Financial Management Handout #1

Prof. Cydnie C. Hieras, CPA

Revisiting Financial Management 1: Financial Statement Analysis

Financial Statements Analysis involves careful selection of data from financial statements in order to assess and
evaluate the firm’s past performance, its present obligation, and future business potentials.

Financial statement analysis is the process of analyzing a company's financial statements for decision-making
purposes. External stakeholders use it to understand the overall health of an organization as well as to evaluate
financial performance and business value. Internal constituents use it as a monitoring tool for managing the
finances.

Objectives of Financial Statement Analysis

The primary purpose of FS Analysis is to evaluate and forecast the company’s financial health. Interested parties,
such as managers, investors, and creditors, can identify the company’s financial strengths and weaknesses and
know about the:
1. Profitability of the business firm;
2. Firm’s ability to meet its obligations;
3. Safety of the investment in the business; and
4. Effectiveness of management in running the firm.

General Approach to Financial Statement Analysis

1. Evaluation of the environment (industry and economy as a whole) where the company conducts business.
2. Analysis of the firm’s short-term solvency*
*Solvency- Ability of an entity to pay off its debts.
3. Safety of the investment in the business; and
4. Effectiveness of management in running the firm.

Problems and Limitations in Financial Statement Analysis

1. Comparison of data
a. Difference between companies – a ratio that is acceptable to one company may not be acceptable to
another when other factors are considered.
b. Differences in accounting methods and estimates
c. Valuation problem – financial statements are based on historical costs and therefore, do not reflect
the current market value of the firm’s assets. Moreso, the effects of price level changes must be
considered.
d. The timing of transactions and use if averages in applying the various techniques in FS Analysis affect
the results obtained.

2. The need to look beyond ratios

Ratios are not sufficient in themselves as basis for judgements about the future. Other factors must be
considered, such as:
a. Industry Trends
b. Changes in technology
c. Changes in consumer tastes
d. Changes in the economy as a whole
e. Changes that are taking place within the company itself

Steps in Financial Statement Analysis

1. Establish objectives of the analysis to be considered
2. Study the industry where the firm belongs
 3. Study the firm’s background and the quality of its management.
4. Evaluate the firm’s financial statements using the evaluation techniques available.
5. Summarize the results of the studies and evaluation conducted.
6. Develop conclusions relevant to the established objectives.

Techniques Used in Financial Statements Analysis

1. Horizontal Analysis (Trend ratios and percentages)
– It involves comparison of figures shown in the financial statements of two or more consecutive
periods. The difference between the figures of the two periods is calculated, and the percentage change
from on period to another period to the next is computed using the earlier period as the base.
Formula:
Percentage Change = Most Recent Value – Period Value
Base Period Value
2. Vertical Analysis (Common-size statements)
-The process of comparing figures in the financial statements of a single period. It involves
converting of figures in the statements to a common base. This is accomplished by expressing all
the figures in the statements as percentages of an important item such as total assets (in the
balance sheet) or total or net sales (in the income statement). These converted statements are
called common size statements or percentage composition statements.

Example: CCH Corporation

Statement of Comprehensive Income
For the Year Ended December 31, 20X1
20X1 Percent
Sales P 3,280 100%
Less: Cost of Sales 2,120 64.63%
Gross Income 1,160 35.37%
Less: Operating Expenses 350 10.67%
Selling Administrative 420 12.80%
Total Operating Expenses P 390 11.90%

Less: Interest Expense 30 0.9%

EBT 360 10.98%
Less: Income Tax 126 3.84
Net Income P 234 7.13%

PERCENTAGE COMPUTED AS:

COST OF SALES: (COST RATE)

2,120/3,280 = 64.63%

GROSS INCOME: (GROSS PROFIT RATE)

1,160/3,280 = 35.37%

OPERATING EXPENSES:
350/3,280 = 10.67%

SELLING ADMINISTRATIVE:
420/3280 = 12.80%

TOTAL OPERATING EXPENSES: (NET INCOME FROM OPERATION / EARNINGS BEFRORE INTEREST AND TAXES)
390/3280 = 11.90%

INTEREST EXPENSE:
 30/3280 = 0.9%

EBT: (EARNINGS BEFORE TAX)

360/3280 = 10.98%

INCOME TAX:
126/3280 = 3.84%

NET INCOME:
234/3280 = 7.13%

3. Ratio Analysis
Ratios are calculated from the financial statements to provide users of such statements with relevant
information about the firm’s liquidity, use of leverage, asset management, cost control, profitability,
growth, and valuation.

