Exam 1 – Version 2 – Finance 3320 – Summer 2010



First Examination – Finance 3320 - Spring 2011 (Moore)

R-Number: ____________________ Printed Name: ____________________

Section and Time: ____________________

Ethical conduct is an important component of any profession. The Texas Tech University Code of Student Conduct is in force during this exam. Students providing or accepting unauthorized assistance will be assigned a score of zero (0) for this piece of assessment. Using unauthorized materials during the exam will result in the same penalty. Ours’ should be a self-monitoring profession. It is the obligation of all students to report violations of the honor code in this course. By signing below, you are acknowledging that you have read the above statement and agree to abide by the stipulated terms.

Student’s Signature: ______________________________

Clearly Fill in the appropriate bubble on the Scantron form for each of the following questions. Choose the BEST response. There is only one answer per question.

1. Which of the following statements is CORRECT?

a. One of the advantages of the corporate form of organization is that it avoids double taxation.

b. It is easier to transfer one’s ownership interest in a partnership than in a corporation.

c. One of the disadvantages of a sole proprietorship is that the proprietor is exposed to unlimited liability.

d. One of the advantages of a corporation from a social standpoint is that every stockholder has equal voting rights, i.e., “one person, one vote.”

e. Corporations of all types are subject to the corporate income tax.

2. Relaxant Inc. operates as a partnership. Now the partners have decided to convert the business into a corporation. Which of the following statements is CORRECT?

a. Relaxant’s shareholders (the ex-partners) will now be exposed to less liability.

b. The company will probably be subject to fewer regulations and required disclosures.

c. Assuming the firm is profitable, none of its income will be subject to federal income taxes.

d. The firm's investors will be exposed to less liability, but they will find it more difficult to transfer their ownership.

e. The firm will find it more difficult to raise additional capital to support its growth.

3. Which of the following statements is CORRECT?

a. One drawback of forming a corporation is that it generally subjects the firm to additional regulations.

b. One drawback of forming a corporation is that it subjects the firm’s investors to increased personal liabilities.

c. One drawback of forming a corporation is that it makes it more difficult for the firm to raise capital.

d. One advantage of forming a corporation is that it subjects the firm’s investors to fewer taxes.

e. One disadvantage of forming a corporation is that this makes it more difficult for the firm’s investors to transfer their ownership interests.

4. Which of the following statements is CORRECT?

a. If a corporation elects to be taxed as an S corporation, then both it and its stockholders can avoid all Federal taxes. This provision was put into the Federal Tax Code in order to encourage the formation of small businesses.

b. The more capital a firm is likely to require, the smaller the probability that it will be organized as a corporation.

c. It is generally easier to transfer one’s ownership interest in a partnership than in a corporation.

d. One danger of starting a proprietorship is that you may be exposed to personal liability if the business goes bankrupt. This problem would be avoided if you formed a corporation to operate the business.

e. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation.

5. Which of the following statements is CORRECT?

a. The ability of firms in competitive industries to voluntarily undertake socially beneficial but costly projects is constrained by competition and the need to attract capital.

b. Any action that would maximize a firm’s stock price must be consistent with the maximization of social welfare.

c. Decisions regarding social and ethical behavior have no effect, either positive or negative, on firms’ stock prices.

d. In a competitive industry, if one group of firms is “socially conscious” and takes costly actions designed to improve social welfare, but other firms do not, then most investors will flock to the socially conscious firms, thus enhancing their ability to attract capital. Eventually, these firms must dominate the industry.

e. Even if the government did not mandate some actions deemed to be socially responsible, such as those relating to fair hiring and environmentally sound practices, most firms in competitive markets would still pursue these policies.

6. Which of the following mechanisms would be most likely to help motivate managers to act in the best interests of shareholders?

a. Decrease the use of restrictive covenants in bond agreements.

b. Take actions that reduce the possibility of a hostile takeover.

c. Elect a board of directors that allows managers greater freedom of action.

d. Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries.

e. Eliminate a requirement that members of the board of directors have a substantial investment in the firm’s stock.

