FINMAN 1

NAME: _________________________ DATE: __________________ SCORE: _______________
chptr1-3

Multiple Choice
Identify the choice that best completes the statement or answers the question.

____
1. Which of the following could explain why a business might choose to operate as a corporation rather than as a
sole proprietorship or a partnership?
a. Corporations generally face fewer regulations.
b. Less of a corporation's income is generally subject to federal taxes.
c. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the
tax advantages of incorporation.
d. Corporate investors are exposed to unlimited liability.
e. Corporations generally find it easier to raise large amounts of capital.


____
2. Which of the following statements is CORRECT?
a. The ability of firms in competitive industries to voluntarily undertake socially beneficial
but costly projects is constrained by competition and the need to attract capital.
b. Any action that would maximize a firm's stock price must be consistent with the
maximization of social welfare.
c. Decisions regarding social and ethical behavior have no effect, either positive or negative,
on firms' stock prices.
d. In a competitive industry, if one group of firms is "socially conscious" and takes costly
actions designed to improve social welfare, but other firms do not, then most investors will
flock to the socially conscious firms, thus enhancing their ability to attract capital.
Eventually, these firms must dominate the industry.
e. Even if the government did not mandate some actions deemed to be socially responsible,
such as those relating to fair hiring and environmentally sound practices, most firms in
competitive markets would still pursue these policies.


____
3. Which of the following statements is CORRECT?
a. The four most important financial statements provided in the annual report are the balance
sheet, income statement, cash budget, and the statement of stockholders' equity.
b. The balance sheet gives us a picture of the firm's financial position at a point in time.
c. The income statement gives us a picture of the firm's financial position at a point in time.
d. The statement of cash flows tells us how much cash the firm must pay out in interest
during the year.
e. The statement of cash needs tells us how much cash the firm will require during some
future period, generally a month or a year.


____
4. Which of the following items is NOT normally considered to be a current asset?
a. Accounts receivable.
b. Inventory.
c. Bonds.
d. Cash.
e. Short-term, highly-liquid, marketable securities.


____
5. Which of the following items cannot be found on a firm's balance sheet under current liabilities?
a. Accounts payable.
b. Short-term notes payable to the bank.

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c. Accrued wages.
d. Cost of goods sold.
e. Accrued payroll taxes.


____
6. Analysts who follow Howe Industries recently noted that, relative to the previous year, the company's net
cash provided from operations increased, yet cash as reported on the balance sheet decreased. Which of the
following factors could explain this situation?
a. The company cut its dividend.
b. The company made large investments in fixed assets.
c. The company sold a division and received cash in return.
d. The company issued new common stock.
e. The company issued new long-term debt.


____
7. Last year Besset Company's operations provided a negative cash flow, yet the cash shown on its balance
sheet increased. Which of the following statements could explain the increase in cash, assuming the
company's financial statements were prepared under generally accepted accounting principles (GAAP)?
a. The company repurchased some of its common stock.
b. The company dramatically increased its capital expenditures.
c. The company retired a large amount of its long-term debt.
d. The company sold some of its fixed assets.
e. The company had high depreciation expenses.


____
8. Which of the following statements is CORRECT?
a. Assume that two firms are both following generally accepted accounting principles. Both
firms commenced operations two years ago with $1 million of identical fixed assets, and
neither firm either sold any of those assets or purchased any new fixed assets. The two
firms would be required to report the same amount of net fixed assets on their balance
sheets as those statements are presented to investors.
b. Assets other than cash are expected to produce cash over time, and the amount of cash
they eventually produce must be the same as the amounts at which the assets are carried
on the books.
c. The income statement shows the difference between a firm's income and its costs--i.e., its
profits--during a specified period of time. However, all reported income comes in the form
of cash, and reported costs likewise are consistent with cash outlays. Therefore, there will
not be a substantial difference between a firm's reported profits and its actual cash flow for
the same period.
d. The primary reason the annual report is important in finance is that it is used by investors
when they form expectations about the firm's future earnings and dividends, and the
riskiness of those cash flows.
e. EPS stands for earnings per share, while DPS stands for dividends per share. We would
normally expect to see DPS exceed EPS.


