Financial Management Flashcards

Question

The capital budgeting model that is generally considered the best model for long-range decision making is the: A. payback model. B. accounting rate of return model. C. unadjusted rate of return model. D. discounted cash flow model.

Answer 1

D. discounted cash flow model. The capital budgeting model that is generally considered the best model for long-range decision making is the discounted cash flow model because the time value of money (present and future values) is considered. The payback model and accounting rate of return model are unadjusted rate of return models which do not consider the time value of money.

Answer 2

Control activities are only designed to provide reasonable assurance related to the achievement of the company's stated objectives; however, risk will never be completely eliminated since there are limitations related to the control process. Limitations would include the following: Small staff size, resulting in the inability to effectively segregate duties The cost of the implementing a control being higher than the benefit of having that control The need for rapid responses by employees, thus affecting their judgment and performance Breakdowns in communication, training, and technology The collusion of two or more employees The override of various controls by management for illegitimate purposes

Answer 3

C. accounting rate of return. The accounting rate of return is a capital budgeting method or technique which disregards the time value of money. It is not a rate used in a net present value analysis. Each of the other terms—cost of capital, hurdle rate, and required rate of return—describes a rate used in net present value analysis.

Answer 4

C. 10.0%. The $300,000 loan is going to cost Dixon Corporation $24,000 (8% times $300,000). However, if the bank is going to require a 20% compensating balance, then Dixon Corporation will only have an effective use of $240,000 ($300,000 - ($20% × $300,000)). The $24,000 interest charge then becomes interest on $240,000, (the amount that Dixon is allowed to use of the $300,000 loan). $24,000 ÷ $240,000 represents an effective interest rate of 10%.

Answer 5

A. Poison put clause A poison put clause is a covenant that obliges the borrower to repay the bonds if a large quantity of common stock is held by a single investor and the bond rating is downgraded. This type of bond covenant is used as a defensive strategy to prevent hostile takeovers.

Answer 6

B. income less the imputed interest on its invested capital. Residual income is the amount of net income in excess of the imputed interest on its invested capital, so "income less the imputed interest on its invested capital" is correct. The imputed interest on investment is a rate determined by corporate headquarters to encourage the investment center managers to invest in projects that would return more than that rate since residual income will be increased. "Income plus the imputed interest on its invested capital" is incorrect because the imputed interest is subtracted from income rather than added. "Contribution margin plus [or less] the imputed interest on its invested capital" is incorrect because the contribution margin is not used in the computation of residual income.

Answer 7

B. $370 The net present value is the excess of the discounted present value of future cash returns less the investment cost. The formula to calculate present value for any single future payment is PV = Payment ÷ (1 + r)n, where r is the interest rate and n is the number of periods. The present value of the payment in the first year is $3,000 ÷ 1.1, or $2,727. The present value of the payment in the second year is $3,000 ÷ (1.1 × 1.1), or $2,479. The present value of the payment in the third year is $3,000 ÷ (1.1 × 1.1 × 1.1), or $2,254. The present value of the payment in the fourth year is $3,000 ÷ (1.1 × 1.1 × 1.1 × 1.1), or $2,049. The present value of the payment in the fifth year is $3,000 ÷ (1.1 × 1.1 × 1.1 × 1.1 × 1.1), or $1,863. The sum of the present value of the five future payments is $11,372. The cost of the investment is $11,000, so the net present value is $11,372 - $11,000, or $372, rounded to $370.

Answer 8

B. the value of the firm is basically related to the assets held. The use of a cost (asset-based) approach for valuation is appropriate when: the company is in liquidation. the company is worth more in liquidation than as a going concern. the company's value is basically related to the assets held. the company has had no income in recent years. future benefit streams cannot be adequately predicted.

Answer 9

A. $1,750. Safety stock is a minimum level of inventory used as a buffer against possible stockouts. As with all inventory, there is a cost of holding this asset. This cost is called carrying cost. Along with carrying cost is the expected cost of running out of stock, called the stockout cost. Total cost is defined in the problem as carrying cost plus expected stockout costs. Carrying cost is stated to be 20% of the investment in inventory. The value of the inventory is $50 per unit. At a safety stock of 100 units, the carrying cost would be 20% of 100 units at $50 a unit or $1000 (0.20 × 100 units × $50). Stockout cost is stated to be $5 per unit and at a safety stock level of 100 units, the stockout in units will be 100 with a 15% probability of occurrence. Therefore, stockout cost per cycle equals 100 units at $5 per unit times a 15% probability of $75 per cycle (100 units × $5 × 0.15). Since the company orders inventory 10 times per year, annual stockout cost will equal $75 times 10 cycles or $750 (10 cycles × $75). The annual carrying cost of $1,000 plus the annual stockout cost of $750 will equal a total annual safety stock cost of $1,750 ($1,000 + $750).

Answer 10

C. risk adverse. The definition of a risk-adverse investor is one who is willing to take risk but believes that they will be reasonably compensated for the level of risk being taken. The security market line is a theoretical construct that provides a graphic representation of the expected return of a particular security as a function of beta, i.e., nondiversifiable risk.

Answer 11

C. $165,625.=（(132,500,000/8)-(132,500,000/10))*5% The key to this problem is to determine how much inventory is reduced by the increased inventory turnover and the resulting savings in interest costs due to reduced working capital requirements. A company must either borrow funds to acquire working capital or give up the next best investment opportunity to fund working capital requirements (opportunity cost). Either way, it costs a company to hold inventory. Any reduction in inventory levels reduces that cost. The formula for inventory turns is annual cost of sales divided by inventory. Solve for inventory by dividing annual cost of sales by inventory turns. Initially, Spotech has an inventory level of $16,562,500 ($132,500,000 divided by 8 turns). Spotech hopes to decrease the level to $13,250,000 by increasing inventory turns to 10 ($132,500,000 divided by 10 turns). Working capital is reduced by this change in inventory ($16,562,500 - $13,250,000 = $3,312,500). The interest avoided on the $3,312,500 represents a savings of $165,625 ($3,312,500 × 5%).

Answer 12

C. stockouts. 无存货 Inventory turnover is costs of goods sold divided by average inventory. A very high inventory turnover could be the result of very low inventory levels. If this is the case, a serious risk of stockouts could exist. Management should certainly check this situation out. Each of the other answers would result from excessive inventory holdings (i.e., a lower than average inventory turnover situation).

Answer 13

D. 90-day Ford Motors commercial paper with a current annual yield of 6% The most appropriate investment would appear to be the 90-day commercial paper. Commercial paper is short-term unsecured debt that may be issued directly to a purchaser on a discount basis and set to mature on a specific date. By purchasing directly, broker fees and other changes are avoided.

Answer 14

B. $61,000 To calculate how much Garth will pay in interest during the first half of the year, the table provided must be used to develop an ongoing cash/credit balance: The total interest payments as shown above equal $60,702. This is approximately $61,000. The trick with this problem is to remember that interest is an additional cash outflow in the month paid. BEG INFLOW OUTFLOW INT-OUTFLOW CR END CASH 2 2 -1 0 0 3 3 2 -4 0 0 1 1 2 -5 0 2 0 0 2 -3 -.002 1.020* 0 0 4 -2 -0.302 -1.9698** 0 0 5 -3 -0.10502 -1.0502 939,298 Opening Balance Change in Ending Balance 0 0 0 0 0 0 0 0 0 2,000,000 2,000,000 0 2,000,000 1,020,000* 3,020,000 20,000 3,020,000 -1,969,800** 1,050,200 30,200 1,050,200 -1,050,200 0 10,502 TOTAL 60,702

Answer 15

B. $25 per share due to the new information; however, the input level would be dropped to Level 2. As a general rule, if observable inputs such as quoted market prices for identical assets are available, the subject asset should be used in determining value, since this would represent a Level 1 input in the fair value hierarchy. However, if a company announces negative information that has a negative impact on the market price shortly after the close of the market, the fair value valuation should employ the use of the new information and list the value of the subject asset at the lower price. This would also drop the input level to Level 2.

Answer 16

B. 6.6%. The weighted cost of capital is 6.6%. Step 1: Calculate the after-tax cost of each source of capital. The cost of long-term debt, after tax, is given at 4.8%. The cost of new preferred stock can be calculated as: kpm = D / (PO - u - f), or kpm = 8.40 / (105 - 0 - 5) = 8.4% Where: D = Annual dividend, or 0.08 × $105 (the par value), or $8.4 PO = Selling price to the public of the new issue u = Underpricing f = Flotation cost per share New equity consists of retained earnings and/or new issues of common stock. In this case, 50% of the 200,000 of total new funds must come from equity. Since the firm has $100,000 in retained earnings, the relevant cost of new equity is the cost of retained earnings, 7 ÷ 100 + 0%, or 7.0%. Step 2: Calculate the Weighted Average Cost of Capital: Source After-Tax Cost x Weight = a. L-T Debt .048 x .30 = .0144 b. Pref. Stock .084 x .20 = .0168 c. Ret. Earnings .070 x .50 = .0350 Weighted Average Cost of Capital = .066 or 6.6%

Answer 17

C. Current CPI Although the consumer price index (CPI) does not have any forecasting capability itself, a forecast of price levels is a necessary component of any business plan. Extrapolating the CPI is often used as an estimate of future prices since it is more stable than the PPI (producer price index).

Answer 18

B. exporter. The basic transaction involves a sale of goods by a foreign exporter to a domestic importer. The letter of credit issued by a bank essentially substitutes the bank's credit, for that of the importer. Thus, the risk of uncollectibility to the exporter is virtually eliminated.

Answer 19

D. uptown has no merchandise inventory. The difference between the current ratio and the quick ratio lies in the numerator. The numerator of the current ratio includes all current assets, usually cash, marketable securities, receivables, and merchandise inventory. Inventory is not included in the numerator used to calculate the quick ratio. Therefore, the only way the two ratios could be exactly the same would be if Uptown has no merchandise inventory.

Answer 20

B. a lower yield. Callable bonds reduce issuer risk by allowing the bonds to be called in if interest rates decline. The holder of callable bonds, however, is exposed to greater risk (i.e., loss of relatively high interest in a declining interest rate period). In contrast, a noncallable bond is less risky for a bondholder, so it should sell at a lower yield.

Answer 21

D. $454,896. Contribution margin calculated as sales revenue less variable costs. The additional contribution margin provided by the new machine is: Sales revenue: 20,000 units x $40 = $800,000 Variable Cost: 20,000 units x $30 = $600,000 Before Tax Contribution Margin $200,000 less taxes ($200,000 x .40) 80,000 After Tax Contribution Margin $120,000 To discount the additional annual contribution margin over five years, apply the Present Value of an Ordinary Annuity of $1 at 10% for five periods provided by the problem. -- After Tax annual Contribution Margin $120,000 -- Present Value of an Ordinary Annuity of $1 at 10% for 5 periods x 3.7908 Discounted net-of-tax contribution margin for the project $454,896

Answer 22

A. Yes As interest rates get higher, the factors for the same number of periods become smaller. This is because, as the interest rates become higher, the time value of the money becomes higher. This makes the present value of the money lower. In this case, the factor of internal rate of return is 6: $120,000 ÷ $20,000 = 6 If the hurdle rate of return is 10%, with a factor of 6.145, then the actual rate of return will be greater than 10%, and the project will be accepted.

Answer 23

B. When the market rate of return is less than the stated coupon rate, the market value of the bond will be more than its face value, and the bond will be selling at a premium. The market value of bonds is based upon the present value of discounted future cash flows, comprised of an annuity plus a lump sum. The bond’s market value fluctuates with changes in the market interest rates. When the face interest rate is the same as the market interest rate, the market value of the bond will be the same as the face (i.e., par) value. If the face interest rate is less than the market interest rate, the bond will sell at a discount; if it is greater, the bond will sell at a premium.

Answer 24

D. utilized in determining the tax costs or benefit. The only effect depreciation expense has on cash flows is the determination of income tax. Depreciation expense is subtracted from income to find taxable income. Therefore, while depreciation is not a cash flow directly, it does affect income tax cash flows. “Included as a cash or other cost” is incorrect because depreciation is not a cash flow. “Excluded for all purposes in the computation” is incorrect because depreciation is considered in determining cash flows for income taxes. “Utilized to estimate the salvage value of an investment” is incorrect because the salvage value is the cash value of the asset at the end of its useful life, which is not related to the book value remaining after deducting annual depreciation expense.

