Exam 1 – Version 2 – Finance 3320 – Summer 2010



Second Examination – Finance 3320 - Spring 2011 (Moore)

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Clearly Fill in the appropriate bubble on the Scantron form for each of the following questions. Choose the BEST response. There is only one answer per question.

1. Which of the following statements is CORRECT?

a. A reduction in inventories would have no effect on the current ratio.

b. An increase in inventories would have no effect on the current ratio.

c. If a firm increases its sales while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase.

d. A reduction in the inventory turnover ratio will generally lead to an increase in the ROE.

e. If a firm increases its sales while holding its inventories constant, then, other things held constant, its fixed assets turnover ratio will decline.

2. Which of the following statements is CORRECT?

a. If a security analyst saw that a firm’s days’ sales outstanding (DSO) was higher than the industry average, and was increasing and trending still higher, this would be interpreted as a sign of strength.

b. If a firm increases its sales while holding its accounts receivable constant, then, other things held constant, its days’ sales outstanding will decline.

c. There is no relationship between the days’ sales outstanding (DSO) and the average collection period (ACP). These ratios measure entirely different things.

d. A reduction in accounts receivable would have no effect on the current ratio, but it would lead to an increase in the quick ratio.

e. A high average DSO indicates that none of its customers are paying on time. In addition, it makes no sense to evaluate the firm's DSO with the firm's credit terms.

3. Companies E and P each reported the same earnings per share (EPS), but Company E’s stock trades at a higher price. Which of the following statements is CORRECT?

a. Company E probably has fewer growth opportunities.

b. Company E is probably judged by investors to be riskier.

c. Company E must have a higher market-to-book ratio.

d. Company E trades at a higher P/E ratio.

e. Company E must pay a lower dividend.

4. Which of the following statements is CORRECT?

a. Debt management ratios show the extent to which a firm's managers are attempting to magnify returns on owners' capital through the use of financial leverage.

b. Other things held constant, the more debt a firm uses, the higher its profit margin will be.

c. Other things held constant, the higher a firm's debt ratio, the higher its TIE ratio will be.

d. Debt management ratios show the extent to which a firm's managers are attempting to reduce risk through the use of financial leverage. The higher the debt ratio, the lower the risk.

e. Other things held constant, the more debt a firm uses, the higher its operating margin will be.

5. Austin Financial recently announced that its net income increased sharply from the previous year, yet its net cash provided from operations declined. Which of the following could explain this performance?

a. The company’s dividend payment to common stockholders declined.

b. The company’s expenditures on fixed assets declined.

c. The company’s cost of goods sold increased.

d. The company’s depreciation expense declined.

e. The company’s interest expense increased.

Use the Financial Statements for Cantel Medical Corporation for the next four questions.

6. Compute Days Supply of Inventory for the year ended 7/31/2008 and assume a 365 day year.

a. 5.92 turns

b. 7.84 turns

c. 46.55 Days

d. 61.65 Days

e. 71.76 Days

7. Compute Return on Equity for the year ended 7/31/2008.

a. 5.01%

b. 5.15%

c. 5.61%

d. 9.85%

e. 10.93%

8. If the company wanted to change its Total Liabilities to Equity ratio on the very last day of the 2008 financial year from its existing level to 1.20, how much would it have to borrow on 7/31/2008 to accomplish this?

a. $75,606

b. $77,483

c. $91,976

d. $186,084

e. $202,454

9. If Cantel had reduced its average collection period on accounts receivables (DSO’s) by 3 days during 2009, how much is the maximum additional cash that could be on the balance sheet at year end? Assume 365 day year.

a. $8.36

b. $43.66

c. $46.66

d. $2,049.65

e. $29,831.35

10. An investment will pay a lump sum of $1,000 exactly 3 years from today. The nominal interest rate is 6%, semiannual compounding. Which of the following statements is CORRECT?

a. The periodic interest rate is greater than 3%.

b. The periodic rate is less than 3%.

c. The present value would be greater if the lump sum were discounted back for more periods.

d. The present value of the $1,000 would be larger if interest were compounded monthly rather than semiannually.

e. The PV of the $1,000 lump sum has a smaller present value than the PV of a 3-year, $333.33 ordinary annuity.

