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Questions and Answers of
Corporate Finance
What is limited liability, and who benefits from it?
How can a small, private firm finance its capital investments? Give two or three examples of financing sources.
Securities traded in active financial markets are liquid assets. Explain why liquidity is important to individual investors and to mutual funds.
Bank deposits are liquid; you can withdraw money on demand. How can the bank provide this liquidity and at the same time make illiquid loans to businesses?
Summarize the differences between a commercial bank and an investment bank.
Why are mutual funds called financial intermediaries? Why does it make sense for an individual to invest her savings in a mutual fund rather than directly in financial markets?
Fill in the blanks in the following passage by choosing the most appropriate term from the following list: CFO, save, financial intermediaries, stock market, savings, real investment, bonds,
List the major functions of financial markets and intermediaries in a modern financial system.
On a mountain trek, you discover a 6-ounce gold nugget. A friend offers to pay you $2,500 for it. How do you check whether this is a fair price?
What kinds of useful information can a financial manager obtain from financial markets? Give examples.
Look back at Section 2.3 and then answer the following questions: a. The price of Estee Lauder stock has risen to $90. What is the market value of the firm's equity? b. The rating agency has revised
True or false? a. The financial crisis was largely caused by banks taking large positions in the options and futures markets. b. The prime cause of the financial crisis was an expansion in bank
The stock and bond markets are not the only financial markets. Give two or three additional examples.
What were the causes of the financial crisis? We mentioned several. Can you suggest others that we have not identified?
True or false? a. Financing for public corporations must flow through financial markets. b. Financing for private corporations must flow through financial intermediaries. c. Almost all foreign
Financial markets and intermediaries channel savings from investors to corporate investment. The savings make this journey by many different routes. Give a specific example for each of the following
You are a beginning investor with only $5,000 in savings. How can you achieve a widely diversified portfolio at reasonable cost?
Is an insurance company also a financial intermediary? How does the insurance company channel savings to corporate investment?
Choose the most appropriate term to complete each sentence. a. Households hold a greater percentage of (corporate equities I corporate bonds). b. (Pension funds I Banks) are major investors in
True or false? a. Exchange traded funds are hedge funds that can be bought and sold on the stock exchange. b. Hedge funds provide small investors with low-cost diversification. c. The sale of
Earlier in the chapter, we characterized the balance sheet as providing a snapshot of the firm at one point in time and the income statement as providing a video. What did we mean by this? Is the
State whether each of the following events would increase or decrease the ratio of market value to book value. a. Big Oil announces the discovery of a major new oil field in Costaguana. b. Big Autos
a. In early 2013, the market values of the shares of many banks (e.g.. Bank of America or Citigroup) were less than book value per share. How would you interpret this pattern? b. At the same time,
Explain why accounting income generally differs from a firm's cash inflows.
Will the following actions increase or decrease the firm's cash balance? a. The firm sells some goods from inventory. b. The firm sells some machinery to a bank and leases it back for a period of 20
Butterfly Tractors had $14 million in sales last year. Cost of goods sold was $8 million, depreciation expense was $2 million, interest payment on outstanding debt was $1 million, and the firm's tax
QuickGrow is in an expanding market, and its sales are increasing by 25% per year. Would you expect its net working capital to be increasing or decreasing?
Sheryl's Shipping had sales last year of $10,000. The cost of goods sold was $6,500, general and administrative expenses were $1,000, interest expenses were $500, and depreciation was $1,000. The
Start-up firms typically have negative net cash flows for several years. a. Does this mean that they are failing? b. Accounting profits for these firms are also commonly negative. How would you
Can cash flow from operations be positive if net income is negative? Can it be negative if net income is positive? Give examples.
During the last year of operations, Theta's accounts receivable increased by $10,000, accounts payable increased by $5,000, and inventories decreased by $2,000. What is the total impact of these
Balance sheet items are usually entered in order of declining liquidity. Place each of the terms below in the appropriate place in the balance sheet.Accounts payable ........................Total
Candy Canes Inc. spends $100,000 to buy sugar and peppermint in April. It produces its candy and sells it to distributors in May for $ 150,000, but it does not receive payment until June. For each
Ponzi Products produced 100 chain-letter kits this quarter, resulting in a total cash outlay of $ 10 per unit. It will sell 50 of the kits next quarter at a price of $ 11, and the other 50 kits in
Value Added Inc. buys $1 million of sow's ears at the beginning of January but doesn't pay immediately. Instead, it agrees to pay the bill in March. It processes the ears into silk purses, which it
Free cash flow measures the cash available for distribution to debt holders and shareholders. Look at Section 3.4 where we calculate free cash flow for Home Depot. Show how this cash was
The following table shows an abbreviated income statement and balance sheet for McDonald's Corporation for 2012.INCOME STATEMENT OF MCDONALD'S CORP., 2012(Figures in $ millions)Net sales
What would be the marginal and average tax rates for a married couple with income of $90,000? For an unmarried taxpayer with the same income?