7. New Business is just being formed by 10 investors, each of whom will own 10% of the business. The firm is expected to earn $1,000,000 before taxes each year. The corporate tax rate is 35% and the personal tax rate for the firm's investors is 38%. The firm does not need to retain any earnings, so all of its after-tax income will be paid out as dividends to its investors. The investors will have to pay personal taxes on whatever they receive. How much additional spendable income will each investor have if the business is organized as a partnership rather than as a corporation?

a. $20,015

b. $20,424

c. $20,841

d. $21,266

e. $21,700

8. Charleston Corporation (CC) now operates as a "regular" corporation, but it is considering a switch to S Corporation status. CC is owned by five stockholders who each hold 20% of the stock, and each faces a personal tax rate of 38%. The firm earns $2,000,000 per year before taxes, and since it has no need for retained earnings, it pays out all of its earnings as dividends. Assume that the corporate tax rate is 35% and the personal tax rate is 38%. How much more (or less) spendable income would each stockholder have if the firm elected S Corporation status?

a. $92,113

b. $90,307

c. $88,536

d. $86,800

e. $85,064

9. Which one of the following Statements is True regarding market efficiency?

a. Weak form market efficiency is plausible since we can observe the existence of futures and options markets.

b. Strong form market efficiency is plausible because we see so many finance students and financial service professionals making the market more efficient by analyzing public data.

c. All capital markets in the world must be equally efficient with respect to information efficiency given that global markets exist in the first place.

d. The existence of semi-strong market efficiency is the most plausible and even that has some unexplained anomalies that can’t be explained.

e. If one believes in strong form market efficiency then he (she) should try to pick individual stocks in order to outperform the market.

10. Which of the following statements is CORRECT?

a. If you purchase 100 shares of Disney stock from your brother-in-law, this is an example of a primary market transaction.

b. If Disney issues additional shares of common stock through an investment banker, this would be a secondary market transaction.

c. The NYSE is an example of an over-the-counter market.

d. Only institutions, and not individuals, can engage in derivative market transactions.

e. As they are generally defined, money market transactions involve debt securities with maturities of less than one year.

11. Which of the following statements is CORRECT?

a. While the distinctions are becoming blurred, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise capital from other parties.

b. A liquid security is a security whose value is derived from the price of some other "underlying" asset.

c. Money market mutual funds usually invest their money in a well-diversified portfolio of liquid common stocks.

d. Money markets are markets for long-term debt and common stocks.

asset.

e. The NYSE operates as an auction market, whereas Nasdaq is an example of a dealer market.

12. At the beginning of the year, you purchased the following two stocks at the price indicated below in the number of shares indicated. You have continued to own these shares all year. Compute the end of year return you earned on Stock A.

Beginning Ending Shares

Stock Dividend Price Price Purchased

A $1.50 $30.00 $32.00 500

C $0.75 $20.00 $24.00 2,000

a. $2.00

b. $3.50

c. 5.00%

d. 6.67%

e. 11.67%

13. At the beginning of the year, you purchased the following two stocks at the price indicated below in the number of shares indicated. You have continued to own these shares all year. Compute the end of year return you earned on your portfolio of stocks.

Beginning Ending Shares

Stock Dividend Price Price Purchased

A $1.50 $30.00 $32.00 500

C $0.75 $20.00 $24.00 2,000

a. 17.29%

b. 17.39%

c. 20.45%

d. 30.40%

e. 35.42%

14. Mark Moore’s Consulting and Crawfish Shack (MMCCS) is going public by issuing 200,000 shares of common stock. The capital raised in the IPO will be used to fund the company’s proposed expansion throughout the United States and into the Cayman Islands. A Dutch auction is being used to allocate shares in the MMCCS IPO. The bids are shown below:

[pic]

Compute MMCCS’s IPO offer price.