A. Liquidity Ratios – provide information about the firm’s ability to pay its current obligations and
continue operations. Measures the short-term debt paying ability.

Current Ratio – Measures short term debt paying ability

Acid Test – Measures the immediate short-term liquidity
B. Leverage Ratios – measure the company’s use of the debt to finance assets and operations.
Finance Leverage (trading on equity) – the use of debt to finance assets and operations; it is advisable
to trade on equity when earnings from borrowed funds exceed the cost of borrowing.

-As leverage increases, the risk borne by creditors, as well as the risk that the firm may not be able to
meet its maturing obligations, increases.

-Since interest expense is tax deductible, leverage increases the company’s return when it is profitable.
**Solvency is the ability of a company to meet its long-term debts and financial obligations.
Solvency can be an important measure of financial health, since its one way of demonstrating a
company’s ability to manage its operations into the foreseeable future. (GOAL CONCERN
ASSUMPTION)

KEY INGREDIENTS OF SOLVENCY

1. Capital Structure – the sources of financing (DEBT / EQUITY)
2. Equity (the risk capital of the firm) – the ownership interest in the firm
3. Debt – the interest of creditors in the firm.

C. Cost Management Ratios- measure how well a firm controls its costs.
 D. Profitability Ratios –
measures earnings in
relation to some base,
such as assets, sales, or
capital.
CCH Corporation Statement of
Financial Position
E. Solvency Ratios-
measures of the ability
of the enterprise to
surviveover a long
period of time.

4. Analysis of variation in gross

profit and net income
5. Cash Flow Analysis
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Lecture Handouts #1-Problems Ratio

Analysis:

Problem 1(Liquidity Ratio)

For the comparative years ended Y1 and Y2

Year 2 Year 1
Cash 140 130

AR 160 140
Inventory 170 150
Prepaid Expense 90 90
Total Current Assets 560 510
 Current Liabilities Accounts
Payable 150 150
Accrued Liabilities 60 60
Notes Payable 60 60
Total Current Liabilities 270 270

FORMULA:

CURRENT RATIO = TOTAL CURRENT ASSETS / TOTAL CURRENT LIABILITY

QUICK RATIO = (CASH + A.R + MARKETTABLE SECURITIES) / TOTAL CURRENT LIABILITIES

1. What is CCH’s Current Ratio?

YEAR 2: YEAR 1:

560/270 = 2.07 510/270 = 1.88

2. What is CCH’s Quick Ratio?

YEAR 2: YEAR 1:

(140 + 160) / 270 = 1.11 (130 + 140) / 270 = 1

Problem 2

You are given an excerpt from the Financial Statement of Do-Turtle Corp. for the year ended 2020. As the Accounting manager of
the company, you are tasked by the CEO to determine the following:

1. What is Do-Turtle’s Current Ratio?

2. What is Do-Turtle’s Quick Ratio? The
following information are as follows:

Cash……………………….XXXX Accounts Payable....................350,000

AR…………………………..XXXX Notes Payable.........................50,000
Marketable Sec……….XXXX Total Current Liabilities…400,000 Inventory
.....................................1,200,000
Total Current Assets....................XXXXX
Problem 3

Winarak Corporation Statement of

Comprehensive Income For the Year Ended
December 31, 2020

Sales 500,000.00
 Cost of Goods Sold (LESS) (200,000.00)
Gross Margin 300,000.00
Selling & Administrative
Expenses (LESS) (50,000.00)

