Islamic University – Gaza Financial Management

Faculty of Commerce Date: 11/1/2015

MBA program Prof. Dr. Faris AbuMouamer
Final-Exam (2014/2015)
Student Name: …………………………………………….……………………… Student No.…………….……………

Question one: true or false

1. Debt management ratios show the relationship of a firm’s current assets to its current
liabilities and thus its ability to meet maturing debts.
2. Benchmarking is the process of comparing a particular company with a group of
similar successful companies.
3. Ratio analysis has no limitations, and when used with care and judgment it can be
very helpful.
4. In trend analysis, all income statement items are divided by sales and all balance
sheet items are divided by total assets.
5. The EBITDA coverage ratio is most useful for relatively short-term lenders such as
banks, which rarely make loans (except real estate-backed loans) for longer than
about 5 years.
6. If a company has excessive investments in assets, then its operating capital will be
unduly high, which will reduce its free cash flow and ultimately its stock price.
7. The coefficient of variation shows the risk per unit of return, and it provides a more
meaningful basis for comparison than σ when the expected returns on two
alternatives are different.
8. Most investors are indeed not risk averse, and certainly the average investor is not
risk averse with regard to his “serious money.”
9. Risk premium, RP, represents the additional compensation investors require for
assuming the additional risk of Sale.com stock.
10. diversification does nothing to reduce risk if the portfolio consists of stocks that are
perfectly positively correlated.
11. in the real world the correlations among the individual stocks are generally positive
but less than -1.0, so some (but not all) risk can be eliminated.
12. Since a stock’s beta coefficient determines how the stock affects the risk of a
diversified portfolio, beta is the most relevant measure of any stock’s risk.
13. The Security Market Line (SML) equation shows the relationship between a
security’s market risk and its expected rate of return.
14. The preemptive right enables new stockholders to maintain control, and it also
prevents a transfer of wealth from current stockholders to new stockholders.
15. When investing in common stocks, the goal is to purchase stocks that are
undervalued and avoid stocks that are overvalued.
16. The expected final stock price includes the return of the original investment plus an
expected capital gain.
17. If growth is greater than rs then the constant growth model can be used.
18. Earnings per share (EPS) growth depends only on industry-wide factors.
19. A body of theory called the Efficient Markets Hypothesis (EMH) asserts only that it
is impossible for an investor to “beat the market”.
20. Technical analysts believe that past trends or patterns in stock prices can be used to
predict future stock prices. In contrast, those who believe in the strong form of the
MH argue that all information contained in past price movements is fully reflected in
current market prices.
21. If a firm’s only investors were common stockholders, then its cost of capital would
be the required rate of return on its equity.
22. Most debt offerings have very low flotation costs, especially for privately placed
debt. Because flotation costs are usually low, most analysts ignore them when
estimating the after-tax cost of preferred stocks.
23. As we mentioned earlier, most U.S. companies use short-term debt primarily to
finance seasonal working capital needs. Seasonal debt fluctuates during the year,
often dropping close to zero, so it is not a permanent source of financing for most
U.S. companies.
24. The greatest benefit of the forecasted financial statements method is its use in
planning to optimize operations and thereby increase the firm’s intrinsic value and
thus its stock price.
25. The higher a firm’s sales growth rate and the higher its payout ratio, the lower will be
its need for additional financing.
26. A firm can determine its AFN by estimating the amount of new assets necessary to
support the forecasted level of sales and then subtracting from this amount the
spontaneous funds that will be generated from operations.
27. The optimal distribution policy strikes a balance between future dividends and future
growth so as to maximize the firm’s stock price.

28. The tax effect theory states that because long-term capital gains are subject to lower
taxes than dividends, investors prefer to have companies dividends rather than retain
earnings.
29. Most firms use the residual distribution model to set the long-run target distribution
ratio at a level that will permit the firm to meet its equity requirements with retained
earnings.
30. A stock dividend is a dividend paid in additional shares rather than in cash. Both
stock dividends and splits are increasing the number of shares.
31. A high degree of operating leverage implies that a relatively small change in sales
results in a relatively large change in EBIT, net operating profits after taxes, and
return on invested capital.
32. Business risk is the additional risk placed on the common stockholders as a result of
the decision to finance with debt.
33. The trade-off theory says that the value of a levered firm is equal to the value of an
unlevered firm plus the value of any side effects, which include the tax shield and the
expected costs due to financial distress.
34. pecking order. In this situation, a firm first raises capital internally by reinvesting its
net income and selling its short-term marketable securities. When that supply of
funds has been exhausted, the firm will issue debt and perhaps preferred stock. Only
as a last resort will the firm issue common stock.
35. Bank loans are an important source of long-term credit. When a bank loan is
approved, a promissory note is signed.
36. Commercial paper is secured short-term debt issued by large, financially strong
corporations. Although the cost of commercial paper is lower than the cost of bank
loans, it can be used only by large firms with exceptionally strong credit ratings.
Question two: choose the correct answer
1-A company has an EPS of $1.50, a cash flow per share of $3.00, and a price/cash flow ratio of 8.0. What is its
P/E ratio?
A . 15 B. 16 C. 17 D. 18