a. $26.00

b. $24.00

c. $20.00

d. $18.00

e. $16.00

15. Which of the following statements is CORRECT?

a. The balance sheet for a given year, say 2008, is designed to give us an idea of what happened to the firm during that year.

b. The balance sheet for a given year, say 2008, tells us how much money the company earned during that year.

c. The difference between the total assets reported on the balance sheet and the liabilities reported on this statement tells us the current market value of the stockholders' equity, assuming the statements are prepared in accordance with generally accepted accounting principles (GAAP).

d. If a company's statements were prepared in accordance with generally accepted accounting principles (GAAP), the market value of the stock equals the book value of the stock as reported on the balance sheet.

e. The assets section of a typical industrial company’s balance sheet begins with cash, then lists the assets in the order in which they will probably be converted to cash, with the longest lived assets listed last.

16. Other things held constant, which of the following actions would increase the amount of cash on a company’s balance sheet?

a. The company repurchases common stock.

b. The company pays a dividend.

c. The company issues new common stock.

d. The company gives customers more time to pay their bills.

e. The company purchases a new piece of equipment.

17. On its 12/31/08 balance sheet, Barnes Inc showed $510 million of retained earnings, and exactly that same amount was shown the previous year. Assuming that no earnings restatements were issued, which of the following statements is CORRECT?

a. If the company lost money in 2008, it must have paid dividends.

b. The company must have had zero net income in 2008.

c. The company must have paid out half of its 2008 earnings as dividends.

d. The company must have paid no dividends in 2008.

e. Dividends could have been paid in 2008, but they would have had to equal the earnings for the year.

18. Which of the following statements is CORRECT?

a. Typically, a firm’s DPS should exceed its EPS.

b. Typically, a firm’s net income should exceed its EBIT.

c. If a firm is more profitable than average (e.g., Google), we would normally expect to see its stock price exceed its book value per share.

d. If a firm is more profitable than most other firms, we would normally expect to see its book value per share exceed its stock price, especially after several years of high inflation.

e. The more depreciation a firm has in a given year, the higher its EPS, other things held constant.

19. Shrives Publishing recently reported $10,750 of sales, $5,500 of operating costs other than depreciation, and $1,250 of depreciation. The company had $3,500 of bonds that carry a 6.25% interest rate, and its federal-plus-state income tax rate was 35%. During the year, the firm had expenditures on fixed assets and net working capital that totaled $1,550. These expenditures were necessary for it to sustain operations and generate future sales and cash flows. What was its free cash flow?

a. $1,873

b. $1,972

c. $2,076

d. $2,185

e. $2,300

20. Vasudevan Inc. recently reported operating income of $2.75 million, depreciation of $1.20 million, and had a tax rate of 40%. The firm's expenditures on fixed assets and net working capital totaled $0.6 million. How much was its free cash flow, in millions?

a. $2.36

b. $2.25

c. $2.14

d. $2.03

e. $1.93

21. Appalachian Airlines began operating in 2004. The company lost money the first two years but has been profitable ever since. The company’s taxable income (EBT) for its first five years is listed below. Each year the company’s corporate tax rate has been 40%. Assume that losses can be carried back 3 years and forward 10 years.

Year Taxable Income

2004 -$3,000,000

2005 -$1,000,000

2006 $1,000,000

2007 $2,000,000

2008 $3,000,000

Assume that the company has taken full advantage of the Tax Code’s carry-back, carry-forward provisions and that the current provisions were applicable in 2004. How much did the company pay in taxes in 2008?

a. $688,500

b. $730,000

c. $765,000

d. $800,000

e. $930,000

22. The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to

a. Maximize its expected total corporate income.

b. Maximize its expected EPS.

c. Minimize the chances of losses.

d. Maximize the stock price per share over the long run, which is the stock’s intrinsic value.

e. Maximize the stock price on a specific target date.

