Section A: Multiple Choice Questions 40 points (20 questions 2

points each )
(There may be more than one reasonable answer, you have to pick the
best alternative. Highlight and/or underline your choice using MS Word.
Check the document to ensure that your choices have been saved.)
Chapter 3
1.
To calculate free cash flow, you must deduct capital expenditures from the
cash flow from operations.
TRUE
FALSE
2.

An increase in inventories uses cash, reducing the firm's net cash balance.

TRUE
FALSE
3.
A reduction in accounts receivable uses cash, reducing the firm's net cash
balance.
TRUE
FALSE
4.

If the balance sheet of a firm indicates that total assets exceed current
liabilities plus shareholders' equity, then the firm has:

A.
B.
C.
D.

no retained earnings.
long-term debt.
no accumulated depreciation.
current assets.

5.

Suppose Dee's just acquired the assets of Flo's Flowers. The book value of
Flo's Flowers assets was $68,000 but Dee's paid a total of $75,000. The
additional $7,000 paid by Dee's will be recorded on Dee's balance sheet as:

A.
B.
C.
D.

accounts payable.
goodwill.
other current assets.
property, plant, and equipment.

6.

Which of the following statements about net working capital (NWC) is correct?

A.
B.
C.

NWC is positive for all firms.

As NWC decreases, potential liquidity increases.
NWC excludes inventory, which is deemed illiquid.

D.
Large decreases in NWC can increase the risk of the firm's
operations.
7.
According to accrual accounting, when goods are not sold until the period
after they were
produced, then the cost of goods sold will be:
A.
B.
C.
D.

recognized when the goods are produced.

recognized when the goods are sold.
recognized when payment is received.
split between the production and the sale periods.

8.
Which of the firm's financial statements most clearly recognizes the payment
for new equipment?
A.
B.
C.
D.

Balance sheet
Income statement
Statement of cash flows
Common-size balance sheet

9.
If a firm pays taxes, which one of these will reduce net income but increase
cash flow?
A.
B.
C.
D.

Depreciation expense
Income taxes
Cash sales
Higher COGS

10.
Which one of the following best explains the combination of a high level of
net income combined with a low level of cash flow during an accounting period?
A.
B.
C.
D.

High depreciation expense

Reduction of inventory levels
Acquisition of equipment
Increase in accounts payable

Chapter 7
11.
Wilt's has earnings per share of $2.98 and dividends per share of $.35. What
is the firm's sustainable rate of growth if its return on assets is 14.6% and its return
on equity is 18.2%?
A.
B.
C.
D.

2.14%
1.71%
12.89%
16.06%

12.
What is the difference between a fundamental analyst and a technical
analyst?
A.
B.

Only a fundamental analyst believes markets are inefficient.

A technical analyst focuses on financial statement analysis.

C.
Only a technical analyst helps keep the market efficient.
D.
A fundamental analyst analyzes information such as earnings and
asset values.
13.
According to the semistrong form of market efficiency, when new information
becomes available in the market, the related stock prices will:
A.
remain unchanged because they already reflect this information.
B.
accurately and rapidly adjust to include this new information.
C.
adjust to accurately reflect this new information over the course of the next
few days.
D.
most likely increase because all new information has a positive effect on
stock prices.
14.

What dividend yield would be reported in the financial press for a stock that
currently pays a $1 dividend per quarter and the most recent stock price was
$40?

A.
B.
C.
D.

2.5%
4.0%
10.0%
5.0%

15.

If a stock's P/E ratio is 13.5 at a time when earnings are $3 per year and the
dividend payout ratio is 40%, what is the stock's current price?

A.
B.
C.
D.

$24.30
$18.00
$22.22
$40.50

16.

With respect to the notion that stock prices follow a random walk, several
researchers have concluded that:

A.
stock prices reflect a majority of available information about the firm.
B.
successive price changes are predictable.
C.
past stock price changes provide little useful information about
current stock prices.
D.
stock prices always rise excessively in January.
17.

A stock paying $5 in annual dividends currently sells for $80 and has an
expected return of 14%. What might investors expect to pay for the stock one
year from now?

A.
B.
C.
D.

$82.20
$86.20
$87.20
$91.20

18.

If the dividend yield for year 1 is expected to be 5% based on a stock price of

$25, what will the year 4 dividend be if dividends grow annually at a constant
rate of 6%?