Answer 25

A. the group of controls with a variety of degrees of precision necessary to achieve a control objective. Two important definitions related to the internal control process are control precision and control sufficiency: Control precision is the alignment between a risk and the control activity designed to mitigate that risk. In other words, a control activity that has a direct influence on the achievement of a stated objective is considered to be more precise than one that only has an indirect influence. Control sufficiency is a group of controls with a variety of degrees of precision necessary to achieve a control objective. For example, there would potentially be a number of control activities such as segregation of duties, reconciliation of bank statements, and daily deposits of receipts in order to protect all incoming receivable payments from theft or fraud.

Answer 26

B. $490,018=(4.5638*110,000)-12,000 Because the machine is expected to generate an after-tax net cash flow from operations each year for seven years, an ordinary annuity situation exists. The cost of the machine is determined as follows: Let NPV = Net present value NPV = Present value of inflows - Present value of outflows $12,000 = (4.5638 x $110,000) - (Cost of machine) $12,000 = $502,018 - Cost of machine Cost of machine = $502,018 - $12,000 = $490,018 The present value of $1 serves to bring a single cash flow to the present, not a series of cash flows ($110,000 per year for seven years) as stated in the question.

Answer 27

B. Business risk Both financial risk and interest rate risk deal with the concept of financial leverage and the cost of debt, and since the firm only utilizes equity financing, these risk types do not apply. Marginal risk is the risk that is assumed by the issuer of a foreign exchange contract or debt (forward contract) in the event that the investor goes bankrupt. It is related to the risk of the last dollar of a transaction defaulting. Business risk is the uncertainty associated with the ability to forecast EBIT (earnings before interest and taxes) due to such things as sales variability and operating leverage. This risk is inherent in equity financing.

Answer 28

B. The discount rate at which the net present value of the project equals zero The internal rate of return is the interest rate that will make the present value of the future net cash flows equal to the initial cash outlay. In other words, it is the interest rate that gives a net present value of zero. The answer choice “the number of years it takes to recover the investment” is incorrect because it is the definition of the payback period, a number of years, not a rate of return. “The discount rate at which the net present value of the project equals one” is incorrect because the internal rate of return is the rate of return where the net present value is zero, not one. “The weighted-average cost of capital used to finance the project” is incorrect because weighted-average cost of capital is the interest rate that the company is paying on its other sources of financing. It is used to determine that project rate of return that would be acceptable to the company, but it is not used to calculate the internal rate of return.

Answer 29

D. Minimum weighted average cost of capital Since capital consists of debt and equity components, answers that regard only one or the other are inadequate. The cost of capital is a weighted average of the various debt and equity portions of capital. Therefore, a firm's optimal capital structure would be the minimum weighted average cost of capital.

Answer 30

A. would most likely be lower than under other business conditions in order that the company can maximize profits while minimizing working capital investment. Net working capital is current assets minus current liabilities. As sales increase, accounts receivable, a component of current assets, will increase providing the receivable collection period (average accounts receivable/average sales per day) remains constant. If credit sales increase by 10%, receivables would be expected to increase by 10%, thus increasing working capital. If the inventory conversion period (average inventory/average sales per day) is decreased, this means that inventory would be held for a shorter amount of time; therefore, in this situation, production has increased in order to accommodate increase sales; however, since the inventory conversion period has decreased, this means that inventory would have decreased or increased slower than sales. As sales and production increase, accounts payable and accrued production costs will increase providing the payables deferral period (average payables/average purchases per day) remains constant. If purchases and production increase by 10%, accounts payable and payables related to variable production costs would be expected to increase by 10% thus decreasing working capital. (This is assuming that unit variable costs of production remain unchanged). If the original balances of accounts receivable were less than the original inventory balances, it would be expected that working capital would decrease since the increase in accounts receivable would be less than the increases in payables related to the increased sales production.

Answer 31

D. Increase the discount rate. The net present value method adjusts for the time value of money. It seeks to determine whether the present value of estimated future cash inflows at a desired rate of return will be greater or lesser than the cost of the proposed investment. The present value of the cash inflows is calculated and compared to the initial investment. The formula for the present value (or discounted value) of $1 is: Present value = F (1)/ (1 + i)'n Where: F is a specified amount in a given number of years. n is a given number of years. i is the interest rate (discount rate). For this formula, if the discount rate is increased, the present value of the future cash inflows will decrease, thus decreasing net present value.

Answer 32

C. Capital asset pricing The capital asset pricing model uses the beta coefficient, the market risk premium, and the risk-free rate. The other answer choices are incorrect: Constant growth is an assumption that dividends increase at a constant rate in perpetuity. The weighted marginal cost of capital combines the rates on all sources of capital; this question asks about only one security, common stock. The overall cost of capital combines the rates on all sources of capital; this question asks about only one security, common stock.

Answer 33

C. $20,155=(25,000*4.355+20,000*0.564)-100,000 The net present value is the excess of the discounted present value of future cash returns above the investment cost. The present value of the future cash returns is the annual cash flow of $25,000 multiplied by the present value of an annuity of $1 a year for six years at 10%, which is 4.355. Thus, the present value of the future cash flows is $108,875 ($25,000 × 4.355). The salvage value of $20,000 will be received in cash in six years, so its present value is $20,000 multiplied by the present value of a single payment of $1 in six years at 10%, or 0.564, giving a present value of the salvage value of $11,280. Summing the present value of the annual payments ($108,875) and the present value of the salvage value ($11,280) gives a total present value of future cash flows of $120,155. The cost of the machine is $100,000, so the net present value is $120,155 less $100,000, or $20,155.

Answer 34

B. $3,464=Square root of( (2*10*12000)/(0.06/12))/2 There are two issues to be careful with in this question: the word “average” and making certain the periods of time are consistent for all factors. Simply calculating the optimal level of cash causes you to arrive at $6,928. This is the square root of 2 times the fixed cost ($10) times the total demand in one month ($12,000) divided by the interest rate for one month (.06 divided by 12). Of course you need to use the interest rate for one month, not one year, because the applicable period of time is one month. The average cash balance will be one-half of the optimal level of cash because the balance will be used down to zero and will be replenished to the optimal level. The average of zero and $6,928 is the sum (0 + $6928) divided by 2, or $3,464.

Answer 35

A. 10.50% To solve this problem, a weighted average of the two different interest rates for the two different forms of capital needs to be calculated. $15 million of the $50 million will be debt with an after-tax cost of 7%. $35 million of the $50 million will be equity with a cost of 12%. $15 million / $50 million x .07 = .021 + $35 million / $50 million x .12 = .084 Weighted average .105 or 10.5%.

Answer 36

A. $425,000 The ratio of the new total fixed assets to sales of $3,000,000 must be the same as the ratio of 95% of $1,000,000 of fixed assets is to sales of $2,000,000. (Total fixed assets) ÷ $3,000,000 = (0.95 × $1,000,000) ÷ $2,000,000 Total fixed assets = ($3,000,000 × $950,000) ÷ $2,000,000 = $1,425,000 Since the company has fixed assets now of $1,000,000, the increase in fixed assets is $425,000.

Answer 37

D. 10% Annual accrual accounting "income" = Annual saving - Depreciation = $20,000 - ($100,000 / 10 years) = $20,000 - $10,000 = $10,000 Accrual accounting rate of return = Accounting "income" / Investment = $10,000 / $100,000 = 10%

Answer 38

D. using the item alone. Per FASB ASC 820, a fair value determination can use either an in-exchange or an in-use premise. An in-exchange premise assumes that the maximum value of the subject item would come from the purchaser's perspective when the item is used alone. An in-use premise assumes that the maximum value of the subject item would come from the purchaser's perspective when the item is used in conjunction with other assets as a group.

Answer 39

C. Any amount greater than $62,500 Transfer Amount = $25 ÷ .0004 or $62,500 Therefore, a transfer amount of at least $62,500 would be necessary to justify a $25 expenditure to achieve the faster transfer. Each day that Troy Toys does not have their money in their possession costs them 0.02% in lost interest. A process that accelerates transfer of cash by two days earns 0.04% (2 days × 0.02%/day) in interest on that cash. If that process costs $25, what amount of cash would have to be transferred to earn at least $25 in interest to offset the cost? To answer this, we restate the simple formula for interest earned. Interest earned equals the principal times the interest rate. In this case, the principal is the transfer amount. This can be restated to be the transfer amount (principal) equals the interest earned divided by the interest rate. Transfer Amount (Principal) = Interest Earned ÷ Interest Rate

Answer 40

B. 8.08%. DQZ Telecom must pay interest at the coupon rate of 8% on $15 million. This amounts to $1,200,000. The money DQZ has received in this transaction comes from $15 million in bonds sold at a premium price of 101, which means DQZ received $15,150,000 ($15,000,000 × 1.01). Out of this amount, DQZ had to pay 2% of $15 million ($300,000) in flotation costs. That means DQZ had effective use of $14,850,000 ($15,150,000 - $300,000). $1,200,000 interest paid on $14,850,000 reflects an 8.08% effective interest rate ($1,200,000 ÷ $14,850,000).

Answer 41

A. An EBIT of $27,000 would result in EPS of $10.80 for both. The raising of funds through taking on additional debt will result in a lower EAT (earnings after taxes) due to the $9,000 of interest expense ($100,000 × 0.09); however, the number of shares will remain at 1,000. EPS calculation for use of debt financing: EPS = (EBIT - Interest - ((EBIT - Interest) × 0.40)) ÷ Number of shares EPS = (EBIT - $9,000 - ((EBIT - $9,000) × 0.40)) ÷ 1,000 shares EPS calculation for sales of additional common shares: EPS = (EBIT - (EBIT × 0.40)) ÷ Number of shares EPS = (EBIT - (EBIT × 0.40)) ÷ 1,500 shares The solution for when EPS is equal under each of these financing options can be determined by setting the two above equations equal to each other and solving for EBIT: (EBIT - $9,000 - ((EBIT - $9,000) × 0.40)) ÷ 1,000 shares = (EBIT - (EBIT × 0.40)) ÷ 1,500 shares 1,500 EBIT - $13,500,000 - (600 EBIT + $5,400,000) = 1,000 EBIT - 400 EBIT 300 EBIT = $8,100,000 EBIT = $27,000 Additional Debt Additional Stock EBIT $27,000 $27,000 Interest 9,000 0 EBT $18,000 $27,000 Tax 7,200 10,800 $10,800 $16,200 Additional debt: EPS = Net income ÷ Number of shares outstanding EPS = $10,800 ÷ 1,000 shares = $10.80 per share Additional stock: ``` EPS = Net income ÷ Number of shares outstanding EPS = $16,200 ÷ 1,500 shares = $10.80 per share ```

Answer 42

C. 65 Cost of Goods Sold = Sales - Gross Profit = $2,100,000 - $600,000 = $1,500,000 Inventory Turnovers = Cost of Goods Sold / Average Inventory = $1,500,000 / (0.5 x ($240,000 + $300,000)) = $1,500,000 / (0.5 x $540,000) = $1,500,000 / $270,000 = 5.56 times Number of Days Sales in Inventory = 360 / Inventory Turnover = 360 / 5.56 = 64.74 or 65 days

Answer 43

D. 1.67 Debt to equity is total debt divided by total stockholders' equity. STC's total stockholders' equity consists of total assets of $16,000,000 less total debt of $10,000,000 for a net of $6,000,000. Thus, STC's ratio of debt to equity is: Debt to Equity = $10,000,000 / $6,000,000 = 1.67

Answer 44

D. A compensating balance of $1,750,000 Considering that each proposal will produce equivalent processing results, the optimal proposal for Newman will be the lowest cost proposal. Consequently, to solve this problem, the costs of each of the proposals must be calculated. A. 700 checks × $0.50 × 360 days = $126,000 per year B. $125,000 per year C. $1,800 per check × 700 checks × 360 days × 0.03% = $136,080 D. $1,750,000 × 7% = $122,500

Answer 45

A. Materials requirements planning Materials requirements planning (MRP) is ordering raw materials and other components used in manufacturing based on needs for completed products. The system uses a bill of material and master production schedule to plan the acquisition of components. It is demand-dependent since materials are not ordered until the system plans when those materials will be used in manufacturing. Cycle counting refers to counting physical inventory in batches, where all inventory is counted over time, but only a subcomponent of it is counted in each separate cycle. It has nothing to do with determining proper levels of inventory. A safety stock reorder point system automatically reorders components when a minimum inventory level is reached. It is not demand-dependent. The economic order quantity is the number of units to order at one time to minimize the total of inventory holding and stockout costs. It is not demand-dependent because it does not determine when to order the components, only the quantity to order.

