IEFINMT REVIEWER FOR QUIZ [#1]

I. Definition of Terms

Index Analysis Return on Assets Inventory Turnover Coverage Ratios

Common Size Analysis Debt Ratios Yield Curve Return on Equity
Quick Ratio Financing Activities Interest Rate Risk Maturity Risk Premium
Investing Activities Net Working Capital Free Cash Flow NOPAT
P/E Ratio Income Statement Current Ratio Statement of Cash
Flow
Leverage Default Risk Premium Basic Earning Power Average Collection
Period
Each of the following statements may or may not describe one of the technical financial terms
above. For each statement, indicate the financial term described or answer None if the statement
does not correctly describe any of the terms.

___________ 1. Alternative measure of income without consideration of the cost of capital or cost of
financing

___________ 2. Changes in financial statement items from a base year to following years expressed as a
percentage of the base year amount and designed to show the extent and direction of change.

___________ 3. The section of a funds flow statement summarizing the cash effects of most
transactions that enter into the determination of net income.

___________ 4. Average time period between the company’s purchase of merchandise and the
conversion (or more likely conversion) of this merchandise back into cash.

___________ 5. Buying assets with money raised through debt or arises as part of the impact of debt
financing.

___________ 6. Considers all current assets to be of the same degree of liquidity and assesses whether
these will be enough to pay for current obligations if these assets are liquidated.

___________ 7. The longer the time to maturity of the debt instrument the higher this will be because
of the greater decrease in the market value of the debt.

___________ 8. Tracks interest rate level of debt instrument of varying periods to maturity

___________ 9. Ratio acting as the profitability measure to the total financing received by the
company.

___________ 10. Indicator of a company’s debt paying and servicing capability.

II. Multiple Choice

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SEBRING CORPORATION INCOME STATEMENTS FOR YEAR ENDING

DECEMBER 31
(MILLIONS OF DOLLARS)
2002 2001
Sales $ 3,600.0 $ 3,000.0
Operating Costs (excluding depreciation and amortization) 3,060.0 2,550.0
EBITDA $ 540.0 $ 450.0
Depreciation and amortization 90.0 75.0
Earnings before interest and taxes $ 450.0 $ 375.0
Interest 65.0 60.0
Earnings before taxes $ 385.0 $ 315.0
Taxes (40%) 154.0 126.0
Net income available to common stockholders $ 231.0 $ 189.0
Common dividends $ 181.5 $ 13.2
SEBRING CORPORATION BALANCE STATEMENTS FOR YEAR ENDING
DECEMBER 31
(MILLIONS OF DOLLARS)
2002 2001
Assets:
Cash and marketable securities $ 36.0 $ 30.0
Accounts Receivable 540. 0 450.0
Inventories 540.0 600.0
Total current assets $ 1,116.0 $ 1,080.0
Net plant and equipment 900.0 750.0
Total assets $ 2,016.0 $ 1,830.0

Liabilities:
Accounts Payable $ 324.0 $ 270.0
Notes Payable 201.0 155.0
Accruals 216.0 180.0
Total current liabilities $ 741.0 $ 605.0
Long-term bonds 450.0 450.0
Total debt $ 1,191.0 $ 1,055.0
Common stock (50 million shares) 150.0 150.0
Retained earnings 675.0 625.0
Total common equity $ 825.0 $ 775.0
Total liabilities and equity $ 2,016.0 $ 1,830.0

