Advanced Finance - Exercise Set 2

1. Considered alone, which of the following would increase a company's current ratio?
a.
An increase in accounts payable.
b.
An increase in net fixed assets.
c.
An increase in accrued liabilities.
d.
An increase in notes payable.
e.
An increase in accounts receivable.

2. Which of the following would, generally, indicate an improvement in a company's financial position, holding other things constant?
a.
The total assets turnover decreases.
b.
The TIE declines.
c.
The DSO increases.
d.
The EBITDA coverage ratio increases.
e.
The current and quick ratios both decline.

3. A firm wants to strengthen its financial position. Which of the following actions would increase its current ratio?
a.
Use cash to increase inventory holdings.
b.
Reduce the company's days' sales outstanding to the industry average and use the resulting cash savings to purchase plant and equipment.
c.
Use cash to repurchase some of the company's own stock.
d.
Borrow using short-term debt and use the proceeds to repay debt that has a maturity of more than one year.
e.
Issue new stock and then use some of the proceeds to purchase additional inventory and hold the remainder as cash.

4. Which of the following statements is CORRECT?
a.
If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will decrease.
b.
A reduction in inventories held would have no effect on the current ratio.
c.
An increase in inventories would have no effect on the current ratio.
d.
If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase.
e.
A reduction in the inventory turnover ratio will generally lead to an increase in the ROE.

5. Companies A and C each reported the same earnings per share (EPS), but Company A's stock trades at a higher price. Which of the following statements is CORRECT?
a.
Company A trades at a higher P/E ratio.
b.
Company A probably has fewer growth opportunities.
c.
Company A is probably judged by investors to be riskier.
d.
Company A must have a higher market-to-book ratio.
e.
Company A must pay a lower dividend.

6. Which of the following statements is CORRECT?
a. If a firm has the highest price/earnings ratio of any firm in its industry, then, other things
held constant, this suggests that the board of directors should fire the president.
b. If a firm has the highest market/book ratio of any firm in its industry, then, other things
held constant, this suggests that the board of directors should fire the president.
c. Other things held constant, the higher a firm's expected future growth rate, the lower its
P/E ratio is likely to be.
d. The higher the market/book ratio, then, other things held constant, the higher one would
expect to find the Market Value Added (MVA).
e. If a firm has a history of high Economic Value Added (EVA) numbers each year, and if
investors expect this situation to continue, then its market/book ratio and MVA are both
likely to be below average.

7. Which of the following statements is CORRECT?
a. "Window dressing" is any action that improves a firm's fundamental, long-run position and thus increases its intrinsic value.
b.
Borrowing by using short-term notes payable and then using the proceeds to retire longterm debt is an example of "window dressing." Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is another example of "window dressing."
c.
Borrowing on a long-term basis and using the proceeds to retire short-term debt would improve the current ratio and thus could be considered to be an example of "window dressing."
d.
Offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is an example of "window dressing."
e.
Using some of the firm's cash to reduce long-term debt is an example of "window
dressing."

8. The Cavendish Company recently issued new common stock and used the proceeds to pay off some of its short-term notes payable. This action had no effect on the company's total assets or operating income. Which of the following effects would occur as a result of this action?

a. The company's debt ratio increased.

b. The company's current ratio increased.

c. The company's times interest earned ratio decreased.

d. The company's basic earning power ratio increased.

e. The company's equity multiplier increased.

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

a. Increase inventories while holding sales and cost of goods sold constant.

b. Increase accounts receivable while holding sales constant.

c. Increase EBIT while holding sales constant.

d. Increase accounts payable while holding sales constant.

e. Increase notes payable while holding sales constant.

10. If the CEO of a large, diversified, firm were filling out a fitness report on a division manager (i.e., "grading" the manager), which of the following situations would be likely to cause the manager to receive a better grade? In all cases, assume that other things are held constant.
a.
The division's DSO (days' sales outstanding) is 40, whereas the average for its competitors is 30.
b.
The division's basic earning power ratio is above the average of other firms in its industry.
c.
The division's total assets turnover ratio is below the average for other firms in its industry.
d.
The division's debt ratio is above the average for other firms in the industry.
e.
The division's inventory turnover is 6, whereas the average for its competitors is 8.

11. Which of the following would indicate an improvement in a company's financial position, holding other things constant?
a.
The current and quick ratios both increase.
b.
The inventory and total assets turnover ratios both decline.
c.
The debt ratio increases.
d.
The profit margin declines.
e.
The EBITDA coverage ratio declines.

12. If a bank loan officer were considering a company's request for a loan, which of the following statements would you consider to be CORRECT?
a.
Other things held constant, the lower the current ratio, the lower the interest rate the bank would charge the firm.
b.
The lower the company's EBITDA coverage ratio, other things held constant, the lower the interest rate the bank would charge the firm.
c.
Other things held constant, the higher the debt ratio, the lower the interest rate the bank would charge the firm.
d.
Other things held constant, the lower the debt ratio, the lower the interest rate the bank would charge the firm.
e.
The lower the company's TIE ratio, other things held constant, the lower the interest rate the bank would charge the firm.

13. Which of the following statements is CORRECT?
a.
All else equal, increasing the debt ratio will increase the ROA.
b.
The use of debt financing will tend to lower the basic earning power ratio, other things held constant.
c.
A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure.
d.
If two firms have identical sales, interest rates paid, operating costs, and assets, but differ in the way they are financed, the firm with less debt will generally have the higher expected ROE.
e.
Holding bonds is better than holding stock for investors because income from bonds is taxed on a more favorable basis than income from stock.

