FIN 534/ FIN 534 FINAL EXAM PART 2 2015 (30/30) - 94566

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1. Which of the following is NOT normally regarded as being a barrier to hostile takeovers? Answer Targeted share repurchases. Shareholder rights provisions. Restricted voting rights. Poison pills. Abnormally high executive compensation. 2. Which of the following is NOT normally regarded as being a good reason to establish an ESOP? Answer To enable the firm to borrow at a below-market interest rate. To make it easier to grant stock options to employees. To help prevent a hostile takeover. To help retain valued employees. To increase worker productivity. 3. Which of the following statements is correct? Answer If a company has an established clientele of investors who prefer a high dividend payout, and if management wants to keep stockholders happy, it should not follow the strict residual dividend policy. If a firm follows a strict residual dividend policy, then, holding all else constant, its dividend payout ratio will tend to rise whenever the firm's investment opportunities improve. If Congress eliminates taxes on capital gains but leaves the personal tax rate on dividends unchanged, this would motivate companies to increase their dividend payout ratios. Despite its drawbacks, following the residual dividend policy will tend to stabilize actual cash dividends, and this will make it easier for firms to attract a clientele that prefers high dividends, such as retirees. One advantage of dividend reinvestment plans is that they enable investors to avoid paying taxes on the dividends they receive. 4. Grandin Inc. is evaluating its dividend policy. It has a capital budget of $625,000, and it wants to maintain a target capital structure of 60% debt and 40% equity. The company forecasts a net income of $475,000. If it follows the residual dividend policy, what is its forecasted dividend payout ratio? Answer 40.61% 42.75% 45.00% 47.37% 49.74% 5. Poff Industries' stock currently sells for $120 a share. You own 100 shares of the stock. The company is contemplating a 2-for-1 stock split. Which of the following best describes what your position will be after such a split takes place? Answer You will have 200 shares of stock, and the stock will trade at or near $60 a share. You will have 100 shares of stock, and the stock will trade at or near $60 a share. You will have 50 shares of stock, and the stock will trade at or near $120 a share. You will have 50 shares of stock, and the stock will trade at or near $60 a share. You will have 200 shares of stock, and the stock will trade at or near $120 a share. 6. Consider two very different firms, M and N. Firm M is a mature firm in a mature industry. Its annual net income and net cash flows are both consistently high and stable. However, M's growth prospects are quite limited, so its capital budget is small relative to its net income. Firm N is a relatively new firm in a new and growing industry. Its markets and products have not stabilized, so its annual operating income fluctuates considerably. However, N has substantial growth opportunities, and its capital budget is expected to be large relative to its net income for the foreseeable future. Which of the following statements is correct? Answer Firm M probably has a higher dividend payout ratio than Firm N. If the corporate tax rate increases, the debt ratio of both firms is likely to decline. The two firms are equally likely to pay high dividends. Firm N is likely to have a clientele of shareholders who want to receive consistent, stable dividend income. Firm M probably has a lower debt ratio than Firm N. 7. If a firm adheres strictly to the residual dividend policy, then if its optimal capital budget requires the use of all earnings for a given year (along with new debt according to the optimal debt/total assets ratio), then the firm should pay Answer no dividends to common stockholders. dividends only out of funds raised by the sale of new common stock. dividends only out of funds raised by borrowing money (i.e., issue debt). dividends only out of funds raised by selling off fixed assets. no dividends except out of past retained earnings. 8. The capital budget of Creative Ventures Inc. is $1,000,000. The company wants to maintain a target capital structure that is 30% debt and 70% equity. The company forecasts that its net income this year will be $800,000. If the company follows a residual dividend policy, what will be its total dividend payment? Answer $100,000 $200,000 $300,000 $400,000 $500,000 9. In the real world, dividends Answer are usually more stable than earnings. fluctuate more widely than earnings. tend to be a lower percentage of earnings for mature firms. are usually changed every year to reflect earnings changes, and these changes are randomly higher or lower, depending on whether earnings increased or decreased. are usually set as a fixed percentage of earnings, e.g., at 40% of earnings, so if EPS = $2.00, then DPS will equal $0.80. Once the percentage is set, then dividend policy is on "automatic pilot" and the actual dividend depends strictly on earnings. 10. Which of the following statements is CORRECT? Answer The capital structure that minimizes the interest rate on debt also maximizes the expected EPS. The capital structure that minimizes the required return on equity also maximizes the stock price. The capital structure that minimizes the WACC also maximizes the price per share of common stock. The capital structure that gives the firm the best credit rating also maximizes the stock price. The capital structure that maximizes expected EPS also maximizes the price per share of common stock. 11. Which of the following events is likely to encourage a company to raise its target debt ratio, other things held constant? Answer An increase in the personal tax rate. An increase in the company's operating leverage. The Federal Reserve tightens interest rates in an effort to fight inflation. The company's stock price hits a new high. An increase in the corporate tax rate. 12. Which of the following would increase the likelihood that a company would increase its debt ratio, other things held constant? Answer An increase in the corporate tax rate. An increase in the personal tax rate. The Federal Reserve tightens interest rates in an effort to fight inflation. The company's stock price hits a new low. An increase in costs incurred when filing for bankruptcy. 13. Which of the following statements is CORRECT? Answer The capital structure that maximizes the stock price is also the capital structure that maximizes earnings per share. The capital structure that maximizes the stock price is also the capital structure that maximizes the firm's times interest earned (TIE) ratio. Increasing a company's debt ratio will typically reduce the marginal costs of both debt and equity financing; however, this still may raise the company's WACC. If Congress were to pass legislation that increases the personal tax rate but decreases the corporate tax rate, this would encourage companies to increase their debt ratios. The capital structure that maximizes the stock price is also the capital structure that minimizes the weighted average cost of capital (WACC). 