Answer 46

B. maintaining the company's cost of capital at current levels. Return on investment (ROI) focuses on optimal use of invested capital. Net income from the income statement is divided by invested capital from the balance sheet; therefore, raising prices, decreasing expenses, and decreasing investment in assets would all affect ROI.

Answer 47

B. cost of capital. For an investment to be undertaken, it should at a minimum produce a return that equals or exceeds the firm's cost of capital.

Answer 48

D. Post a sign in a visible spot near the checkout counter that states, “If you do not get a receipt, your purchase is free.” Internal controls are designed to provide reasonable assurance that objectives are achieved and compliance to laws and regulations is obtained. All of the items listed would be reasonable control procedures; however, the store receipts may not be able to support a minimum of three employees at the store at any given time. The cost of an internal control procedure is not expected to exceed its benefit. Although it would be important to carefully screen all new employees, it is often difficult to judge an individual's character during one or two short interviews, and in today's litigious society, it is often difficult to get valuable information from prior employees or other references. Following are some of the internal control goals related to this transaction: Validity: The owner would want only valid, authorized, and legal transactions to be processed. By requiring all transactions to be rung up on the cash register, the owner has the ability to review all transactions. The owner could examine items sold, discounts given, and any other adjustments recorded in sales. However, when only one employee is in the store, it would be difficult to enforce the use of the cash register for cash sales. Accuracy of recording and evidence of supportability: The owner would want transactions to be recorded free of omissions. By using the customer as a part of the internal control process, the customer can be a “monitor” of the transaction when the owner is not in the store and/or when only one employee is on the selling floor. The transaction would need to be entered into the cash register (recorded) in order to print a register receipt. Given that it may be necessary to have only one employee in the store at slower times during the day, the owner has a final “backup” to have reasonable assurance that the employees are using the other required internal control procedures—thus making this procedure key in the internal control process.

Answer 49

D. Yes, because the workers' real income might fall if price increases are proportionally greater than the wage increases received by the workers Even though the workers received a 3% annual increase in their nominal wages, their real income (standard-of-living) could have declined if inflation had averaged more than 3% annually during the contract period.

Answer 50

A. 7.31%. Interest payment per year ($1,000 x 12%) = $120 Before-tax cost = 120 / 985 = .1218 After-tax cost = .1218 x (1-40%) = 7.31% Note the use of the $985 proceeds, not the par value, in this calculation. Alternative Calculation: Interest payment per year ($1,000 x 12%) = $120 Tax Savings per year ($120 x 40%) = $ 48 Effective Interest paid per year = $ 72 After-tax cost ($72 / $985) = 7.31%

Answer 51

D. The fluctuations are from the seasonal demand for Emerald's products, and Emerald should manage its inventories and cash flow to match the cycle. The pattern of demand shown in the table shows a consistent pattern of growth on a year-to-year basis with a similar pattern of fluctuations within each year where demand peaks during the fourth quarter. This is what is defined as a seasonal pattern of demand. It is also reasonable for a firm to attempt to manage inventories and cash flow to match their demand cycle

Answer 52

D. $810,000. (10*150*300*.6)+(30*150*300*.4) 10-Day Accounts Receivable: Collection Ratio = 10 = Accounts receivable / Average daily sales 10 = Accounts receivable / ($45,000 x 60%) solve for A/R: Accounts receivable = $270,000 30-Day Accounts Receivable: Collection ratio = 30 = Accounts receivable / Average daily sales 30 = Accounts receivable / ($45,000 x 40%) solve for A/R: Accounts receivable $540,000 Total Accounts Receivable: $810,000

Answer 53

D. Wholesale price index The wholesale price index (WPI) reflects the change in prices of goods at the wholesale level. Since price increases are generally passed on to consumers, the WPI serves as an early predictor for changes in consumer price levels.

Answer 54

D. 3.47 The inventory turnover ratio can be calculated as follows: Cost of goods sold (COGS) ÷ Average inventory The cost of goods sold (COGS) for the current period can be determined with the help of the gross profit percentage: Revenue - COGS = Gross profit If gross profit represents 40% of sales, then COGS represents 60% of sales; therefore: Sales × 0.60 = COGS $2,525,000 × 0.60 = $1,515,000 The beginning and ending inventory value can be calculated using the percentage of sales given in the problem: Beginning FG (finished goods) inventory = 0.15 × $2,125,000 = $318,750 Ending FG inventory = 0.22 × $2,525,000 = $555,500 The company's current inventory turnover can now be calculated: COGS ÷ Average inventory = $1,515,000 ÷ (($318,750 + $555,500) ÷ 2) = 3.47 times

Answer 55

C. Liquidity Liquid assets are those most easily converted to cash. The average collection period is a measure of how long it takes to collect accounts receivable after a sale is made; thus, how long it takes to collect the cash, a measure of liquidity. Financing refers to raising money using debt or equity securities, not a measure of immediate liquidity. Return on equity is a measure of profitability, not liquidity. Profitability does not measure liquidity; many potentially profitable businesses have failed due to an inability to pay debts currently due.

Answer 56

D. a discretionary item for $35,000 since the going market rate for the work performed by the son would have been $5,000. Business valuators often have to make adjustments during the normalization process. There are four basic categories of normalization adjustments: Nonoperating adjustments: the removal of nonoperating items included in the historical financial statements that are not part of normal operations. The performance of “odd jobs” around a business facility would be normal operating items. Nonrecurring adjustments: the removal of unusual, unexpected, or items not likely to occur again from the financial statements. Although the son is not likely to perform these duties in the future, someone would need to do general maintenance on an ongoing basis. Comparability adjustments: adjustments of the historical financial statements to match GAAP choices of potential guideline companies. The payment of wages is not a “GAAP” question, even though they may be excessive. Discretionary adjustments: adjustments to the historical financial statement to include or to remove items not considered part of normal operations. Excessive wages paid to family members are considered to be discretionary items. The normalization adjustment would need to be made to bring the amount paid within going market rates.

Answer 57

C. Net present value The profitability index is also known as the excess present value index. It is calculated by dividing the project's initial (or average) cost into the present value of the cash flows. If the profitability index is greater than one, then a project's net present value (NPV) is positive. This index allows comparisons between two projects. The profitability index is a variation on the net present value method of capital budgeting. The net present value method adjusts for the time value of money by comparing the present value of the estimated net future cash inflows to the cost of the investment. The profitability index uses these same two variables in its calculation. The internal rate of return budgeting model calculates the rate of discount (interest) that equates the present value of the net cash flows (including the initial cash outlay) to zero. If the resulting rate of return is lower than the desired rate of return, the project should not be undertaken. The calculation of the economic value added amount (EVA) is not considered a capital budgeting method. The discounted payback method is the length of time required to recover the initial cash investment using a sum of the discounted future cash flows.

Answer 58

C. 28.0%. Because CyberAge ignores the payment discount offered in the suppliers' payment terms, CyberAge is essentially borrowing money at an interest rate which equals the cost (forfeited discount) of holding on to the money for the extra period of time beyond the discount terms. The trick to solving this problem correctly is realizing that CyberAge is not paying 2% or 5% on the entire balance, but is paying the entire balance and forfeiting a 2% or 5% savings. This really represents an interest rate of 2% divided by 98% of the balance (100% - 2% = 98%) or 2.041% for Web Master, and 5% divided by 95% of the balance (100% - 5% = 95%) or 5.263% for SoftIdee's. With this in mind, the correct weighted annual interest rate for trade credit may be calculated as follows: Web Master: It costs 2.041% to hold money for the extra 20 days (30 - 10 = 20). There are 18 20-day periods in a 360-day year (360/20) and Web Master represents one-third of the purchases ($25,000 ÷ $25,000 + $50,000). Therefore, Web Master's contribution to the weighted annual interest rate is .02041 × 18 × .3333 = .12245 or 12.245%. SoftIdee's: It costs 5.263% to hold money for extra 80 days (90 - 10 = 80). There are 4.5 80-day periods in a 360-day year (360 ÷ 80) and SoftIdee's represents two-thirds of the purchases ($50,000 ÷ ($25,000 + $50,000)). Therefore, SoftIdee's contribution to the weighted annual interest rate is .05263 × 4.5 × .6667 = .15789 or 15.789%. Add these two contributions to arrive at the annual weighted interest rate: .12245 + .15789 = .28034, or 28.034%, rounded to 28%. Note that if you ignored the consideration that this is 2% on 98% and 5% on 95%, you would have incorrectly calculated the annual weighted interest rate at 27%, one of the alternative responses.

Answer 59

B. $2.50 To determine the maximum amount that MFC can pay in cash dividends per share and maintain a minimum current ratio of at least 2 to 1, you must set up an algebraic problem based on the current ratio formula: Total Current Assets ÷ Total Current Liabilities = Current Ratio We know Total Current Liabilities equals $900,000 and our desired minimum current ratio is 2.0. We also know cash dividends reduce cash, which reduces Current Assets, and have no affect on Current Liabilities. Replace these terms with these values and solve for Total Current Assets. If Total Current Assets ÷ $900,000 = 2.0, then Total Current Assets = $1,800,000 If Total Current Assets are now $2,050,000, a maximum of $250,000 may be paid out in cash dividends to keep Total Current Assets from dropping below $1,800,000 ($2,050,000 - $1,800,000 = $250,000). $250,000 of cash dividends divided by 100,000 of stock outstanding equals $2.50 per share ($250,000 ÷ 100,000 = $2.50).

Answer 60

C. II and III Accounting rate of return (ARR) is simply “accounting income” from a project divided by the investment cost of the project. Internal rate of return (IRR) considers the amount and timing of cash inflows and outflows in calculating a “true” (internal) rate of return on a project. Concerning the characteristics: Both ARR and IRR consider salvage value—ARR in computation of depreciation expense and IRR as a future cash flow. The primary emphasis in IRR is cash flows. Cash flows are not addressed in ARR. Time value of money lies at the heart of IRR analysis but is not considered in ARR. Thus, (2) and (3) are advantages of the IRR analysis.

Answer 61

C. 5.00. The payback period serves as a fair approximation of the annuity factor value from the table of present values of an annuity. Using the data given: Payback = Investment / Annual saving = $100,000 / $20,000 = 5.00 Thus, internal rate of return can be obtained as a percentage rate from an annuity table for 10 periods nearest the annuity factor of 5.00.

Answer 62

C. $1,620,000. The firm wants to relax credit standards and increase the average collection period. Previous sales are $40,500,000 and 80% of these, or $32,400,000, are credit sales. The new policies will increase these credit sales by 20%, to $38,880,000 ($32,400,000 × 1.20). Under the old system, the average day's credit sales were $32,400,000 ÷ 360 or $90,000. Each day's credit sales remained in accounts payable for 30 days, so the total amount in accounts payable under the old system was $90,000 × 30 days = $2,700,000. Under the new system, average day's credit sales will be $38,880,000 ÷ 360, or $108,000. These daily sales will remain in accounts payable for 40 days, so the new accounts receivable balance will be $108,000 × 40 = $4,320,000. The expected increase in accounts receivable will be ($4,320,000 - $2,700,000) = $1,620,000.

Answer 63

A. $242,000. Net investment: Cash outflows - Cash inflows = $251,000 - $9,000 = $242,000 Cash outflows: The new press costs $225,000 and will require $20,000 to install ($225,000 + $20,000 = $245,000). In addition, the investment in the new press will require an increase in working capital of $6,000. Increase in inventory: $ 4,000 Increase in accounts receivable: 16,000 Increase in accounts payable: (14,000) Increase in working capital: $ 6,000 From a cash flow perspective, an increase in inventory and accounts receivable is a reduction of cash. An increase in accounts payable is an increase in cash. Therefore, the total cash outflow is $251,000 ($245,000 + $6,000). Cash inflows: The old press has a book value of $15,000. The loss on the sale is $10,000 ($15,000 book value - $5,000 cash received) and the tax savings from the loss is $4,000 (40% × $10,000). Thus, total cash inflows are $9,000 ($5,000 + $4,000).