A.
B.
C.
D.

$1.33
$1.49
$1.58
$1.67

19.

What constant-growth rate in dividends is expected for a stock valued at

$32.40 if next year's dividend is forecast at $2.20 and the appropriate
discount rate is 13.6%?

A.
B.
C.
D.

7.02%
6.59%
6.81%
7.38%

20.

ABC common stock is expected to have extraordinary growth of 20% per year
for 2 years, after which the growth rate will settle into a constant 6%. If the
discount rate is 15% and the most recent dividend was $2.50, what should be
the approximate current share price?

A.
B.
C.
D.

$31.16
$33.23
$37.39
$47.77
Section B: Essay Questions and Problems - 60 points (6 questions 10
points each)

(Show your work as clearly and in as much detail as possible. If your final
answer is wrong, I can give you partial credit for your work. This partial
credit will be given on the legibility of the work you show.) From the endof-the-chapter Questions and Problems answer the following:
Chapter 3 Question 6, Question 14, Question 24
6)
a)
Shareholders equity in 2013
800+90-50-600=240
Shareholders equity in 2014
140+900-60-750=230
b) Net working capital, current assets current liabilities
In 2013

90-50=40
In 2014
140-60=80
c) Taxable income = 1950-1030-350-240= 330
Taxes @ 35% = 330*.35= 115.5
d) Cash provided by operations
Net income = 1950-1030-350-240-115.5=214.5
Dep = 350
Changes in working capital =
In Assets = -50
Current liabilities= 10
Cash by operations = 214.5+350-50+10= 524.5
e) Gross Investments in 2014 if net fixed assets increase from 800 to 900
Dep + net fixed assets = 900+ 350= 1250
f) If south sea reduced its outstanding a/c payables by 35, cash provided by
operations would have reduced also by 35m too
14)
a)
Sales = 14
COGS= 8
Dep=2
Int Expense = 1
Taxabke Incme = 14-8-2-1=3
Txaes @35% = 1.05
NI= 1.95
Net Cash flow = 1.95+dep= 1.95+2=3.95
b)
If Depreciation was increased by 1Million,
NI would have reduced by 1.95-1.3=0.65
Cash flows would have increased by 4.3-3.95= 0.35
c) the impact on the stock price is likely to be positive. Cash available to the firm
would increase and reduction in NI would be seen entirely from accounting changes
and not as a result of any changes in the underlying profitability
d) NI would not change
e) Cash flows would have reduced to 2.95
3.95-1= 2.95

24)
a) Free cash flow FCF = net income +interest+dep-addition to NWC-capital
expenditures
Changes to NWC
In Receivables = -40
Inventory = -5
Other current assets = -473
a/c payables = 260
Net = -258
FCF= 5465+517+1402-258-3049= 4077
b) if the company was financed entirely by financing
taxes would have been 8596*.35= 3008.6
Additional taxes would have been = 3008.6-2614= 394.6
c) If it was all equity financed, FCF would have been
NI= 8596-3008.6=5587.4
FCF= 5587.4+1402-258-3049= 3682.4

Chapter 7 Question 15, Question 28, Question 29

15)
a) 27= 1.64/(r-0.03), r= 9.07%
b) 27= 1.64/(0.10-g), g= 3.925%
c) Using sustainable growth rate = ROE*plowback ratio
ROE= 0.05/.4= 12.5%

28)
a) g= 0.2*0.3= 6%
ROE=20%, earnings = $4, dividend= 0.7* 4 = 2.8, r =12%
P=2.8/(0.12-0.06)= 46.67
P/E=46.67/4= 11.67
b) If the plow back ratio is reduced to 20%
div= 4*0.8= 3.2, g = 0.2*0.2= 4%
P= 3.2/(0.12-0.04), P= 40
P/E=40/4 =10
c) If plow back ratio equals zero, P= 4/0.12= 33.33
E/P= 4/33.33 = 12% which is expected rate of return on the stock

29)
a) g =ROE*plowback raio= 0.2*0.3= 6%
b) earnigs =3, div= 0.7*3= 2.1
P= 2.1/(0.12-0.06)=35
c)PVGO=stockprice- earnings/rate of return= 35-(3/0.12)=35-25=10
d)P/E=35/3= 11.67
e) Price= 3/0.12=25
P/E= 25/3 =8.33
f) Higher the P/E ratio, higher is the PV of the growth opportunities