14. A firm wants to strengthen its financial position. Which of the following actions would increase its quick ratio?
a.
Issue new common stock and use the proceeds to acquire additional fixed assets.
b.
Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2) lead to an increase in accounts receivable.
c.
Issue new common stock and use the proceeds to increase inventories.
d.
Speed up the collection of receivables and use the cash generated to increase inventories.
e.
Use some of its cash to purchase additional inventories.

15. Amram Company's current ratio is 1.9. Considered alone, which of the following actions would reduce the company's current ratio?
a.
Use cash to reduce accounts payable.
b.
Borrow using short-term notes payable and use the proceeds to reduce accruals.
c.
Borrow using short-term notes payable and use the proceeds to reduce long-term debt.
d.
Use cash to reduce accruals.
e.
Use cash to reduce short-term notes payable.

16. Which of the following statements is CORRECT?
a.
Some of the cash flows shown on a time line can be in the form of annuity payments, but none can be uneven amounts.
b.
A time line is not meaningful unless all cash flows occur annually.
c.
Time lines are useful for visualizing complex problems prior to doing actual calculations.
d.
Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.
e.
Time lines cannot be constructed for annuities where the payments occur at the beginning of the periods.

17. You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would lower the calculated value of the investment?
a.
The discount rate decreases.
b.
The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for only 5 rather than 10 years, hence that each payment is for $20,000 rather than for $10,000.
c.
The discount rate increases.
d.
The riskiness of the investment's cash flows decreases.
e.
The total amount of cash flows remains the same, but more of the cash flows are received in the earlier years and less are received in the later years.

18. You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would increase the calculated value of the investment?
a.
The discount rate increases.
b.
The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for 10 years rather than 5 years, hence that each payment is for $10,000 rather than for $20,000.
c.
The discount rate decreases.
d.
The riskiness of the investment's cash flows increases.
e.
The total amount of cash flows remains the same, but more of the cash flows are received in the later years and less are received in the earlier years.

19. Which of the following statements is CORRECT?
a.
If some cash flows occur at the beginning of the periods while others occur at the ends, then we have what the textbook defines as a variable annuity.
b.
The cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods.
c.
If a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity.
d.
The cash flows for an annuity due must all occur at the ends of the periods.
e.
The cash flows for an annuity must all be equal, and they must occur at regular intervals, such as once a year or once a month.

20. Your bank account pays a 5% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT?
a.
The periodic rate of interest is 5% and the effective rate of interest is also 5%.
b.
The periodic rate of interest is 1.25% and the effective rate of interest is 2.5%.
c.
The periodic rate of interest is 5% and the effective rate of interest is greater than 5%.
d.
The periodic rate of interest is 1.25% and the effective rate of interest is greater than 5%.
e.
The periodic rate of interest is 2.5% and the effective rate of interest is 5%.

21. A $250,000 loan is to be amortized over 8 years, with annual end-of-year payments. Which of these statements is CORRECT?
a.
The proportion of interest versus principal repayment would be the same for each of the 8 payments.
b.
The annual payments would be larger if the interest rate were lower.
c.
If the loan were amortized over 10 years rather than 8 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 8-year amortization plan.
d.
The proportion of each payment that represents interest as opposed to repayment of principal would be lower if the interest rate were lower.
e.
The last payment would have a higher proportion of interest than the first payment.

22. At the end of 10 years, which of the following investments would have the highest future value? Assume that the effective annual rate for all investments is the same and is greater than zero.
a.
Investment A pays $250 at the beginning of every year for the next 10 years (a total of 10 payments).
b.
Investment B pays $125 at the end of every 6-month period for the next 10 years (a total of 20 payments).
c.
Investment C pays $125 at the beginning of every 6-month period for the next 10 years (a total of 20 payments).
d.
Investment D pays $2,500 at the end of 10 years (just one payment).
e.
Investment E pays $250 at the end of every year for the next 10 years (a total of 10 payments).

23. Of the following investments, which would have the lowest present value? Assume that the effective annual rate for all investments is the same and is greater than zero.
a.
Investment A pays $250 at the end of every year for the next 10 years (a total of 10 payments).
b.
Investment B pays $125 at the end of every 6-month period for the next 10 years (a total of 20 payments).
c.
Investment C pays $125 at the beginning of every 6-month period for the next 10 years (a total of 20 payments).
d.
Investment D pays $2,500 at the end of 10 years (just one payment).
e.
Investment E pays $250 at the beginning of every year for the next 10 years (a total of 10 payments).

24. A U.S. Treasury bond will pay a lump sum of $1,000 exactly 3 years from today. The nominal interest rate is 6%, semiannual compounding. Which of the following statements is CORRECT?
a.
The PV of the $1,000 lump sum has a smaller present value than the PV of a 3-year, $333.33 ordinary annuity.
b.
The periodic interest rate is greater than 3%.
c.
The periodic rate is less than 3%.
d.
The present value would be greater if the lump sum were discounted back for more periods.
e.
The present value of the $1,000 would be larger if interest were compounded monthly rather than semiannually.

25. Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant?
a.
Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays semiannually. Deposits in Bank B will provide the higher future value if you leave your funds on deposit.
b.
The present value of a 5-year, $250 annuity due will be lower than the PV of a similar ordinary annuity.
c.
A 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage.
d.
A bank loan's nominal interest rate will always be equal to or less than its effective annual rate.
e.
If an investment pays 10% interest, compounded annually, its effective annual rate will be less than 10%.