Net Operating Income/EBIT 250,000

Interest Expense (LESS) (12,000.00)

Net Income Before Taxes 238,000 – “TAXABLE INCOME”
Income Tax (30%) (238,000 x 30%) (71,400)
Net Income After Taxes 166,600

1. What is Winarak Corporation’s Gross Margin? 300,000

2. What is Winarak Corporation’s Sales Rate? 100%
3. What is Winarak Corporation’s COGS Rate? 40%
4. What is Winarak Corporation’s Gross Profit Rate? 60%
5. How much is Winarak Corp’s Income Tax? 71,400
6. How much is Winarak Corp’s Earnings Before Interest and Taxes (EBIT)? 250,000
7. How much is Winarak Corp’s Net Income Before Tax? 238,000
8. How much is Winarak Corp’s Net Income After Tax? 166,600
9. How much is Winarak Corp’s Profit Margin?
PROFIT MARGIN = NET INCOME / SALES
= 166,600 / 500,000
= 33.28%

10. How much is Winarak Corp’s Time Interest Earned Ratio?

TIME INTEREST EARNED RATIO = EBIT / INTEREST EXPENSE
= 250,000 / 12,000
= 20.83%
 Problem 4(Asset Turnover)
Digs Drama Series Inc.(DDS Inc.) has the following information lifted from its Statement of Comprehensive
Income for the year 2020.
Sales 350,000.00
Sales Discounts 20,000.00
Sales Returns 30,000.00
It also has reported total Assets of 800,000 pesos for the year 2020 (ENDING BALANCE) while its assets in 2019
was 680,000 pesos (BEGINNING BALANCE). As the consultant of DDS Inc., what is the Asset Turnover?

ASSET TURNOVER = NET SALES / AVERAGE ASSETS

=350,000 / [(680,000 + 800,000) / 2]
= 350,000 / (1,480,000 / 2)
= 350,000 / 740,000
= 47.3 / 40.54

Problem 5(Return on Assets 1)

Bong Gotohan Corp.’s net income last year is P65,000 and its interest income expense was P15,000. Total assets the
beginning of the year were P620,000 and total assets at the end of the yeat was P650,000. Bong Gotohan’s income
tax rate was 40%. The company’s return on total assets or the year is?
 CCH

RETURN OF ASSETS = NET INCOME (ADJUSTED INCOME) / AVERAGE TOTAL ASSETS

= (65,000 + 9,000) / [(620,000 + 650,000) / 2]
= 74,000 / 635,000
= 11.65%
INTEREST x (1 – TAX RATE)
15,000 x (1 – 40%)
15,000 x 60%
9000

Problem 6(Return on Assets 2)

MokaPeyk News Company’s most recent income statement appears below:

Sales (all on account) 610,000.00

Cost of Goods Sold (350,000.00)
Gross Margin 260,000
Selling and administrative expenses (110,000.00)
Net operating Income 150,000
Interest Expense (30,000.00)
Net Income before Taxes 120,000
Income Tax (30%) (36,000) -
Net Income After Taxes 84,000 -

The beginning balance of total assets was P650,000 and the ending balance was P580,000. As the consultant of
MokaPeyk News, what is the return on total assets (RoA)?

RETURN ON TOTAL ASSETS = 84,000 / [(650,000 + 580,000) /2)

= 84,000 / 615,000
= 13.65% / 13.66%

MAS Handout No.2-1

Interest Rates

I. Fundamentals of Interest Rate:

Interest rate or the required rate of return represents the cost of money.
Interest rate is usually applied to debt instruments such as bonds and bank loans.
Required rate of Return is usually applied to equity investments such as common stock capital (ordinary share
capital)

II. Factors that Influence The Equilibrium Interest Rate

1. Inflation:
Sources: 1
Fundamentals of Financial Management by Brigham and Houston 13th Edition
Financial Management by Gitman
Basic Finance by Besley and Brigham 2013-2015 Edition
 CCH

A rising trend in prices of goods and services. Typically, savers demand higher interest
returns (interest rates) when inflation is high because they want their investments to
more than keep pace with the rising prices.