Answer 64

D. Sales-type lease If at the inception of a lease involving land only, Criterion A1 (transfer of ownership) is met and the lease gives rise to dealer's profit (loss), the lease is classified as a sales-type lease. FASB ASC 840

Answer 65

A. The higher the perceived risk involved in a particular investment, the greater the return that an investor would demand on that investment; therefore, the higher the discount rate used, the lower the present value. IRS Revenue Ruling 68-609 states, “The 8 percent rate of return and the 15 percent rate of capitalization are applied to tangibles and intangibles, respectively, of businesses with a small risk factor and stable and regular earnings; the 10 percent rate of return and 20 percent rate of capitalization are applied to businesses in which the hazards of business are relatively high.” However, even the IRS has denounced the use of the treasury method discussed in Revenue Ruling 68-609 as well as a blanket approach to determine discount and capitalization rates. There are a number of ways to determine the discount rate: CAPM (capital asset pricing model), build-up methods, and the weighted average cost of capital. Although CAPM is a frequently used tool in finance, it is generally not used in business valuations. Discount and capitalization rates are not the same. A company's capitalization rate is often derived by subtracting a company's expected long-term annual growth rate from its discount rate; therefore, a growing company's capitalization rate is usually lower than its discount rate.

Answer 66

D. $107,464 The problem is set up to enable you to use both the “Future value of $1” factors and the “Future value of an annuity of $1” factors. The initial investment will earn interest for three years (December 31, 2007, until December 31, 2010) and will be factored with a “future value” factor of 1.2597. The three deposits of $4,000 are an annuity of $4,000 for three years. This annuity will use a “future value of an annuity” factor of 3.2464. Initial Deposit: $75,000 x 1.2597 = $ 94,478 Annuity of $4,000 for 3 years at 8%: $ 4,000 x 3.2464 = $ 12,986 Total account balance at 12/31/10 $107,464

Answer 67

B. $(1,508.48)=20,000-(4000*4.62288) The net present value is the excess of the discounted present value of future cash returns above the investment cost. An ordinary annuity assumes payments at the end of each year, while an annuity due assumes payments at the beginning of each year. The present value of an ordinary annuity factor of 4.62288 is used because the payments will be received at the end of each period. The present value of the future cash returns is the annual cash flow of $4,000 multiplied by the present value of an annuity of $1 a year for six years at 8%, or 4.62288. Thus, the present value of the future cash flows is $18,491.52. The cost of the machine is $20,000, so the net present value is $18,492 less $20,000, or a negative net present value of $1,508.48.

Answer 68

D. As part of the TDRA, management will develop a list related to a particular account that would have a reasonable likelihood of material misstatement, focusing on problems that have been encountered in the past and the solutions that were developed to avoid such errors in the future. The purpose of the TDRA is for the company to analyze the internal controls currently in place and to assess the effectiveness of those controls to avoid material misstatement in the firm's financial reporting. The focus of the assessment of internal controls will deal with significant (material) accounts. The TDRA will focus on the identification and analysis of pertinent risks related to the achievement of the company's objectives. The higher levels are examined first in the assessment process. Based upon the identification and analysis of risks and the associated internal control to mitigate those risks, management needs to conclude whether the danger of an internal control failure is low, medium, or high. This step is taken after the internal controls in place have been assessed.

Answer 69

C. 10.4%. The cost of the preferred stock to the firm will be 10.4%. The cost to the firm of selling preferred stock is equal to the annual dividend the firm must pay, divided by the net funds received when the stock was sold. Since preferred dividends are not tax deductible, there is no tax adjustment for the cost of preferred stock as there is for debt. The formula for calculating the cost of preferred stock to the firm is as follows: ks = D1 / (PO - u - f) Where: D1 = Annual preferred dividends PO = Current market price of the stock u = Underpricing per share, if any f = Flotation costs paid the investment banker Here, ks = 10 / (101 - 0 - 5) = 10 / 96 = 0.104, or 10.4%.

Answer 70

B. The products a company buys differ from those a consumer buys and therefore the CPI is not the appropriate index for estimating the decrease in a company's purchasing power. The CPI is determined on a monthly basis by the prices of a particular market basket of goods purchased by consumers and does not include prices of goods purchased specifically by companies. The producer price index measures the average change over time in the selling prices received by domestic producers for their output and that purchasers pay for their inputs and thus is the appropriate index for measuring the decrease in a company's purchasing power.

Answer 71

C. $1,102,500 Copper purchases in year 2 will increase due to two factors: inflation in the cost of copper, and an increase in the actual usage of copper (i.e., quantity needed). To adjust for changes in price, the following formula is used: Cost in year 1 × Change in price index: $1,000,000 × (126 ÷ 120) = $1,050,000 The second step is to adjust for increased demand: $1,050,000 × 1.05 = $1,102,500

Answer 72

D. 20.0% The Dividend Growth Model is a way to value stocks by valuing the dividend cash flow. The value per share is calculated by dividing the annual dividends per share by the difference between the required rate of return and the dividend growth rate. The formula is: Value per Share = Annual Dividends per Share/ (Required Rate of Return - Dividend Growth Rate) If we are calculating the cost of equity capital then we solve for the rate of return required by the investor. Therefore: Required Rate of Return = (Annual Dividends per Share/Dividend Growth Rate) +Value per Share or the cost of equity capital = (3.00 ÷ 30.00) + .10 = 20%.

Answer 73

A. $9,091 The net present value (NPV) method adjusts for the time value of money. It determines whether the present value of the estimated net future cash inflows at a desired (or required) rate of return will be greater or less than the cost of the proposed investment. The present value (PV) of the net cash inflows is calculated and compared to the initial investment. An investment proposal is desirable if its NPV is positive. The PV factor for a single sum for one period at 10% is .90909. PV = $120,000 × .90909 (rounded) = $109,091 Cash outflow (cost) = (100,000) Net present value = $ 9,091

Answer 74

B. 13.33%. Morton Co. must borrow $54,444 ($49,000 plus compensating balance of 10% of loan). To calculate: $49,000(0.98*50,000) represents 90% of the loan. $49,000 ÷ .9 = $54,444. Algebraically, if X = amount of loan, then .9x = $49,000, and X = $54,444. Breakdown of loan proceeds: Cash needed for payment to vendor $49,000 90% Compensating balance 5,444 10% Total loan $54,444 100% Interest at 12% per annum on this amount for 30 days, totals: 0.12 × (30 ÷ 360) × $54,444 = $544.44 The effective yield is then (annualized): $544.44 ÷ $49,000 × 12 months = 0.1333, or 13.33% The invoice total less the cash discount ($50,000 - 2%) is $49,000. This amount is used in this calculation because that is the amount required to pay the supplier's invoice and usable by the company.

Answer 75

D. $54,444. The total amount of the loan must be the amount due the supplier less the 2% discount plus the compensating balance of 10% of the total loan, or: $50,000(1.00 - 0.02) + 0.10(Loan) = Loan $49,000 + 0.10X = X $49,000 = X - 0.10X $49,000 = 0.90X $54,444 = X

Answer 76

C. Affirmative covenant肯定条款 An affirmative covenant is a covenant that requires a corporation to maintain, at all times, some minimum level of working capital.

Answer 77

B. $21,353. Discounted cash flow for 2014 MACRS Depreciation= Cost of new assets *MACRS rate for period 4* INT TAX RATE* PV Factor for Period 4 at 12% = $1,200,000 x .07 x .40 x .6355 = $21,353

Answer 78

B. cost of carrying inventory decreases. The EOQ model formula attempts to minimize costs when faced with the trade-off between the cost to procure and the cost to hold inventory. The formula is the square root of the quotient of two times the annual demand multiplied by the order cost (or setup cost), divided by the annual unit carrying cost. EOQ = Square root of 2DS/Ci Where: D = Demand per year in units S = Setup or ordering cost per order C = Cost per unit i = Carrying cost, expressed as a percentage of inventory cost (C × i is the carrying cost per unit.) For this formula, if carrying costs are decreased, then the EOQ will increase. As the EOQ increases, the amount of inventory that a company would tend to hold also increases.

Answer 79

C. Internal rate of return The internal rate of return (IRR) can be referred to as the yield (return) expected over the life of a project. It is computed by equating the initial investment with the present value of the cash flows over the life of the project. IRR is the discount rate that results in the net present value of all cash flows to be zero. Neither the accounting rate of return nor the payback methods consider the time value of money, and the cost-benefit ratio is not a capital budgeting tool.

Answer 80

D. strong The efficient market hypothesis relates to the degree to which past or current information is incorporated in and/or influences the current market prices of securities. The strong form of the hypothesis states that all available information is incorporated in the current market prices of securities, and thus the investor cannot find undervalued securities and would be unable to make choices that would allow him or her to outperform the market index in the long run. The semi-strong form of the hypothesis assumes that all readily available information is incorporated into current market prices of securities and that fundamental analysis would be unlikely to identify inaccurately valued securities. The weak form of the hypothesis assumes that current market prices reflect all past prices and information, and therefore this information cannot be used for predictive purposes.

Answer 81

B. 9.8% The cost of debt is the expected interest cost on new debt minus the marginal tax rate due to the fact that interest payments are tax deductible. The interest cost of the bonds is 14%. Use the effective rate rather than the standard rate; it is adjusted for compounding the interest more than annually. The tax savings equals 30% of 14%, or 4.2% (.30 × .14). Subtracting the tax savings from the interest cost yields the true cost of the debt: 14% - 4.2% = 9.8%

Answer 82

A. earnings should be retained and reinvested as long as profitable projects are available. Treating dividends as the residual part of a financing decision assumes that earnings should be retained and reinvested as long as profitable projects are available. Dividends do not need to be a focus of company strategy, since in a world with taxes, dividends can be problematic for both the company (dividends are not tax deductible) and the stockholder (dividends are taxable). In addition, the transaction and other costs of financing by selling additional stock (as discussed by Rozeff) lead a company to prefer using internal funds (i.e., retained earnings) for expansion. Masulis and Trueman suggest that firms will use internal funds to finance all investments that have high returns—younger firms will invest more and older firms will pay more dividends since profitable investment opportunities for older firms will be smaller relative to funds available.

Answer 83

D. 9.8% The weighted average cost of capital is the weighted average of the debt and equity used to finance the assets of the company. This weighted average can be based upon either the current capital structure of the organization or on a particular target structure desired by management, both using market values of the various components. The cost of debt is the before-tax rate. Since interest expense is a tax-deductible item, thus providing a depreciation shield, an after-tax cost must first be determined: After-tax cost of debt = kd × (1 - T) After-tax cost of debt = .10 × (1 - 0.30) = 0.07 (7%) (kd = Pretax cost of debt; T = Tax rate) Now the weighted average of the cost of capital can be calculated: Capital Item Weight Cost Weighting Factor Debt 40% 7% 2.8% Preferred Stock 10% 20% 2.0% Common Stock 50% 10% 5.0% 100% WACC 9.8%

Answer 84

D. Depreciation increases cash flow by reducing income ta Depreciation is the systematic expensing of a prior cash outflow. It is not a cash flow in a current period; however, it does reduce the amount of taxes that are paid in a particular period since it is a deductible expense. Since taxes are a cash outflow, any deductible expense reduces the amount of taxes that must be paid, thus increasing cash flow for that period.

Answer 85

C. $12,075. The discounted payback period is the length of time required for discounted cash flows to recover the cost of the investment. The year two cash inflow for project D which is consistent with a discounted payback period of two years can be calculated as follows: Investment cost = Present value of Year 1 and 2 cash inflows $30,000 = ($20,000 × PVIF(5%, 1)) + (Year 2 cash inflow × PVIF(5%, 2)) $30,000 = ($20,000 × .9524) + (Year 2 cash inflow × .9070) Year 2 cash inflow = ($30,000 - ($20,000 × .9524)) ÷ .9070 = $12,074.97

Answer 86

D. Short-term credit can generally be obtained quicker than long-term credit; however, short-term credit holds more risk due to the need to renew more often. Short-term credit can generally be obtained quicker than long-term credit. Generally short-term credit is more flexible than long-term credit. Short-term credit is generally less costly than long-term credit as shown by the yield curve. Prepayment penalties are generally associated with long-term credit, but these penalties are not the basic reasons for a higher cost for long-term credit. Short-term credit holds more risk than long-term credit due to the need to renew more often.

Answer 87

A. 7.0%. The cost of retained earnings is 7.0%. The cost of retained earnings, using the Gordon Model, ignores flotation costs and underpricing, since the firm does not need to issue new stock. However, it must earn a return for the owners of the retained earnings, that is, the existing shareholders, as follows: krm = (D1 / PO) + g, or krm = 7 / 100 + 0% = 7.0% Where: krm = Cost, in percentage, of using existing equity in the form of retained earnings D1 = Estimated dividend that will be paid next year PO = Current market price of the stock g = Estimated annual growth rate in dividends, in percentage

Answer 88

C. $1,010,000. The amount the issuing company receives on February 1, 20X1, is the face value of the issue plus one month of accrued interest: $1,000,000 + ($1,000,000 × 0.12 × 1/12) = $1,010,000 The buyers of the bond must pay the seller the interest accrued from the last interest payment date to the date of issue in advance. In effect, they are paying for the portion of the first full 6-month interest payment that they are not entitled to because they did not hold the bonds for the full 6-month period.