____
9. Bauer Software's current balance sheet shows total common equity of $5,125,000. The company has 490,000
shares of stock outstanding, and they sell at a price of $27.50 per share. By how much do the firm's market
and book values per share differ?
a. $18.57
b. $19.09
c. $20.28
d. $17.04
e. $18.23

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____ 10. Brown Fashions Inc.'s December 31, 2008 balance sheet showed total common equity of $4,050,000 and
295,000 shares of stock outstanding. During 2008, the firm had $450,000 of net income, and it paid out
$100,000 as dividends. What was the book value per share at 12/31/08, assuming no common stock was
either issued or retired during 2008?
a. $11.34
b. $13.87
c. $16.56
d. $12.38
e. $14.92


____ 11. Your corporation has the following cash flows: If the applicable income tax rate is 40% (federal and state
combined), and if 70% of dividends received are exempt from taxes, what is the corporation's tax liability?

Operating income
$250,000
Interest received
$10,000
Interest paid
$45,000
Dividends received
$15,000
Dividends paid
$50,000

a. $71,118
b. $87,800
c. $86,044
d. $102,726
e. $98,336


____ 12. Garner Grocers began operations in 2005. Garner has reported the following levels of taxable income (EBT)
over the past several years. The corporate tax rate was 34% each year. Assume that the company has taken
full advantage of the Tax Code's carry-back, carry-forward provisions, and assume that the current provisions
were applicable in 2005. What is the amount of taxes the company paid in 2008?

Year
Taxable Income
2005
-$2,750,000
2006
$200,000
2007
$500,000
2008
$2,800,000

a. $295,800
b. $272,850
c. $288,150
d. $255,000
e. $201,450


____ 13. A 5-year corporate bond yields 10.8%. A 5-year municipal bond of equal risk yields 6.5%. Assume that the
state tax rate is zero. At what federal tax rate are you indifferent between the two bonds?
a. 32.65%
b. 32.25%
c. 41.41%
d. 36.63%
e. 39.81%

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____ 14. A corporation can earn 7.5% if it invests in municipal bonds. The corporation can also earn 8.7% (before-tax)
by investing in preferred stock. Assume that the two investments have equal risk. What is the break-even
corporate tax rate that makes the corporation indifferent between the two investments?
a. 44.14%
b. 34.94%
c. 45.06%
d. 45.98%
e. 53.79%


____ 15. Which of the following statements is CORRECT?
a. Borrowing by using short-term notes payable and then using the proceeds to retire long-
term debt is an example of "window dressing." Offering discounts to customers who pay
with cash rather than buy on credit and then using the funds that come in quicker to
purchase additional inventories is another example of "window dressing."
b. Borrowing on a long-term basis and using the proceeds to retire short-term debt would
improve the current ratio and thus could be considered to be an example of "window
dressing."
c. Offering discounts to customers who pay with cash rather than buy on credit and then
using the funds that come in quicker to purchase fixed assets is an example of "window
dressing."
d. Using some of the firm's cash to reduce long-term debt is an example of "window
dressing."
e. "Window dressing" is any action that does not improve a firm's fundamental long-run
position and thus increases its intrinsic value.


____ 16. If the CEO of a large, diversified, firm were filling out a fitness report on a division manager (i.e., "grading"
the manager), which of the following situations would be likely to cause the manager to receive a BETTER
GRADE? In all cases, assume that other things are held constant.
a. The division's basic earning power ratio is above the average of other firms in its industry.
b. The division's total assets turnover ratio is below the average for other firms in its
industry.
c. The division's debt ratio is above the average for other firms in the industry.
d. The division's inventory turnover is 6, whereas the average for its competitors is 8.
e. The division's DSO (days' sales outstanding) is 40, whereas the average for its
competitors is 30.


____ 17. You observe that a firm's ROE is above the industry average, but its profit margin and debt ratio are both
below the industry average. Which of the following statements is CORRECT?
a. Its total assets turnover must be above the industry average.
b. Its return on assets must equal the industry average.
c. Its TIE ratio must be below the industry average.
d. Its total assets turnover must be below the industry average.
e. Its total assets turnover must equal the industry average.


