Finance 3155 – Exam 1 – Fall 2000


Dr. Dowling                                         Name___________________________________


Instructions – Circle the letter representing the correct answer to as many of the following questions as time permits.  Where necessary, justify your answers appropriately so that credit can be awarded…


1.     An S-type corporation is different from a C-type corporation in which of the following way(s):


a.       the way they are taxed

b.       liability

c.       general stockholder rights

d.       all of the above


2.       The accounting and finance disciplines are committed to similar firm goals, but they specifically differ in that:


a.       accounting is more concerned with the operating performance of the firm's economic resources

b.       finance is more attuned to the inventory methods of the firms

c.       finance is more concerned with the flow of cash, while accounting attempts to reflect an unbiased portrayal of the firm's operations and its asset utilization

d.       accounting places more emphasis on earnings per share than does finance


3.        Often even shareholders and bondholders find themselves with conflicting interests, but such conflicts are lessened by the bondholders through:


a.       a cooperative agreement signed by the shareholders and the lenders

b.       limiting the amount of funds bondholders will lend

c.       loan agreements that restrict the borrowing company from undertaking excessive risk

d.       offering the lenders a share of the profit


4.       Financial assets can be distinguished most specifically from real assets in that financial assets:


a.       do not have a tangible or physical substance

b.       are not intended to provide specific services like transportation or shelter

c.       are intended to provide their owners with claims to future cash flows

d.       all of the above


5.      Without an effective incentive to perform, management will:


a.       still acknowledge its primary responsibilities

b.       not be motivated to maximize shareholder value

c.       not be influenced by power for the mere sake of its prestige

d.       look for higher base salaries

 6.      Assume a municipal bond is issued by the State of New York. Its yield is

stated at 6%. A taxable corporate bond of equivalent investment grade   and duration is yielding 9%. You are in the 36% tax bracket and your son is in the 15% tax bracket. Which would be the correct investment strategy for both you and your son?


a.       you and your son should acquire the municipal bond

b.       your son should acquire the municipal bond, but you should acquire the corporate bond

c.       you and your son should acquire the corporate bond

d.       your son should acquire the corporate bond, but you should acquire the municipal bond






7.       The following imaginary marginal tax rates apply to an individual.  His/her taxable income is $40,000. How much is his/her total tax?


             10% of the first $10,000

             15% of the next $15,000

             25% of the next $10,000

             35% of the next $20,000


a.       $8,500

b.       $10,000

c.       $7,500

d.       $7,000






8.            Assume the following is a listing of the equity accounts of a firm. How

     much is the ending equity of the firm?


              Additional paid in excess                         $12,000

             Income for the year                                   25,000

             Dividends paid                                            6,000

             Beginning equity for the year                      56,000

             Additional stock sold at par                       10,000


a.       $103,000

b.       $97,000

c.       $19,000

d.       $85,000



 9.      To avoid a tax inequity, our federal tax system allows firms that have a tax loss for a given year to apply the loss against both past and future earnings. The process is referred to as loss carrybacks and carryforwards and permits the loss to be:


a.       carried forward for 15 years after having been carried back evenly over the past three years

b.       carried back, first to the first preceding year, then to the second, and then to the third preceding years, before being carried forward for 20 years

c.       spread evenly over the last three years and evenly over the next 15 years

d.       carried back first to the third preceding year, then to the second preceding year, and then to the first preceding year before being carried forward for the next 15 years until it is fully consumed



10.     The following is a condensed version of a firm's comparative balance   sheets for this year and last year, as well as a condensed version of this year's income statement. The firm has paid a $1,000 dividend.

                                                                          TY                LY 

            Cash                                               $ 2,000           $ 1,600

            Accounts receivable                        12,000             5,200

            Inventory                                         14,000            15,600

            Fixed assets                                    27,000            20,000

            Accumulated depreciation             (16,000)          (14,400)

              Total assets                                 $39,000           $28,000

                                             =======       ======




Sales              100,000

COGS               80,000

Gross Profit      20,000

Cash Exp.          8,000

Depreciation      1,600

EBIT                10,400

Interest                 800

EBT                    9,600

Taxes                  2,600

Net Income      $  7,000











            Accounts payable                          $ 3,000           $ 2,500

            Accrued expense                              1,000             1,500

            Notes payable - long term               10,000             5,000

            Common stock                                 5,000             5,000

            Retained earnings                           20,000            14,000

              Total liabilities & capital              $39,000           $28,000

                                                 ======    =======











          The net cash affected by financing activities is:


a.       $4,000

b.       $6,000

c.       ($4,000)

d.       ($6,000)