2. Risk:
When people perceive that a particular investment is riskier, they will expect a higher return on that
investment as compensation for bearing the risk.
**Risk: In financial market context, the chance that a financial asset will bot earn the
return promised.

3. Liquidity Preference (Time Preference For Consumption):

The term liquidity preference pertains to the general tendency of investors to prefer shot-term securities
(more liquid)

4. Production Opportunity
The higher the expected return on the investment would be, the more the investor could
afford to offer potential investors their savings.

Real Rate of Interest – Rate that creates equilibrium between the supply of savings and the demand for
investment funds in a perfect world, without inflation, where suppliers and demanders of funds have no liquidity
preferences and there is no risk.

Nominal or Actual Rate of Interest (Return)

The actual rate of interest charged by supplier of funds and paid by the demander (Just like in
Intermediate/Financial Accounting, the Nominal Rate is the Stated Interest which could be seen in the contract
agreed upon by the debtor and the creditor)

The nominal rate of interest differs from the real rate of interest, r*, as a result of two factors, inflation and risk.
When people save money and save it, they are sacrificing consumption today (that is, they are spending less than
they could) in return for higher future consumption. When

Sources: 2
Fundamentals of Financial Management by Brigham and Houston 13th Edition
Financial Management by Gitman
Basic Finance by Besley and Brigham 2013-2015 Edition
 investors expect inflation to occur, they believe that the price of consuming goods and services will be higher in
the future than in the present.

When investors expect inflation to occur, they believe that the price of consuming goods and services will be
higher in the future than the present. Therefore, they will be reluctant to sacrifice today’s consumption unless the
return they can earn on the money they save (or invest) will be high enough to allow them to purchase the
goods and services they desire at higher future price.

(Meaning, Investors will require higher nominal rate of return if they expect inflation, the
higher rate of return is called INFLATION PREMIUM{IP})

Similarly, investors generally demand higher rates of return on risky investment as compared to
safe ones. Otherwise, there is little incentive for investors to bear the additional risk. Therefore,
investors will demand a higher nominal rate of return in risky investment. This additional rate
of return is called the RISK PREMIUM{RP}

Formula of Nominal Interest:

R1= R* + IP + RP1
NOMINAL INTEREST = NOMINAL RATE + INFLATION PREMIUM + RISK PREMIUM

Illustrative Problems:
Candy Corporation has a budget of P100,000 to buy its premium candies which are to be resold to its consumers.
Candy Corporation’s supplier offers them a price of 25 pesos for each candy. The accounting manager currently
ponders if he is to invest the P100,000 on a 1-year deposit, it will earn 7%. The current inflation rate is 4%.

Questions:
1. How many candies should Candy Corporation buy, if the accounting manager decides
not to invest the P100,000?

100,000 / 25 = 4,000

2. How much would Candy Corporation earn if the accounting manager opted to save the
P100,000 in the company’s deposit for a year?

(100,000 x 7%) x 100,000 = 170,000

3. How much would the candies cost after a year?

25 x 1.04 = 26
4. How much would be the effect of the inflation to the candies’ cost?

(26 – 25) / 25 = 0.04

5. What is the real rate of return? (Show two analysis)

a. [(107,000 / 26) – 4000] / 4,000 = 0.0288 / 3%

b. 7% - 4% = 3%

III. Term Structure of Interest Rates

 Term Structure of Interest Rates
- The relationship between the maturity and rate of return for bonds with similar
levels of risk.
Yield Curve
- A graphic depiction of the term structure of interest rates.
Yield to maturity
- Compound annual rate of return earned on a debt security purchased on a given
day and held to maturity.
Inverted Yield Curve
- A downward-sloping yield curve indicates that short-term interest rates are
generally higher than long-term interest rates.
Normal Yield Curve
- An upward-sloping yield curve indicates that long-term interest rates are generally
higher than short-term interest rates.
Flat Yield Curve
- A yield curve that indicates that interest rates do not vary much at different
maturities.
Expectations Theory
- The theory that yield curve reflects investor expectations about future interest
rates; an expectation of RISING interest rates results in an upward-sloping yield
curve, and an expectation of DECLINING rates results in a downward-sloping yield
curve.

