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Hult International Business School - Dubai - EMBA Post Course Individual Assignment Course: Financial Management EMBA Lecturer: Alek Grzeszczak Date: March 2016 Please answer each question below, either by circling the appropriate answer or by writing out a short response in the space provided. (Total available 152 points). Question 1 (4 points) Which of the following statements concerning a firm's cash flows and profits is false? A. Managers must be at least as concerned with cash flows as with profits. B. A company that sells merchandise at a profit will generate cash soon enough to replenish cash flows required for continued production. C. The cash flows generated in a given time period can differ from the profits reported. D. Profits are no assurance that cash flow will be sufficient to maintain solvency. E. Due to required cash investments in current assets, fast-growing and profitable companies can literally "grow broke". Question 2 (4 points) The sources and uses of cash over a stated period of time are reflected on the: A. income statement. B. balance sheet. C. shareholders' equity statement. D. cash flow statement. E. statement of operating position. 1 A Grzeszczak 2016. Question 3 (4 points) Ptarmigan Travelers had sales of $480,000 in 2010 and $420,000 in 2011. The firm's current accounts remained constant. Given this information, which one of the following statements must be true? A. The total asset turnover rate increased. B. The days' sales in receivables increased. C. The inventory turnover rate increased. D. The fixed asset turnover decreased. E. The collection period decreased. Question 4 (4 points) Which of the following can affect a firm's sustainable rate of growth? I. Asset turnover ratio II. Profit margin III. Dividend policy IV. Financial leverage A. III only B. I and III only C. II, III, and IV only D. I, II, and IV only E. I, II, III, and IV F. None of the above. Question 5 (4 points) Ruff Wear expects sales of $560, $650, $670, and $760 for the months of May through August, respectively. The firm collects 20 percent of sales in the month of sale, 70 percent in the month following the month of sale, and 8 percent in the second month following the month of sale. The remaining 2 percent of sales is never collected. How much money does the firm expect to collect in the month of August? A. $621 B. $628 C. $673 D. $639 E. $643 C. None of the above Collection in Aug = (0.08*650) + (0.7*670) + (0.2*760) = $673 2 A Grzeszczak 2016. Question 6 (4 points) Looking at the data above and assuming that there were no financing cash flows during 2011 and basing your answer solely on the information provided, what were the cash flows from operations (in $ millions) for 2011? A. 45 B. 106 C. 15 D. 76 E. 31 F. None of the above. Question 7 (4 points) Which of these ratios are the determinants of a firm's sustainable growth rate? I. Debt-to-equity ratio II. Profit margin III. Retention ratio IV. Asset turnover ratio A. I and III only B. II and III only C. II, III, and IV only D. I, II, and III only E. I, II, III, and IV F. None of the above. 3 A Grzeszczak 2016. Question 8 (4 points) Wax Music expects sales of $437,500 next year. The profit margin is 4.8 percent and the firm has a 40 percent dividend payout ratio. What is the projected increase in retained earnings? A. $14,700 B. $17,500 C. $18,300 D. $12,600 E. $21,000 F. None of the above. Change in RE = 437,500*0.048*(1-0.4) = $12,600 Question 9 (4 points) Westcomb, Inc. had equity of $150,000 at the beginning of the year. At the end of the year, the company had total assets of $195,000. During the year, the company sold no new equity. Net income for the year was $72,000 and dividends were $40,640. What is the sustainable growth rate? A. 15.32 percent B. 15.79 percent C. 17.78 percent D. 18.01 percent E. 18.24 percent F. None of the above G* = R * ROE (bop) = (72,000 - 40,640)/72,000 * (72,000/150,000) = 20.9% Question 10 (4 points) Which of the following actions might a firm take if its actual sales growth exceeds its sustainable rate of growth? I. Increase prices II. Buy back shares III. Decrease dividends IV. Prune away less marginal products A. I and II only B. I and III only C. I, II, and IV only D. I, III, and IV only E. I, II, III, and IV F. None of the above. 4 A Grzeszczak 2016. Selected financial information for Hard Knock Doors is presented below. Use the information from Hard Knock's annual financial statements to answer question 11: Question 11 (6 points) A. Calculate the actual and sustainable growth rate for 2005 and 2006. B. Do you think Hard Knock Doors is having a problem financing its growth? C. Is the increase in dividends a good idea for Hard Knock? 