QUESTION 1 MCQS (14 MARKS)

1. A decrease in the debt ratio will generally have no effect on ____________

a. Financial risk
b. Total risk.
c. Business risk
d. Market risk

2. Business risk is concerned with the operations of the firm. Which of the following is not
associated with (or not a part of) business risk?
a. Demand variability
b. Sales price variability
c. The extent to which operating costs are fixed.
d. Changes in required returns due to financing decisions.

3. The firm's target capital structure is consistent with which of the following?
a. Maximum earnings per share (EPS).
b. Minimum cost of debt (kd).
c. Minimum cost of equity (ks).
d. weighted average cost of capital (WACC).
4. Which of the following factors is likely to encourage a corporation to increase the proportion
of debt in its capita structure?
a. An increase in the corporate tax rate.
b. An increase in the personal tax rate
c. An increase in the company's degree of operating leverage.
d. The company's assets become less liquid.

5. Which of the following would increase the likelihood that a company would increase its debt
ratio in its capital structure?
a. An increase in costs incurred when filing for bankruptcy.
b. An increase in the corporate tax rate.
c. An increase in the personal tax rate.
d. An increase in the firm's business risk.

6. As a general rule, the capital structure that

a. Maximizes expected EPS also maximizes the priceper share of common stock.
b. Minimizes the interest rate on debt also maximizesthe expected EPS.
c. Minimizes the required rate on equity alsomaximizes the stock price
d. Maximizes the price per share of common stock also

7. Which of the following statements is most correct?

a. Firms whose sales are very sensitive to changes in the business cycle are more likely
to rely on debt financing
b. Firms with large tax loss carry forwards are more likely to rely on debt financing
c. Firms with a high operating leverage are more likely to rely on debt financing.
d. None of the statements above is correct.
8. In the real world, we find that dividends
a. Usually exhibit greater stability than earnings.
b. Fluctuate more widely than earnings.
c. Tend to be a lower percentage of earnings for mature firms.
d. Are usually changed every year to reflect earnings changes.

9. A decrease in a firm's willingness to pay dividends is likely to result from an increase in its
a. Earnings stability.
b. Access to capital markets.
c. Profitable investment opportunities.
d. Collection of accounts receivable.

10. The lease analysis should compare the cost of leasing to the
a. Cost of owning using debt.
b. Cost of owning using equity
c. After-tax cost of debt to measure the effect of leasing on the cost of equity
d. Average cost of all fixed charges.

11. A lockbox plan is most beneficial to firms that

a. Send payables over a wide geographic area.
b. Have widely disbursed manufacturing facilities.
c. Hold inventories at many different sites.
d. Make collections over a wide geographic area

12. Which of the following would not have an influence on the optimal dividend policy?
a. The possibility of accelerating or delaying investment projects
(All of the above can have an effect on dividend policy)
13. A stock split will cause a change in the total dollar amounts shown in which of the following
balance sheet accounts?
a. Common stock.
b. Paid-in capital.
c. Retained earnings.
d. None of the statements above is correct.

14. If a firm adheres strictly to the residual dividend policy, a sale of new common stock by the
company would suggest that
a. The dividend payout ratio has remained constant.
b. The dividend payout ratio is increasing.
c. No dividends were paid for the year.
d. The dividend payout ratio is decreasing
15. Which of the following is not commonly regarded as being a corporate's credit policy
variable?
a. Credit period.
b. Collection policy.
c. Credit standards
d. Credit manager salary
16. The riskiness of the cash flows to the lessee with the possible exception of residual value, is
about the same the riskiness of the lessee's
a. Equity cash flows.
b. Capital budgeting project cash flows
c. Debt cash flows.
d. Pension fund cash flows.

17. Which of the following actions will enable a company to raise additional equity capital (that
is, which of the following will raise the total book value of equity)?
a. The establishment of a new-stock dividend reinvestment plan
b. A stock split.
c. The establishment of an open-market purchase dividend reinvestment plan.
d. A stock repurchase.

18. Which of the following statements is most correct?

a. Financial leases are fully amortized.
b. Financial leases can be cancelled.
c. Financial leases provide for maintenance services
d. Operating leases can never be cancelled.

19. Other things held constant, which of the following will cause an increase in working capital?
a. Cash is used to buy marketable securities.
b. A cash dividend in declared and paid
c. Merchandise is sold at a profit, but the sale is on credit
d. Lone-term bonds are returned with the proceeds of

20. A lockbox plan is

a. A method for safe keeping of marketable securities.
b. Used to identify inventory safety stocks.
c. A system for slowing down the collection of checkswritten by a firm
d. A system for speeding up a firm's collections ofchecks received

21. Which one of the following aspects of banks is consideredmost relevant to businesses when
choosing a bank?
a. Convenience of location
b. Competitive cost of services provided.
c. Size of the bank's deposits.
d. Loyalty and willingness to assume lending risks,

22. The Price Company will produce $5,000 widgets nextyear. Variable costs will equal 40
percent of sales, whilefixed costs will total $110,000. At what price must eachwidget be sold
for the company to achieve an EBIT of$95,000?
a. $2:00
b. $4.45
c. $5.00
d. $6.21
 23. Texas Products Inc has a division that makes burlap bags for the citrus industry. The division
has fixed costs of $10.000 per month, and it expect to sell 42,000 bags per month. If the
variable cost per bag is $2.00, what price must the division charge in order to break even?
a. $2.24
b. $2.47
c. $2.82
d. $2.00

24. Loiselle Graphics recently announced a 3-for-1 stock split. Prior to the split, the company a
stock was trading at $90 per share. The split had no effect on the wealth of the company's
investor, what will be the new stock price?
a. $270
b. $ 45
c. $180
d. $ 30

Question 4 ( Marks)

Callison Airlines is deciding whether to pursue a restricted or relaxed current asset investment
policy. Callison's annual sales are expected to total $3.6 million, its fixed assets turnover ratio equals
4.0, and its debt and common equity are each 50 percent of total assets. EBIT is $150,000, the
interest rate on the firm's debt is 10 percent, and the firm's tax rate is 40 percent. If the company
follows a restricted policy, its total assets turnover will be 2.5. Under a relaxed policy, its total assets
turnover will be 2.2.