Answer 89

D. 17.5% A factor buys a company's accounts receivables, assumes the risk of collection and the company gets its money immediately. In this problem, the standard factoring solution is complicated by the fact the fees and interest are not deducted in advance, changing the amount of interest. Amount of receivables to be factored $100,000 Less: 20% factoring reserve (1.00 - .80) (20,000) Amount loaned to company $ 80,000 2% factoring fee (assessed on entire $100,000) $2000 10% interest for 30 days (assessed on the entire $80,000) 667 Total fees assessed on $80,000 loan $2,667 These fees are offset by the savings in collection expenses. This amount is $1,500 for one month ($18,000 divided by 12). The net cost per month is $1,167 ($2,667 - 1,500). The monthly interest rate is 1.46% ($1,167 divided by $80,000). This represents an annual rate of 17.5% (1.46% × 12).

Answer 90

D. inspections. Inventory carrying costs are those costs incurred as a result of holding inventory for a period of time. All of the following are considered carrying costs: Storage Insurance Opportunity cost of inventory investment (i.e., the lost return that could have been earned by investing the cash used to purchase the inventory in some other way) The cost of inspections is not a function of the holding of inventory.

Answer 91

A. Decrease tax credits on the asset Two general rules can be developed related to the internal rate of return (IRR) of a proposed asset purchase: Increases in cash inflows (decreases in cash outflows) will result in a higher internal rate of return. The earlier the cash inflows (the later the cash outflows) the higher the internal rate of return, all else being equal. Taxes in general will lower the IRR of a proposed asset purchase, as will decreases in the tax credits available when an asset is purchased

Answer 92

D. a going concern. As defined in the International Glossary of Business Valuation Terms, the premise of value is defined as “an assumption regarding the most likely set of transactional circumstances that may be applicable to the subject valuation.” The premise of value will be one of two situations: a going concern or liquidation. Although The Charter Company has displayed poor performance in the past few years, the business does not appear to be in liquidation at this time. Companies can falter, regroup, and continue. It appears that The Charter Company is currently in the process of regrouping, as demonstrated by the owner's attempts to obtain and implement expert advice; therefore, this business valuation should use a “going concern” as the premise of value.

Answer 93

C. 5.1%. The problem provides the information that Martin Corporation can now issue debt at 150 basis points over U.S. Treasury bonds and that U.S. Treasury bonds have a current rate of 7%. This means Martin Corporation can now issue debt at 8.5%= 7.0% plus 1.50% (150 basis points). Because interest is tax deductible, the cost of debt is less than the interest rate and equals the interest rate times 1 minus the tax rate. Cost of debt = 8.5% × (1 - .40) = 5.1%.

Answer 94

A. liquidity. Payback period is the length of time in years required to recover the cash invested in a project. Payback is computed as net investment divided by average expected annual cash inflow. Payback focuses on rapid recovery of cash investment (i.e., liquidity).

Answer 95

A. Matching the maturities of assets and liabilities reduces risk. Temporary assets are often represented by temporary working capital—that is, the working capital that supports the company's operations above a minimal level and does not need to be maintained throughout the annual business cycle. The maturity matching concept states that the maturity date of the financing for an asset or project should match the maturity of the related asset. This means that the loan will be repaid at approximately the same time that cash becomes available at the end of a project or sale (or collection) of the asset. This situation is considered to be self-liquidating since the funds that become available at the end of the temporary period will be used to repay the short-term loan. The risk is considered to be lower for such a loan since the funds that will be used to repay the short-term loan are definite (reduction in working capital) as opposed to being dependent upon the general profitability of the organization.

Answer 96

C. Entering into a factoring agreement with a finance company The accounts receivable turnover ratio measures how quickly these receivables are collected. The quicker that they are collected, the less financing that is needed to support receivables. One method of speeding up the collection process is to offer discounts for quick payment, such as 3/10. (The customer can take a 3% discount if the invoice is paid within 10 days.) By reducing the discount to 1/10 or 3/20, the customers are less likely to pay quickly, resulting in a deterioration of the accounts receivable turnover ratio. Pledging is using the accounts receivable balance to secure a loan. This would have no effect on the accounts receivable turnover ratio. Factoring is a situation where a company sells its accounts receivable at a discount, thus resulting in an immediate receipt of cash related to the receivables sold. This situation would likely improve the company's accounts receivable turnover.

Answer 97

B. firm's profits are more sensitive to changes in sales volume. Operating leverage is the impact on operating income resulting from a change in sales. The change in operating income is affected by the relative amounts of fixed and variable costs within total costs. The higher the fixed costs in relation to variable costs (due to such things as large investments in automation, etc.), the greater the impact on operating income from a change in sales. The degree of operating leverage is calculated from the ratio of the operating income change divided by the change in sales. A high degree of operating leverage indicates a firm's profits will be more sensitive to changes in sales.

Answer 98

C. The bond is issued at a premium. If the Alda Company issues bonds with a maturity value of $1,000,000, a stated rate of interest of 10%, and an effective rate of interest (also known as the yield to maturity) of 9%, then the bonds are not issued at a discount. Bonds are issued at par when both rates are equal and at a premium when the stated rate of interest is more than the effective rate.

Answer 99

C. $166,400=(5.2*(35000-(7000-4000))) The payback period is the length of time required to recover the initial cash investment with net cash flows. In this case, the operating expenses of $7,000 include depreciation of $4,000, so the cash operating expenses are $3,000 per year. Subtracting $3,000 of annual cash operating expenses from the $35,000 annual revenue gives a net cash inflow of $32,000 per year. Since the investment will be recovered in 5.2 years, we multiply the 5.2 years by the annual net cash inflow of $32,000 to find the cost of the investment must be $166,400.

Answer 100

B. line of credit. XYZ should use the line of credit form of financing because of its flexibility and having interest charged only for funds actually being used. None of the other methods of financing listed provides this degree of flexibility.

Answer 101

C. An increase in the corporate income tax rate Firms respond to an increase in corporate income tax rates by increasing their explicit costs (i.e., those which are tax deductible). Therefore, debt financing which requires specific (tax deductible) interest payments would be preferred to equity (dividends are not tax deductible) financing when tax rates rise. Increased operating leverage and a decreased times interest earned ratio would increase the risk to the firm's investors; thus, the cost to the firm of borrowed funds would also increase, discouraging further debt financing.

Answer 102

A. The net present value of the new system would be lower, and the investment would be judged less desirable. The use of MACRS depreciation would result in a greater deduction in Year 2 (40% MACRS versus 25% straight line). This will result in tax dollars saved in the early life of the project. The use of straight line (SL) would, of course, not provide this saving until the third and fourth years. The result would be: a slightly lower net cash flow from the use of SL in year 2. lower net present value using SL. less desirable investment.

Answer 103

A. generally lower than long-term rates. Short-term interest rates are usually lower than long-term rates, because there is less risk involved in a shorter time period, and lenders require less compensation since their money is tied up for a shorter time. Short-term rates are definitely related to long-term rates, but tend to be more volatile, in part due to the exercise of monetary policy actions by the Federal Reserve.

Answer 104

A. 12.0% The dividend growth model estimates the cost of common equity. The formula used is: Cost of common equity = (Dividend ÷ Price) + Growth percentage Cost of common equity = ($4.25 ÷ $85) + 7% = 5% + 7% = 12% Since dividends paid on common stock are not deductible by the corporation for tax purposes, the cost does not include any tax effect.

Answer 105

D. production setup. The EOQ model formula attempts to minimize costs when faced with the trade-off between the cost to procure and the cost to hold inventory. The formula is the square root of the quotient of two times the annual demand multiplied by the order cost (or setup cost), divided by the annual unit carrying cost. EOQ = Square root of (2DS/Ci) Where: D = Demand per year in units S = Production setup or ordering cost per order C = Cost per unit i = Carrying cost, expressed as a percentage of inventory cost (C × i is the carrying cost per unit.) Costs to procure inventory are ordering cost for a reseller and production setup costs for a manufacturer.

Answer 106

C. $181,800 The net present value is the excess of the discounted present value of future cash returns above the investment cost. The present value of the future cash returns is the annual cash flow of $150,000 multiplied by the present value of an annuity of $1 a year for five years at 6%, which is 4.212. Thus, the present value of the future cash flows is $631,800 ($150,000 × 4.212). The cost of the machine is $450,000, so the net present value is: $631,800 - $450,000 = $181,800.

Answer 107

B. (6 / 4) × (1 / 6) = ROI =1/4=25% Return on investment (ROI) is net income ($100,000) divided by investment ($400,000), or 25%. (6 / 4) × (1 / 6) = ROI is correct because it simplifies to 1/4, which equals 25%. (4 / 6) × (6 / 1) = ROI is incorrect because it simplifies to 4/1, which is 400% rather than 25%. (4 / 6) × (1 / 6) = ROI is incorrect because it simplifies to 4/36, which is 11.1% rather than 25%. (6 / 4) × (6 / 1) = ROI is incorrect because it simplifies to 36/4, which is 900% rather than 25%.

Answer 108

B. Less than the project's internal rate of return The net present value of an investment is calculated by subtracting the initial investment from the present value of the future cash flows. A positive net present value means that the investment should be made, because the cash to be received (taking into account the time value of money) is greater than the initial investment. By definition, an acceptable investment would also have an internal rate of return that is greater than the required rate of return—or, as the question states it, the required rate of return would be less than the project's internal rate of return. Weighted average cost of capital has no bearing on this problem.

Answer 109

A. $15,000 Project profitability index = Present value of future inflows / Initial investment 1.15 = Present value of future inflows / $100,000 $100,000 x 1.15 = Present value of future inflows $115,000 = Present value of future inflows Net present value: = Present value of future inflows - Initial investment = $115,000 - $100,000 = $15,000

Answer 110

B. $110,000. Payback period is the number years required to repay the initial investment in a capital project. A $360,000 capital investment would need an after-tax cash flow of $90,000 to meet the goal of a 4-year payback. The key to solving this problem involves remembering to consider the cash savings resulting from decreased taxes due to the depreciation expense. Note that the problem asks for the operating cash savings. In this problem, operating cash savings would be total cash savings less nonoperating cash savings (e.g., cash savings from lower taxes). Annual depreciation on a $360,000 asset with an estimated 6-year life with zero salvage value using straight-line depreciation is $60,000. The tax savings generated by this depreciation is $60,000 times 40%, or $24,000. Now calculate after-tax operating cash savings: $90,000 - $24,000 = $66,000. However, the problem asks for before-tax operating cash savings, calculated as follows: $66,000 ÷ (1 - Tax rate of 0.40) = $66,000 ÷ 0.60 = $110,000

Answer 111

A. Participating preferred stock acts more like equity than cumulative preferred stock. Participating preferred stock acts more like equity than cumulative preferred stock when a corporation is earning excess profits because the stock does not receive a fixed percentage like debt. When excess profits are earned, the participating preferred stock receives additional dividends.

Answer 112

B. move funds from one account to another Depositor transfer checks are non-negotiable. They are used to move funds from one account to another (i.e., from a local bank to a concentration bank). This allows companies to have flexibility and control over their cash accounts but it can be somewhat time consuming.

Answer 113

Correct B. $1,512 Cost of holding accounts receivable before credit policy change: $360,000 sales ÷ 360 days = $1,000 average daily sales: 30 days average collection period = $30,000 average A/R balance 12% required rate of return = $3,600 annual interest Cost of holding accounts receivable after credit policy change: $432,000 sales ÷ 360 days = $1,200 average daily sales: 40 days average collection period = $48,000 average A/R balance 12% required rate of return = $5,760 annual interest $5,760 - $3,600 = $2,160 additional annual interest on holding A/R balance. However, by stating the variable cost ratio, the problem implies it expects a distinction made between actual investment in A/R and margin earned. The actual investment by Gartshore is its variable cost, which for a mail-order book company represents cost of goods purchased for sale. That is, there is no change in fixed costs. Consequently, the $2,160 needs to be reduced to represent only the interest on the variable cost portion: $2,160 × 70% variable cost = $1,512.