14. Companies HD and LD have identical tax rates, total assets, and basic earning power ratios, and their basic earning power exceeds their before-tax cost of debt, rd. However, Company HD has a higher debt ratio and thus more interest expense than Company LD. Which of the following statements is CORRECT? Answer Company HD has a lower ROA than Company LD. Company HD has a lower ROE than Company LD. The two companies have the same ROA. The two companies have the same ROE. Company HD has a higher net income than Company LD. 15. Daylight Solutions is considering a recapitalization that would increase its debt ratio and increase its interest expense. The company would issue new bonds and use the proceeds to buy back shares of its common stock. The company's CFO thinks the plan will not change total assets or operating income, but that it will increase earnings per share (EPS). Assuming the CFO's estimates are correct, which of the following statements is CORRECT? Answer If the plan reduces the WACC, the stock price is also likely to decline. Since the plan is expected to increase EPS, this implies that net income is also expected to increase. If the plan does increase the EPS, the stock price will automatically increase at the same rate. Under the plan there will be more bonds outstanding, and that will increase their liquidity and thus lower the interest rate on the currently outstanding bonds. Since the proposed plan increases Daylight's financial risk, the company's stock price still might fall even if EPS increases. 16. Which of the following statements is CORRECT? Answer The capital structure that minimizes a firm's weighted average cost of capital is also the capital structure that maximizes its stock price. The capital structure that minimizes the firm's weighted average cost of capital is also the capital structure that maximizes its earnings per share. If a firm finds that the cost of debt is less than the cost of equity, increasing its debt ratio must reduce its WACC. Other things held constant, if corporate tax rates declined, then the Modigliani-Miller tax-adjusted tradeoff theory would suggest that firms should increase their use of debt. A firm can use retained earnings without paying a flotation cost. Therefore, while the cost of retained earnings is not zero, its cost is generally lower than the after-tax cost of debt. 17. Which of the following items should a company report directly in its monthly cash budget? Answer Cash proceeds from selling one of its divisions. Accrued interest on zero coupon bonds that it issued. New shares issued in a stock split. New shares issued in a stock dividend. Its monthly depreciation expense. 18. Which of the following will cause an increase in net working capital, other things held constant? Answer A cash dividend is declared and paid. Merchandise is sold at a profit, but the sale is on credit. Long-term bonds are retired with the proceeds of a preferred stock issue. Missing inventory is written off against retained earnings. 19. Which of the following statements is most consistent with efficient inventory management? The firm has a Answer low incidence of production schedule disruptions. below average total assets turnover ratio. relatively high current ratio. relatively low DSO. below average inventory turnover ratio. 20. A lockbox plan is Answer used to identify inventory safety stocks. used to slow down the collection of checks our firm writes. used to speed up the collection of checks received. used primarily by firms where currency is used frequently in transactions, such as fast food restaurants, and less frequently by firms that receive payments as checks. used to protect cash, i.e., to keep it from being stolen. 21. Other things held constant, which of the following would tend to reduce the cash conversion cycle? Answer Place larger orders for raw materials to take advantage of price breaks. Take all discounts that are offered. Continue to take all discounts that are offered and pay on the net date. Offer longer payment terms to customers. Carry a constant amount of receivables as sales decline. 22. A lockbox plan is most beneficial to firms that Answer have widely dispersed manufacturing facilities. have a large marketable securities portfolio and cash to protect. receive payments in the form of currency, such as fast food restaurants, rather than in the form of checks. have customers who operate in many different parts of the country. have suppliers who operate in many different parts of the country. 23. In Japan, 90-day securities have a 4% annualized return and 180-day securities have a 5% annualized return. In the United States, 90-day securities have a 4% annualized return and 180-day securities have an annualized return of 4.5%. All securities are of equal risk, and Japanese securities are denominated in terms of the Japanese yen. Assuming that interest rate parity holds in all markets, which of the following statements is most CORRECT? Answer The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 180-day forward market. The yen-dollar exchange rate in the 90-day forward market equals the yen-dollar exchange rate in the 180-day forward market. The spot rate equals the 90-day forward rate. The spot rate equals the 180-day forward rate. The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market. 24. If 1.64 Canadian dollars can purchase one U.S. dollar, how many U.S. dollars can you purchase for one Canadian dollar? Answer 0.37 0.61 1.00 1.64 3.28 25. Suppose Yates Inc., a U.S. exporter, sold a consignment of antique American muscle-cars to a Japanese customer at a price of 143.5 million yen, when the exchange rate was 140 yen per dollar. In order to close the sale, Yates agreed to make the bill payable in yen, thus agreeing to take some exchange rate risk for the transaction. The terms were net 6 months. If the yen fell against the dollar such that one dollar would buy 154.4 yen when the invoice was paid, what dollar amount would Yates actually receive after it exchanged yen for U.S. dollars? Answer $1,075,958 $1,025,000 $1,000,000 $975,610 $929,404 26. Suppose that 1 British pound currently equals 1.62 U.S. dollars and 1 U.S. dollar equals 1.62 Swiss francs. What is the cross exchange rate between the pound and the franc? Answer 1 British pound equals 3.2400 Swiss francs 1 British pound equals 2.6244 Swiss francs 1 British pound equals 1.8588 Swiss francs 1 British pound equals 1.0000 Swiss francs 1 British pound equals 0.3810 Swiss francs 27. Suppose a carton of hockey pucks sell in Canada for 105 Canadian dollars, and 1 Canadian dollar equals 0.71 U.S. dollars. If purchasing power parity (PPP) holds, what is the price of hockey pucks in the United States? Answer $14.79 $63.00 $74.55 $85.88 $147.88 28. Suppose one U.S. dollar can purchase 144 yen today in the foreign exchange market. If the yen depreciates by 8.0% tomorrow, how many yen could one U.S. dollar buy tomorrow? Answer 155.5 yen 144.0 yen 133.5 yen 78.0 yen 72.0 yen 29. Suppose a foreign investor who holds tax-exempt Eurobonds paying 9% is considering investing in an equivalent-risk domestic bond in a country with a 28% withholding tax on interest paid to foreigners. If 9% after-tax is the investor's required return, what before-tax rate would the domestic bond need to pay to provide the required after-tax return? Answer 9.00% 10.20% 11.28% 12.50% 13.75% 30. In 1985, a given Japanese imported automobile sold for 1,476,000 yen, or $8,200. If the car still sold for the same amount of yen today but the current exchange rate is 144 yen per dollar, what would the car be selling for today in U.S. dollars? Answer $5.964 $8,200 $10,250 $12,628 $13,525
Solution Description