Theories of Term Structure

Three theories are frequently cited to explain the general shape of the yield curve:
1. The expectations theory
2. The liquidity preference theory
3. Market Segmentation Theory

Expectations Theory
- Suggests that the yield curve reflects investor expectations about future interest
rates. According to this theory, when investors expect short-term interest rates to
rise in the future (perhaps because investors believe that inflation will rise in the
future), today’s long-term rates will be higher than current short-term rates, and
the yield curve will be upward sloping. The opposite is true when investors expect
declining short-term rates- today’s short-term rates will be higher than current
long-term rates, and the yield curve will be inverted.

Liquidity Preference Theory

- Theory suggesting that long-term rates are generally higher than short-term rates
(hence, the yield curve is upward sloping) because investors perceive short-term
investments to be more liquid and less risky than long-term investments to be more
liquid and less risky than long-term investments. Borrowers must offer higher rates
on long-term bonds to entice investors away from their preferred short-term
securities.
Market Segmentation Theory
- Theory suggesting that the market for loans is segmented on the basis of
maturity and that the supply of and demand for loans within each segment
determine its prevailing interest rate; the slope of the yield curve is
determined by the general relationship between the prevailing rates in each
market segment.

IV. RISK PREMIUMS: ISSUER AND ISSUE CHARACTERISTICS

R1= r* + IP +RP1
RP1 – the risk premium consists of a number of issuer and issue related components, including business
risk, financial risk, interest rate risk, liquidity risk, and tax risk, as well as the purely debt-specific risks-
default risk, maturity risk and contractual provision risk.

In general, the highest risk premiums and therefore the highest returns result from securities issued by
firms with a high risk of default and from long-term maturities that have unfavorable contractual
provisions.

Default Risk – The possibility that the issuer of debt will not pay the contractual interest or principal as
scheduled. The greater the uncertainty as to the borrower’s ability to meet these payments, the greater
the risk premium. High bond ratings reflect low default risk, and low bond ratings reflect high default risk.

Maturity Risk – the fact that longer the maturity, the more the value of a security will change in response
to a given change in interest rates. If the interest rates on otherwise similar-risk securities suddenly rise as
a result of a change in the money supply, the prices of long-term bonds will decline by more than the
prices of short-term bonds, and vice- versa.

Contractual Provision Risk – Conditions that are often included in a debt agreement or a stock issue.
Some of theses reduce risk, whereas others may increase risk. For example, a provision allowing a bond
issuer to retire its bonds prior to their maturity under favorable terms increases the bond’s risk.

Quiz 1: Fznanc?a2 Managemen[ Overwzev & F1 Ana2yszs:

Theory:

1. Which of the following statements is CORRECT?

a. One of the advantages of the corporate form of organization is that it avoids double taxation.
b. It is easier to transfer one’s ownership interest in a partnership than in a corporation.
C.

d. One of the advantages of a corporation from a social standpoint is that every stockholder has equal
voting rights, i.e., “one person, one vote.”
e. Corporations of all types are subject to the corporate income tax.

2. Which of the
conflicts of following actions would be most likely to reduce potential interest between
a. Pay managers stockholders and managers?
large cash salaries and give them no stock options.
b.

C. Beef up the restrictive covenants in the firm’s debt agreements.

 d. Eliminate a requirement that members of the board of directors must hold a high percentage of their
personal wealth in the firm’s stock.
e. For a firm that compensates managers with stock options, reduce the time before options are vested,
i.e., the time before options can be exercised and the shares that are received can be sold.

