FIN 323

Quiz #2

Solutions

1. The internal growth rate of a firm is best described as the:

A. minimum growth rate achievable assuming a 100 percent retention ratio.
B. minimum growth rate achievable if the firm maintains a constant equity
multiplier.
C. maximum growth rate achievable with unlimited debt financing.
D. maximum growth rate achievable while maintaining a constant debt-equity
ratio.
E. maximum growth rate achievable excluding external financing of any kind.
Refer to section 4.4
2.

Describe the difference between simple and compound interest with an example?

Consider the example

FV with simple interest = 1,000 + 50 + 50 = 1,100
FV with compound interest = 1,102.50
The extra 2.50 comes from the interest of .05(50) = 2.50 earned on the first interest
payment

In simple interest, the interest is taken out and not added back to the principal, and
so the interest every year remains the same, while in compound interest, every year
interest is added back to the principal, so there is interest on interest.

3 One year ago, you invested $1,800. Today it is worth $1,924.62. What rate of
interest did you earn?
A. 6.59 percent
B. 6.67 percent
C. 6.88 percent
D. 6.92 percent
E. 7.01 percent

4. Your father invested a lump sum 26 years ago at 4.25 percent interest. Today, he
gave you the proceeds of that investment which totaled $51,480.79. How much did
your father originally invest?
A. $13,929.47
B. $14,500.00
C. $15,146.45
D. $16,274.37
E. $17,444.86

5. The Cookie Shoppe expects sales of $437,500 next year, net income of $21,000,
a profit margin of 4.8 percent and the firm has a 20 percent dividend payout ratio.
What is the projected addition to retained earnings?
A. $14,700
B. $16,800
C. $18,300
D. $20,600
E. $21,000
Change in retained earnings = $21,000 * .8 = $16,800

6. Frifeldt Farm just paid a dividend of $3,380, has total equity of $39,000, and a
net income of $13,000. What is the sustainable growth rate?
A. 12.57%
B. 22.49%
C. 28.04%
D. 32.74%
E. 38.55%
ROE = 13,000/39,000 = 0.3333 = 33.33%
Beta = 1 (3,380/13,000) = 0.74 = 74%

Sustainable growth rate = (ROE b) / [1 (ROE b)]

Sustainable growth rate = (.3333 .74) / [1 (.3333 .74)]
Sustainable growth rate = (..246642) / [1 (.246642)]
Sustainable growth rate = 0.32739 = 32.74%
7. Buchis Bazooka Factory has a payout ratio of 50%, and return on assets of
12.63%. What is the internal growth rate?
A. 2.57%
B. 6.74%
C. 8.94%
D. 12.74%
E. 18.55%

7. Pro-forma income statement

Sales

36800 (32000*1.15)

Costs

28060

Net Income 8740

Dividend paid: 50% of net income=4370
Addition to retained earnings: 8740-4370=4370
Pro forma balance sheet
Assets:

29095

Debt:

5800

Equity: 19500+4370=23870
Total: 29670
EFN=-575, No EFN needed in this case.