Answer 114

C. 12 times Accounts receivable turnover is net credit sales of $300,000 divided by the average accounts receivable (($20,000 + $30,000) ÷ 2, or $25,000). This equals a turnover of 12.

Answer 115

B. 150 units The average inventory level when the standard economic order quantity model is used is one-half of the EOQ. The EOQ for Product A is 200 units. One-half of 200 is 100. Add the 50-unit safety stock to arrive at 150 units as the average inventory of Product A.

Answer 116

C. 95 days. The cash flow cycle is the full cycle of cash inflows adjusted for outflows, calculated as 90 + 65 - 60 = 95 days. By this formula, one can see that reducing either the inventory holding period or the collection period for receivables will reduce the number of days in the cash flow cycle by accelerating sales turnover and cash collections, respectively. Increasing the payables period also reduces the cash flow cycle, since cash outflows can be delayed while new inventory and receivables periods can begin.

Answer 117

D. Profitability index The profitability index is the present values of the cash flows after the initial investment divided by the amount of that investment. This allows the comparison of projects with differing investment amounts. It represents the percentage that a project's net present value exceeds the cost of the project. Since it is expressed as a percentage rather than a dollar amount of net present value, the profitability index allows comparisons of mutually exclusive projects. The project with the highest profitability index is selected. The other answer choices (net present value, internal rate of return, and return on investment) are incorrect because they calculate rates of return for a specific project, but do not facilitate a comparison of the capital investments required among separate projects, which is necessary if investment capital is limited.

Answer 118

C. $(13,268) The overall discounted cash flow impact of Gunning Industries' Working Capital investment for the new production machine is calculated as follows: -- Initial working capital investment at beginning of Year 1: $(35,000) -- Discounted return of initial WC investment at end of Year 5: ``` $35,000 x Present value of $1 at 10% for 5 periods (.6209) 21,732 ``` Overall discounted cash flow of Working Capital Investment: $(13,268)

Answer 119

C. lowest total weighted-average cost of capital (WACC). The cost of capital is the weighted-average cost (percentage) that a firm will incur in raising new funds to finance future investment. Given a need to finance specific assets, the optimal capital structure is determined by computing the lowest weighted-average cost of capital to raise that amount. The maximum degree of financial leverage (DFL). and maximum degree of total leverage (DTL) are incorrect because leverage is a measure of the portions of capital from debt and from equity; it does not determine the optimal allocation between the two. "Intersection of the marginal cost of capital and the marginal efficiency of investment" is incorrect because the marginal efficiency of investment indicates the sensitivity of the cost of capital to changes in interest rates.

Answer 120

C. Economic value-added Economic value added (EVA) is after-tax operating income less the weighted average cost of capital. Free cash flow is a measure of financial performance calculated as operating cash flow minus capital expenditures, not a measure of income. Market value added is the difference between the current market value of a firm measured by the price of stock on the stock exchange and the capital contributed by investors, not the income remaining after cost of capital is deducted. Net operating capital is a term used to describe working capital (current assets less current liabilities), not the cost of capital.

Answer 121

D. the point where discounted cumulative cash inflows on a project equal discounted total cash outflows. Stated very simply, the discounted breakeven period is the time required to recover the cash invested in a project. However, since almost all investment projects span several years, it is necessary to discount both cash inflows and outflows. When this is done, breakeven time becomes “the point where discounted cumulative cash inflows on a project equal discounted total cash outflows.”

Answer 122

A. investors are exposed to greater risk with equity capital. Stockholders are the last to be paid, making their risk in the company greater. The greater degree of risk requires a greater reward. Bondholders, on the other hand, can expect a fixed return, known in advance, and therefore have a lower degree of risk.

Answer 123

B. The payback rule ignores all cash flows after the end of the payback period. The payback period method can be used as an easy screening tool for capital budgeting projects since it determines the length of time required to recover the initial cash investment through net cash flows. As a general rule, the sooner the investment is recovered, the better. Weaknesses of the payback method include the following: All cash flows occurring after the payback period are ignored. The time value of money is not considered.

Answer 124

C. $(152,200) Net present value is a measure of the projected return on investment that accounts for the time value of money. It is the difference between the present value of future cash inflows from an investment and the costs related to the investment, including the investment's initial cost. Using a 10% interest rate, the present value of an annuity of $420,000 a year for five years is $420,000 × 3.79, or $1,591,800. The present value of a single payment of $100,000 in six years is $100,000 × 0.56, or $56,000. These sum to a present value of future cash inflows of $1,647,800. The net present value is this sum ($1,647,800) less the original investment of $1,800,000. The difference is a negative net present value of $152,200.

Answer 125

C. $62,900=（30,000*1.6467)+)20,000*(2.3216-1.6467) Present value of Year 1 and 2 savings of $30,000 = Savings x Annuity factor for 2 years = $30,000 x 1.6467= $49,401 Present value of Year 3 savings of $20,000 = Savings x Difference between second- and third-year annuity factor = $20,000 x (2.3216 -1.6467) = $20,000 x 0.6749 = $13,498 Present value of Years 1-3 savings = Present value of Year 1 and 2 savings + Present value of Year 3 savings = $49,401 + $13,498 = $62,899, or $62,900 rounded

Answer 126

C. Projects 2, 4, and 5 only Several alternative projects can be ranked by comparing their profitability indexes (PV (present value) of future cash flows divided by the initial investment). For these projects, the index is found as follows: ``` $625/$500 = 1.25 $325/$250 = 1.33 $175/$150 = 1.17 $150/$100 = 1.50 $200/$150 = 1.33 ``` The projects with the highest profitability index should be selected first. This includes #4, #2, and #5. At that point the entire $500,000 that is available has been invested in the most profitable alternatives.

Answer 127

D. 12.13%. Use the Gordon Growth Model on this one, and remember that it is the next dividend that is used. In this case, this year's dividend will be 6% greater than last year's $2.20, or $2.33. In the formula, capital cost equals dividend/net proceeds of stock sale plus growth rate. Ks = Dividend/Price (1-flotation) + G Here Ks = 2.33/[40(1-.05)] + .06 = 2.33/38 + .06 = 12.13 The cost of equity using the Gordon Growth Models equals the quotient of the next dividend divided by the stock price, plus the growth rate in earnings per share. To account for flotation costs, the stock price is multiplied by one minus the flotation cost. Given that the next dividend is $2.332 (1.06 × $2.20), the cost of the new common stock is 12.13% ([2.332 ÷ ($40 × (1 -.05))] + .06).

Answer 128

D. include all areas of potential risk to the misstatement of the financial statements in this documentation, testing, and reporting process. Section 404 of the Sarbanes-Oxley Act of 2002 (SOX) requires that all publicly traded firms establish internal controls related to financial reporting that are documented, tested, and maintained. The purpose of these controls is to reduce the probabilities of corporate fraud. In order to be in compliance with SOX 404, a company needs to: develop documentation of existing internal controls and procedures associated with financial reporting, test the effectiveness of those controls and procedures, and provide details on any deficiencies in the controls and/or documentation. Although the initial response to SOX was to document, test, and report on both high- and low-risk areas related to financial reporting, the Public Company Accounting Oversight Board (PCAOB) developed Auditing Standard 5 (An Audit of Internal Control Over Financial Reporting That Is Integrated with an Audit of Financial Statements), approved by the SEC, that limits such activities. This standard takes a risk-based approach related to internal control documentation and testing, thus limiting the compliance measures necessary under SOX. SOX was never meant to create unnecessary compliance burdens on a company, but rather to protect shareholders' investment from fraud.

Answer 129

B. a decrease of $30,000. Net working capital is defined as current assets minus current liabilities. To calculate the change in net working capital, calculate the current level of net working capital and compare it to the proposed level: Current Proposal Cash $100,000 $120,000 Mkt. Sec. 200,000 200,000 Acc. Rec. 400,000 500,000 Inven. 380,000 460,000 TOTAL CUR. ASSETS: $1,080,000 $1,280,000 Less Acc. Pay (350,000) (430,000) Less Mort. Pay (175,000) (325,000) WORKING CAPITAL: $555,000 $525,000 The change in net working capital is a decrease of $30,000 ($555,000 - $525,000).

Answer 130

A. greater than; increase Investments with present values in excess of their costs (that is, positive net present values) that can be identified or created by the capital budgeting activities of the firm will have a positive impact on firm value and on the price of the common stock of the firm. Positive net present value investments will increase, not decrease, firm value and share prices for a firm. Investments with present values equal to their costs have a zero net present value and neither increase nor decrease firm value and share price.

Answer 131

A. company risk. Market or systemic risk is risk that cannot be eliminated through diversification. It includes noncontrollable factors such as inflation or recession, fluctuations in world energy markets, and congressional tax reform. Company risk is not a component of market risk. It is related to a particular company and is much more specific than market risk. Company risk can be alleviated or avoided through diversification.

Answer 132

D. II only Average daily sales times average collection period represents a firm's average gross receivable balance. Because the average collection period is the time it takes to collect on a sale (indicated in days, this is the average age of a receivable in accounts receivable), multiplying this by average daily sales would give you the average gross receivable balance. Alternately, average gross receivable divided by average daily sales gives you the average collection period.

Answer 133

C. No, since the benefit to the company is $0.17 per check processed The cost to the company in terms of the cost per check being cleared can be stated as: Cost per check cleared = (D)(S)(i) D = days saved in the collection process S = average check size i = daily interest rate or opportunity cost (5% ÷ 360 = .0139%) Substituting the given information into the equation: Cost per check cleared = 1.2 days × $1,000 × .0139% = $0.17 per check cleared Since the cost of the service would be $.20 per check cleared, the Jones Company should not adopt this alternative.

Answer 134

A. Increase In general, bond prices increase when interest rates decline because the stated rate of interest on the bond is more attractive relative to the market interest rate.

Answer 135

A. A $100 decrease in taxes each year for four years Two general rules can be developed related to present value calculations: Increases in cash inflows (decreases in cash outflows) will result in higher present values, all else being equal. The earlier the cash inflows (the later the cash outflows) the higher the present value, all else being equal. Increases in cash flows can be the result of increased revenues, increases in other cash inflows, or decreases in cash outflows. Of the answer choices available, only one (a $100 decrease in taxes each year for four years) results in increased net cash inflows for each of four years, thus resulting in the highest present value.

Answer 136

C. Purchase price of new van, disposal price of old van Relevant costs include all expected future costs that will differ among alternatives for a particular decision. Other costs will not change and are not relevant to the decision. Purchase price of the new van is relevant because that cost will not be incurred if the van is not replaced. Disposal price of the old van is relevant because that cash will not be received unless the van is replaced. The other answer choices are incorrect because they include the gain on the sale of the old van, the difference between its sales price and book value. That book value (cost less accumulated depreciation) is a sunk cost and cannot be changed by the decision to replace the van.

Answer 137

A. High-risk divisions will over-invest in new projects and low-risk divisions will under-invest in new projects. Using a single company-wide cost of capital means each division will invest in projects with a rate of return above the company-wide cost of capital. Low-risk divisions will find low-return investments and invest very little. Since those divisions will have a lower divisional cost of capital, they will reject some investments based on the corporate cost of capital even though that investment would have been profitable for the division with a low cost of capital. High-risk divisions will find high-return investments and invest in those projects with a return higher than the company-wide cost of capital even though it is lower than that division's cost of capital. Since those divisions have a higher divisional cost of capital, they will accept some investments that are not profitable for that division. Such a firm should use division cost of capital to evaluate investments in that division, resulting in each division maximizing its return to the company as a whole.

Answer 138

D. Project A, accept; Project B, reject Residual income is the amount of net income in excess of the imputed interest charge, so the division’s historical return is irrelevant if the goal is to maximize residual income. A project should be accepted if it has a rate of return above the implicit rate of return and rejected otherwise. Therefore, Project A should be accepted (rate of return above the implicit rate) and Project B should be rejected (rate of return below the implicit rate).

Answer 139

C. select projects when capital budgeting funds are limited. The excess present value index, or profitability index, is computed as the present value of future net cash inflows divided by the discounted initial investment. The result is an index number rather than a dollar amount. Because of this, the excess present value is particularly useful in evaluating different-sized projects when capital budgeting funds are limited.

Answer 140

D. $13,000 Net present value is the difference between the present value of future cash inflows from an investment and the investment’s initial cost. The present value of $20,000 per year for 10 years at 12% is 5.65 × $20,000, or $113,000. The investment cost is $100,000, so the difference, the net present value, is $13,000.