11. Which of the following investments would have the highest future value at the end of 10 years? Assume that the effective annual rate for all investments is the same and is greater than zero.

a. Investment A pays $250 at the beginning of every year for the next 10 years (a total of 10 payments).

b. Investment B pays $125 at the end of every 6-month period for the next 10 years (a total of 20 payments).

c. Investment C pays $125 at the beginning of every 6-month period for the next 10 years (a total of 20 payments).

d. Investment D pays $2,500 at the end of 10 years (just one payment).

e. Investment E pays $250 at the end of every year for the next 10 years (a total of 10 payments).

12. You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would increase the calculated value of the investment?

a. The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for 10 years rather than 5 years, hence that each payment is for $10,000 rather than for $20,000.

b. The discount rate decreases.

c. The riskiness of the investment’s cash flows increases.

d. The total amount of cash flows remains the same, but more of the cash flows are received in the later years and less are received in the earlier years.

e. The discount rate increases.

13. Which of the following statements regarding a 15-year (180-month) $125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.)

a. The remaining balance after three years will be $125,000 less one third of the interest paid during the first three years.

b. Because it is a fixed-rate mortgage, the monthly loan payments (which include both interest and principal payments) are constant.

c. Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant.

d. The proportion of the monthly payment that goes towards repayment of principal will be lower 10 years from now than it will be the first year.

e. The outstanding balance declines at a slower rate in the later years of the loan’s life.

14. Your bank account pays an 8% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT?

a. The periodic rate of interest is 2% and the effective rate of interest is 4%.

b. The periodic rate of interest is 8% and the effective rate of interest is greater than 8%.

c. The periodic rate of interest is 4% and the effective rate of interest is less than 8%.

d. The periodic rate of interest is 2% and the effective rate of interest is greater than 8%.

e. The periodic rate of interest is 8% and the effective rate of interest is also 8%.

15. Which of the following statements is CORRECT?

a. The present value of a 3-year, $150 annuity due will exceed the present value of a 3-year, $150 ordinary annuity.

b. If a loan has a nominal annual rate of 8%, then the effective rate can never be greater than 8%.

c. If a loan or investment has annual payments, then the effective, periodic, and nominal rates of interest will all be different.

d. The proportion of the payment that goes toward interest on a fully amortized loan increases over time.

e. An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is smaller than 6%.

16. Your father is about to retire, and he wants to buy an annuity that will provide him with $85,000 of income a year for 25 years, with the first payment coming immediately. The going rate on such annuities is 5.15%. How much would it cost him to buy the annuity today?

a. $1,063,968

b. $1,119,966

c. $1,178,912

d. $1,240,960

e. $1,303,008

17. Your aunt is about to retire, and she wants to sell some of her stock and buy an annuity that will provide her with income of $50,000 per year for 30 years, beginning a year from today. The going rate on such annuities is 7.25%. How much would it cost her to buy such an annuity today?

a. $574,924

b. $605,183

c. $635,442

d. $667,214

e. $700,575

18. What is the present value of the following cash flow stream at a rate of 8.0%?

Years: 0 1 2 3

| | | |

CFs: $750 $2,450 $3,175 $4,400

a. $7,917

b. $8,333

c. $8,772

d. $9,233

e. $9,695

19. You want to go to Europe 5 years from now, and you can save $3,100 per year, beginning one year from today. You plan to deposit the funds in a mutual fund that you think will return 8.5% per year. Under these conditions, how much would you have just after you make the 5th deposit, 5 years from now?

a. $18,369

b. $19,287

c. $20,251

d. $21,264

e. $22,327

20. You plan to invest some money in a bank account. Which of the following banks provides you with the highest effective rate of interest?

a. Bank 1; 6.1% with annual compounding.

b. Bank 2; 6.0% with monthly compounding.

c. Bank 3; 6.0% with annual compounding.

d. Bank 4; 6.0% with quarterly compounding.

e. Bank 5; 6.0% with daily (365-day) compounding.

