Questions and Answers of Fundamentals Of Financial Management

If you wanted to evaluate a firm’s DSO, with what could you compare it?
How might the different ages of firms distort comparisons of their fixed assets turnover ratios?
A firm has annual sales of $100 million, $80 million of cost of goods, $20 million of inventory, and $30 million of accounts receivable. What is its inventory turnover ratio? (43) What is its DSO?
How does the use of financial leverage affect stockholders’ control position?
How does the U.S. tax structure influence a firm’s willingness to finance with debt?
How does the decision to use debt involve a risk-versus-return trade-off?
Explain the following statement: Analysts look at both balance sheet and income statement ratios when appraising a firm’s financial condition.
Name two ratios that are used to measure financial leverage and write their equations.
Identify six profitability ratios, and write their equations.
Why does the use of debt lower the profit margin and the ROA?
Using more debt lowers profits and thus the ROA. Why doesn’t debt have the same negative effect on the ROE?
A company has a 10% ROA. Assume that a company’s total assets equal total invested capital, and that the company has no debt, so its total invested capital equals total equity. What are the
Describe the three ratios discussed in this section and write their equations.
In what sense do these market value ratios reflect investors’ opinions about a stock’s risk and expected future growth?
What does the price/earnings (P/E) ratio show? If one firm’s P/E ratio is lower than that of another firm, what factors might explain the difference?
How is book value per share calculated? Explain how inflation and R&D programs might cause book values to deviate from market values.
Write the equation for the DuPont equation.
What is the equity multiplier, and why is it used?
How can management use the DuPont equation to analyze ways of improving the firm’s performance?
A company has $20 billion of sales and $1 billion of net income. Its total assets are $10 billion.The company’s total assets equal total invested capital, and its capital consists of half debt and
Baker Industries’s net income is $24,000, its interest expense is $5,000, and its tax rate is 25%. Its notes payable equals $27,000, long-term debt equals $75,000, and common equity equals
Broward Manufacturing recently reported the following information:Broward’s tax rate is 25%. Broward finances with only debt and common equity, so it has no preferred stock. 40% of its total
Thomson Trucking has $12 billion in assets, and its tax rate is 25%.Its basic earning power (BEP) ratio is 10%, and its return on assets (ROA) is 5.25%. What is its times-interest-earned (TIE) ratio?
The W.C. Pruett Corp. has $600,000 of interest-bearing debt outstanding, and it pays an annual interest rate of 7%. In addition, it has $600,000 of common equity on its balance sheet. It finances
Pacific Packaging’s ROE last year was only 5%, but its management has developed a new operating plan that calls for a debt-to-capital ratio of 40%, which will result in annual interest charges of
Lloyd Inc. has sales of $200,000, a net income of$15,000, and the following balance sheet:The new owner thinks that inventories are excessive and can be lowered to the point where the current ratio
MPI Incorporated has $6 billion in assets, and its tax rate is 25%. Its basic earning power (BEP) ratio is 11%, and its return on assets (ROA) is 6%. What is MPI’s times interest-earned (TIE) ratio?
Data for Barry Computer Co. and its industry averages follow. The firm’s debt is priced at par, so the market value of its debt equals its book value. Since dollars are in thousands, the number of
The Corrigan Corporation’s 2020 and 2021 financial statements follow, along with some industry average ratios. Corrigan is exempt from the interest deduction limitation because its average gross
Part I of this case, presented in Chapter 3, discussed the situation of D’Leon Inc., a regional snack foods producer, after an expansion program. D’Leon had increased plant capacity and
In Chapter 3, we looked at Dunkin’ Brands’ financial statements. In this chapter, we will use a financial Internet website, morningstar.com, to analyze HP Inc., a computer hardware company. Once
Do time lines deal only with years, or can other time periods be used?
Set up a time line to illustrate the following situation: You currently have $2,000 in a 3-year certificate of deposit (CD) that pays a guaranteed 4% annually.