Using Table 3.7, calculate the marginal and average tax rates for a single taxpayer with the following incomes:a. $20,000b. $50,000c. $300,000d. $3,000,000
A married couple earned $95,000 in 2014. How much did they pay in taxes?a. What was their marginal tax bracket?b. What was their average tax bracket?
What would be the marginal and average tax rates for a corporation with an income level of $ 100,000?
Turn back to Table 3.7, which shows marginal personal tax rates. Make a table in Excel that calculates taxes due for income levels ranging from $10,000 to $10 million. a. For each income, calculate
Construct a balance sheet for Sophie's Sofas given the following data. What is shareholders' equity? Cash balances = $10,000 Inventory of sofas = $200,000 Store and property = $100,000 Accounts
Construct a balance sheet for Fincorp for 2013 and 2014. What is shareholders' equity?
What was the change in net working capital during the year?
Construct an income statement for Fincorp for 2013 and 2014. What were reinvested earnings for 2014?
Suppose that the market value (in thousands of dollars) of Fincorp's fixed assets in 2014 is $6,000 and that the value of its long-term debt is only $2,200. In addition, the consensus among investors
Construct a statement of cash flows for Fincorp for 2014.
a. What was the firm's average tax bracket for each year? b. Do you have enough information to determine the marginal tax bracket?
You have set up your tax preparation firm as an incorporated business. You took $70,000 from the firm as your salary. The firm's taxable income for the year (net of your salary) was $30,000. How much
A firm's income statement included the following data. The firm's average tax rate was 20%. Cost of goods sold ................................... $8,000 Income taxes paid
South Sea Baubles has the following (incomplete) balance sheet and income statement.a. What is shareholders' equity in 2013 and 2014?b. What is net working capital in 2013 and 2014?c. What are taxes
Here are the 2013 and 2014 (incomplete) balance sheets for Newble Oil Corp.a. What was owners' equity at the end of 2013 and 2014? b. If Newble paid dividends of $100 in 2014 and made no stock
Henry Josstick has just started his first accounting course and has prepared the following balance sheet and income statement for Omega Corp. Unfortunately, although the data for the individual items
The founder of Alchemy Products Inc. discovered a way to turn gold into lead and patented this new technology. He then formed a corporation and invested $200,(XX) in setting up a production plant. He
Here is a simplified balance sheet for Caterpillar Tractor:Caterpillar has 657 million shares outstanding with a market price of $83 a share. a. Calculate the company's market value added. b.
Salad Daze maintains an inventory of produce worth $400. Its total bill for produce over the course of the year was $73,000. How old on average is the lettuce it serves its customers?
In the past year, TVG had revenues of $3 million, cost of goods sold of $2.5 million, and depreciation expense of $200,000. The firm has a single issue of debt outstanding with book value of $1
Lever Age pays an 8% rate of interest on $10 million of outstanding debt with face value $10 million. The firm's EBIT was $1 million.a. What is times interest earned?b. If depreciation is $200,000,
In each case, choose the firm that you expect to have the higher asset turnover ratio. a. Economics Consulting Group or Home Depot b. Catalog Shopping Network or Neiman Marcus c. Electric Utility
If a firm's inventory level of $ 10,000 represents 30 days' sales, what is the annual cost of goods sold? What is the inventory turnover ratio?
A firm has a long-term debt-equity ratio of .4. Shareholders' equity is $1 million. Current assets are $200,000, and the current ratio is 2. The only current liabilities are notes payable. What is
A firm has a debt-to-equity ratio of .5 and a market-to-book ratio of 2. What is the ratio of the book value of debt to the market value of equity?
A firm uses $1 million in cash to purchase inventories. a. Will its current ratio rise or fall? b. Will its quick ratio rise or fall?
Suppose the broad stock market falls 20% in a year and Home Depot's stock price falls by 10%.a. Will the company's market value added rise or fall?b. Should this change affect our assessment of the
True or false? a. A company's debt-equity ratio is always less than 1. b. The quick ratio is always less than the current ratio. c. For a profitable company, the return on equity is always less than
In each of the following cases, state which of the two companies is likely to be characterized by the higher ratio. a. Debt-equity ratio: a shipping company or a computer software company b. Payout
a. Turn back to Table 4.8. For the sample of industries in that table, plot operating profit margin against asset turnover in a scatter diagram. What is the apparent relationship between these two
In 2014 Electric Autos had sales of $ 100 million and assets at the start of the year of $150 million. If its return on start-of-year assets was 15%, what was its operating profit margin?