11.     Which business transaction will affect the quick ratio?


a.       Purchase of plant and equipment with long-term debt

b.       Temporary cash investments liquidated and proceeds placed in checking account

c.       Employee loans receivable paid off

d.       Payment made on accounts payable balance


12.     If a company is facing default with its bondholders because of a deteriorating current ratio, which of the following actions could it take to improve its current ratio?


a.       Take a nine-month loan from the bank to pay off some of its suppliers

b.       Accelerate the collection of accounts receivable

c.       Sell off some old equipment that is no longer being used

d.       All of the above


13.      There are three essentially different, yet interrelated, relative  measurements of debt: the debt ratio, the debt to equity ratio, and the equity multiplier. If the firm's total assets equal $1,200,000 and the equity multiplier is stated as 3:1, the debt ratio is:


a.       66.67%

b.       33.33%

c.       2:1

d.       50.00%





14.  Many lending institutions rely on the "times interest earned" formula    because it discloses the firm's ability to cover the interest charge on outstanding debt. With earnings before taxes of $30,000, interest expense of $3,000, and net income after taxes of $24,000, times interest earned is:


a.       8 times

b.       10 times

c.       11 times

d.       none of the above



   15.             Assume that interest rates for years one and two are expected to be 5% 

          and 7% in years three, four, and five. If you were to make a five- year loan, the appropriate rate of interest to charge under the expectations theory would be:


a.       6.375%

b.       6.000%

c.       6.200%

d.              none of the above


16.     Which of the following is not considered a component of the interest rate model?


a.       default risk premium

b.       deferred consumption risk premium

c.       pure interest rate

d.       maturity risk premium


17.     The over-the-counter market differs from the New York Stock Exchange in that:


a.       the stocks, although publicly traded, are not listed on an exchange

b.       only relatively small companies are traded because larger companies are required to be traded on exchanges

c.       NASDAQ quotations apply only to smaller, less capitalized firms

d.       all of the above


   18.             Investors' overall required rate of return on equity investments increases    

          as a result of:


a.       inflationary pressures

b.       increases in the general level of interest on debt investments

c.       both of the above

d.       none of the above


19.   Retailers Inc. and Computer Corp. each have assets of $10,000 and  a    return on common equity equal to 15%. Retailers has twice as much debt and twice as many sales relative to Computer Corp. Retailers' net income equals $750, and its total asset turnover is equal to 3. What is Computer Corp.'s profit margin?

a.    2.50%

b.    5.00%

c. 7.50%

d. 10.00%

e. 12.50%








20.      Aurillo Equipment Company (AEC) projected that its ROE for next year would be just 6%. However, the financial staff has determined that the firm can increase its ROE by refinancing some high interest bonds currently outstanding. The firm's total debt will remain at $200,000 and the debt ratio will hold constant at 80%, but the interest rate on the refinanced debt will be 10%. The rate on the old debt is 14%. Refinancing will not affect sales which are projected to be $300,000. EBIT will be 11% of sales, and the firm's tax rate is 40%. If AEC refinances its high interest bonds, what will be its projected new ROE?

a. 3.0%

b. 8.2%

c. 10.0%

d. 15.6%

e. 18.7%







21.      A fire has destroyed a large percentage of the financial records of the Carter Company. You have the task of piecing together information in order to release a financial report. You have found the return on equity to be 18 percent. If sales were $4 million, the debt ratio was 0.40, and total liabilities were $2 million, what was the return on assets (ROA)?

a. 10.8%

b. 0.8%

c. 1.25%

d. 12.6%

e. Insufficient information.







22.      Alumbat Corporation has $800,000 of debt outstanding, and it pays an interest rate of 10 percent annually on its bank loan. Alumbat's annual sales are $3,200,000; its average tax rate is 40 percent; and its net profit margin on sales is 6 percent. If the company does not maintain a TIE ratio of at least 4 times, its bank will refuse to renew its loan, and bankruptcy will result. What is Alumbat's current TIE ratio?

a. 2.4

b. 3.4

c. 3.6

d. 4.0

e. 5.0







23.     Lone Star Plastics has the following data:

Assets: $100,000 Profit margin: 6.0% Tax rate: 40%

Debt ratio: 40.0% Interest rate: 8.0%

Total asset turnover: 3.0

What is Lone Star's EBIT?

a. $ 3,200

b. $12,000

c. $18,000

d. $30,000

e. $33,200