Finance I Study Guide Chapter 1-4 Multiple Choice Identify the choice that best completes the statement or answers the question 1. Which of the following statements is CORRECT? a. One advantage of forming a corporation is that equity investors are usually exposed to less liability than they would be in a partnership b. Corporations face fewer regulations than sole proprietorships. c. One disadvantage of operating a business as a sole proprietor is that the firm is subject to double taxation, because taxes are levied at both the firm level and the owner level. d. It is generally less expensive to form a corporation than a proprietorship because, with a proprietorship, extensive legal documents are required. e. If a partnership goes bankrupt, each partner is exposed to liabilities only up to the amount of his or her investment in the business. 2. Relaxant Inc. operates as a partnership. Now the partners have decided to convert the business into a corporation. Which of the following statements is CORRECT? a. Relaxant's shareholders (the ex-partners) will now be exposed to less liability. b. The company will probably be subject to fewer regulations and required disclosures. c. Assuming the firm is profitable, none of its income will be subject to federal income taxes. d. The firm's investors will be exposed to less liability, but they will find it more difficult to transfer their ownership e. The firm will find it more difficult to raise additional capital to support its growth. 3. Which of the following statements is CORRECT? a. Corporations generally face fewer regulations than sole proprietorships. b. Corporate shareholders are exposed to unlimited liability. C. It is usually casier to transfer ownership in a corporation than in a partnership. d. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation. c. There is a tax disadvantage to incorporation, and there is no way any corporation can escape this disadvantage, even if it is very small. 4. Charleston Corporation (CC) now operates as a "regular" corporation, but it is considering a switch to S Corporation status. CC is owned by five stockholders who each hold 20% of the stock, and each faces a personal tax rate of 38%. The firm earns $1,200,000 per year before taxes, and since it has no need for retained earnings, it pays out all of its earnings as dividends. Assume that the corporate tax rate is 35% and the personal tax rate is 38%. How much more or less) spendable income would each stockholder have if the firm elected S Corporation status? a. $40,102 b. $52,080 c. $53,122 d $57,809 e. $45,310 5. You recently sold 100 shares of Microsoft stock to your brother at a family reunion. At the reunion your brother gave you a check for the stock and you gave your brother the stock certificates. Which of the following best describes this transaction? a. This is an example of a direct transfer of capital. b. This is an example of a primary market transaction. C. This is an example of an exchange of physical assets. d. This is an example of a money market transaction. e. This is an example of a derivative market transaction. 6. Which of the following statements is CORRECT? a. The NYSE does not exist as a physical location. Rather it represents a loose collection of dealers who trade stock electronically. b. An example of a primary market transaction would be your uncle transferring 100 shares of Wal-Mart stock to you as a birthday gift. c. Capital market instruments include both long-term debt and common stocks. d. If your uncle in New York sold 100 shares of Microsoft through his broker to an investor in Los Angeles, this would be a primary market transaction. e. While the two frequently perform similar functions, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise large blocks of capital from investors. 7. Which of the following is a primary market transaction? a. You sell 200 shares of IBM stock on the NYSE through your broker. b. You buy 200 shares of IBM stock from your brother. The trade is not made through a broker--you just give him cash and he gives you the stock. c. IBM issues 2,000,000 shares of new stock and sells them to the public through an investment banker d. One financial institution buys 200,000 shares of IBM stock from another institution. An investment banker arranges the transaction. 6. IBM sells 2,000,000 shares of treasury stock to its employees when they exercise options that were granted in prior years. 8. Money markets are markets for a. Foreign currencies. b. Consumer automobile loans. C. Common stocks d. Long-term bonds e. Short-term debt securities such as Treasury bills and commercial paper. 