5 A Grzeszczak 2016. Question 12 (4 points) Financial leverage: I. decreases expected ROE but does not affect its variability. II. increases breakeven, like operating leverage, but increases the rate of earnings per share growth once breakeven is achieved. III. is a fundamental financial variable affecting sustainable growth. IV. increases expected return and risk to owners. A. I and II only D. II, III, and IV only B. I and III only E. I, II, III, and IV C. II and IV only F. None of the above. Question 13 (4 points) Which one of the following accurately orders the rate of return on financial securities from highest to lowest over most of recorded market history (the 1900-2010 period)? A. Short-term government bills, long-term corporate bonds, long-term government bonds, common stocks B. Long-term corporate bonds, long-term government bonds, common stocks, short-term government bills C. Common stocks, long-term government bonds, long-term corporate bonds, short-term government bills D. Preferred stocks, long-term government bonds, long-term corporate bonds, short-term government bills E. Long-term corporate bonds, common stocks, short-term government bills, long-term government bonds F. None of the above. 6 A Grzeszczak 2016. Question 14 (4 points) Investments A and B both cost $100,000 and each promises a single payoff in one year. The distribution of payoffs for each investment appears below. Ignoring possible differences in non-diversifiable risk, which investment would a risk-averse investor prefer, and why? (A risk averse person means ... someone who dislikes risk). Question 15 (6 points) Himmel Corp. wants to raise $100 million in a new stock issue. Its investment banker indicates that the sale of new stock will require 12 percent under-pricing and a 7 percent spread. (Hint: The underpricing is 12 percent of the current stock price, and the spread is 7 percent of the issue price.) A. Assuming Himmel's stock price does not change from its current price of $50 per share, how many shares must the company sell and at what price to the public? B. How much money will the investment banking syndicates earn on the sale? C. Is the 12 percent under-pricing a cash flow? Is it a cost? If so, to whom? 7 A Grzeszczak 2016. The following (selected) information about Nile Holdings, a carpet wholesaler refers to Questions 16 to 18. Information as of December 2011: Nile has an attractive investment opportunity, and to finance it, must decide whether to issue $100 million in new debt or new equity. Question 16 (6 points) Assume Nile raises $100 million of new debt at the end of 2011, at an interest rate of 7%. Assuming Nile must make a $20 million payment on the new debt next year, calculate the firm's: A. times burden covered ratio and B. times common covered (including debt payments) ratio. 8 A Grzeszczak 2016. Question 17 (6 points) Calculate next year's earnings per share assuming Nile raises the $100 million of new debt. Question 18 (6 points) Calculate next year's times burden covered ratio and earnings per share if Nile sells 2 million new shares at $50 a share instead of raising new debt. 9 A Grzeszczak 2016. Question 19 (4 points) Which of the following figures of merit might not use all possible cash flows in its calculations? I. Payback period II. Internal rate of return III. Net present value (NPV) IV. Accounting rate of return A. III only B. I & III only C. II & III only D. I & IV only E. III & IV only F. I, II, III, and IV Question 20 (4 points) A project will produce after-tax operating cash inflows of $3,200 a year for 5 years. The after-tax salvage value of the project is expected to be $2,500 in year 5. The project's initial cost is $9,500. What is the net present value of this project if the required rate of return is 16 percent? A. -$311.02 B. $2,168.02 C. $4,650.11 D. $9,188.98 E. $21,168.02 F. None of the above. Solve for the PV of the cash inflows, and then subtract the initial investment: 10 A Grzeszczak 2016. Question 21 (6 points) An investment costing $100,000 promises an after-tax cash flow of $26,000 per year for 6 years. A. Find the investment's accounting rate of return and its payback period. B. Find the investment's net present value at a 15 percent discount rate. C. Find the investment's benefit-cost ratio (profitability index) at a 15 percent discount rate. Question 22 (6 points) 11 A Grzeszczak 2016. Consider the following investment opportunity. Assume the annual figures are unchanged for the expected life of the investment. 