23. Which of the following statements is CORRECT?

a. A hostile takeover is the main method of transferring ownership interest in a corporation.

b. A corporation is a legal entity created by a state, and it has a life and existence that is separate from the lives and existence of its owners and managers.

c. Unlimited liability and limited life are two key advantages of the corporate form over other forms of business organization.

d. Limited liability is an advantage of the corporate form of organization to its owners (stockholders), but corporations have more trouble raising money in financial markets because of the complexity of this form of organization.

e. Although the stockholders of the corporation are insulated by limited legal liability, the legal status of the corporation does not protect the firm’s managers in the same way, i.e., bondholders can sue its managers if the firm defaults on its debt.

24. Which of the following statements is CORRECT?

a. One of the ways in which firms can mitigate or reduce potential conflicts between bondholders and stockholders is by increasing the amount of debt in the firm's capital structure.

b. The threat of takeover generally increases potential conflicts between stockholders and managers.

c. Managerial compensation plans cannot be used to reduce potential conflicts between stockholders and managers.

d. The threat of takeovers tends to reduce potential conflicts between stockholders and managers.

e. The creation of the Securities and Exchange Commission (SEC) has eliminated conflicts between managers and stockholders.

25. Which of the following statements is CORRECT?

a. The NYSE does not exist as a physical location. Rather it represents a loose collection of dealers who trade stock electronically.

b. An example of a primary market transaction would be your uncle transferring 100 shares of Wal-Mart stock to you as a birthday gift.

c. Capital market instruments include both long-term debt and common stocks.

d. If your uncle in New York sold 100 shares of Microsoft through his broker to an investor in Los Angeles, this would be a primary market transaction.

e. While the two frequently perform similar functions, investment banks generally specialize in lending money, whereas commercial banks generally help companies raise large blocks of capital from investors.

26. Money markets are markets for

a. Foreign currencies.

b. Consumer automobile loans.

c. Common stocks.

d. Long-term bonds.

e. Short-term debt securities such as Treasury bills and commercial paper.

27. Which of the following statements is CORRECT?

a. The most important difference between spot markets versus futures markets is the maturity of the instruments that are traded. Spot market transactions involve securities that have maturities of less than one year whereas futures markets transactions involve securities with maturities greater than one year.

b. Capital market transactions involve only preferred stock or common stock.

c. If General Electric were to issue new stock this year, this would be considered a secondary market transaction since the company already has stock outstanding.

d. Both Nasdaq dealers and "specialists" on the NYSE hold inventories of stocks.

e. Money market transactions do not involve securities denominated in currencies other than the U.S. dollar.

28. Below is the common equity section (in millions) of Timeless Technology’s last two year-end balance sheets:

2008 2007

Common stock $2,000 $1,000

Retained earnings 2,000 2,340

Total common equity $4,000 $3,340

The firm has never paid a dividend to its common stockholders. Which of the following statements is CORRECT?

a. The company’s net income in 2008 was higher than in 2007.

b. The firm issued common stock in 2008. 

c. The market price of the firm's stock doubled in 2008.

d. The firm had positive net income in both 2007 and 2008, but its net income in 2008 was lower than it was in 2007.

e. The company has more equity than debt on its balance sheet.

29. The CFO of Daves Industries plans to have the company issue $300 million of new common stock and use the proceeds to pay off some of its outstanding bonds that carry a 7% interest rate. Assume that the company, which does not pay any dividends, takes this action, and that total assets, operating income (EBIT), and its tax rate all remain constant. Which of the following would occur?

a. The company’s taxable income would fall.

b. The company’s interest expense would remain constant.

c. The company would have less common equity than before.

d. The company’s net income would increase.

e. The company would have to pay less taxes.

30. Your corporation has the following cash flows:

Operating income $250,000

Interest received $10,000

Interest paid $45,000

Dividends received $20,000

Dividends paid $50,000

If the applicable income tax rate is 40% (federal and state combined), and if 70% of dividends received are exempt from taxes, what is the corporation's tax liability?

a. $83,980

b. $88,400

c. $92,820

d. $97,461

e. $102,334

................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download