____ 18. HD Corp and LD Corp have identical assets, sales, interest rates paid on their debt, tax rates, and EBIT.
However, HD uses more debt than LD. Which of the following statements is CORRECT?
a. Without more information, we cannot tell if HD or LD would have a higher or lower net
income.
b. HD would have the lower equity multiplier for use in the DuPont equation.
c. HD would have to pay more in income taxes.
d. HD would have the lower net income as shown on the income statement.
e. HD would have the higher operating margin.

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____ 19. Zero Corp's total common equity at the end of last year was $430,000 and its net income was $70,000. What
was its ROE?
a. 14.98%
b. 16.28%
c. 12.70%
d. 15.79%
e. 12.21%


____ 20. Hoagland Corp's stock price at the end of last year was $22.50, and its book value per share was $25.00.
What was its market/book ratio?
a. 0.85
b. 0.90
c. 0.86
d. 0.97
e. 1.00


____ 21. Helmuth Inc's latest net income was $1,210,000, and it had 225,000 shares outstanding. The company wants
to pay out 45% of its income. What dividend per share should it declare?
a. $2.49
b. $2.06
c. $2.11
d. $2.69
e. $2.42


____ 22. Han Corp's sales last year were $395,000, and its year-end receivables were $52,500. The firm sells on terms
that call for customers to pay 30 days after the purchase, but some delay payment beyond Day 30. On
average, how many days late do customers pay? Base your answer on this equation: DSO - Allowed credit
period = Average days late, and use a 365-day year when calculating the DSO.
a. 15.92
b. 15.18
c. 13.88
d. 18.51
e. 14.07


____ 23. Wie Corp's sales last year were $365,000, and its year-end total assets were $355,000. The average firm in
the industry has a total assets turnover ratio (TATO) of 2.4. The firm's new CFO believes the firm has excess
assets that can be sold so as to bring the TATO down to the industry average without affecting sales. By how
much must the assets be reduced to bring the TATO to the industry average, holding sales constant?
a. $202,917
b. $221,179
c. $213,063
d. $160,304
e. $184,654


____ 24. A new firm is developing its business plan. It will require $635,000 of assets, and it projects $450,000 of
sales and $355,000 of operating costs for the first year. Management is reasonably sure of these numbers
because of contracts with its customers and suppliers. It can borrow at a rate of 7.5%, but the bank requires it
to have a TIE of at least 4.0, and if the TIE falls below this level the bank will call in the loan and the firm
will go bankrupt. What is the maximum debt ratio the firm can use? (Hint: Find the maximum dollars of
interest, then the debt that produces that interest, and then the related debt ratio.)
a. 50.87%

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b. 59.34%
c. 49.87%
d. 62.34%
e. 42.89%


____ 25. What is the firm's current ratio?
a. 1.17
b. 1.04
c. 1.28
d. 1.32
e. 1.11


____ 26. What is the firm's inventory turnover ratio?
a. 3.75
b. 3.98
c. 3.19
d. 3.23
e. 3.79


____ 27. What is the firm's ROA?
a. 2.30%
b. 1.96%
c. 2.44%
d. 2.51%
e. 1.87%


____ 28. What is the firm's dividends per share?
a. $0.85
b. $0.69
c. $0.79
d. $0.73
e. $0.65


____ 29. What is the firm's P/E ratio?
a. 12.0
b. 12.6
c. 13.2
d. 13.9
e. 14.6


____ 30. What is the firm's book value per share?
a. $28.09
b. $30.84
c. $28.39
d. $30.53
e. $38.16

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chptr1-3
Answer Section

MULTIPLE CHOICE


1. ANS: E
Outsiders thinking about investing in a business are generally not willing to be subjected to unlimited
liability, and they also want to be able to sell their shares should they choose to do so. Corporations
provide these advantages, hence firms that need large amounts of capital that must be raised in capital
markets generally choose to incorporate.

PTS: 1
DIF: EASY
NAT: Reflective thinking

LOC: Students will understand and be able to articulate the goals of the firm, the role of the finance
function in the enterprise's organization, and as an analyst using public information.


2. ANS: A
PTS: 1
DIF: MEDIUM

NAT: Ethical understanding and reasoning | Reflective thinking
LOC: Students will understand and be able to articulate the goals of the firm, the role of the finance
function in the enterprise's organization, and as an analyst using public information.