1. If the firm adopts a restricted policy, how much will it save in interest expense what is the
difference in the projected ROEs between the restricted and relaxed policies?
2. Assume now the company expects that if it adopts a restricted policy, its sales will fall by 15
percent, EBIT will fall by 10 percent, but its total assets turnover, debt ratio, interest rate,
and tax rate will remain the same. In this situation, what is the difference in the projected
ROEs between the restricted and relaxed policies?

Question 6 (3 Marks)

Your company has decided that its capital budget during the coming year will be $20 million. Its
optimal capital structure is 60percent equity and 40 percent debt. Its earnings before interest and
taxes (BIT) are projected to be $34.667 million for the year.The company has $200 million of assets;
its average interest rate on outstanding debt is 10 percent; and its tax rate is 40 percent. Ifthe
company follows the residual dividend policy and maintains the same capital structure, what will its
dividend payout ratio be?
Question 3 (4 Marks)

Garlington Technologies Inc.' 2007 financial statements are shown below.

Garlington Technologies Inc.

Balance Sheet

As Of December 31, 2007

Cash 180,000 Accounts Payable 360,000

Receivables 360,000 Notes Payable 156,000

Inventories 720,000 Accruals 180,000

Total current assets 1,260,000 Total current Liabilities 696,000

Fixed Assets 1,440,000 Common stock 1,800,000

Retained Earnings 204,000

Total Assets 2,700,000 Total Liabilities & Equity 2,700,000

Garlington Technologies Inc.

Income Statement
 For the year ended December 31, 2007

Sales 3,600,000

Operating costs 3,279,720

EBIT 320,280

Interest 18,280

EBIT 302,000

Taxes (40%) 120,800

Net Income 181,200

Dividends 108,000

Suppose that in 2008 sales increase by 10% over 2007 sales and that 2008 dividends will increase to
$112,000. Construct the pro forma financial statements using the percent of sales method. Assume
the firm operated at full capacity in 2007, Use an interest rate of 13% on the debt balance at the
beginning of the year.
Question 5 (4 Marks)

The balance sheet of Roop Industries is shown below. The 12/31/2007 value of operations is $651
million and there are 10 million shares of common equity. What is the price per share?

Balance Sheet

31 Dec 07

(Million of Dollars)

Assets Liabilities & Equity

Cash 20 Account Payable 19

Marketable Securities 47 Notes Payable 65

Account Receivable 100 Accruals 51

Inventories 200 Total current liabilities 135

Total Current Assets 367 Long-term bonds 131

Net Plant and equipment 2790 Preferred stock 33

Common stock (per plus PIC) 160

Retained earnings 187

Common equity 347

Total Assets 646 Total liabilities & equity 646

Question 7 (6 Marks)

The Randolph Teweles Company (RTC) has decided to acquire a new truck, One alternative is to
lease the truck on a 4-year guideline contract for a lease payment of $10,000 per year, with
payments to be made at the beginning of each year. The lease would include maintenance.
Alternatively, RTC could purchase the truck outright for $40,000, financing the purchase by a bank
loan for the net purchase price and amortizing the loan over a 4-year period at an interest rate of
10% per year.

Under the borrow-to-purchase arrangement, RTC would have to maintain the truck at a cost of
$1,000 per year, payable at year end. The truck falls into the MACRS 3-year class. It has a residual
value of $10,000, which is the expected market value after 4 years, when RTC plans to replace the
truck irrespective of whether it leases or buys. RTC has a marginal federal-plus-state tax rate of 40%.

a. What is RT's PV cost of leasing?

b. What is RT's PV cost of owning? Should the truck be leased or purchased?

QUESTION 2:

A consultant has collected the following information regarding Young Publishing:

Total assets 3,000 million tax rate 40%

Operating income (EBIT) 800 million debt ratio 0%

Interest expense 0 million WACC 10%

Net income 480 million M/B ratio 1.00x

Share price 32 share EPS=DPS 3.20

The company has no growth opportunities so the company pays out all of the earning
dividend’syoung’s stock price can be calculated simply dividing earning per share by the required on
equity capital which currently equals the WACC because the company has no debt.

The consultant believes that the company would be much better off it were change its capital
structure to 40 percent debt and 60 percent equity after meeting with investment bankers the
concludes that the company could issue $1,200 million of debt at a before tax cost of 7 percent
leaving the company with interest expense of $84 million the $1,200 million raised from the debt
issues would be used to repurchase stock at $32 per share. The repurchase will have no effect on
that firms EBIT however after the repurchase the cost of equity will increase to 11 percent if the frim
follow the consultant advice what will be its estimated stock price after the capital structure change?