Sample Exam Questions and Items to Review



Fourth Examination – Finance 3321

Summer II (Moore)

Thursday or Friday Final Exam: ________ Printed Name: ____________________

Ethical conduct is an important component of any profession. The Texas Tech University Code of Student Conduct is in force during this exam. Students providing or accepting unauthorized assistance will be assigned a score of zero (0) for this piece of assessment. Using unauthorized materials during the exam will result in the same penalty. Ours’ should be a self-monitoring profession. It is the obligation of all students to report violations of the honor code in this course. By signing below, you are acknowledging that you have read the above statement and agree to abide by the stipulated terms.

Student’s Signature: ______________________________

Where indicated, use the financial statement for Dell-U-Dead, Inc. (a large computer manufacturer and distributor that sells in both the wholesale and retail markets).

Multiple Choice Format Examples:

Clearly Circle the BEST response (letter) for each of the following questions:

1. Which of the following types of market return measures would be most appropriate for estimating Beta for a large firm (greater than $4 billion market capitalization)?

a. S&P 500 monthly return

b. New York Stock Exchange Monthly Return

c. Dow Jones Industrial Average’s monthly return

d. A broad-based market composite return with representation of small, medium and large cap firms

e. The 3-month treasury yield

2. What is the main disadvantage of using daily returns to compute the firm’s Beta?

a. The data is not available to the public

b. Daily returns are inconsistent with the theoretical model

c. Daily returns are computed only on a Monday through Friday basis, and weekends (when markets are closed) renders the model useless

d. Daily returns are “noisy” and provide less explanatory power than longer-term measures.

e. The true value of a firm’s Beta changes on a daily basis.

3. Assume the market return and risk-free rate remain unchanged. Which of the following must be true if the firm’s Beta suddenly changes from 1.8 to 0.9?

a. The firms cost of equity declines by 50%

b. The firm’s cost of debt increases in direct proportion to the decrease in the cost of equity because the WACC must remain constant

c. The WACC of the firm decreases

d. The value of the equity doubles

e. The share price will decrease

4. Which is incorrect regarding the Abnormal Earnings Growth valuation model?

a. Although the model incorporates cumulative dividend earnings, it is still appropriate for valuing firms that don’t pay dividends

b. A firm that, on average, has earned more than its Ke has negative AEG

c. A firm that, on average, has earned less than its Ke has negative AEG

d. A firm with forecast earnings growth less than Ke will increase shareholder value by increasing dividends.

e. A decrease in the cost of sales percentage will increase the AEG

5. Which of the following types of investment funds would have junk bonds representing a high percentage of its portfolio value?

a. Income Funds

b. Balanced Funds

c. Municipal Funds

d. Investment Grade Corporate Bond Funds

e. Hi Yield Corporate Bond Funds

6. Which of the following should, per recent regulatory statutes, no longer be a reason sell-side analysts make overly optimistic forecasts?

a. Conflicts of interests

b. 5 martini lunches

c. Herding

d. Under-confidence

e. Fears over access to information from corporations

7. Which component of an Interest and Principal strips faces prepayment risk?

a. The interest payment stream

b. The principal payment

c. Both principal and interest payment streams

d. Neither

e. The interest payment stream and only when principal is defaulted

8. Old Reliable Manufacturing Company's stock has a market price of $20 per share and a book value of $10 per share. If its cost of equity capital is 15 percent and its book value is expected to grow at 5 percent per year indefinitely, what is the market’s assessment of its steady state return on equity?

a. 25%

b. 30%

c. 35%

d. 40%

e. 45%

9. YouPay is a publicly traded internet-based garage sale intermediary. It’s Market-to-Book ratio is 7. Assuming YouPay has a cost of equity capital of 15% and that its Return on equity has been consistently at 21% for the past 3 years. What growth rate in book value (per year) must YouPay average in the long run in order to support its current stock price?

a. 2%

b. 5%

c. 6%

d. 10%

e. 14%

10. You have just computed the Beta of a stock to be 1.5 and the estimate of the relevant risk-free rate is 3%. The expected market return next period is 2% and the long-run market risk premium is expected to hold at its historical level of 7%. What is the appropriate estimate of the firm’s Ke?

a. 1.5%

b. 3%

c. 7%

d. 10.5%

e. 13.5%

11. The appropriate collateral a bank would use on a 10-year term loan to a rail car manufacturer would be:

a. Accounts Receivable

b. Inventory

c. Working Capital

d. Lease rail cars

e. all of the above

12. “Thou shall not” protective covenants are loan contract provisions set by the lender that restrict firms from undertaking certain actions during the life of the loan agreement. Which of the following covenants would satisfy this definition?

a. The firm must maintain a current ratio greater than 2

b. Working capital must be greater than 10% of total assets

c. Fixed assets used as collateral may not be sold by the firm

d. Interest payments must be satisfied before dividends can be paid

e. The firm must not default on its debt

Use the following information to answer questions 13-15

Altman’s Z-Score model for Credit Ratings is defined as follows:

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13. Which of the following is correct regarding the use of Altman’s Z-Score?

a. A company with a score of 2.6 is twice as likely to get credit as a company with a 1.3

b. A company with a score of 1.0 is more credit worthy than a company with a 5.0

c. A company with a 3.3 is considered to be a low credit risk (in terms of bankruptcy)

d. A company with a 2.3 is considered to be a low credit risk (in terms of bankruptcy)

e. A company with a 1.3 is considered to be a low credit risk (in terms of bankruptcy)