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1. What is Sebring’s net operating profit after taxes (NOPAT) for 2002?
a. $100,000,000
b. $150,000,000
c. $225,000,000
d. $270,000,000
e. $375,000,000
2. What is Sebring’s amount of total investor-supplied operating capital for 2002?
a. $576,000,000
b. $888,000,000
c. $900,000,000
d. $1,275,000,000
e. $1,476,000,000
3. What is Sebring’s free cash flow for 2002?
a. $85,000,000
b. $146,000,000
c. $174,000,000
d. $255,000,000
e. $366,000,000
4. Which of the following statements is most correct for Sebring?
a. The dramatic increase in dividends was most likely funded by debt.
b. Net working capital requirements increased from 2001 to 2002.
c. The company did not use additional external financing for its 2002 operations and
investments.
d. Statements a and b are correct.
e. None of the statements are correct.
5. Kansas Office Supply had $24,000,000 in sales last year. The company’s net income was
$400,000. Its total assets turnover was 6.0 and the company’s ROE was 15%. The company is
financed entirely with debt and common equity. What is the company’s debt-asset ratio?
a. 0.20
b. 0.30
c. 0.33
d. 0.60
e. 0.66
6. As a short-term creditor concerned with a company’s ability to meet as financial obligation to
you, which one of the following combinations of ratios would you most likely prefer?

Quick Ratio TIE Debt Ratio Inventory Loan

a. 0.5 0.5 0.33 8
b. 1.0 1.5 0.50 3

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c. 1.5 1.0 0.50 5

d. 2.0 1.0 0.67 7
e. 2.5 0.5 0.71 7
7. You recently sold 100 shares of Microsoft stock to your brother at a family reunion. At the
reunion, your brother gave you a check for the stock and you gave your brother the stock
certificates. Which of the following best describes the transaction?
a. Futures market.
b. Primary market transaction.
c. Exchange of physical assets.
d. Money-market transaction.
e. None of the above.
8. Which of the following statements is most correct?
a. The yield on a 3-year Treasury bond cannot exceed the yield on a 10-year Treasury bond.
b. The yield on a 2-year corporate bond will always exceed the yield on a 2-year Treasury bond.
c. The yield on a 3 year corporate bond will always exceed the yield on a 2-year corporate
bond if the yield curve is normal.
d. Statements b and c are correct.
e. All of the statements above are correct.
9. Which of the following factors are likely to lead to an increase in nominal interest rates?
a. Households increase that saving rate
b. Companies see an increase in their production opportunities that leads to an increase the
demand for funds.
c. There is an increase in expected inflation.
d. Statements b and c are correct.
e. All of the statements above are correct.
10. The real risk-free rate is expected to remain constant at 3 percent inflation is expected to be 2
percent a year for the next 3 years, and then 4 percent a year thereafter. The maturity risk
premium is 0.1%(t-1), where t equals the years to maturity of the bond. (The maturity risk
premium on a 5-year bond is 0.4 percent.) A 5-year corporate bond has a yield of 8.4 percent.
What is the yield on a 7-year corporate bond that has the same default risk and liquidity
premiums as the 5-year corporate bond?
a. 8.73%
b. 8.94%
c. 8.65%
d. 7.98%
e. 9.24%
11. What is the appropriate inflation premium for the 12-year treasury bond?
a. 4%
b. 3%

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c. 3.33%
d. 5.4%
III. Professor Oak, the new financial manager of Pokemart, Inc., a producer of Super Potions
and other specialized chemicals for use in Pokemon battles must prepare a formal financial
forecast for 2006. Pokemart’s 2005 sales were 52 billion and the marketing department is
forecasting a 25% increase for 2006. Oak thinks the company was operating at full capacity
in 2005. The first step in his forecast was to assume that the ratios would remain unchanged
and that it would be “business as usual” at Pokemart. The 2005 financial statements, the
2006 initial forecast, and a ratio analysis for 2005 and the 2006 initial forecast are given as
follows.

A. Balance Sheet
2005 2006 (Estimate)
Cash and Cash Equivalents 20 25
Accounts Receivable 240 300
Inventories 240 300
Total Current Assets 500 625
Net Fixed Assets 500 625
Total Assets 1000 1250

Accounts Payable and Accrued 100 125

Liabilities
Notes Payable 100 190
Total Current Liabilities 200 315
Long Term Debt 100 190
Common Stock 500 500
Retained Earnings 200 245
Total Liabilities and Equity 1000 1250

