compounding. You can move your money to Harris Bank that pays 6.25% annual compound interest rate, or to First Chicago Bank, which pays 6.8% compounded semiannually. To maximize your return, which bank should you choose?

Questions Set 82: Solution

To guide cost allocation decisions, the cause-and-effect criterion:
may allocate corporate salaries to divisions based on profits
is used less frequently than the other criteria
is the primary criterion used in activity-based costing
is a difficult criterion on which to obtain agreement
Which cost-allocation criterion is superior when making an economic decision?
the fairness or equity criterion
the ability to bear criterion
the cause-and-effect criterion
All of these answers are correct.
The MOST likely reason for NOT allocating corporate costs to divisions include that:
divisions receive no benefits from corporate costs
these costs are not controllable by division managers
these costs are incurred to support division activities, not corporate activities
division resources are already used to attain corporate goals
Identifying homogeneous cost pools: (Points: 3)
requires judgment and should be reevaluated on a regular basis
should include the input of management
should include a cost-benefit analysis
All of these answers are correct
The Hassan Corporation has an Electric Mixer Division and an Electric Lamp Division. Of a $20,000,000 bond issuance, the Electric Mixer Division used $14,000,000 and the Electric Lamp Division used $6,000,000 for expansion. Interest costs on the bond totaled $1,500,000 for the year. Which corporate costs should be allocated to divisions? (Points: 3)
Variable Costs
Fixed Costs
Neither fixed nor variable costs
Both fixed and variable costs
All of the following are methods that aid management in analyzing the expected results of capital budgeting decisions EXCEPT: (Points: 3)
payback method
future-value cash-flow method
discounted cash-flow method
accrual accounting rate-of-return method
Assume your goal in life is to retire with one million dollars. How much would you need to save at the end of each year if interest rates average 6% and you have a 20-year work life? (Points: 3)
$376,476
$120,102
$27,184
$14,565
The definition of an annuity is: (Points: 3)
similar to the definition of a life insurance policy
a series of equal cash flows at intervals
an investment product whose funds are invested in the stock market
Both 1 and 2 are correct
An important advantage of the net present value method of capital budgeting over the internal rate-of-return method is: (Points: 3)
the net present value method is expressed as a percentage
the net present values of individual projects can be added to determine the effects of accepting a combination of projects
There is no advantage
Both 1 and 2 are correct
The Zeron Corporation wants to purchase a new machine for its factory operations at a cost of $950,000. The investment is expected to generate $350,000 in annual cash flows for a period of four years. The required rate of return is 14%. The old machine can be sold for $50,000. The machine is expected to have zero value at the end of the four-year period. What is the net present value of the investment? Would the company want to purchase the new machine? Income taxes are not considered. (Points: 3)
$119,550; yes
$326,750; no
$1,019,550; yes
$69,550; no

Saturday, June 4, 2011

Questions Set 80: Solution

Solution
Duncombe Village Golf Course is considering the purchase of new equipment that will cost $1,200,000 if purchased today and will generate the following cash disbursements and receipts. Should Duncombe pursue the investment if the cost of capital is 8 percent? Why? Clearly label your calculations in your analysis. See attachment for additional information for this problem.
Year
Cash Receipts
Cash Disbursements
Net Cash Flow
1
1,000,000
500,000
500,000
2
925,000
475,000
450,000
3
800,000
450,000
350,000
4
750,000
430,000
320,000

Questions Set 79: Solution

Solution
Financial Forecasting
As a financial analyst of FalconBuy.com, you need to prepare pro forma financial statements for 2012. FalconBuy.com has the following balance sheet as of December 31, 2011 ($ millions).
_____________________________________________________________________________________
Cash $ 3.5 Accounts payable $ 9.0
Receivables 26.0 Notes payable 18.0
Inventory 58.0 Accruals 8.5
Total current assets $ 87.5 Total current liabilities $ 35.5
Net fixed assets 35.0 Mortgage loan 6.0
Common stock 15.0
Retained earnings 66.0
Total Assets $122.5 Total Liab. & Capital $122.5
===== ======
_____________________________________________________________________________________
In 2011, FalconBuy.com had sales of $350 million, net income of $10.5 million, and paid dividends of $4.2 million to common stockholders. The firm has been operating at full capacity. Assume that all ratios remain constant.
For the year 2012, FalconBuy.com projects its sales to be $420 million (an increase of $70 million). (1) Use the AFN general formula to compute the projected additional funds needed (AFN) for 2012; (2) What does your estimated AFN figure tell you about FalconBuy.com’s financing to support the sales increase in 2012?
Short-Term Financing Choices
Falcon Ski Company estimates that for the next quarter there is a 60% probability that it will have a $2 million cash deficit, and a 40% probability that it will have no deficit at all. The company can either (1) take out a 90-day unsecured loan at an interest rate of 1% per month or (2) establish a line of credit, costing an interest rate of 1% per month on the amount borrowed plus a commitment fee of $15,000. Both alternatives also require a 20% compensating balance for outstanding loans, and excess cash can be reinvested at a quarterly rate of 2.5%. Which source of financing gives the lower expected cost? Which financing option would you recommend?
Long-Term Financing Decisions
Falcon Air Conditioner (FAC) has $1 million in EBIT for year ended 2011 with the following balance sheet:
Balance Sheet As of December 31, 2011
_____________________________________________________________________________________
Assets Liabilities & Capital
_____________________________________________________________________________________
Current assets $2,000,000 Debt(@ 8%) $1,250,000
Net fixed assets 4,750,000 Common stock; $10 par 2,500,000
Preferred stock (@ 10%) 2,000,000
Retained earnings 1,000,000
Total Assets $6,750,000 Total Liabilities & Capital $6,750,000
======== ========
_____________________________________________________________________________________
FAC expects that the existing debt and preferred stock will not be retired until the year 2014; hence they will remain in the same amount next year. FAC is expected to maintain its dividend payout ratio on common stock at the level of 10% next year. FAC’s corporate tax rate is 40%.
FAC plans to undertake an expansion project, which is expected to increase EBIT to $1.2 million in 2012 (an increase of $200,000 from the year 2008 EBIT). It needs $500,000 of external capital to finance the expansion, and it is considering the following three possibilities:
1. New bank term loan, with an interest rate of 10%; its sinking fund provision requires the loan to be fully amortized over the next 5 years, commencing in 2013.
2. New preferred stock, with a dividend rate of 12%.
3. 50,000 shares of new common stock to net the firm $10 per share.
Given the information above, compute the EPS under each alternative for the year 2012 using the following table (you don’t have to fill up all cells).
Items
DEBT
PREFERRED STOCK
COMMON
STOCK
EBIT $1,200,000 $1,200,000 $1,200,000
EPS