Explain why this statement is true: A dollar in hand today is worth more than a dollar to be received next year.
What is compounding? What’s the difference between simple interest and compound interest? What would the future value of $100 be after 5 years at 10% compound interest? At 10% simple interest?
Suppose you currently have $2,000 and plan to purchase a 3-year certificate of deposit (CD) that pays 4% interest compounded annually. How much will you have when the CD matures? How would your
A company’s sales in 2021 were $100 million. If sales grow at 8%, what will they be 10 years later, in 2031?
How much would $1 growing at 5% per year be worth after 100 years? What would the FV be if the growth rate were 10%?
What is discounting, and how is it related to compounding? How is the future value equation (Equation 5.1) related to the present value equation (Equation 5.2)?Equation 5.1Equation 5.2 Future value =
How does the present value of a future payment change as the time to receipt is lengthened? As the interest rate increases?
Suppose a U.S. government bond promises to pay $2,249.73 three years from now.If the going interest rate on 3-year government bonds is 4%, how much is the bond worth today? How much is it worth today
How much would $1,000,000 due in 100 years be worth today if the discount rate was 5%? If the discount rate was 20%?
The U.S. Treasury offers to sell you a bond for $585.43. No payments will be made until the bond matures 10 years from now, at which time it will be redeemed for $1,000.What interest rate would you
Microsoft earned $1.42 per share in 2007. Ten years later in 2017 it earned $3.08.What was the growth rate in Microsoft’s earnings per share (EPS) over the 10-year period? If EPS in 2017 had been
How long would it take $1,000 to double if it was invested in a bank that paid 6% per year? How long would it take if the rate was 10%?
Microsoft’s 2019 earnings per share were $5.06, and its growth rate during the prior 10 years was 12.06% per year. If that growth rate was maintained, how long would it take for Microsoft’s EPS
What’s the difference between an ordinary annuity and an annuity due?
Why would you prefer to receive an annuity due for $10,000 per year for 10 years than an otherwise similar ordinary annuity?
For an ordinary annuity with five annual payments of $100 and a 10% interest rate, how many years will the first payment earn interest? What will this payment’s value be at the end? Answer this
Assume that you plan to buy a condo 5 years from now, and you estimate that you can save $2,500 per year. You plan to deposit the money in a bank account that pays 4% interest, and you will make the
Why does an annuity due always have a higher future value than an ordinary annuity?
If you calculated the value of an ordinary annuity, how could you find the value of the corresponding annuity due?
Assume that you plan to buy a condo 5 years from now, and you need to save for a down payment. You plan to save $2,500 per year (with the first deposit made immediately), and you will deposit the
Why does an annuity due have a higher present value than a similar ordinary annuity?
If you know the present value of an ordinary annuity, how can you find the PV of the corresponding annuity due?
What is the PVA of an ordinary annuity with 10 payments of $100 if the appropriate interest rate is 10%? What would the PVA be if the interest rate was 4%?What if the interest rate was 0%? How much
At the beginning of your freshman year, your favorite aunt and uncle deposit $10,000 intoa 4-year bank certificate of deposit (CD) that pays 5% annual interest. You will receive themoney in the
Your grandfather urged you to begin a habit of saving money early in your life. He suggestedthat you put $5 a day into an envelope. If you follow his advice, at the end of the year youwill have
You just won the Florida lottery. To receive your winnings, you must select ONE of the twofollowing choices:1. You can receive $1,000,000 a year at the end of each of the next 30 years.2. You can
You just received your first credit card and decided to purchase a new Apple iPad.You charged the iPad’s $500 purchase price on your new credit card. Assume thatthe nominal interest rate on the
Sawyer Corporation’s 2020 sales were $5 million. Its 2015 sales were$2.5 million.a. At what rate have sales been growing?b. Suppose someone made this statement: “Sales doubled in 5 years. This
You want to buy a house that costs $140,000. You have $14,000 for a down payment, but your credit is such that mortgage companies will not lend you the required $126,000. However, the realtor
Simon recently received a credit card with an 18% nominal interest rate. With the card, he purchased an Apple iPhone 11 for $700. The minimum payment on the card is $20 per month.a. If Simon makes
It is now December 31, 2020 (t = 0), and a jury just found in favor of a woman who sued the city for injuries sustained in a January 2019 accident.She requested recovery of lost wages plus $300,000
A father is now planning a savings program to put his daughter through college. She is 13, plans to enroll at the university in 5 years, and should graduate 4 years later. Currently, the annual cost
Answer the following questions:a. Assuming a rate of 10% annually, find the FV of $1,000 after 5 years.b. What is the investment’s FV at rates of 0%, 5%, and 20% after 0, 1, 2, 3, 4, and 5 years?c.