3. ANS: B
PTS: 1
DIF: EASY
NAT: Reflective thinking
LOC: Students will acquire knowledge of financial statements, financial analysis, financial forecasting,
and cash flows.


4. ANS: C
PTS: 1
DIF: EASY
NAT: Analytic skills
LOC: Students will acquire knowledge of financial statements, financial analysis, financial forecasting,
and cash flows. | Students will understand and be able to articulate the goals of the firm, the role of the
finance function in the enterprise's organization, and as an analyst using public information.


5. ANS: D
PTS: 1
DIF: EASY
NAT: Analytic skills
LOC: Students will acquire knowledge of financial statements, financial analysis, financial forecasting,
and cash flows. | Students will understand and be able to articulate the goals of the firm, the role of the
finance function in the enterprise's organization, and as an analyst using public information.


6. ANS: B
PTS: 1
DIF: MEDIUM
NAT: Analytic skills
LOC: Students will acquire knowledge of financial statements, financial analysis, financial forecasting,
and cash flows. | Students will understand and be able to articulate the goals of the firm, the role of the
finance function in the enterprise's organization, and as an analyst using public information.


7. ANS: D
PTS: 1
DIF: HARD
NAT: Analytic skills
LOC: Students will acquire knowledge of financial statements, financial analysis, financial forecasting,
and cash flows. | Students will understand and be able to articulate the goals of the firm, the role of the
finance function in the enterprise's organization, and as an analyst using public information.


8. ANS: D
PTS: 1
DIF: HARD
NAT: Reflective thinking
LOC: Students will acquire knowledge of financial statements, financial analysis, financial forecasting,
and cash flows.


9. ANS: D
Shares outstanding
490,000
Price per share
$27.50
Total book common equity
$5,125,000
Book value per share = Total book equity/Number of shares
$10.46
Difference between book and market values $17.04

PTS: 1
DIF: EASY
NAT: Analytic skills

LOC: Students will acquire knowledge of financial statements, financial analysis, financial forecasting,

---

and cash flows. | Students will understand and be able to articulate the goals of the firm, the role of the
finance function in the enterprise's organization, and as an analyst using public information.


10. ANS: E
12/31/08 common equity
$4,050,000
2008 net income
$450,000
2008 dividends
$100,000
2008 addition to retained earnings
$350,000
12/31/08 common equity
$4,400,000
Shares outstanding
295,000
12/31/08 BVPS $14.92

PTS: 1
DIF: EASY
NAT: Analytic skills

LOC: Students will acquire knowledge of financial statements, financial analysis, financial forecasting,
and cash flows. | Students will understand and be able to articulate the goals of the firm, the role of the
finance function in the enterprise's organization, and as an analyst using public information.


11. ANS: B
Operating income
$250,000
Interest received
$10,000
Interest paid
$45,000
Dividends received
$15,000
Divdend exclusion %
70%
Dividends paid
$50,000
Tax rate (T)
40%
Taxable income = Oper. income + Interest received - Interest paid + Taxable dividends received
Taxable income = Oper. income + Interest received - Interest paid + dividends received
(1 - Div exclusion %)
Taxable income = $219,500
Taxes paid = Taxable income Tax rate
Taxes paid = $87,800

PTS: 1
DIF: EASY | MEDIUM

NAT: Analytic skills
LOC: Students will acquire knowledge of financial statements, financial analysis, financial forecasting,
and cash flows. | Students will understand and be able to articulate the goals of the firm, the role of the
finance function in the enterprise's organization, and as an analyst using public information.


12. ANS: D
Tax rate
34%






EBT After
Unused


Carry-Forward
Forward
Carryable
Year
Tax. Income
Used
Applied
Amount
2005
-$2,750,000
$0
$0
$2,750,000
2006
$200,000
$200,000
$0
$2,550,000
2007
$500,000
$500,000
$0
$2,050,000
2008
$2,800,000
$2,050,000
$750,000
$0

2008
Tax liability =
EBT Tax rate
2008
Tax liability =
$255,000


PTS: 1
DIF: MEDIUM
NAT: Analytic skills

LOC: Students will acquire knowledge of financial statements, financial analysis, financial forecasting,

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and cash flows. | Students will understand and be able to articulate the goals of the firm, the role of the
finance function in the enterprise's organization, and as an analyst using public information.