Answer 141

A. Economic value added Economic value added (EVA) is the economic profit of a project, and focuses on the earnings above the required cost of capital for shareholders. EVA is the after-tax profit of operating income less the product of total assets times WACC. Return on investment (ROI) focuses on the optimal use of invested capital, and is net income divided by invested capital. Net realizable value (NRV) is not a performance measurement. The profitability index considers both the size of the investment and the value of the discounted cash flow. The present value of cash flows not including the initial investment is divided by the initial investment.

Answer 142

B. $12,000 The key to solving this problem is separating the cash flow items from the noncash items. The $40,000 cost to remove the asset is a cash outflow. The scrap salvage value of $10,000 is a cash inflow. Both of these items are also part of the net income upon which tax must be computed. The $75,000 loss that will result from the disposal is also part of the net income upon which tax must be computed. However, the loss is not a cash outflow. What is a cash flow is the tax or tax savings in the net income or loss. The “end-of-life” cash flow may be calculated as follows: Outflow: Cost to remove ($ 40,000) Inflow: Salvage value $ 10,000 Inflow: Tax savings from net loss $ 42,000 * Net cash inflow $ 12,000 *105,000*0.4=75000+40000-10000 * The tax savings is calculated on a net loss of $105,000. The loss is a result of the $65,000 tax loss on the asset disposal ($75,000 tax basis offset by $10,000 scrap value) and the $40,000 cost to remove the asset.

Answer 143

C. Cash flow Capital structure is defined as the percentage of debt, preferred stock, and common stock used for financing a firm's assets. The company must decide whether to issue stock (and what kind) or to borrow money in order to conduct business. Debt and equity both have costs associated with them. These costs may be explicit or implicit. The cost of equity is higher than the cost of debt, since stockholders are subject to more risk than debt holders. Firms must have the cash to pay dividends in order to keep their stockholders happy. For a company that chooses the debt option, in a period of declining earnings, the risk is higher that the cash flow may not be available to pay the interest and principal payments in a timely manner. Cash flow represents a business risk in capital structure decisions. The responsibility to maintain a certain debt-to-equity ratio per contractual obligations is something that management must keep in mind when deciding the makeup of its capital structure. However, it is not a business risk. Although management may have certain preferences regarding the capital structure, these preferences do not represent a business risk. The timing of information provided to management is essential in making capital structure decisions. However, it is not a business risk.

Answer 144

D. To reduce the interest rate on the bonds being sold Agreeing to a debt covenant limiting the percentage of long-term debt would have an effect on a company's capital structure (debt-to-equity ratio). A favorable debt-to-equity ratio (along with other indicators of financial health) means a higher bond rating. A high bond rating means lower interest rates for bonds being sold, which also lowers the cost of capital for future bond issuances. A debt covenant would not have any effect on risk for current bondholders or on the price of the company's stock.

Answer 145

A. cashable at any bank. Depository transfer checks, or official bank checks, are used to move funds from one account to another as part of a firm's cash management process. These checks are not cashable at any bank. They are related to the characteristics described in the other answers.

Answer 146

A. $10,000 The delay for the checks and deposits to clear the company's account is called the “float.” During the float, the company has the use of the cash equal to the amount of checks written but does not have the use of deposits until they clear its bank. Since it takes five days for the checks to clear (i.e., be deducted from the company's account), the company has the use of $10,000 for five days or what is essentially a “loan” of $50,000. However, for the four days required for the deposits to clear, the company is losing the use of $10,000 × 4 or $40,000. Thus, the company enjoys a net 1-day float on the checks it writes of $10,000. Thus, skillful management of the float requires the company to delay the coverage of checks as long as possible and to deposit checks received as quickly as possible.

Answer 147

A. $68,400 The problem specifically states that the federal regulation used does not recognize salvage value. The net cash flow for the third year that Moore Corporation should use in a capital budgeting analysis should include net cash inflow expected from the sale and production of 2,000 units less tax on income. In calculating tax, one should remember to consider depreciation. Although depreciation is not a cash outflow, it does reduce the amount of income upon which tax is calculated. Inflow = 2000 units x ($500 - $450) = $100,000 Outflow (tax): = Income from production = $100,000 Less depreciation = (21,000)* Operating income = $ 79,000 x Tax rate x .40 = Tax $ 31,600 Net cash flow = $100,000 - 31,600 = $68,400 * Depreciation = ($90,000 + $6,000 + $9,000) / 5 = $21,000

Answer 148

A. 1,291 units. Moss Converters wants to find the economic order quantity, utilizing the formula which is given: EOQ = Square root of 2AD × OC/K EOQ = Square root of (2 × Annual demand) × (Order cost ÷ Unit carrying cost). To replace the unknowns with numeric values, solve for each. Annual Demand = A = 100,000 Units (Given) Cost per Order = D = $35 (Variable Cost Only, Ignore Allocation of Fixed Cost) Carrying Cost/Unit/Year = K = Handling Costs + Interest Handling Cost = 20% of Cost (Given) = (.2) ($12) = $2.40 Interest (Capital Cost) = 15% (Given) of Cost (Given) = (.15) ($12) = $1.80 Carrying Cost = K = $2.40 + $1.80 = $4.20 EOQ = Sq. Root of 2AD/K = Sq. Root of ((2 x 100,000 x $35)/$4.20) EOQ = Sq. Root of 7,000,000/4.20 EOQ = Sq. Root of 1,666,666 EOQ = 1,291

Answer 149

B. 6,750 units. The reorder point is that quantity of materials on hand that equals the lead time quantity plus safety stock (i.e., the total needed to continue production until the next delivery is received): Daily usage = 60,000/240 Days= 250 units Safety Maximum Average Daily stock = (lead time - lead time) x usage = (27 - 20) x 250 = 1,750 units Reorder Purchase point = lead time units + safety stock = (20 days x 250 units) + 1,750 = 5,000 + 1,750 = 6,750 units

Answer 150

The discounted payback method uses the present value of the projected cash flows in determining the payback period; thus, the payback period is longer than one calculated using the more traditional payback method. The first step is to calculate the present value of the projected cash flows: Net Cash Flow PV Factor at 8% Present Value Year 1 $10,000 0.926 $ 9,260 Year 2 15,000 0.857 12,855 Year 3 20,000 0.794 15,880 Year 4 27,000 0.735 19,845 The discounted payback can then be calculated: Year 0 Year 1 Year 2 Year 3 Year 4 Annual cash flow $ 9,260 $12,855 $15,880 $19,845 Cum cash flow -$43,000 -33,470 -20,885 -5,005 14,840 The payback period falls between Year 3 and Year 4, and extrapolating (3 years + ($5,005 ÷ $19,845) = 3.25 years), it can be determined that the projected discounted payback period would be 3.25 years.

Answer 151

D. (Current balance - Prior balance) / Prior balance The question concerns the change for Year 2 compared to Year 1. The amount of change is the increase or decrease from the prior year to the current year, equal to the current balance less the prior balance. The percentage change is calculated by dividing the amount of change by the beginning balance.

Answer 152

A. Economic order quantity Economic order quantity (EOQ) is the quantity of inventory that should be ordered at one time in order to minimize the associated costs of carrying and ordering inventory, such as purchase-order processing, transportation, and insurance. Carrying costs increase as the size of the order increases. Setup or ordering costs, however, decrease as the size of the production run or order increases. Just-in-time (JIT) is a manufacturing philosophy where the company receives raw materials just in time to go into production, manufactures parts just in time to be assembled into products, and completes products just in time to be shipped to customers. JIT reduces the cost of carrying inventory but does not equate inventory carry costs with restocking costs. Materials requirements planning (MRP) meets forecasted sales demand by balancing existing production capacity and raw materials needs. MRP does not attempt to equalize restocking and carrying costs. The ABC inventory management system establishes priorities based on valuation of the inventory items (A = high value; B = medium value; C = small value) so that management can pay more attention to categories A and B. It has nothing to do with ordering points.

Answer 153

A. decrease in proportion to a decrease in financial leverage. The degree of total leverage decreases proportionately to a decrease in financial leverage. Leverage, whether financial or operating, is based on the relationship between fixed and variable costs. Operating leverage increases when the proportion of fixed operating costs to variable operating costs increases. Financial leverage increases when the proportion of fixed payment obligations from interest and preferred dividends increases relative to the “variable” payments to common stockholders. Common stock dividends are variable, in the sense that there is no fixed, definite amount of dividends that must be paid each year. Interest, on the other hand, must be paid regardless of the firm's profits or cash flow, or the firm may face bankruptcy and preferred must be paid for the company to remain credible. A decrease in preferred stock dividends thus decreases financial leverage. The formula for total leverage shows that as preferred dividends decrease (increasing the value of the denominator), total leverage decreases.

Answer 154

D. payback. The payback capital budgeting technique indicates how soon a project will recover its cost. The sooner the cost is recovered, the less risky the project—returns are less knowable the further in the future they are.

Answer 155

C. 2.47. The degree of financial leverage: % change in net income/ % change in operating income = 42 / 17 = 2.47

Answer 156

A. periodic demand for the good is known. Assumptions of economic order quantity analysis include the following: Periodic demand for the good is known. Total carrying costs vary with quantity ordered. Costs of placing an order are unaffected by quantity ordered. Purchase costs per unit are not affected by quantity discounts.

Answer 157

C. $17,400. Cash outlay for new grinder: Cash paid for new grinder $25,000 Less: Proceeds from sale of old grinder $6,000 Net of cash tax "saving" resulting from loss on sale (1)(40% x $4,000) 1,600 = 7,600 Net cash outlay $17,400 (1) Cost of old grinder $15,000 Less accumulated depreciation (5/15 x $15,000) 5,000 Book value of old grinder = 10,000 Less proceeds from sale 6,000 Loss on sale $ 4,000

Answer 158

C. Idle space that has no alternative use has an opportunity cost of zero. An opportunity cost is the lost inflow of the next best alternative that is forgone as the result of a decision. Although opportunity costs are important in the decision-making process, they are not included as actual costs in financial statements. For example, a company has idle space that could be used for the production of a new product or could be rented to a third party. If the production of a new product is considered, then the lost rental income would be an opportunity cost that would have to be considered during the decision-making process. If idle space has no alternative use, it has an opportunity cost of zero.

Answer 159

C. long-term Long-term fixed interest rate loans create the greatest interest-rate risk for both borrowers and lenders. Borrowers benefit from fixed rates when interest rates go up but lose when they decline. Lenders' risk is in the opposite direction. The chance for interest rates to change is much greater over a long time period than over a short time period.

Answer 160

D. cost to reorder stock. The level of safety stock does not depend on the cost to reorder stock. Safety stock is held in order to avoid the likelihood of a stock out, or running out of inventory. A higher level of safety stock is needed when sales forecasts are uncertain. Customers dislike waiting for orders to be filled, and lead time from suppliers is uncertain. The cost of reordering inventory is a consideration in the optimal quantity of inventory to order each time an order is placed, but not in the additional safety stock that should be held. When the inventory falls to the level of minimum safety stock, then a new order should be placed.

Answer 161

D. discount each cash flow using a discount rate that reflects the degree of risk. Risk analysis tries to evaluate the probability of the achievement of future returns from the proposed investment. Discount rates are often risk-adjusted to address the risk in an investment (adjusting the discount rate upward would require the expected net cash flow to be larger and thus compensating for a riskier project). This same technique may be applied to individual components of a project's cash flows to produce acceptable results in a capital budgeting analysis.

Answer 162

C. Interest is deductible for tax purposes. Brewer Corporation's cost of debt is lower than the current yield of their bonds because interest expenses are tax deductible. The cost of capital is almost always calculated on an after-tax basis, since the payments to the suppliers of the capital are made from after-tax cash flows. Consider a firm with interest expense of $80 annually: Case A: Firm With Interest Case B: Firm Without Interest EBIT $100 EBIT $100 less Int (80) less Int 0 EBT 20 EBT 100 less Tax (40%) ( 8) less Tax (40%) (40) EAT $ 12 EAT $ 60 The firm with interest expense has cash flows that are $48 less than a no-interest case, not the $80 less that would be expected without the tax benefit. The cost of debt to the firm is: Interest × (1 - Tax rate). The cost of the interest is thus Interest × (1 - .40), or $80 × .6 = $48. 8% bonds paying $80 in interest per year would have a face value of $1,000 ($1,000 × 8% = $80). The actual after tax cost of debt for case A would be 4.8% ($48 ÷ $1,000), which would be lower than the marketplace 8%.