3. Which of the following actions would be most likely to reduce potential conflicts of interest between
stockholders and bondholders?
a. Compensating managers with stock options.
b. Financing risky projects with additional debt.
C. The threat of hostile takeovers.

d.
e. Abolishing the Security and Exchange Commission.

4. Which of the following statements is most correct?

a. ONE ADVANTAGE OF FORMING A CORPORATION IS THAT YOU HAVE
LIMITED LIABILITY
b. Corporations face fewer regulations than sole proprietorships.
c. One disadvantage of being a sole proprietor is that you have to pay corporate taxes, even though you don’t
realize the benefits of being a corporation.
d. Statements b and c are correct.
e. None of the statements above is correct.

5. Which of the following could explain why a business might choose to organize as a
corporation rather than as a sole proprietorship or a partnership?
a. Corporations generally face fewer regulations.
b. Corporations generally face lower taxes.
d. Corporations enjoy unlimited liability.
e. Statements c and d are correct.
CORRECT: CORPORATIONS GENERALLY FIND IT EASIER TO RAISE CAPITAL

6. Which of the following is an example of an area of business in which the use of

“questionable” ethics is considered a necessity?
a. Attracting and sustaining new customers.
b. Hiring and keeping skilled employees.
c. Keeping up with competition.
d. Dealing with firms who use “questionable” ethics.
e. NONE OF THE STATEMENTS ABOVE IS CORRECT

7. Which of the following statements is most correct?

a. A hostile takeover is the main method of transferring ownership interest in a corporation.
b. The corporation is a legal entity created by the state and is a direct extension of the legal status of its owners and
managers, that is, the owners and managers are the corporation.
c. Unlimited liability and limited life are two key advantages of the corporate form over other forms of business
organization.
d.

e. Although stockholders of the corporation are insulated by limited legal liability, the legal status of the
corporation does not protect the firm’s managers in the same way.
8. Which of the following statements is most correct?
a. The optimal dividend policy is the one that satisfies the shareholders because they supply the firm’s capital.
b. The use of debt financing has no effect on cash flow or stock price.
C. THE RISKINESS OF PROJECTED CASH FLOWS DEPENDS UPON HOW THE FILM IS FINANCED
d. Stock price is dependent on the projected cash flows and the use of debt, but not on the timing of the cash flow
stream.
e. Dividend policy is one aspect of the firm’s financial policy that is determined directly by the shareholders.

9. Which of the following statements is most correct?

a. Agency conflicts between stockholders and managers are not really a problem when outsiders (that is, non-
managers) own shares in a corporation.
b. Managers may operate in stockholders’ best interests, or managers may operate in their own personal best interests.
As long as managers stay within the law, there are no effective controls that stockholders can implement to control
managerial decision making.
C.

d. An agency relationship exists when one or more persons hire another person to
perform some service but withhold decision-making authority from that person.
e. None of the statements above is correct.
10. Which of the following statements is most correct?
a. One of the ways in which firms can mitigate or reduce agency problems between bondholders and
stockholders is by increasing the amount of debt in the capital structure.
b. The threat of takeover is one way in which the agency problem between stockholders and managers can be
alleviated.
c. Managerial compensation can be structured to reduce agency problems between stockholders and
managers.
d. STATEMENTS B AND C ARE CORRECT
e. All of the statements above are correct.

11. ARCY CORP’S CURRENT RATIO IS 0.5, WHILE SARSI COMPANY’S CURRENT RATIO IS 1.5. BOTH FIRMS WANT TO “WINDOW
DRESS”
Quiz 2 - Stocks and Bond Valuation 10/6/21, 4:02 PM

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Points 35 ! Published "

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# Question 2 pts

$%
1. The Jones Company has decided to undertake a large project. Consequently, there is a

need for additional funds. The financial manager plans to issue preferred stock with a
perpetual annual dividend of $10 per share and a par value of $30. If the required return
on this stock is currently 20 percent, what should be the stock’s market value?