Torrid Romance Publishers has total receivables of $3,000, which represents 20 days' sales. Total assets are $75,000. The firm's operating profit margin is 5%. Find the firm's ROA and asset turnover
Keller Cosmetics maintains an operating profit margin of 5% and asset turnover ratio of 3.a. What is its ROA?b. If its debt-equity ratio is 1, its interest payments and taxes are each $8,000, and
CFA Corp. has a debt-equity ratio that is lower than the industry average, but its cash coverage ratio is also lower than the industry average. What might explain this seeming contradiction?
For each category of financial ratios discussed in this chapter, give some examples of who would be likely to examine these ratios and why.
Here are simplified financial statements for Watervan Corporation:The company's cost of capital is 8.5%.a. Calculate Watervan's economic value added (EVA).b. What is the company's return on
EVA will be positive whenever ROC is positive and greater than the cost of capital. Explain why this is so.
Microlimp does not raise any new finance during the year, but it generates a lot of earnings, which are immediately reinvested. If you were calculating the company's return on capital, would it make
Here are simplified financial statements for Phone Corporation in a recent year:Calculate the following financial ratios for Phone Corporation:a. Return on equityb. Return on assetsc. Return on
Consider this simplified balance sheet for Geomorph Trading:a. What is the company's debt-equity ratio? b. What is the ratio of total long-term debt to total long-term capital? c. What is its net
Chik's Chickens has average accounts receivable of $6,333. Sales for the year were $9,800. What is its average collection period?
Old Time Savings Bank pays 4% interest on its savings accounts. If you deposit $ 1,000 in the bank and leave it there a. How much interest will you earn in the first year? b. How much interest will
You can buy property today for $3 million and sell it in 5 years for $4 million. (You earn no rental income on the property.)a. If the interest rate is 8%, what is the present value of the sales
Compute the present value of a $ 100 cash flow for the following combinations of discount rates and times. a. r = 8%, t = 10 years b. r = 8%, t = 20 years c. r = 4%, t = 10 years d. r = 4%, t = 20
What is the present value of the following cash-flow stream if the interest rate is 6%?Year Cash
Find the interest rate implied by the following combinations of present and future values.
Find the annual interest rate.
A zero-coupon bond that will pay $1,000 in 10 years is selling today for $422.41. What interest rate does the bond offer?
Would you rather receive $ 1,000 a year for 10 years or $800 a year for 15 years if the interest rate is 5%? What if the interest rate is 20%?
New Savings Bank pays 4% interest on its deposits. If you deposit $1,000 in the bank and leave it there, will it take more or less than 25 years for your money to double? You should be able to answer
A local bank advertises the following deal: "Pay us $100 a year for 10 years and then we will pay you (or your beneficiaries) $100 a year forever." Is this a good deal if the interest rate available
a. What is the present value of a 3-year annuity of $100 if the discount rate is 6%?b. What is the present value of the annuity in (a) if you have to wait 2 years instead of 1 year for the first
Professor's Annuity Corp. offers a lifetime annuity to retiring professors. For a payment of $80,000 at age 65, the firm will pay the retiring professor $600 a month until death.a. If the professor's
You want to buy a new car, but you can make an initial payment of only $2,000 and can afford monthly payments of at most $400.a. If the APR on auto loans is 12% and you finance the purchase over 48
You can buy a car that is advertised for $24,000 on the following terms:(a) Pay $24,000 and receive a $2,000 rebate from the manufacturer;(b) Pay $500 a month for 4 years for total payments of
You have just borrowed $100,000 to buy a condo. You will repay the loan in equal monthly payments of $804.62 over the next 30 years.a. What monthly interest rate are you paying on the loan? What is
I now have $20,000 in the bank earning interest of .5% per month. I need $30,000 to make a down payment on a house. 1 can save an additional $100 per month. How long will it take me to accumulate the
Investments in the stock market have increased at an average compound rate of about 5% since 1900. It is now 2013. a. If you invested $1,000 in the stock market in 1900, how much would that
Suppose that you will receive annual payments of $10,000 for a period of 10 years. The first payment will be made 4 years from now. If the interest rate is 5%, what is the present value of this
Your landscaping company can lease a truck for $8,000 a year (paid at year-end) for 6 years. It can instead buy the truck for $40,000. The truck will be valueless after 6 years. The interest rate
Recall that an annuity due is like an ordinary annuity except that the first payment is made immediately instead of at the end of the first period. a. Why is the present value of an annuity due equal
A store offers two payment plans. Under the installment plan, you pay 25% down and 25% of the purchase price in each of the next 3 years. If you pay the entire bill immediately, you can take a 10%
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