Finance Exam Task - Assignment Example

Finance Part I Answer (b) Explanation- The market value of stocks incorporates the risk associated with the likely returns at different points of time in future. Market value of stock is computed by taking into account the time value of money and the future returns from stock are discounted at appropriate rate (appropriate risk associated with investment). Therefore, the objective of maximizing shareholders wealth provides for risk associated with the investment (stock). 2. Answer (D) Explanation- Agency problems arise from the divergent objectives between owners and managers 3. Answer (b) Explanation- Inclusion of more and more debt content in the capital structure will increase the financial risk of the firm. 4. Answer (b) Explanation- In a weak form of market, the data used are related to the past performance of the firm and they are called publicly available information. But, an investment strategy that ensures excess return should use both public as well as private information. 5. Answer (a) Explanation- (45x100) - (48x100) + (4x100) / (48x100) = 2.08% 6. Answer (c ) Explanation- Financial leverage is the use of fixed cost bearing securities in the capital structure of a firm. When such securities are used, the firm is under obligation to pay off fixed financial claims such as interest regardless of the volume of earnings. Therefore, when the firm earns no profit or low profit, same fixed interest must be paid and it results in the decreased return to equity share holders. Hence, inclusion of high debt content in the capital structure is risky. 7. Answer (c ) Explanation- Buying treasury stock with sale proceeds of the current year can enhance the present current ratio of 2: 1 as it will affect only one of the two aspects of current ratio (i.e., current asset). 8. Answer (c ) Explanation- When assets of no use are sold off, the return to existing assets increases. The return on total assets is calculated by dividing total return by total assets. So, when total assets are reduced by unused assets, the denominator is reduced and that results in increased firm’s return on total assets. 9. Answer (b ) Explanation- Collection period extensions can nothing to do with customers’ inability to pay their dues in time. If customers are unable to pay their dues, take appropriate actions such as deploying collection staff etc. 10. Answer (b) Explanation- Collecting the dues from the customers is the only possible way for Christy to enhance her firm’s current ratio. 11. Answer (b) Explanation: Current Liabilities = 12, 000 / 2.5 = 4, 800 Quick Assets = 4, 800 x 1.2 = 5760 Therefore, inventory = Current assets – Quick Assets = 12, 000 – 5760 = 6240 12. Answer (b) Explanation- The firm can raise additional debt of $6 million only to maintain the times interest ratio of 3.0. 13. Answer (b) Explanation- The frequency with which present money is converted in to future determines the volume of future value. 14. Answer (d) Explanation: 1, 000 x 1.469 (compound value factor for five years at 8% )= 1, 469 15. Answer (b) (3.16 – 0.30) / 7 yrs = 0.4085 x 100= 40% 16. Answer (b) If the money is invested in the beginning of the year- 2000x 199.021 = 398042 If money is invested at the end of the year = 2000 x 12477 = 361853. Therefore, Difference = 36,189 17. Answer (c) Present Value Interest Annuity (PVIFA) for 15 years = 109,296/ 12000 = 9.108 The interest rate corresponding to 15 years and factor 9.108 is 7% 18. Answer (d) The lease requires six beginning of the year payments that will fully amortize the cost of and if the amount of payment at 12 percent interest is 6,081.25 19. Answer (c) “The investor is theoretically faced with an infinite number of possible combinations of the risk-free asset and the market portfolio but the ultimate allocation depends on the investor’s utility function to which we now extend the fuzzy preference relation”( Allen 14). 20. Answer (b) Explanation- The competition from the foreign similar firms is specific to the industry and is an example of unsystematic risk 21. Answer (b) Explanation- If the security moves less than the market, the stocks beta is less than 1.0. Therefore, the security has above-average systematic risk. 22. Answer (d) Explanation- The increase in inflation would cause the SML to shift up, and investors becoming more risk averse would cause the slope to increase 23. Answer (d) Explanation- for a given standard deviation, there is no other portfolio with a higher expected return and if, for a given expected return, there is no other portfolio with a lower standard deviation 24. Answer (b) Year Price Rate of Return Return Probability Expected Return 1 16 -0.2 -3.2 0.25 -0.8 2 20 0 0 0.3 0 3 24 0.2 4.8 0.25 1.2 4 28 0.4 11.2 0.2 2.24 Current 20 0 0 0 0 25. Answer ( b) The probability of earning more than 21% on common stock is 0.8413 26. Answer (a) Investment Return (Rate) Return Absolute Expected Return on Portfolio 3000 11.6 34800 348 10000 12.8 128000 1280 6000 12.2 73200 732 19000 2360 0.124210526 (2360/19000) 27. Answer (c ) = 1.9188/ 0.082 = 23. 40 28. Answer (c ) 29. Answer (c ) 30. Answer ( a) If a firm is able to sell a debt for which a mortgage is created at 8% only, then it can sell similar debenture only at a rate less than 8% because, debenture without mortgage is more risky than mortgaged one from investor point of view. 31. Answer (a ) Explanation- As the period of investment increases, the risk of investment also increases 32. Answer (b) The decrease in market interest rate can be used to float new debt by redeeming the outstanding debentures. 33. Answer (c) 34. Answer (c ) 35. Answer (c) Bond Value = 120 x 5.773 (PVIFA) + 1000 x 0.208 = 896 36. Answer ( d) 37. Answer (b) 38. Answer (c ) 39. Answer (c ) Explanation- when the general level of interest rates in the economy moves up, then investors also requires a high rate of return on securities, and, in general, stock prices may come down 40. Answer (b) Explanation- It is impossible to increase retained earnings by stock repurchasing. 41. Answer (C) PART II 1) Year Future Amount Present Value Factor Present Value Tax rate (%) tax amount Money to be contributed each year 1 15000 0.909 13635 30 4090.5 9544.5 2 16000 0.826 13216 30 3964.8 9251.2 3 17000 0.751 12767 30 3830.1 8936.9 4 18000 0.683 12294 30 3688.2 8605.8 5 0 0 0 0 0 6 0 0 0 0 0 7 25000 0.513 12825 30 3847.5 8977.5 2) The earnings of Mylanta Company are expected to grow at an annual rate of 14% over the next 5 years and then slow to a constant rate of 10% per year. Mylanta currently pays a dividend of $0.36 per share. What is the value of Mylantas stock to an investor who requires a 16% rate of return? Year Return Return @10% 1 0.36 2 0.36+14%= 0.4104 0.396 3 0.4104+ 14%= .467856 0.4356 4 .467856+ 14%= 0.608026 0.47916 5 0.608026+14%= 0.693148 0.527076 Work Cited Allen Jack, Sukanto Bhattacharya2, “Florentin Smarandache: Modeling fuzziness in the funds allocation behavior of an individual investor”, 5 March 2009 Bond Yield to Maturity, American Investment Training: The Financial Training Professionals, 5 March 2009 Lambert George D., Call Features: Dont Get Caught off Guard, Investopedia, 5 March 2009 Read More