04 May WHY IS AN UNDERSTANDING OF CASH FLOW SO IMPORTANT IN THE STUDY OF FINANCE?
About 2.50 years B) About 3.67 years
C) About 2.67 years D) About 4.50 years
21) Bacon Signs Inc., purchases a machine for $70,000. This machine qualifies as a five-year recovery asset under MACRS
with the fixed depreciation percentages as follows: year 1 = 20.00%; year 2 = 32.00%; year 3 = 19.20%; year 4 = 11.52%, etc.
The firm has a tax rate of 40%. If the machine is sold at the end of two years for $50,000, what is the cash flow from
disposal? 21) ______
A) $50,000 B) $33,600 C) $43,440 D) $39,875
22) The following information comes from the Galaxy Construction balance sheet. The value of common stock is $10,000,
retained earnings equals $7,000, total common equity equals $17,000, preferred stock has a value of $3,000, and long-term
debt totals $15,000. If the cost of debt is 8.00%, preferred stock has a cost of 10.00%, common stock has a cost of 12.00%,
and the firm has a corporate tax rate of 30%, calculate the firms WACC adjusted for taxes. 22) ______
A) 10.00%
B) 9.09%
C) 10.11% D) There is not enough information to answer this question.
23) Use the dividend growth model to determine the required rate of return for equity. Your firm intends to issue new
common stock. Your investment bankers have determined that the stock should be offered at a price of $20.00 per share
and that you should anticipate paying a dividend of $0.75 in one year. If you anticipate a constant growth in dividends of
3.00% per year and the investment banking firm will take 8.00% per share as flotation costs, what is the required rate of
return for this issue of new common stock? 23) ______
A) 7.08% B) 6.83% C) 10.20% D) 7.19%
24) Perfect Purchase Electronics
Selected Income Statement Items, 2009
Cash Sales $1,500,000
Credit Sales $7,500,000
Total Sales $9,000,000
COGS $6,000,000
Perfect Purchase Electronics
Selected Balance Sheet Accounts
12/31/2009 12/31/2008 Change
Accounts Receivable $270,000 $240,000 $30,000
Inventory $125,000 $100,000 $25,000
Accounts Payable $110,000 $90,000 $20,000
Using the information provided, what is the accounts payable cycle for the firm? 24) ______
A) 6.08 days B) 24.33 days C) 4.87 days D) 4.06 days
25) Orange Electronics Inc. has a profitability ratio of 0.14, an asset turnover ratio of 1.7, a debt to equity ratio of 0.60 and a
total asset to equity ratio of 1.60. What is the firms ROE? 25) ______
A) 38.08% B) 14.28% C) 41.76% D) 22.85%
II. SHORT ANSWER (5 questions 5 points each). Write a paragraph answers the question.
26) Assume that todays date is August 15, 2010 and that the Rite Aid Bond is an annual-coupon bond. Describe what each
of the following terms mean and how each value was determined if appropriate.
Company Price Coupon Rate Maturity DateYTM Current Yield Rating
Rite Aid 84.00 6.875% 8-15-2015 10.576% 8.185% B2
26) _____________
27) Why is an understanding of cash flow so important in the study of finance?
28) The Fisher Effect states the relationship between the nominal rate (r), the real rate (r*), and inflation (h). Suppose r= 5%
and h = 4%. Many would say that the nominal rate is 9%. Is this true? Explain in terms of the relationship between the real
rate and the inflation rate over time.
29) Explain the distinction between profits and cash flow. 30) Market value ratios try to answer what question for potential investors? Do financial statements contain all of the
necessary information to answer this question? Explain in terms of the P/E (price earnings) ratio.
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