$150

$100

Correct Answer $ 50

$ 25

$ 10

# Question 2 pts

Johnston Corporation is growing at a constant rate of 6 percent per year. It has both common
stock and non-participating preferred stock outstanding. The cost of preferred stock (kp) is 20
percent. The par value of the preferred stock is $120, and the stock has a stated dividend of
10 percent of par. What is the market value of the preferred stock?

$125

Correct Answer $60

$175

$150
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Quiz 2 - Stocks and Bond Valuation 10/6/21, 4:02 PM

$200

# Question 2 pts

A share of preferred stock pays a dividend of $0.50 each quarter. If you are willing to pay
$100.00 for this preferred stock, what is your nominal (not effective) annual rate of return?

10%

8%

Correct Answer 2%

12%

14%

# Question 2 pts

Assume that you plan to buy a share of XYZ stock today and to hold it for 2 years. Your
expectations are that you will not receive a dividend at the end of Year 1, but you will receive a
dividend of $9.25 at the end of Year 2. In addition, you expect to sell the stock for $150 at the
end of Year 2. If your expected rate of return is 16 percent, how much should you be willing to
pay for this stock today?

$164.19

$ 75.29

Correct Answer $122.54

$118.35

$131.74

# Question 2 pts

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Quiz 2 - Stocks and Bond Valuation 10/6/21, 4:02 PM

Assume that the average firm in your company’s industry is expected to grow at a constant rate of
5 percent, and its dividend yield is 4 percent. Your company is about as risky as the average firm
in the industry, but it has just developed a line of innovative new products, which leads you to
expect that its earnings and dividends will grow at a rate of 40 percent (D1 = D0(1.40)) this year
and 25 percent the following year after which growth should match the 5 percent industry average
rate. The last dividend paid (D0) was $2. What is the stock’s value per share?

$ 42.60

Correct Answer $ 82.84

$ 91.88

$101.15

$110.37

# Question 2 pts

Lamonica Motors just reported earnings per share of $2.00. The stock has a price earnings
ratio of 40, so the stock’s current price is $80 per share. Analysts expect that one year from
now the company will have an EPS of $2.40, and it will pay its first dividend of $1.00 per
share.

The stock has a required return of 10 percent. What price earnings ratio must the stock have
one year from now so that investors realize their expected return?

44.00

Correct Answer 36.25

4.17

40.00

36.67

# Question 2 pts

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Quiz 2 - Stocks and Bond Valuation 10/6/21, 4:02 PM

Newburn Entertainment’s stock is expected to pay a year-end dividend of $3.00 a share (D1 =
$3.00). The stock’s dividend is expected to grow at a constant rate of 5 percent a year. The risk-
free rate, kRF, is 6 percent and the market risk premium, (kM – kRF), is 5 percent.

The stock has a beta of 0.8. What is the stock’s expected price five years from now?

$60.00

Correct Answer $76.58

$96.63

$72.11

$68.96

# Question 2 pts

You have been given the following projections for Cali Corporation for the coming year.

Sales = 10,000 units.

Sales price per unit = $10.

Variable cost per unit = $5.

Fixed costs = $10,000.

Bonds outstanding = $15,000.

kd on outstanding bonds = 8%.

Tax rate = 40%.

Shares of common stock outstanding = 20,000 shares.

Beta = 1.4.

kRF = 5%.

kM = 9%.

Dividend payout ratio = 60%.

Growth rate = 8%.

Calculate the current price per share for Cali Corporation.

 $35.22

$46.27

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Quiz 2 - Stocks and Bond Valuation 10/6/21, 4:02 PM

Correct Answer $107.45

$53.72

# Question 2 pts

An annual coupon bond with a $1,000 face value matures in 10 years. The bond currently sells
for $903.7351 and has a 9 percent yield to maturity. What is the bond’s annual coupon rate?

6.7%

7.0%

7.2%

Correct Answer 7.5%

# Question 2 pts

A 12-year bond has a 9 percent annual coupon, a yield to maturity of 8 percent, and a face
value of $1,000. What is the price of the bond?

