Final Exam Questions

Question 1
When developing a new financial plan, it is important to ask various questions. You should
consider how much the sales will grow, what fixed assets will be required for the plan to
work, the dividends to be paid to shareholders, and how much debt you will have to obtain
for the plan to be successful. (I, II, III, and IV).
Question 2
P/E (Price-to-Earnings) = Stock Price/Earnings per Share (EPS)
P/E for Firm A = $25/$1.25
= 20
P/E for Firm B = $35/$2.50
= 14
Firm A has a higher P/E of 20 meaning the investors are willing to pay a higher price.
Fair Stock value $500,000/1000000
= 0.5*20
= $10.50.

Question 3
Interest tax shield = Value of Tax – Deductible * Tax Rate
= $15,000,000 - $120,000
= $14,880,000 * 21%
= $3,124,800
Question 4
Given that
E(Ri) = Expected return on asset i
Rf = Risk-free rate of return
βi = Beta of asset i
and
E(Rm) = Expected market return
E(Ri) = Rf + βi * [E(Rm) – Rf]
= Rf = 21, [E(Rm) = 15%, βi = 1.5
 = 12.0%
Question 5
Minimum economic value in PV terms = $250 million - $175 million
= $75 Million
Question 6
Income - dividends =5
Share value = 79% of (112% of 5)/20
= $5.29
Question 7
Terminal Value = (FCF * (1 + g)) / (d - g)
Where:

FCF = Free cash flow for the last forecast period 

g = Terminal growth rate 

d = discount rate

TV = (39 *(1-4)/(4-12)

=246 million.

Question 8
When the capital costs are high, the elevated risk degree may result in risk of bankruptcy.
When more debts are added to the firm’s capital structure, its WACC increases way past the
normal level which increased bankruptcy. In this case, the ABC’s assets should have a higher
resale value than XYZ's assets.
Question 9
Current Ratio = Total Current Assets / Total Current Liabilities = 100300 / 400 = 250.7500
Quick Ratio = (Total Current Assets - Inventory) / Total Current Liabilities = (100300 -
100000) / 400 = 0.7500
Receivable Turnover = Sales / Accounts Receivable = 1000 / 0 = Infinity
Days' Receivables = Days / Receivable Turnover = 365 / Infinity = 0.0000
Inventory Turnover = Cost of Goods Sold / Inventory = 700 / 100000 = 0.0070
Days' Inventory = Days / Inventory Turnover = 365 / 0.0070 = 52142.8571
Fixed Assets Turnover = Sales / Net Fixed Assets = 1000 / 500 = 2.0000
Total Assets Turnover = Sales / Total Assets = 1000 / 100800 = 0.0099
Times Interest Earned = Earnings Before Interest and Taxes / Interest Expense = 70 / 20 =
3.5000
Debt Ratio = (Total Assets - Total Owner's Equity) / Total Assets = (100800 - 200) / 100800
= 0.9980
Debt to Equity Ratio = (Total Assets - Total Owner's Equity) / Total Owner's Equity =
(100800 - 200) / 200 = 503.0000
Equity Multiplier = Total Assets / Total Owner's Equity = 100800 / 200 = 504.0000
Profit Margin = Net Income / Sales = 25 / 1000 = 0.0250
Return on Assets (ROA) = Net Income / Total Assets = 25 / 100800 = 0.0002
Return on Equity (ROE) = Net Income / Total Owner's Equity = 25 / 200 = 0.1250
Payout and Retention Ratios = Dividend / Net Income = 0 / 25 = 0.0000
Earning per Share = Net Income / Shares Outstanding = 25 / 0 = Infinity
Price/Earning Ratio = Price per Share / Earning per Share = 0 / Infinity = 0.0000
Book Value per Share = Total Owner's Equity / Shares Outstanding = 200 / 0 = Infinity
Market-to-Book Ratio = Price per Share / Book Value per Share = 0 / Infinity = 0.0000
Question 10
Using the formula
WACC = (E/V * Re) + (D/V*Rd*(1-Tc)
Where
Re -cost of equity
Rd – cost of debt
E – Market Value of the firm’s equity
D - Market Value of the firm’s debt
V = E+D
E/V – Percentage of financing that is equity.
D/V - Percentage of financing that is
Tc – Corporate tax rate
E/V = 18/300 *100
= 0.06* 100
= 6%
Re = $3500
Rd = 3500 * (1 – 0.21)/2500 * 100
=110.6
(1+Tc) = 1.79
Market value of debt (D) = 300* 15
= 4500
V = 18+4500 = 4518.
WACC= (0.06*3500) – (4500/4518) *1.79*110.6
=12.81%
Question 11
BCR is an indicator used in identifying the benefits of a project vis-à-vis relative costs. So the
statement; Although BCR is scale insensitive, it can be a useful tool when ranking projects
under capital rationing. Is true.
Question 17
A. For a fast-growing firm, it is important to understand and trust the firm that a business
wants to finance its funding shortages. In this case, Signalling would be the most appropriate
since the other company have to credibly convey some of its information to you to gain your
trust.
B. For a mature firm with stable cash flow, management of incentives would be the most
relevant in addressing the excess cash flows. Employees play a key role in ensuring the
company’s success and it would be a good idea if the firm offers the benefits from the excess
cash flow.