You have applied for a job with a local bank. As part of its evaluation process, you must take an examination on time value of money analysis covering the following questions:a. Draw time lines for
What is the price paid to borrow debt capital called?
What are the two items whose sum is the cost of equity?
What four fundamental factors affect the cost of money?
Which factor sets an upper limit on how much can be paid for savings?
Which factor determines how much will be saved at different interest rates?
How do risk and inflation impact interest rates in the economy?
What role do interest rates play in allocating capital to different potential borrowers?
What happens to market-clearing, or equilibrium, interest rates in a capital market when the supply of funds declines? What happens when expected inflation increases or decreases?
How does the price of capital tend to change during a boom? During a recession?
How does risk affect interest rates?
If inflation during the last 12 months was 2% and the interest rate during that period was 5%, what was the real rate of interest? If inflation is expected to average 4% during the next year and the
Write an equation for the nominal interest rate on any security.
Distinguish between the real risk-free rate of interest, r*, and the nominal, or quoted, risk-free rate of interest, rRF.
How do investors deal with inflation when they determine interest rates in the financial markets?
Does the interest rate on a T-bond include a default risk premium? Explain.
Distinguish between liquid and illiquid assets, and list some assets that are liquid and some that are illiquid.
Briefly explain the following statement: Although long-term bonds are heavily exposed to interest rate risk, short-term T-bills are heavily exposed to reinvestment rate risk. The maturity risk
Assume that the real risk-free rate is r* = 2% and the average expected inflation rate is 3% for each future year. The DRP and LP for Bond X are each 1%, and the applicable MRP is 2%. What is Bond
What is a yield curve, and what information would you need to draw this curve?
Distinguish among the shapes of a “normal” yield curve, an “abnormal” curve, and a“humped” curve.
If the interest rates on 1-, 5-, 10-, and 30-year bonds are 4%, 5%, 6%, and 7%, respectively, how would you describe the yield curve? If the rates were reversed, how would you describe it?
How do maturity risk premiums affect the yield curve?
If the inflation rate is expected to increase, would this increase or decrease the slope of the yield curve?
If the inflation rate is expected to remain constant at the current level in the future, would the yield curve slope up, slope down, or be horizontal? Consider all factors that affect the yield
Explain why corporate bonds’ default and liquidity premiums are likely to increase with their maturity.
Explain why corporate bonds always yield more than Treasury bonds and why BBB-rated bonds always yield more than AA-rated bonds.
What key assumption underlies the pure expectations theory?
Assuming that the pure expectations theory is correct, how are expected short-term rates used to calculate expected long-term rates?
According to the pure expectations theory, what would happen if long-term rates were not an average of expected short-term rates?
Most evidence suggests that a positive maturity risk premium exists. How would this affect your calculations when determining interest rates?
Assume that the interest rate on a 1-year T-bond is currently 7% and the rate on a 2-year bond is 9%. If the maturity risk premium is zero, what is a reasonable forecast of the rate on a 1-year bond
Identify some macroeconomic factors that influence interest rates and explain the effects of each.
How does the Fed stimulate the economy? How does the Fed affect interest rates?

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