1. Which of the following is NOT normally regarded as being a barrier to hostile takeovers?

Answer

Targeted share repurchases.

Shareholder rights provisions.

Restricted voting rights.

Poison pills.

Abnormally high executive compensation.

2. Which of the following is NOT normally regarded as being a good reason to establish an ESOP?

Answer

To enable the firm to borrow at a below-market interest rate.

To make it easier to grant stock options to employees.

To help prevent a hostile takeover.

To help retain valued employees.

To increase worker productivity.

3. Which of the following statements is correct?

Answer

If a company has an established clientele of investors who prefer a high dividend payout, and if management wants to keep stockholders happy, it should not follow the strict residual dividend policy.

If a firm follows a strict residual dividend policy, then, holding all else constant, its dividend payout ratio will tend to rise whenever the firm's investment opportunities improve.

If Congress eliminates taxes on capital gains but leaves the personal tax rate on dividends unchanged, this would motivate companies to increase their dividend payout ratios.

Despite its drawbacks, following the residual dividend policy will tend to stabilize actual cash dividends, and this will make it easier for firms to attract a clientele that prefers high dividends, such as retirees.

One advantage of dividend reinvestment plans is that they enable investors to avoid paying taxes on the dividends they receive.

4. Grandin Inc. is evaluating its dividend policy. It has a capital budget of $625,000, and it wants to maintain a target capital structure of 60% debt and 40% equity. The company forecasts a net income of $475,000. If it follows the residual dividend policy, what is its forecasted dividend payout ratio?

Answer

40.61%

42.75%

45.00%

47.37%

49.74%

5. Poff Industries' stock currently sells for $120 a share. You own 100 shares of the stock. The company is contemplating a 2-for-1 stock split. Which of the following best describes what your position will be after such a split takes place?

Answer

You will have 200 shares of stock, and the stock will trade at or near $60 a share.

You will have 100 shares of stock, and the stock will trade at or near $60 a share.

You will have 50 shares of stock, and the stock will trade at or near $120 a share.

You will have 50 shares of stock, and the stock will trade at or near $60 a share.

You will have 200 shares of stock, and the stock will trade at or near $120 a share.

6. Consider two very different firms, M and N. Firm M is a mature firm in a mature industry. Its annual net income and net cash flows are both consistently high and stable. However, M's growth prospects are quite limited, so its capital budget is small relative to its net income. Firm N is a relatively new firm in a new and growing industry. Its markets and products have not stabilized, so its annual operating income fluctuates considerably. However, N has substantial growth opportu

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