1,469

1,000

928

Correct Answer 1,075

1,957

# Question 2 pts

Palmer Products has outstanding bonds with an annual 8 percent coupon. The bonds have a
par value of $1,000 and a price of $865. The bonds will mature in 11 years. What is the yield to
maturity on the bonds?

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Quiz 2 - Stocks and Bond Valuation 10/6/21, 4:02 PM

Correct Answer 10.09%

11.13%

9.25%

8.00%

9.89%

# Question 2 pts

A corporate bond has a face value of $1,000, and pays a $50 coupon every six months (that
is, the bond has a 10 percent semiannual coupon). The bond matures in 12 years and sells at
a price of $1,080. What is the bond’s nominal yield to maturity?

8.28%

8.65%

Correct Answer 8.90%

9.31%

10.78%

# Question 2 pts

A bond matures in 12 years and pays an 8 percent annual coupon. The bond has a face value
of $1,000 and currently sells for $985. What is the bond’s current yield and yield to maturity?

Current yield = 8.00%; yield to maturity = 7.92%

Correct Answer Current yield = 8.12%; yield to maturity = 8.20%

Current yield = 8.20%; yield to maturity = 8.37%

Current yield = 8.12%; yield to maturity = 8.37%

 Current yield = 8.12%; yield to maturity = 7.92%

# Question 2 pts

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Quiz 2 - Stocks and Bond Valuation 10/6/21, 4:02 PM

A bond with a face value of $1,000 matures in 12 years and has a 9 percent semiannual
coupon. (That is, the bond pays a $45 coupon every six months.) The bond has a nominal
yield to maturity of 7.5 percent, and it can be called in 4 years at a call price of $1,045. What is
the bond’s nominal yield to call?

Correct Answer 6.61%

11.36%

3.31%

9.98%

5.68%

# Question 2 pts

A corporate bond that matures in 12 years pays a 9 percent annual coupon, has a face value
of $1,000, and a yield to maturity of 7.5 percent. The bond can first be called four years from
now. The call price is $1,050. What is the bond’s yield to call?

Correct Answer 6.73%

7.10%

7.50%

11.86%

# Question 1 pts

One of the basic relationships in interest rate theory is that, other things held constant, for a
given change in the required rate of return, the the time to maturity, the the change in price.

a. longer; smaller.
 b. shorter; larger.

c. longer; greater.

d. shorter; smaller.

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Quiz 2 - Stocks and Bond Valuation 10/6/21, 4:02 PM

Correct Answer e. statements C and D are correct

# Question 1 pts

Which of the following statements is most correct?

All else equal, long-term bonds have more interest rate risk than short-term bonds.

Correct Answer All of the statements above are correct.

All else equal, high-coupon bonds have more reinvestment rate risk than low-coupon
bonds.

All else equal, short-term bonds have more reinvestment rate risk than do long-term
bonds.

Statements a and c are correct.

# Question 1 pts

Which of the following events would make it more likely that a company would choose to call
its outstanding callable bonds?

Correct Answer A reduction in market interest rates.

The company’s bonds are downgraded.

An increase in the call premium.

Statements a and b are correct.

Statements a, b, and c are correct.

# Question 1 pts

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Quiz 2 - Stocks and Bond Valuation 10/6/21, 4:02 PM

Other things held constant, if a bond indenture contains a call provision, the yield to maturity that
would exist without such a call provision will generally be the YTM with a call provision.

Higher than.

Correct Answer Lower than.

The same as

Either higher or lower (depending on the level of the call premium)than.

# Question 1 pts

Which of the following statements is most correct?

Correct Answer All else equal, if a bond’s yield to maturity increases, its price will fall.

All else equal, if a bond’s yield to maturity increases, its current yield will fall.

If a bond’s yield to maturity exceeds the coupon rate, the bond will sell at a premium
over par.

All of the statements above are correct.

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