21. Suppose your credit card issuer states that it charges a 15.00% nominal annual rate, but you must make monthly payments, which amounts to monthly compounding. What is the effective annual rate?

a. 15.27%

b. 16.08%

c. 16.88%

d. 17.72%

e. 18.61%

22. Your uncle will sell you his bicycle shop for $250,000, with "seller financing," at a 6.0% nominal annual rate. The terms of the loan would require you to make 12 equal end-of-month payments per year for 4 years, and then make an additional final (balloon) payment of $50,000 at the end of the last month. What would your equal monthly payments be?

a. $4,029.37

b. $4,241.44

c. $4,464.67

d. $4,699.66

e. $4,947.01

23. You plan to borrow $35,000 at a 7.5% annual interest rate. The terms require you to amortize the loan with 7 equal end-of-year payments. How much interest would you be paying in Year 2?

a. $1,994.49

b. $2,099.46

c. $2,209.96

d. $2,326.27

e. $2,442.59

24. Assuming the pure expectations theory is correct, which of the following statements is CORRECT?

a. If 2-year Treasury bond rates exceed 1-year rates, then the market must expect interest rates to rise.

b. If both 2-year and 3-year Treasury rates are 7%, then 5-year rates must also be 7%.

c. If 1-year rates are 6% and 2-year rates are 7%, then the market expects 1-year rates to be 6.5% in one year.

d. Reinvestment rate risk is higher on long-term bonds, and interest rate price risk is higher on short-term bonds.

e. Interest rate price risk and reinvestment rate risk are relevant to investors in corporate bonds, but these concepts do not apply to Treasury bonds.

25. Assume that interest rates on 20-year Treasury and corporate bonds are as follows:

T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18%

The differences in these rates were probably caused primarily by:

a. Tax effects.

b. Default risk differences.

c. Maturity risk differences.

d. Inflation differences.

e. Real risk-free rate differences.

26. Assume that inflation is expected to decline steadily in the future, but that the real risk-free rate, r*, will remain constant. Which of the following statements is CORRECT, other things held constant?

a. If the pure expectations theory holds, the Treasury yield curve must be downward sloping.

b. If the pure expectations theory holds, the corporate yield curve must be downward sloping.

c. If there is a positive maturity risk premium, the Treasury yield curve must be upward sloping.

d. If inflation is expected to decline, there can be no maturity risk premium.

e. The expectations theory cannot hold if inflation is decreasing.

27. Which of the following statements is CORRECT?

a. The yield on a 3-year Treasury bond cannot exceed the yield on a 10-year Treasury bond.

b. The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.

c. The yield on a 3-year corporate bond should always exceed the yield on a 2-year corporate bond.

d. The yield on a 10-year AAA-rated corporate bond should always exceed the yield on a 5-year AAA-rated corporate bond.

e. The following represents a "possibly reasonable" formula for the maturity risk premium on bonds: MRP = -0.1%(t), where t is the years to maturity.

28. Suppose 1-year Treasury bonds yield 4.00% while 2-year T-bonds yield 5.10%. Assuming the pure expectations theory is correct, and thus the maturity risk premium for T-bonds is zero, what is the yield on a 1-year T-bond expected to be one year from now?

a. 5.90%

b. 6.21%

c. 6.52%

d. 6.85%

e. 7.19%

29. Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 3.20% per year. What is the real risk-free rate of return, r*? Disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average.

a. 3.80%

b. 3.99%

c. 4.19%

d. 4.40%

e. 4.62%

30. Keys Corporation's 5-year bonds yield 6.20% and 5-year T-bonds yield 4.40%. The real risk-free rate is r* = 2.5%, the inflation premium for 5-year bonds is IP = 1.50%, the liquidity premium for Keys' bonds is LP = 0.5% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t – 1) × 0.1%, where t = number of years to maturity. What is the default risk premium (DRP) on Keys' bonds?

a. 1.17%

b. 1.30%

c. 1.43%

d. 1.57%

e. 1.73%

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