2-Complete the balance sheet and sales information in the table that follows for Hoffmeister Industries using
the following financial data:
Debt ratio: 50%
Quick ratio: 0.80
Total assets turnover: 1.5
Days sales outstanding: 36.5 daysa
Gross profit margin on sales: (Sales – Cost of goods sold)/Sales = 25%
Inventory turnover ratio: 5.0
calculation is based on a 365-day year.
Balance Sheet
Cash Accounts payable
Accounts receivable Long-term debt 60,000
Inventories Common stock
Fixed assets Retained earnings 97,500
Total assets $300,000 Total liabilities and equity
Sales Cost of goods sold
A/P A . 60000 B. 70000 C. 80000 D. 90000
INV. A . 60000 B. 70000 C. 80000 D. 90000
FA A. 128000 B. 138000 C.1480000 D.1580000

3-Assume you are given the following relationships for the Clayton Corporation:
Sales/total assets 1.5
Return on assets (ROA) 3%
Return on equity (ROE) 5%
Calculate Clayton’s profit margin and debt ratio.
profit margin A . 2% B. 4% C. 6% D. 8%
debt ratio A . 20% B. 30% C. 40% D. 50%

4-Ace Industries has current assets equal to $3 million. The company’s current ratio is
1.5, and its quick ratio is 1.0. What is the firm’s level of current liabilities? What is
the firm’s level of inventories?
CL A . 2m B. 4m C. 6m D. 8m
INV. A . 1m B. 3m C. 5m D. 7m

5-Assume that the risk-free rate is 6% and that the expected return on the market is
13%. What is the required rate of return on a stock that has a beta of 0.7?
A . 10.9% B. 11.4 % C. 11.9% D. 12.9%

6-Assume that the risk-free rate is 5% and that the market risk premium is 6%. What
is the required return on the market, on a stock with a beta of 1.0, and on a stock
with a beta of 1.2?
rm A . 9% B. 10 % C. 11% D. 12%
rs A . 10.2% B. 11.2 % C. 12.2% D. 13.2%

7-An individual has $35,000 invested in a stock with a beta of 0.8 and another $40,000
invested in a stock with a beta of 1.4. If these are the only two investments in her
portfolio, what is her portfolio’s beta?
A . 1.0 B. 1.11 C. 1.12 D. 1.13
8-Boehm Incorporated is expected to pay a $1.50 per share dividend at the end of this
year (i.e., D1 = $1.50). The dividend is expected to grow at a constant rate of 7%
a year. The required rate of return on the stock, rs, is 15%. What is the value per
share of Boehm’s stock?
A . $16.25 B. $16.75 C. $18.25 D. $ 18.75

9-A stock is trading at $80 per share. The stock is expected to have a year-end dividend
of $4 per share (D1 = $4), and it is expected to grow at some constant rate g throughout
time. The stock’s required rate of return is 14%. If markets are efficient, what is
your forecast of g?
A . 8% B. 9% C. 10% D. 11%

10-Nick’s Enchiladas Incorporated has preferred stock outstanding that pays a dividend
of $5 at the end of each year. The preferred sells for $50 a share. What is the stock’s
required rate of return?
A . 10% B. 11% C. 12% D 13%

11-Summerdahl Resort’s common stock is currently trading at $36 a share. The stock is
expected to pay a dividend of $3.00 a share at the end of the year (D1 = $3.00), and
the dividend is expected to grow at a constant rate of 5% a year. What is its cost of
common equity?
A . 13.13% B. 14.13% C. 15.13% D. 116.13%

