Corporate Finance Midterm 1, Spring 2013Name: ID:1.Multiple Choices (3 points×20 = 60 points):1. Which of the following is not considered one of the basic questions of corporate finance?A) What long-lived assets should the firm invest?B) How much inventory should the firm hold?C) How can the firm raise cash for required capital expenditures?D) How should the short-term operating cash flows be managed?E) All of the above.Answer: B Difficulty: Medium Page: 42. Generally accepted accounting principles may recognize and record a saleA) before a customer pays assuming they will pay soon.B) only after the company receives payment in full.C) when the company receives at least 50% of the total revenue from the customer.D) All of the above.E) None of the above.Answer: A Difficulty: Medium Page: 73. The _____ tax rate is equal to total taxes divided by total taxable income.A. deductibleB. residualC. totalD. averageE. marginalD4. Which one of the following will increase the value of a firm's net working capital?A. using cash to pay a supplierB. depreciating an assetC. collecting an accounts receivableD. purchasing inventory on creditE. selling inventory at a profitE5. The higher the degree of financial leverage employed by a firm, the:A. higher the probability that the firm will encounter financial distress.B. lower the amount of debt incurred.C. less debt a firm has per dollar of total assets.D. higher the number of outstanding shares of stock.E. lower the balance in accounts payable.A6. Depreciation:A. reduces both taxes and net income.B. increases the net fixed assets as shown on the balance sheet.C. reduces both the net fixed assets and the costs of a firm.D. is a noncash expense which increases the net income.E. decreases net fixed assets, net income, and operating cash flows.A7. Which one of the following must be true if a firm had a negative cash flow from assets?A. The firm borrowed money.B. The firm acquired new fixed assets.C. The firm had a net loss for the period.D. The firm utilized outside funding.E. Newly issued shares of stock were sold.D8. A firm has net working capital of $640. Long-term debt is $4,180, total assets are $6,230, and fixed assets are $3,910. What is the amount of the total liabilities?A. $2,050B. $2,690C. $4,130D. $5,590E. $5,860Current assets = $6,230 - $3,910 = $2,320Current liabilities = $2,320 - $640 = $1,680Total liabilities = $1,680 + $4,180 = $5,860E9. Bonner Collision has shareholders' equity of $141,800. The firm owes a total of $126,000 of which 60 percent is payable within the next year. The firm net fixed assets of $161,900. What is the amount of the net working capital?A. $25,300B. $30,300C. $75,600D. $86,300E. $111,500Current liabilities = .60 $126,000 = $75,600Total assets = $141,800 + $126,000 = $267,800Current assets = $267,800 - $161,900 = $105,900Net working capital = $105,900 - $75,600 = $30,300B10. Kaylor Equipment Rental paid $75 in dividends and $511 in interest expense. The addition to retained earnings is $418 and net new equity is $500. The tax rate is 35 percent. Sales are $15,900 and depreciation is $680. What are the earnings before interest and taxes?A. $589.46B. $1,269.46C. $1,331.54D. $1,951.54E. $1,949.46Net income = $75 + $418 = $493Taxable income = $493/(1 - .35) = $758.46Earnings before interest and taxes = $758.46 + $511 = $1,269.46B11. Given the tax rates as shown, what is the average tax rate for a firm with taxable income of $311,360?A. 28.25 percentB. 31.09 percentC. 33.62 percentD. 35.48 percentE. 39.00 percentTax = .15($50,000) + .25($25,000) + .34($25,000) + .39($211,360) = $104,680.40 Average tax rate = $104,680.40/$311,360 = 33.62 percent12. Crandall Oil has total sales of $1,349,800 and costs of $903,500. Depreciation is $42,700 and the tax rate is 34 percent. The firm does not have any interest expense. What is the operating cash flow?A. $129,152B. $171,852C. $179,924D. $281,417E. $309,076Earnings before interest and taxes = $1,349,800 - $903,500 - $42,700 = $403,600 Tax = $403,600 .34 = $137,224Operating cash flow = $403,600 + $42,700 - $137,224 = $309,076E13. At the beginning of the year, a firm had current assets of $121,306 and current liabilities of $124,509. At the end of the year, the current assets were $122,418 and the current liabilities were $103,718. What is the change in net working capital?A. -$19,679B. -$11,503C. -$9,387D. $1,809E. $21,903Change in net working capital = ($122,418 - $103,718) - ($121,306 - $124,509) = $21,903E14. The Lakeside Inn had operating cash flow of $48,450. Depreciation was $6,700 and interest paid was $2,480. A net total of $2,620 was paid on long-term debt. The firm spent $24,000 on fixed assets and decreased net working capital by $1,330. What is the amount of the cash flow to stockholders?A. $5,100B. $7,830C. $18,020D. $19,998E. $20,680Cash flow from assets = $48,450 - (-$1,330) - $24,000 = $25,780Cash flow to creditors =$2,480 - (-$2,620) = $5,100Cash flow to stockholders = $25,780 - $5,100 = $20,680E15. You are scheduled to receive annual payments of $4,800 for each of the next 7 years. The discount rate is 8 percent. What is the difference in the present value if you receive these payments at the beginning of each year rather than at the end of each year?A. $1,999B. $2,013C. $2,221D. $2,227E. $2,304Difference = $26,990 - $24,991 = $1,999Note: The difference = 0.08 $24,991 = $1,999A16. Your local travel agent is advertising an upscale winter vacation package for travel three years from now to Antarctica. The package requires that you pay $25,000 today, $30,000 one year from today, and a final payment of $45,000 on the day you depart three years from today. What is the cost of this vacation in today's dollars if the discount rate is 9.75 percent?A. $86,376B. $89,695C. $91,219D. $91,407E. $93,478A17. You are going to loan a friend $900 for one year at a 5 percent rate of interest, compounded annually. How much additional interest could you have earned if you had compounded the rate continuously rather than annually?A. $0.97B. $1.14C. $1.23D. $1.36E. $1.41Additional interest = $900 (0.0512711 - 0.05) = $1.14B18. First Century Bank wants to earn an effective annual return on its consumer loans of 10 percent per year. The bank uses daily compounding on its loans. By law, what interest rate is the bank required to report to potential borrowers?A. 9.23 percentB. 9.38 percentC. 9.53 percentD. 9.72 percentE. 10.00 percentAPR = 365×[(1 + 0.10)1/365 - 1] = 9.53 percent19. You have just won the lottery and will receive $540,000 as your first payment one year from now. You will receive payments for 26 years. The payments will increase in value by 4 percent each year. The appropriate discount rate is 10 percent. What is the present value of your winnings?A. $6,221,407B. $6,906,372C. $7,559,613D. $7,811,406E. $8,003.1120. Consider a firm with a contract to sell an asset 3 years from now for $90,000. The asset costs $71,000 to produce today. At what rate will the firm just break even on this contract?A. 7.87 percentB. 8.01 percentC. 8.23 percentD. 8.57 percentE. 8.90 percent$90,000 = $71,000×(1 + r)3; r = 8.23 percent2.Concept Questions(1). Companies pa y rating agencies such as Moody’s and S&P to rate their bonds, and the costs can be substantial. However, companies are not required to have their bonds rated; doing so is strictly volunteer. Why do you think they do it? (3 Points)Ans: Companies pay to have their bonds rated simply because unrated bonds can be difficult to sell; many large investors are prohibited from investing in unrated issues.(2) Corporate ownership varies around the world. Historically individuals have owned the majority of shares in public corporations in the United States. In Germany and Japan, however, banks, other large financial institutions, and other companies own most of the stock in public corporations. Do you thinks agency problems are likely to be more or less severe in Germany and Japan than in the United States? Why? In recent years, large financial institutions such as mutual funds and pension funds have been becoming the dominant owners of stock in the United States, and these institutions are becoming more active in corporate affairs. What are the implications of this trend for agency problems and corporate control? (7 Points)Ans: We would expect agency problems to be less severe in countries with a relatively small percentage of individual ownership. Fewer individual owners should reduce the number of diverse opinions concerning corporate goals. The high percentage of institutional ownership might lead to a higher degree of agreement between owners and managers on decisions concerning risky projects. In addition, institutions may be better able to implement effective monitoring mechanisms on managers than can individual owners, based on the institutions’ deeper resources and experiences with their own management. The increase in institutional ownership of stock in the United States and the growing activism of these large shareholder groups may lead to a reduction in agency problems for U.S. corporations and a more efficient market for corporate control.3. Computations(1). (15 points) A local finance company quotes a 16% interest rate on one-year loans. So, if you borrow $25,000, the interest for the year will be $4,000. Because you must repay a total of $29,000 in one year, the finance company requires you to pay$29,000/12 or $2,416.67 per month over the next 12 months. Is this a 16% loan? What rate would legally have to be quoted? What is the effective annual rate?T o find the APR and EAR, we need to use the actual cash flows of the loan. In other words, the interest rate quoted in the problem is only relevant to determine the total interest under the terms given. The interest rate for the cash flows of the loan is:PVA = $25,000 = $2,416.67{(1 – [1 / (1 + r)]12 ) / r }Again, we cannot solve this equation for r, so we need to solve this equation on a financial calculator, using a spreadsheet, or by trial and error. Using a spreadsheet, we find:r = 2.361% per monthSo the APR is:APR = 12(2.361%) = 28.33%And the EAR is:EAR = (1.02361)12– 1 = .3231 or 32.31%(2). (15) You have just won the lottery and will receive $1,000,000 in one year. You will receive payments for 30 years, which will increase 5% per year. If the appropriate discount rate is 8%, what is the present value of your winnings?We can use the present value of a growing perpetuity equation to find the value of your deposits today. Doing so, we find:PV = C {[1/(r–g)] – [1/(r–g)] × [(1 + g)/(1 + r)]t}PV = $1,000,000{[1/(.08 – .05)] – [1/(.08 – .05)] × [(1 + .05)/(1 + .08)]30}PV = $19,016,563.18。