12 A Grzeszczak 2016. A. Calculate the yearly after tax cashflows from the investment. B. Calculate the NPV of the investment (discount rate: 12%). C. Assuming the investor wants to earn at least 12 percent, is this investment an attractive one? 13 A Grzeszczak 2016. Question 23 (6 points) ROE can be expressed in terms of ROIC. A. How ?, show the relationship between the two performance metrics. B. Explain the key conclusions that flow out of the relationship. Question 24 (4 points) Which one of the following is an example of systematic risk? A. The Federal Reserve unexpectedly announces an increase in target interest rates. B. A flood washes away a firm's warehouse. C. A city imposes an additional one percent sales tax on all products. D. A toymaker has to recall its top-selling toy. E. Corn prices increase due to increased demand for alternative fuels. F. None of the above. 14 A Grzeszczak 2016. Key facts and assumptions concerning FM Foods, Inc. at December 31, 2011, appear below. (Questions 25 and 26) (Yield means Return). Question 25 (4 points) Estimate FM's after-tax cost of equity capital. A. 4.50% B. 6.92% C. 7.93% D. 12.20% E. 17.48% F. None of the above Question 26 (4 points) 15 A Grzeszczak 2016. Estimate FM's after-tax cost of debt capital. A. 2.21% B. 4.10% C. 4.55% D. 6.30% E. 7.00% F. None of the above. Question 27 (4 points) Which of the following statements related to the internal rate of return (IRR) are correct? I. The IRR is the discount rate at which an investment's NPV equals zero. II. An investment should be undertaken if the discount rate exceeds the IRR. III. The IRR tends to be used more than the Payback Period because its results are economically more meaningful. IV. The IRR is the best tool available for deciding between mutually exclusive investments. A. I and II only B. I and III only C. II and III only D. I, II, and IV only E. I, II, III, and IV F. None of the above. 16 A Grzeszczak 2016. Question 28 (4 points) You plan to pay $50 for a share of preferred stock that pays a $2.40 dividend per year forever. What annual rate of return will you realize? A. 0.48 percent B. 2.40 percent C. 4.80 percent D. 5.10 percent E. 20.83 percent F. None of the above. Question 29 (4 points) Which of the following statements are correct? I. Using the same risk-adjusted discount rate to discount all future cash flows adjusts for the fact that the more distant cash flows are often more risky than cash flows occurring sooner. II. If you can borrow all of the money you need for a project at 5%, the cost of capital for this project is 5%. III. The best way to obtain the cost of debt capital for a firm is to use the coupon rates on its bonds. IV. The cost of capital, or WACC, is not the correct discount rate to use for all projects undertaken by a firm. A. I and III only B. II and IV only C. I and II only D. I and IV only E. I, II, and III only F. None of the above 17 A Grzeszczak 2016. Question 30 (4 points) Honest Abe's is a chain of furniture retail stores. Integral Designs is a furniture maker and a supplier to Honest Abe's. Honest Abe's has a beta of 1.38 as compared to Integral Designs' beta of 1.12. Both firms carry no debt, i.e., are 100% equity-financed. The risk-free rate of return is 3.5 percent and the market risk premium is 8 percent. What discount rate should Honest Abe's use if it considers a project that involves the manufacturing of furniture? A. 12.46 percent B. 12.92 percent C. 13.50 percent D. 14.08 percent E. 14.54 percent F. None of the above. Question 31 (3 points) Explain the difference between systematic and unsystematic risk, and why one of these types of risks is rewarded with a risk premium while the other type is not. Question 32 (3 points) Suppose that your company's weighted-average cost of capital is 9 percent. Your company is planning to undertake a project with an internal rate of return of 12%, but you believe that this project is not a good investment for the firm. What logical arguments might you use to convince your boss to forego the project despite its high rate of return? Is it possible that making investments with expected returns higher than your company's cost of capital will destroy value? If so, how? 18 A Grzeszczak 2016. Question 33 (10 points) By circling the appropriate answer indicate your choice (True or False). A. A company with zero value of bank debt but with bonds outstanding is likely to have its ROE equal to ROIC. (True / False) B. Depreciation must first be deducted in calculating relevant cashflows (as it impacts taxes paid), but must be added back (since it is a non cash deduction). (True / False) C. By far managers' preferred way of financing company's growth is with debt. (True / False) D. The internal rate of return (IRR) is \"the\" discount rate that makes the PV of a stream of cash flows equal to company's weighted average cost of capital (WACC). (True / False) E. For a company which (on average) is as risky as the overall market Beta is zero. (True / False) 19