12-Shi Importer’s balance sheet shows $300 million in debt, $50 million in preferred
stock, and $250 million in total common equity. Shi’s tax rate is 40%, rd = 6%, rps =
5.8%, and rs = 12%. If Shi has a target capital structure of 30% debt, 5% preferred
stock, and 65% common stock, what is its WACC?
A . 8.17% B. 9.17% C. 10.17% D. 11.17%

13-Spencer Supplies’ stock is currently selling for $60 a share. The firm is expected to
earn $5.40 per share this year and to pay a year-end dividend of $3.60.
a. If investors require a 9% return, what rate of growth must be expected for
Spencer?
A . 3% B. 4% C. 5% D. 6%
b. If Spencer reinvests earnings in projects with average returns equal to the
stock’s expected rate of return, then what will be next year’s EPS?
A . $3.562 B. $ 4.562 C. $ 5.562 D. $ 6.562

14-Baxter Video Products’s sales are expected to increase by 20% from $5 million in
2010 to $6 million in 2011. Its assets totaled $3 million at the end of 2010. Baxter
is already at full capacity, so its assets must grow at the same rate as projected sales.
At the end of 2010, current liabilities were $1 million, consisting of $250,000 of
accounts payable, $500,000 of notes payable, and $250,000 of accruals. The aftertax
profit margin is forecasted to be 5%, and the forecasted payout ratio is 70%.
Use the AFN equation to forecast Baxter’s additional funds needed for the
coming year.
A . $400000 B. $410000 C. $220000 D. $430000
15-The Booth Company’s sales are forecasted to double from $1,000 in 2010 to $2,000
in 2011. Here is the December 31, 2010, balance sheet:
Cash $ 100 Accounts payable $ 50
Accounts receivable 200 Notes payable 150
Inventories 200 Accruals 50
Net fixed assets 500 Long-term debt 400
Common stock 100
Retained earnings 250
Total assets $1,000 Total liabilities and equity $1,000
Booth’s fixed assets were used to only 50% of capacity during 2010, but its current
assets were at their proper levels in relation to sales. All assets except fixed assets must
increase at the same rate as sales, and fixed assets would also have to increase at the
same rate if the current excess capacity did not exist. Booth’s after-tax profit margin
is forecasted to be 5% and its payout ratio to be 60%. What is Booth’s additional
funds needed (AFN) for the coming year?
A . $320 B. $340 C. $350 D. $360

16-Axel Telecommunications has a target capital structure that consists of 70% debt and
30% equity. The company anticipates that its capital budget for the upcoming year
will be $3 million. If Axel reports net income of $2 million and follows a residual
distribution model with all distributions as dividends, what will be its dividend payout
ratio?
A . 45% B. 50% C. 55% D. 60%

17-Petersen Company has a capital budget of $1.2 million. The company wants to maintain
a target capital structure which is 60% debt and 40% equity. The company forecasts that its net income this
year will be $600,000. If the company follows a residual distribution model and pays all distributions as
dividends, what will be its payout ratio?
A . 10% B. 20% C. 30% D. 40%

18-Gamma Medical’s stock trades at $90 a share. The company is contemplating a 3-for-2 stock split.
Assuming the stock split will have no effect on the total market value of its equity, what will be the company’s
stock price following the stock split?
A . $30 B. $40% C. $50% D. $60%

19-Shapland Inc. has fixed operating costs of $500,000 and variable costs of $50 per unit.
If it sells the product for $75 per unit, what is the break-even quantity?
A . $20000 B. $30000 C. $40000 D. $50000

20-Medwig Corporation has a DSO of 17 days. The company averages $3,500 in credit
sales each day. What is the company’s average accounts receivable?
A . $49500 B. $59500 C. $69500 D. $79500

21-What is the nominal cost of trade credit under the credit terms of 3/15,
net 30?
A . 57.75% B. 75.26% C. 26.75% D. 75.57%

22-Calculate the nominal annual cost of nonfree trade credit under each of the following
terms. Assume that payment is made either on the discount date or on the due date.
a. 1/15, net 20
A . 73.74% B. $74.73% C. 75.74% D. 76.73%

b. 2/10, net 60
A . 9.14% B. 14.9% C. 19.4% D. 4.19%

c. 3/10, net 45
A . 25.32% B. 15.32% C. 32.25% D. 25.25%
Question three:
What are the disadvantages/limitations of using financial ratios?

Why companies holding cash?

Best wishes