9. Which of the following statements is CORRECT? a. The term "IPO" stands for Introductory Price Offered, and it is the price at which shares of a new company are offered to the public. b. IPO prices are generally established by the market, and buyers of the new stock must pay the price that prevails at the close of trading on the day the stock is offered to the public. c. In a "Dutch auction," investors who want to buy shares in an IPO submit bids indicating how many shares they want to buy and the price they are willing to pay. The company determines how many share it wants to sell. The highest price that enables the company to sell the desired number of shares is the price that all buyers must pay. d. It is possible that the price set in an IPO is so high that investors will refuse to buy the number of shares that the company wants to sell. In that case, the company is said to have "left money on the table." e. It is possible that the price set in an IPO is so low that investors will want to buy more shares than the company wants to sell. In that case, the company will have to issue more shares than it wants to sell 10. 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 11. Emery Mining Inc. recently reported $167,500 of sales, $75,500 of operating costs other than depreciation, and $10.200 of depreciation. The company had $16,500 of outstanding bonds that carry a 7.25% interest rate, and its federal-plus-state income tax rate was 35%. How much was the firm's net income? The firm uses the same depreciation expense for tax and stockholder reporting purposes. a. S44,533.57 b. $50,296.74 c. $64,442.70 d. $57,107.76 e. $52,392.44 12. During 2008, Bascom Bakery paid out $33,525 of common dividends. It ended the year with $155,000 of retained earnings versus the prior year's retained earnings of $159,600. How much net income did the firm carn during the year? a $23.719 b. $28.057 c. $24,008 d. $28.925 e. $27.768 13. Lovell Co. purchased preferred stock in another company. The preferred stock's before-tax yield was 13.2%. The corporate tax rate is 40%. What is the after-tax return on the preferred stock, assuming a 70% dividend exclusion? a. 12.55% b. 14.52% c. 11.62% d. 11.15% e. 11.27% 14. 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. 15. Companies E and Peach 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 must pay a lower dividend. e. Company E trades at a higher P/E ratio. 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. Ryngard Corp's sales last year were $27,000, and its total assets were $16,000. What was its total assets turnover ratio (TATO)? a. 1.57 b. 1.64 c. 1.49 d. 1.94 1.69 e. 18. Ajax Corp's sales last year were $460,000, its operating costs were $362,500, and its interest charges were $12,500. What was the firm's times-interest-earned (TIE) ratio? a. 7.80 b. 7.18 c. 8.19 d. 7.72 e. 9.75 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% 12.21% 20. Meyer Inc's assets are $745,000, and its total debt outstanding is $185,000. The new CFO wants to establish a debt ratio of 55%. The size of the firm does not change. How much debt must the company add or subtract to achieve the target debt ratio? a. S168,563 b. $224.750 c. $191,038 d. $211.265 e. $271.948 e. The balance sheet and income statement shown below are for Koski Inc. Note that the firm has no amortization charges, it does not lease any assets, none of its debt must be retired during the next 5 years, and the notes payable will be rolled over. Balance Sheet (Millions of S) Assets 2007 Cash and securities $1.290 Accounts receivable 9,890 Inventories 13.760 Total current assets $24.940 Net plant and equipment $18.060 Total assets S43.000 Liabilities and Equity Accounts payable $8,170 Notes payable 6,020 Accruals 4.730 Total current liabilities $18,920 Long-term bonds $8.815 Total debt $27.735 Common stock $5,805 Retained earnings 9.460 Total common equity $15.265 Total liabilities and equity $43.000 Income Statement (Millions of S) 2007 Net sales $51.600 Operating costs except depreciation 48,246 Depreciation 903 Earnings bef interest and taxes (EBIT) $2,451 Less interest 927 Earnings before taxes (EBT) $1.524 Taxes 533 Net income $990 500.00 $346,67 6.25% 35% $23.77 Other data: Shares outstanding (millions) Common dividends (millions of S) Int rate on notes payable & L-T bonds Federal plus state income tax rate Year-end stock price 21. What is the firm's inventory turnover ratio? a. 3.75 b. 3.98 3.19 d. 3.23 3.79 e. 22. What is the firm's profit margin? a. 1.79% b. 1.90% c. 1.88% d. 1.92% e. 1.96% 23. What is the firm's operating margin? a. 3.75% b. 4.51% c. 5.27% d. 5.42% 4.75% 24. What is the firm's P/E ratio? 12.0 b. 12.6 c. 13.2 d. 13.9 e. 14.6 25. What is the firm's market-to-book ratio? 0.65 b. 0.85 c. 0.74 d. 0.95 e. 0.78