13. ANS: E
BT Bond yield
10.80%
Municipal bond yield
6.50%
Remember that municipal bonds are tax exempt, so their BT yield = AT yield.
Municipal yield
=
After-tax bond yield

6.50%
=
10.80%

(1 - T)
0.6019
=
(1 - T)

T
=
39.81%




PTS: 1
DIF: MEDIUM
NAT: Analytic skills

LOC: Students will acquire knowledge of financial statements, financial analysis, financial forecasting,
and cash flows. | Students will understand and be able to articulate the goals of the firm, the role of the
finance function in the enterprise's organization, and as an analyst using public information.


14. ANS: D
BT Preferred stock yield
8.70%
Municipal yield
7.50%
Dividend exclusion %
70.00%
Remember that municipal bonds are tax exempt, so their BT yield = AT yield.
Muni yield
=
After-tax preferred yield
7.50%
=
BT pref. return

[1 -
(1 - Div exclusion%)(T)]
7.50%
=
8.70%

[1 -
30.00%

(T)]
86.21%
=
[1 -
30.00%

(T)]

T
=
45.98%






PTS: 1
DIF: MEDIUM | HARD

NAT: Analytic skills
LOC: Students will acquire knowledge of financial statements, financial analysis, financial forecasting,
and cash flows. | Students will understand and be able to articulate the goals of the firm, the role of the
finance function in the enterprise's organization, and as an analyst using public information.


15. ANS: B
PTS: 1
DIF: EASY
NAT: Analytic skills | Reflective
thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.


16. ANS: A
PTS: 1
DIF: EASY
NAT: Analytic skills | Reflective
thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.


17. ANS: A
PTS: 1
DIF: MEDIUM
NAT: Analytic skills | Reflective
thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.


18. ANS: D
PTS: 1
DIF: MEDIUM
NAT: Analytic skills | Reflective
thinking
LOC: Students will acquire knowledge of financial analysis and cash flows.


19. ANS: B
Common equity


$430,000
Net income



$70,000
ROE = NI/Equity =



16.28%


PTS: 1
DIF: EASY
NAT: Analytic skills

LOC: Students will acquire knowledge of financial analysis and cash flows.

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20. ANS: B
Stock price



$22.50
Book value per share



$25.00
M/B ratio = Stock price / Book value per share =

0.90


PTS: 1
DIF: EASY
NAT: Analytic skills

LOC: Students will acquire knowledge of financial analysis and cash flows.


21. ANS: E
Net income



$1,210,000
Shares outstanding



225,000
Payout ratio



45%
EPS = NI / shares outstanding =


$5.38
DPS = EPS Payout% =



$2.42


PTS: 1
DIF: EASY | MEDIUM

NAT: Analytic skills
LOC: Students will acquire knowledge of financial analysis and cash flows.


22. ANS: D
Sales


$395,000
Sales/day = Sales / 365 =

$1,082.19
Receivables



$52,500
Company DSO = Receivables / Sales per day =

48.51
Credit period



30
DSO - Credit period = Days late


18.51


PTS: 1
DIF: MEDIUM
NAT: Analytic skills

LOC: Students will acquire knowledge of financial analysis and cash flows.


23. ANS: A
Sales


$365,000
Actual total assets


$355,000
Target TATO = Sales / Total assets =


2.40
Target assets = Sales / Target TATO =

$152,083
Asset reduction = Actual assets - Target assets =
$202,917


PTS: 1
DIF: MEDIUM
NAT: Analytic skills

LOC: Students will acquire knowledge of financial analysis and cash flows.


24. ANS: C
Assets


$635,000
Sales


$450,000
Operating costs


$355,000
Operating income



$95,000
(EBIT)
Target TIE



4.00
Maximum interest expense = EBIT / Target TIE

$23,750
Interest rate



7.50%
Max. debt = Max interest expense/Interest rate
$316,667
Maximum debt ratio = Debt/Assets


49.87%


PTS: 1
DIF: MEDIUM
NAT: Analytic skills

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