EXAM (all printed)

Question 1

Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 4.80%. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average ………………………………………………………………?

Answer 1

So, the expected rate of return would be:
Expected Return = Real Risk-Free
Rate + Expected Inflation
= 3.50% + 4.80%
= 8.30%

So, according to the pure expectations theory, you would expect a return of 8.30% on a 1-year Treasury security.

Question 1

Dontrell now has $500. How much would he have after 5 years if he leaves it invested at 5.7% with annual compounding ………………………………………………………………?

FAST ROUTE
PV= $500
I/YR= 5.7%
N= 5
PRESS FV
ANWSER= $659.70

Answer 1

FV = PV * (1 + r)^n

FV = $500 * (1 + 0.057)^5
FV = $500 * (1.057)^5
FV = $500 * 1.3081
FV = $659.6976558 –> $659.70*

Question 2

A bond trader observes the following information:

• The Treasury yield curve is downward sloping.
• Empirical data indicate that a positive maturity risk premium applies to both Treasury and corporate bonds.
• Empirical data also indicate that there is no liquidity premium for Treasury securities but that a positive liquidity premium is built into corporate bond yields.

On the basis of this information, which of the following statements is most CORRECT ………………………………………………………………?

Answer 2

b. A 10-year corporate bond must have a higher yield than a 5-year Treasury bond

Question 3

A bond issued by the State of Pennsylvania provides a 5.75% yield. What yield on a Synthetic Chemical Company bond would cause the two bonds to provide the same after-tax rate of return to an investor in the 35.00% tax bracket? (Round your final answer to two decimal places.) ………………………………………………………………….?

Answer 3

Taxable Yield = Tax-Exempt Yield / (1 - Tax Rate)
Substituting the given values into the formula, we get:
Taxable Yield = 5.75% / (1 - 0.35)
Taxable Yield = 0.0575 / 0.65
Taxable Yield = 0.08846 or 8.85%

Question 4

a. Partnerships have more difficulty attracting large amounts of capital than corporations because of such factors as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and selling) of partnership interests ………………………………………………………………….?

THIS STATEMENT IS CORRECT

Answer 4

ANS-REF

Question 5

Short Corp just issued bonds that will mature in 10 years, and Long Corp issued bonds that will mature in 20 years. Both bonds promise to pay a semiannual coupon, they are not callable or convertible, and they are equally liquid. Further assume that the Treasury yield curve is based only on the pure expectations theory. Under these conditions, which of the following statements is CORRECT ………………………………………………………………….?

Answer 5

a. If the Treasury yield curve is upward sloping and Short has less default risk than Long, then Short’s bonds must under all conditions have a lower yield than Long’s bonds.

Question 6

You plan to borrow $32,200 at a 7.3% annual interest rate. The terms require you to amortize the loan with 7 equal end-of-year payments. How much interest would you be paying in Year 2 ………………………………………………………………………?

PLUG
N= 7
I/YR = 7.3%
PV = 32,200
Press PMT
= $6,037.45

Yearly payment = PMT(annual rate, year, -borrowing)
= PMT (7.3%, 7, -32,200)
= $6,037.45

Answer 6

Closing balance year 1 = Borrowing × (1+ Interest %) - Yearly payment
= $32,200 × (1 + 7.3%) - $6,037.45
= $28,513.15

Interest year 2 = Closing balance year 1 × Interest %
= $28,513.15 × 7.3%
= $2,081.46

Question 7

Suppose an Exxon Corporation bond will pay $1,000 ten years from now. If the going interest rate on safe 10-year bonds is 7.00%, how much is the bond worth today ………………………………………………………………….?

PV = FV / (1 + r)^n

Answer 7

Substituting the given values into the formula, we get
PV = $1,000 / (1 + 0.07)^10
PV = $1,000 / (1.07)^10
PV = $1,000 / 1.967151
PV = $508.35
So, the bond is worth $508.35 today.

Question 8

What is the present value of the following cash flow stream at a rate of 10.0% ………………………………………………………………….?

Answer 8

PLUG=
PV0 = 750
PV2= 2450 / (1+0.10)^1 = 2,227.27
PV3= 3175 / (1 + 0.10)^2= 2623.97
PV4 = 4400 / (1 + 0.10)^3 = 3,305.79
= $8,907.3

Question 9

In 2020, Appalachian Airlines had taxable income of -$3,000,000. In 2021, the company has taxable income of $5,000,000 and its corporate tax rate is 25%.

Assume that the company takes full advantage of the Tax Code’s carry-forward provision. How much will the company pay in taxes in 2021 ………………………………………………………………….?

Answer 9

So, the taxable income for 2021 will be
$5,000,000 - $3,000,000 =
$2,000,000.
At a tax rate of 25%, the company will pay $2,000,000 * 0.25 = $500,000 in taxes in 2021.

Question 10

Moose Industries has a corporate tax rate of 25%.

Last year the company realized $14,000,000 in operating income (EBIT). Its annual interest expense is $1,500,000. What was the company’s net income for the year ………………………………………………………………….?

First, we need to calculate the company’s taxable income. This is done by subtracting the interest expense from the operating income.
So, $14,000,000 - $1,500,000 =
$12,500,000.