B. Income Statement
2005 2006 (Estimates)
Sales 2000 2500
Less: Variable Costs 1200 1500
Fixed Costs 700 875
Earnings Before Interest and Tax 100 125
(EBIT)
Interest 16 16
Earnings Before Taxes 84 109
Taxes (40%) 33.60 43.60
Net Income 50.40 65.40
Dividends 15.12 19.62

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Addition to Retained Earnings 35.28 45.78

C. Key Ratios
Pokemart (2005) Pokemart (2006 Est.) Industry
Basic Earning Power 10% 10% 20%
Profit Margin 2.52 2.62 4.00
Return on Equity 7.20 8.77 15.60
DSO (365 days) 43.80 43.80 32.00
Inventory 8.33 8.33 11.00
Turnover(Sales/Inventory
)
Fixed Asset Turnover 4.00 4.00 5.00
Total Asset Turnover 2.00 2.00 2.50
Debt/Assets 30% 40.34% 36.00%
Times Interest Earned 6.25 7.81 9.40
Current Ratio 2.5 1.99 3.00
Payout Ratio 30% 30% 30%
a. Assume (1) that Pokemart was operating at full capacity in 2005 with respect to all of its assets,
(2) that all assets must grow at the same rate as sales, (3) that accounts payable and accrued
liabilities will also grow at the same rate as sales, and (4) that the 2005 profit margin and
dividend payout will be maintained. Under these conditions, what would the AFN equation
predict the company’s financial requirements to be for the coming year?
b. Consultations with several key managers within Pokemart, including production, inventory, and
receivable managers, have yielded some very useful information.
1. Pokemart’s high DSO is largely due to one significant customer who battled through some
hardships over the past 2 years, but who appears to be financially healthy again and is
generating strong cash flow. As a result, Pokemart’s accounts receivable manager expects
the firm to lower receivables enough to make DSO equal to 34 dats, without adversely
affecting sales.
2. NWC was operating a little below capacity, but its forecasted growth will require a new
facility, which is expected to increase Pokemart’s net fixed assets to $700 million.
3. A relatively new inventory management system (installed last year) has taken some time to
catch on and operate efficiently. Pokemart’s inventory turnover improved lightly last year,
but this year Pokemart expects even more improvements as inventories decrease and
inventory turnover is expected to rise to 10x.

Incorporate these information into the 2006 initial financial forecast results, as these adjustments to the
initial forecast represent the final forecast for 2006. Any funds needed wil be sourced equally from
Notes Payable to Long Term Debt.

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c. Compute Pokemart’s forecasted ratios based on its final forecast and compare them with the
company’s 2005 historical ratios, the 2006 initial ratios, and with the industry average. Assess
the statements that follow whether each of them is true or false. (This part was right minus in
the quiz.)
1. The company’s financing strategy for the additional funds it needs (equally sourcing it from
notes payable and long-term debt) seems to have improved its riskiness profile and led to a
better ROE position relative to 2005.
2. If the company is currently operating for one shift only (that is, for a single 8-hour
production run), the possibility of going overtime rather than purchasing more assets is an
option worth looking into.
3. Reducing the usage of debt and funding by common stocks instead would lead to a
significant improvement in the company’s BEP and might even put it at par with the
industry’s average standing. [BEP is basic earning power ratio which is EBIT divided by total
assets.]
4. The ratios seem to highlight a need to improve the company’s asset management practices
or policies. This seems to be a good move to take as any improvement done on this area
could send ripple (chain reaction) effects on the other areas of the company’s financial
performance, leading to a slight to moderate improvement in profitability as well.
d. Several factors may affect a company’s AFN. Evaluate the following statements again as to their
truth or falsity, on how the factor specified relate to the additional external financing
requirements of a company.
1. If the company is profitable and has any payout ratio less than 100%, it will have some
retained earnings; so if the company’s sales growth rate is zero, the firm will have surplus
funds. As growth rate rises above zero, these surplus funds would be used to finance
growth.
2. Even in the presence of excess capacity in the company’s assets, the AFN equation gives a
highly reliable forecast of the external financing requirement needed.
3. If the company’s payment terms with the supplier will be increased from net 30 to net 60,
the amount of external financing would also go up.
4. The higher the capital intensity ratio, the more new money would be required to support an
additional dollar of sales. Thus, the higher tha capital intensity ratio, the greater the AFN,
other things held constant.
5. In the presence of a significant amount of a significant amount of base or safety stock of
inventory, the AFN equation would overestimate the amount of funds being freed up (or
surplus funds) compared to situations wherein such kind of stocks is absent or insignificant
in amount.
IV. The financial statements of Dalton Corp are given below:

December 31

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Assets
Cash 15,000 90,000
Short Term Investments 200,000 -
Accounts Receivable (net) 590,000 440,000
Inventory 600,000 615,000
Long Term Investments 310,000 390,000
Property, Plan and Equipment 1,905,000 1,205,000
Accumulated Depreciation (510,000) (500,000)
Total Assets 3,110,000 2,240,000
Liabilities and Stockholders’
Equity
Accounts Payable and Accrued 900,000 850,000
Liabilities
Short-Term Debt 190,000 -
Common Stock, $10 par value 775,000 675,000
Additional Paid-in-Capital 380,000 300,000
Retained Earnings 865,000 415,000
Total Liabilities and 3,110,000 2,240,000
Stockholders’ Equity
Information relating to 20X6 Activities.

 Net Income was $800,000

 Cash dividends of $350,000 were declared and paid
 Equipment costing $450,000 and having a book value of $200,000 was sold for $200,000
 A long-term investment was sold for $150,000. There was no other transactions affecting long-
term investment in 20X6. This transaction resulted in a gain of $70,000 recognized in the income
statement.
 10,000 shares of common stock were issued for $18 per share.
 Short-term investments consist of Treasury bills maturing on June 30, 20X7.

OPERATING ACTIVITIES
Sources of Cash Amount Uses of Cash Amount

NET CASH GENERATED BY OPERATING ACTIVITIES =

INVESTING ACTIVITIES
Sources of Cash Amount Uses of Cash Amount

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NET CASH GENERATED BY INVESTING ACTIVITIES =

FINANCING ACTIVITIES
Sources of Cash Amount Uses of Cash Amount

NET CASH GENERATED BY FINANCING ACTIVITIES =

ANSWER KEY:

I. Definition of Terms
1. NOPAT
2. Index Analysis
3. None
4. DSO
5. Leverage
6. Current Ratio
7. Maturity risk premium
8. None
9. ROE
10. Quick Ratio
II. Multiple Choice
1. D
2. E
3. C
4. E
5. C
6. B
7. E
8. B
9. D

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10. B
11. C
III. Professor Oak problem

a. What is the final forecasted accounts receivable value? 232.875 M

Final forecasted total assets: 1207.875 M

Final forecasted total current liabilities: 293.9375 M

Final forecasted retained earnings: 245 M

b.

1. False

2. True

3. False

4. True

c.

1. True

2. False

3. False

4. True

5. True

IV. Statement of Cash Flow

OPERATING ACTIVITIES
Sources of Cash Amount Uses of Cash Amount
Net Income 800,000 Inc in A/% 150,000
Depreciation 10,000
Decrease in Inventory 15,000
Increase in B/P 50,000
875,000 150,000
NET CASH GENERATED BY OPERATING ACTIVITIES = 725,000

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INVESTING ACTIVITIES
Sources of Cash Amount Uses of Cash Amount
Dec. in Long Term 80,000 Inc. in Short Term 200,000
Investments Investments
Inc. in Fixed Assets 710,000

80,000 910,000
NET CASH GENERATED BY INVESTING ACTIVITIES = (830,000)

FINANCING ACTIVITIES
Sources of Cash Amount Uses of Cash Amount
Inc. in Common Stock 100,000
Inc. in Paid-in-Capital
80,000
Inc. in Short Term Debt
190,000
Issuance of Stock 180,000
550,000 0
NET CASH GENERATED BY FINANCING ACTIVITIES = 550,000

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