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FIN 515 WEEK 4 EXAM Week 4 : Business Valuation and Stock Valuation - Exam 1. (TCO A) Which of the following statements is CORRECT? (Points : 10) One of the disadvantages of incorporating a business is that the owners then become subject to liabilities in the event the firm goes bankrupt. Sole proprietorships are subject to more regulations than corporations. In any type of partnership, every partner has the same rights, privileges, and liability exposure as every other partner. Sole proprietorships and partnerships generally have a tax advantage over many corporations, especially large ones. Corporations of all types are subject to the corporate income tax. 1. (TCO A) Which of the following statements is CORRECT? (Points : 10) It is generally more expensive to form a proprietorship than a corporation because, with a proprietorship, extensive legal documents are required. Corporations face fewer regulations than sole proprietorships. One disadvantage of operating a business as a sole proprietorship is that the firm is subject to double taxation, at both the firm level and the owner level. One advantage of forming a corporation is that equity investors are usually exposed to less liability than in a regular partnership. If a regular partnership goes bankrupt, each partner is exposed to liabilities only up to the amount of his or her investment in the business. 2. (TCO G) A security analyst obtained the following information from Prestopino Products’ financial statements: • Retained earnings at the end of 2009 were $700,000, but retained earnings at the end of 2010 had declined to $320,000. • The company does not pay dividends. • The company’s depreciation expense is its only non-cash expense; it has no amortization charges. • The company has no non-cash revenues. • The company’s net cash flow (NCF) for 2010 was $150,000. On the basis of this information, which of the following statements is CORRECT? (Points : 10) Prestopino had negative net income in 2010. Prestopino’s depreciation expense in 2010 was less than $150,000. Prestopino had positive net income in 2010, but its income was less than its 2009 income. Prestopino's NCF in 2010 must be higher than its NCF in 2009. Prestopino’s cash on the balance sheet at the end of 2010 must be lower than the cash it had on the balance sheet at the end of 2009. 3. (TCO G) LeCompte Corp. has $312,900 of assets, and it uses only common equity capital (zero debt). Its sales for the last year were $620,000, and its net income after taxes was $24,655. Stockholders recently voted in a new management team that has promised to lower costs and get the return on equity up to 15%. What profit margin would LeCompte need in order to achieve the 15% ROE, holding everything else constant? (Points : 10) 7.57% 7.95% 8.35% 8.76% 9.20% 3. (TCO G) Beranek Corp. has $410,000 of assets, and it uses no debt—it is financed only with common equity. The new CFO wants to employ enough debt to bring the debt/assets ratio to 40%, using the proceeds from the borrowing to buy back common stock at its book value. How much must the firm borrow to achieve the target debt ratio? (Points : 10) $155,800 $164,000 $172,200 $180,810 $189,851 4. (TCO B) You want to buy a new sports car three years from now, and you plan to save $4,200 per year, beginning one year from today. You will deposit your savings in an account that pays 5.2% interest. How much will you have just after you make the third deposit, three years from now? (Points : 10) $11,973 $12,603 $13,267 $13,930 $14,626 4. (TCO B) You deposit $1,000 today in a savings account that pays 3.5% interest, compounded annually. How much will your account be worth at the end of 25 years? (Points : 10) $2,245.08 $2,363.24 $2,481.41 $2,605.48 $2,735.75 5. (TCO B) At a rate of 6.5%, what is the future value of the following cash flow stream? Years: 0 1 2 3 4 |--------|-----------|----------|---------| CFs: $0 $75 $225 $0 $300 (Points : 10) $526.01 $553.69 $582.83 $613.51 $645.80 5. (TCO B) You sold a car and accepted a note with the following cash flow stream as your payment. What was the effective price you received for the car assuming an interest rate of 6.0%? Years: 0 1 2 3 4 |-----------|--------------|--------------|--------------| CFs: $0 $1,000 $2,000 $2,000 $2,000 (Points : 10) $5,987 $6,286 $6,600 $6,930 $7,277 6. (TCO B) Farmers Bank offers to lend you $50,000 at a nominal rate of 5.0%, simple interest, with interest paid quarterly. Merchants Bank offers to lend you the $50,000, but it will charge 6.0%, simple interest, with interest paid at the end of the year. What's the difference in the effective annual rates charged by the two banks? (Points : 10) 1.56% 1.30% 1.09% 0.91% 0.72% 6. (TCO B) Suppose you borrowed $12,000 at a rate of 9.0% and must repay it in four equal installments at the end of each of the next four years. How large would your payments be? (Points : 10) $3,704.02 $3,889.23 $4,083.69 $4,287.87 $4,502.26 7. (TCO D) A 15-year bond with a face value of $1,000 currently sells for $850. Which of the following statements is CORRECT? (Points : 10) The bond’s coupon rate exceeds its current yield. The bond’s current yield exceeds its yield to maturity. The bond’s yield to maturity is greater than its coupon rate. The bond’s current yield is equal to its coupon rate. If the yield to maturity stays constant until the bond matures, the bond’s price will remain at $850. 7. (TCO D) Which of the following statements is CORRECT? (Points : 10) If a bond is selling at a discount, the yield to call is a better measure of return than the yield to maturity. On an expected yield basis, the expected capital gains yield will always be positive because an investor would not purchase a bond with an expected capital loss. On an expected yield basis, the expected current yield will always be positive because an investor would not purchase a bond that is not expected to pay any cash coupon interest. If a coupon bond is selling at par, its current yield equals its yield to maturity. The current yield on Bond A exceeds the current yield on Bond B; therefore, Bond A must have a higher yield to maturity than Bond B. 8. (TCO D) Ezzell Enterprises’ noncallable bonds currently sell for $1,165. They have a 15-year maturity, an annual coupon of $95, and a par value of $1,000. What is their yield to maturity? (Points : 10) 6.20% 6.53% 6.87% 7.24% 7.62% 9. (TCO C) Keys Corporation's five-year bonds yield 7.00%, and five-year T-bonds yield 5.15%. The real risk-free rate is r* = 3.0%, the inflation premium for five-year bonds is IP = 1.75%, the liquidity premium for Keys' bonds is LP = 0.75% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t - 1) x 0.1%, where t = number of years to maturity. What is the default risk premium (DRP) on Keys' bonds? (Points : 10) 0.99% 1.10% 1.21% 1.33% 1.46% 9. (TCO C) Niendorf Corporation's five-year bonds yield 6.75%, and five-year T-bonds yield 4.80%. The real risk-free rate is r* = 2.75%, the inflation premium for five-year bonds is IP = 1.65%, the default risk premium for Niendorf's bonds is DRP = 1.20% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t - 1) x 0.1%, where t = number of years to maturity. What is the liquidity premium (LP) on Niendorf's bonds? (Points : 10) 0.49% 0.55% 0.61% 0.68% 0.75% 10. (TCO C) Assume that the risk-free rate remains constant, but the market risk premium declines. Which of the following is most likely to occur? (Points : 10) The required return on a stock with beta = 1.0 will not change. The required return on a stock with beta > 1.0 will increase. The return on "the market" will remain constant. The return on "the market" will increase. The required return on a stock with beta < 1.0 will decline. 10. (TCO C) Assume that investors have recently become more risk averse, so the market risk premium has increased. Also, assume that the risk-free rate and expected inflation have not changed. Which of the following is most likely to occur? (Points : 10) The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium. The required rate of return will decline for stocks whose betas are less than 1.0. The required rate of return on the market, rM, will not change as a result of these changes. The required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market risk premium. The required rate of return on a riskless bond will decline.