Answer 163

C. There are no restrictions as to the type of corporation that can enter into this market. Commercial paper is a short-term note payable which is unsecured and usually discounted. It is issued in large denominations with maturities ranging from 2 to 270 days. There are several advantages to a corporation using commercial paper for short-term financing. The commercial paper market provides more funds at lower rates than other methods available. There is no required compensating balance at a lending bank. There is a broad and efficient distribution and the borrower's name becomes more widely known through this market. What is not an advantage to a corporation that uses the commercial paper market is the statement “there are no restrictions as to the type of corporation that can enter into this market.” This is false. Commercial paper is issued in denominations of $100,000 or more and is almost always backed by bank lines of credit. This limits the access to this market to large corporations only. Plus, commercial paper is rated by Standard & Poor's and Moody's and, consequently, only top-rated corporations with high credit ratings can enter this market.

Answer 164

C. 10.30% The weighted-average cost of capital is the weighted average of the cost of debt and the various equity components of the firm's capital structure. The marginal tax rate is considered in determining the cost of capital for each component that has a tax effect (such as the debt interest). Since the interest is deductible, the cost of debt is 10% less 30% tax savings, or 7%. Multiply the cost of each source of capital by the proportion of capital from that source, and add the results: Debt = 0.30 × 0.07 = 0.021 Common stock = 0.60 × 0.12 = 0.072 Preferred stock = 0.10 × 0.10 = 0.01 These total 10.3%.

Answer 165

A. When bad debts expense is recorded for the period, working capital decreases. ``` Working capital (WC) is short-term assets such as cash, receivables, and inventory. Net working capital is current assets less current liabilities. An increase in bad debt expense results in a corresponding increase in the Allowance for Doubtful Accounts. Since the Allowance account is a contra-current asset, any increase results in a decrease to current assets, which leads to a decrease in WC. ``` Bad debt expense and account write-offs do not affect cash. Writing an account receivable off against the allowance is a wash entry: the decrease in accounts receivable decreases WC while the decrease in the Allowance account increases WC.

Answer 166

B. the Sharpe measure. The formula for the Sharpe measure for portfolio performance is (Portfolio return - Risk-free rate) ÷ Standard deviation. The formula for the Treynor index for portfolio performance is (Portfolio return - Risk-free rate) ÷ Beta. The formula for the Jensen measure of portfolio performance measure of return on portfolio is Risk-free rate + ((Return on market index - Risk-free rate) × Beta).

Answer 167

A. Treynor index The Treynor index is based on the premise that there are two components of risk: Risk produced by fluctuations in the market Risk produced by fluctuations of the individual stock The index measures the portfolio return per unit of risk using the following equation: (Portfolio return - Risk-free rate) ÷ Beta The Sharpe measure of portfolio risk provides information similar to that of the Treynor index, except that the risk measure is the standard deviation of the portfolio rather than beta. The Jensen measure of portfolio risk measures the absolute value of performance of a portfolio on a risk-adjusted basis.

Answer 168

C. Project B because after-tax cash inflow equals $635 Project A produces taxable income of $450 ($1,000 less $400 less $150). Multiplying taxable income of $450 by a 30% tax rate gives income tax of $135. After-tax cash inflow for Project A is $1,000 sales less cash expenses of $400 and income tax of $135, or $465. Project B produces taxable income of $550 ($1,500 less $700 less $250). Multiplying taxable income of $550 by a 30% tax rate gives income tax of $165. After-tax cash inflow for Project B is $1,500 sales less cash expenses of $700 and income tax of $165, or $635.

Answer 169

D. $11,281 Net annual cash inflows = Cash inflow - income taxes = $7,500 - (.40 x ($7,500 - $5,000)) = $7,500 - (.40 x ($2,500)) = $7,500 - $1,000 = $6,500 Present value of cash inflow = Net annual cash inflow x PV factor = $6,500 x 1.7355 = $11,280.75, or 11,281 rounded

Answer 170

C. Yes, because the weighted average cost of capital will decrease Required rate of return for equity = Risk-free rate + beta(LT average risk premium for the market - Risk-free rate) Expected return for equity = 16% Risk-free rate = 6% beta = .95 Substituting the known items in the CAPM equation, the LT average risk premium for the market can be determined: Required rate of return for equity = Risk-free rate + beta(LT average risk premium for the market - Risk-free rate) 16% = 6% + .95(LT average risk premium for the market - 6%) LT average risk premium for the market = 16.5% Step 2: The proposed change to 30% debt and 70% equity provides the following known information: LT average risk premium for the market = 16.5% Risk-free rate = 6% beta = 1.05 The new required rate of return for equity can now be calculated as: Required rate of return for equity = Risk-free rate + beta(LT average risk premium for the market - Risk-free rate) Required rate of return for equity = 6% +1.05(16.5% - 6%) Required rate of return for equity = 17.0% Step 3: The WACC of capital under the proposed capital structure can then be calculated as: Proposed WACC = Weighted cost of debt + Weighted cost of equity = (30% x 7.5%) + (70% x 17.0%) = 2.3% + 11.9% = 14.2% Comparison of the current structure and the proposed structure: Current Proposed Structure Structure Cost of debt 7.5% Cost of equity 16.0% 17.0% WACC 16.0% 14.2%

Answer 171

B. 5.1%=((20*0.09)/(40-5)) The cost of preferred stock is the annual dividend payment divided by the net issuance price for the preferred stock. Since dividends paid on preferred stock are not deductible by the corporation for tax purposes, the cost does not include any tax effect. The annual dividend per share is 9% multiplied by the par value of $20, or $1.80. The stock sold for $40. Subtracting the $5 issue costs gives net proceeds of $35 a share. The cost of preferred stock is the $1.80 dividend divided by proceeds of $35 a share, which is 5.1%.

Answer 172

C. $40,000 Accounting rate of return = Increase in income ÷ Required investment Increase in income (numerator) = $40,000

Answer 173

B. $169,285. Proceeds from sale of asset on January 1, 2008 $180,000 (1) Less present value of income taxes on gain ($30,000 gain x 40% x .8929) $(10,715) (2) Discounted net-of-tax amount related to disposal of existing asset $169,285 1 Proceeds from the sale on January 1, 2008, is the present value at that date. 2 Taxes on gain are assumed payable at the end of 2008.

Answer 174

B. 7.6%. The cost of funds from the sale of common stock is 7.6%. According to the Gordon Dividend Capitalization Model, the market value of a share of stock is equal to the present value of future dividend streams. This formula states: kcm = (D / (P - u - f)) + g = (7 / (100 - 3 - 5)) + 0 = 7 / 92 = 7.6% Where: ``` kcm = Cost, in percentage, of issuing new common stock D = Dividend the firm is expected to pay next year P = Current price of a share u = Dollar amount of underpricing per share from the market price needed to sell the new issue f = Flotation cost per share paid to the investment banking firm for selling the new issue g = Expected annual growth rate in dividends, in percentage ```

Answer 175

D. When there are net cash inflows of sizable amounts early in the project The real issue here is the reinvestment assumption applied to “recovered funds.” Net present value (NPV) assumes reinvestment at the cost of capital whereas internal rate of return (IRR) assumes reinvestment at the IRR. NPV makes the more realistic assumption about the rate of return that can be earned on cash flows from the project.

Answer 176

B. Zero-balance account A zero-balance account (imprest fund) is a checking account that normally carries a zero balance. When a large number of checks will be written at once (such as for payroll), the net amount of the checks is deposited in the account. As the checks clear, the balance in the account equals the outstanding checks, and when all have cleared, the balance in the account is again zero. It is a common control on cash disbursements 垫付款. A lockbox system is used with cash deposits, not cash disbursements. Preauthorized checks are not a cash management technique; they speed the issuance of checks for small payments. Depository transfer checks are official bank checks used to move funds from one account to another within the banking system; they are not used as a cash disbursement management technique.

Answer 177

A. Accounting rate of return is included; internal rate of return and payback are excluded. Internal rate of return is a capital budgeting method which attempts to determine the internal return from a proposed project (NPV inflows = NPV outflows). The internal rate of return is that rate which produces a zero net present value. With this in mind, depreciation is only relevant if it affects cash flows. So, if tax considerations are ignored, depreciation must be excluded in performing internal rate of return analysis. Accounting rate of return is calculated as follows: Accounting ROR= Increase in accounting income/Cash invested in project Since depreciation is used in computing accounting income, it must be included. Payback, like internal rate of return, focuses on cash flows. Because of this, if tax considerations are ignored, there is no cash flow effect from depreciation so it is excluded from the calculation.

Answer 178

A. Accounts payable Because trade credit arises automatically from purchase transactions, it provides a spontaneous 无意识的 source of financing for the firm. Trade credit is represented on the balance sheet of the borrowing firm as Accounts Payable.

Answer 179

B. 10% ``` Compensating balances increase the cost of the loan due to the fact that fewer funds are available for use. The effective interest rate for a loan requiring a compensating balance for which the company would not otherwise hold such funds would be the actual interest paid divided by the funds available for use. In this case: Full amount of loan $500,000 Stated interest rate 8% Compensating balance ($500,000 x 0.20) $100,000 Annual interest expense ($500,000 x 0.08) $ 40,000 ``` The effective interest rate for the loan requiring a compensating balance would be: Annual interest expense ÷ (Full loan amount - Compensating balance) = $40,000 ÷ ($500,000 - $100,000) = 0.10 (10%)

Answer 180

A. Payback period The payback period method can be used as an easy screening tool for capital budgeting projects since it determines the length of time required to recover the initial cash investment through net cash flows. As a general rule, the sooner the investment is recovered, the better. Weaknesses of the payback method are the following: All cash flows occurring after the payback period are ignored. The time value of money is not considered.

Answer 181

D. 10.0 The times-interest-earned ratio is (Net income before tax + Interest expense) ÷ Interest expense. To find net income before tax: Before-tax income - (0.40 × Before-tax income) = After-tax income 0.60 × Before-tax income = After-tax income = $5.4 million Before-tax income = $5.4 million ÷ 0.60 = $9 million To find the times-interest-earned ratio: Times interest earned = (Net income before tax + Interest expense / Interest expense = ($9 million + $1 million) / $1 million = 10.0

Answer 182

C. Internal rate of return The internal rate of return is the interest rate that will make the present value of future net cash flows equal to the initial cash outlay. In other words, it is the interest rate that gives a net present value of zero. The net present value metric is calculated using an assumed minimum desired interest rate that normally would not result in a present value equal to cost. Return on assets is the current net income divided by the total assets; it does not consider future cash flows. Economic value-added (EVA) is the earnings above the required cost of capital for shareholders, a dollar figure that does not consider future cash flows.

Answer 183

D. 36.7%=18*2.041%=2%/(100-2)*(360/20) The annual cost of credit if the cash discount is not taken and Garo pays net 30 is calculated as follows. The lost discount of holding onto money for an additional 20 days (2/10 means 2% discount if paid in 10 days) is 2% for those 20 days; however, the trick is to realize that the principal upon which the 2% is compared is really gross less 2%; e.g., if a $100 invoice is paid in 10 days with terms of 2/10, the amount paid is $98. The 2% discount ($2) is really potential interest that could be charged on the principal amount of $98. This results in an interest rate that is really 2/98 or 2.041% for 20 days. The 30 in “2/10 net 30” means the total amount of the invoice must be paid in 30 days. If the discount is not taken, the cash is held onto for an additional 20 days (30 - 10 = 20). In a 360-day year, 20 days represents 18 periods. 18 × 2.041% = 36.738%, or 36.7%.

Answer 184

D. 6.09%.=Ks = 3.90 / 64 = (6%*$65)/(68-4) Use the Gordon Growth Model to calculate the cost of capital: Capital cost Ks = (Next Dividend/ Mkt Price (1- Flotation cost) + Dividend growth rate Ks = ( D/ P(1-F))+ G Here, the dividend = 6% of par value of $65 so D = $3.90. We have the net proceeds of the stock sale rather than the flotation cost as a percentage. The net proceeds to Acme are $64 per share, and no dividend growth is mentioned.

Answer 185

B. 110.3. In the first year it cost the consumers $990 to purchase the market-basket of goods ((20 × $15) + (18 × $25) + (6 × $40)). In year 2 it took $1,092 to purchase the same market-basket of goods ((20 × $18) + (18 × $28) + (6 × $38)). Thus, if the base year is 100 = ($990 ÷ $990) × 100, the CPI for the second year would be ($1,092 ÷ $990) × 100 = 110.3.

Financial Management Flashcards

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