14. Which of the following corporate activities will unambiguously raise the firm’s Z-score

a. Decreasing Inventory while sales decline

b. Selling un-needed Assets and using the proceeds to pay of debt

c. Increasing working capital without incurring more current liabilities

d. Increasing total assets with borrowed funds

e. Increasing dividends (assuming no information asymmetry or signalling)

15. Which of the following would best describe the problems associated with loan officers and bankers focusing only on the current z-score to make credit decisions?

a. It becomes a self-fulfilling prophecy

b. Established, profitable companies will get credit funds while young firms without a long track-record may be denied access to traditional cost-effective financing

c. It gives firms incentives to manage earnings and accounts for the purpose of making the z-score look better than it really is (cooking the books)

d. all of the above

e. none of the above

16. The intrinsic P/E multiple would be computed using:

a. Trailing EPS

b. The Current market price you observe

c. The Forecast Book value per share you prepare

d. The Intrinsic Market Price you estimate

e. The normal earnings you estimate

17. You are comparing the published P/E multiple with the intrinsic P/E multiple based on your valuation of a company and they differ. Both ratios use the same earnings denominator. Which of the following must be true.

a. Intrinsic P/E > Published P/E implies you believe the firm is overvalued

b. Intrinsic P/E < Published P/E implies you believe the firm is undervalued

c. The published P/E must be wrong

d. The intrinsic P/E must be wrong

e. None of the above must be true

18. You used the AEG model to value a non-dividend paying company that has Ke of 10% and assumed the AEG after year 7 would be equal to zero. In performing sensitivity analysis, you want to see the effect including a constant AEG perpetuity from year 8 onward of $0.20 per share. The incremental impact on your intrinsic valuation would be:

a. $0.20 increase in the price per share

b. $2.00 increase in the price per share

c. $1.13 increase in the price per share

d. $11.30 increase in the price per share

e. $20.00 increase in the price per share

19. Which of the following is incorrect regarding passive investors?

a. They spend less time performing fundamental analysis that active investors

b. Portfolio diversification and rebalancing is key to their success

c. They are price takers

d. They spend a lot of time trying to find mis-priced securities

e. They are strong believers in market efficiency

20. Which of the following is a consequence of a firm having its debt rating lowered from AA to B grade?

a. Access to capital in the debt market will become more restricted

b. Assessed default risk has increased

c. The WACC will likely increase

d. All of the above

e. None of the above

Short Problem 1 (Show all work)

Use the AEG model and the following information to estimate a share value for General Motors at the end of 1986. Assume dividends are paid on the last day of the year.

General Electric Co.

In this case, abnormal earnings growth is expected to grow at a 5 percent rate after 1989. Assume a cost of equity equal to 15%

Short Problem 2 (Show all work)

Use the information provided to answer the following credit worthiness questions regarding Dell-U-Dead Inc. The financial statements are on the following pages.

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Required:

Part A: Compute the Z-score for Dell-U-Dead for 2001 and 2002.

Part B: Evaluate both whether their credit worthiness has improved (or declined) and identify the major sources of the change from 2001 to 2002.

Dell-U-Dead Computer Corporation

Balance Sheet (in Millions) (1 February 20XX)

ASSETS 2002 2001

Current Assets:

Cash and equivalents $ 3,641 $ 4,910

Short-term Investments 273 525

Accounts Receivable (net) 2,269 2,424

Inventories 278 400

Other 1,419 1,467

Total Current Assets $ 7,877 $ 9,726

Non-Current Assets:

Total non-current assets $ 5,658 $ 3,499

Total Assets $13,535 $13,670

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current Liabilities:

Accounts Payable $ 5,075 $ 4,286

Accrued Liabilities 1,600 1,550

Unearned Revenues 444 192

Notes Payable – Current 300 450

Other 100 300

Total Current Liabilities $ 7,519 $ 6,778

Non-Current Liabilities:

Total Non-Current Liabilities $ 1,322 $ 1,270

Total Liabilities $ 8,841 $ 8,048

Stockholders’ Equity:

Common Stock Issued and Outstanding $ 5,605 $ 4,795

Treasury Stock (2,249) ---

Retained Earnings 1,364 839

Other Comprehensive Income ( 26) (12)

Total Stockholders’ Equity $ 4,694 $ 5,622

Total Liabilities & Stockholders’ Equity $13,535 $13,670

Dell-U-Dead Computer Corporation

Income Statement (in Millions**)

For the Year Ending February 1, 20XX)=

2002 2001

Net Revenue $31,168 $31,888

Less: Cost of Goods Sold 25,661 25,445

Gross Profit $ 5,507 $ 6,433

Operating Expenses

Selling, General and Administrative $ 1,900 $ 2,400

Lease Expenses 884 793

Research, Development and Engineering 452 482

Special charges 482 105

Total operating expenses $ 3,718 $ 3,780

Operating Income $ 1,789 $ 2,663

Investment and other income (loss), net of tax (58) 581

Income before taxes and cumulative effect

of change in accounting principle $ 1,731 $ 3,194

Provision for income taxes 485 958

Income before cumulative effect of change

in accounting principle $ 1,246 $ 2,236

Cumulative effect of change in accounting principle --- 59

Net Income $ 1,246 $ 2,177

Earnings Per Common Share:

Basic EPS $ 0.48 $ 0.87

Diluted EPS $ 0.26 $ 0.79

Weighted Average Shares Outstanding:

Basic 2,602 2,582

Diluted 4,543 2,746

Market Price Per Share $35.00 $60.00

** All items in millions of dollars except Earnings per Share data

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