Answer 10

So, $12,500,000 * 0.25 =
$3,125,000.
Finally, we subtract the tax from the taxable income to get the net income.
So, $12,500,000 - $3,125,000 =
$9,375,000

Question 11

A firm’s new president wants to strengthen the company’s financial position. Which of the following actions would make the company financially stronger ………………………………………………………………….?

a. Increase accounts receivable while holding sales constant.
b. Increase inventories while holding sales constant.
c. Increase accounts payable while holding sales constant.
d. Increase EBIT while holding sales and assets constant
e. Increase notes payable while holding sales constant.

Answer 11

ANS-REF

Question 12

Griffey Communications recently realized $112,500 in operating income. The company had interest income of $30,000 and realized $70,000 in dividend income. The company’s interest expense was $55,000. Its corporate tax rate is 25%. Griffey is a small company, so it is not subject to the interest expense deduction limitation.

Assume a 50% dividend exclusion for taxes on dividends.

Which of the following most closely matches the tax liability of Griffey Communications?

1) So, $112,500 + $30,000 + ($70,000 * 0.50) - $55,000 =
$122,500

Answer 12

Next, we calculate the tax the company has to pay. This is done by multiplying the taxable income by the tax rate.
So, $122,500 * 0.25 = $30,625

Question 13

What is their marginal tax rate ………………………………………………………………….?

Answer 13

The Winthrop’s taxable income is their total income from wages minus their itemized deductions.
So, $225,400 - $27,250 =
$198,150.

Looking at the tax table, their taxable income of $198,150 falls into the bracket of $171,050-$326,600. Therefore, their marginal tax rate is 24%

Question 14

Suppose the real risk-free rate is 3.80% and the future rate of inflation is expected to be constant at 4.00%. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is valid? Include cross-product terms, i.e., if averaging is required, use the geometric average. (Round your final answer to 2 decimal places ………………………………………………………………….?

Answer 14

So, (1 + nominal rate) = (1 + 0.038)
* (1 + 0.04) = 1.07952
Subtracting 1 from both sides gives the nominal rate, or the expected return on the 1-year
Treasury security.
So, nominal rate = 1.07952 - 1 = .07952 * 100
or when rounded to two decimal places
= 7.95

Question 15

X-1 Corp’s total assets at the end of last year were $310,000 and its EBIT was $50,000. What was its basic earning power (BEP) ratio ………………………………………………………………….?

Answer 15

The Basic Earning Power (BEP)
ratio is calculated by dividing
Earnings Before Interest and Taxes
(EBIT) by total assets.
So, BEP = EBIT / Total Assets =
$50,000 / $310,000 = 0.16129 or
16.13% when rounded to two decimal places.

Question 16

In 2020, Garner Grocers had taxable income of -$2,000,000. The corporate tax rate is 25%. Assume that the company takes full advantage of the Tax Code’s carry-forward provision. In 2021, Garner has taxable income of $1,000,000. What is the amount of taxes the company paid in 2021 ………………………………………………………………….?

FINAL ANWSER = $0

Answer 16

The carry-forward provision allows companies to apply their net operating losses to future tax payments. In this case, Garner Grocers can apply its $2,000,000 loss from 2020 to its 2021 income.
Since the loss from 2020 is greater than the income in 2021, the company can offset the entire $1,000,000 of income in 2021.
Therefore, the company’s taxable income for 2021 is SO and it will not pay any taxes in 2021.

Question 17

Companies HD and LD are both profitable, and they have the same total assets (TA), total invested capital, sales (S), return on assets (ROA), and profit margin (PM). Both firms finance using only debt and common equity. However, Company HD has the higher total debt to total capital ratio. Which of the following statements is CORRECT ………………………………………………………………….?

a. Company HD has a higher fixed assets turnover than Company LD.
b. Company HD has a higher ROE than Company LD
c. Company HD has a lower total assets turnover than Company LD.
d. Company HD has a lower equity multiplier than Company LD.
e. Company HD has a lower operating income (EBIT) than Company LD.

Answer 17

ROE, or Return on Equity, is a measure of financial performance calculated by dividing net income by shareholders’ equity. Because shareholders’ equity is equal to a company’s assets minus its debt, equity is smaller when a company has more debt. Since Company HD has a higher debt ratio, it has less equity. Therefore, for the same net income, Company HD will have a higher ROE.

Question 18

A U.S. Treasury bond will pay a lump sum of $1,000 exactly 3 years from today. The nominal interest rate is 6%, semiannual compounding. Which of the following statements is CORRECT ………………………………………………………………….?

a. The periodic interest rate is greater than 3%.	
b. The present value would be greater if the lump sum were discounted back for more periods.	
**c. The present value of the $1,000 would be smaller if interest were compounded monthly rather than semiannually**
d. The periodic rate is less than 3%.	
e. The PV of the $1,000 lump sum has a higher present value than the PV of a 3-year, $333.33 ordinary annuity.

Answer 18

ANS-REF

Question 19

Which of the following statements is CORRECT ………………………………………………………………….?

d. The statement of cash flows shows how much the firm’s cash–the total of currency, bank deposits, and short-term liquid securities (or cash equivalents)-
-increased or decreased during a given vear.

Answer 19

ANS-REF