FIN3716- Fall 2010

MIDTERM 1 SOLUTION

Name ________________________________________________ Section____________

Time: 75 Min Total Point: 70

Work on this exam is to be yours alone. Any discussion of either the questions or your answers

with anyone other than your instructor will be considered as cheating and, thus, as a violation of the

LSU honor code. For Multiple Choice questions, circle the letter/s of the correct multiple-choice

answer. You have to show your work to receive partial credit (if applicable and when possible) for

the answer. Your answers must be COMPREHENSIBLE and your work “CLEAN”.

Multiple Choice Questions (Each question 4 points)

1. Which of the following are advantages of the corporate form of business ownership?

I. limited liability for firm debt

II. double taxation

III. ability to raise capital

IV. unlimited life

A. I and II only

B. III and IV only

C. I, III, and IV only

D. II, III, and IV only

E. I, II, III, and IV

2. Which one of the following best states the primary goal of financial management?

A. maximize current dividends per share

B. maximize the current value per share

C. increase cash flow and avoid financial distress

D. minimize operational costs while maximizing firm efficiency

E. maintain steady growth while increasing current profits

3. Which of the following represent cash outflows from a corporation?

I. issuance of common shares

II. payment of dividends

III. new loan proceeds

IV. payment of government taxes

A. I and III only

B. II and IV only

C. I and IV only

D. I, II, and IV only

E. II, III, and IV only

4. Sally and Alicia currently are general partners in a business located in Atlanta, Georgia. They are

content with their current tax situation but are both very uncomfortable with the unlimited

liability to which they are each subjected. Which form of business entity should they consider to

replace their general partnership assuming they wish to remain the only two owners of their

business? Whichever organization they select, they wish to be treated equally.

A. sole proprietorship

B. joint stock company

C. limited partnership

D. limited liability company

E. corporation

5. Which one of the following actions by a financial manager is most likely to create an agency

problem?

A. refusing to borrow money when doing so will create losses for the firm

B. refusing to lower selling prices if doing so will reduce the net profits

C. refusing to expand the company if doing so will lower the value of the equity

D. agreeing to pay bonuses based on the market value of the company stock rather than on the

firm's level of sales

E. increasing current profits when doing so lowers the value of the firm's equity

6. A firm has net working capital of $640. Long-term debt is $4,180, total assets are $6,230, and

fixed assets are $3,910. What is the amount of the total liabilities?

A. $2,050

B. $2,690

C. $4,130

D. $5,590

E. $5,860

Current assets = $6,230 - $3,910 = $2,320

Current liabilities = $2,320 - $640 = $1,680

Total liabilities = $1,680 + $4,180 = $5,860

7. Jensen Enterprises paid $1,300 in dividends and $920 in interest this year. Common stock

increased by $1,200 and retained earnings decreased by $310. What is the net income for the

year?

A. -$210

B. $990

C. $1,610

D. $1,910

E. $2,190

Net income = $1,300 + (-$310) = $990

8. Crandall Oil has total sales of $1,349,800 and costs of $903,500. Depreciation is $42,700 and the

tax rate is 34 percent. The firm does not have any interest expense. What is the operating cash

flow?

A. $129,152

B. $171,852

C. $179,924

D. $281,417

E. $309,076

Earnings before interest and taxes = $1,349,800 - $903,500 - $42,700 = $403,600

Tax = $403,600 .34 = $137,224

Operating cash flow = $403,600 + $42,700 - $137,224 = $309,076

9. The Lakeside Inn had operating cash flow of $48,450. Depreciation was $6,700 and interest paid

was $2,480. A net total of $2,620 was paid on long-term debt. The firm spent $24,000 on fixed

assets and decreased net working capital by $1,330. What is the amount of the cash flow to

stockholders?

A. $5,100

B. $7,830

C. $18,020

D. $19,998

E. $20,680

Cash flow from assets = $48,450 - (-$1,330) - $24,000 = $25,780

Cash flow to creditors =$2,480 - (-$2,620) = $5,100

Cash flow to stockholders = $25,780 - $5,100 = $20,680

10. Winston Industries had sales of $843,800 and costs of $609,900. The firm paid $38,200 in

interest and $18,000 in dividends. It also increased retained earnings by $62,138 for the year. The

depreciation was $76,400. What is the average tax rate?

A. 32.83 percent

B. 33.33 percent

C. 38.17 percent

D. 43.39 percent

E. 48.87 percent

Earnings before taxes = $843,800 - $609,900 - $76,400 - $38,200 = $119,300

Net income = $18,000 + $62,138 = $80,138

Taxes = $119,300 - $80,138 = $39,162

Tax rate = $39,162/$119,300 = 32.83 percent

11. A common-size income statement is an accounting statement that expresses all of a firm's

expenses as percentage of:

A. total assets

B. total equity

C. net income

D. taxable income

E. sales

12. An increase in current liabilities will have which one of the following effects, all else held

constant? Assume all ratios have positive values.

A. increase in the cash ratio

B. increase in the net working capital to total assets ratio

C. decrease in the quick ratio

D. decrease in the cash coverage ratio

E. increase in the current ratio

13. A firm generated net income of $878. The depreciation expense was $47 and dividends were

paid in the amount of $25. Accounts payables decreased by $13, accounts receivables increased

by $22, inventory decreased by $14, and net fixed assets decreased by $8. There was no

interest expense. What was the net cash flow from operating activity?

A. $876

B. $902

C. $904

D. $922

E. $930

Net cash from operating activities = $878 + $47 - $13 - $22 + $14 = $904

14. A firm has a debt-equity ratio of 0.42. What is the total debt ratio?

A. 0.30

B. 0.36

C. 0.44

D. 1.58

E. 2.38

The debt-equity ratio is 0.42. It implies if total debt is $42 and total equity is $100, then total assets

are $142. Total debt ratio = $42/$142 = 0.30.

15. A firm has 160,000 shares of stock outstanding, sales of $1.94 million, net income of $126,400,

a price-earnings ratio of 18.7, and a book value per share of $9.12. What is the market-to-book

ratio?

A. 1.62

B. 1.84

C. 2.23

D. 2.45

E. 2.57

Earnings per share = $126,400/160,000 = $0.79

Price per share = $0.79 18.7 = $14.773

Market-to-book ratio = $14.773/$9.12 = 1.62

16. Canine Supply has sales of $2,200, total assets of $1,400, and a debt-equity ratio of 0.3. Its

return on equity is 15 percent. What is the net income?

A. $138.16

B. $141.41

C. $152.09

D. $156.67

E. $161.54

Return on equity = .15 = (Net income/$2,200) ($2,200/$1,400) (1 + 0.30)

Net income = $161.54

17. Beach Wear has current liabilities of $350,000, a quick ratio of 1.65, inventory turnover of 3.2,

and a current ratio of 2.9. What is the cost of goods sold?

A. $980,000

B. $1,060,000

C. $1,200,000

D. $1,400,000

E. $1,560,000

Current assets = 2.9 $350,000 = $1,015,000

($1,015,000 - Inventory)/$350,000 = 1.65; Inventory = $437,500

Costs of goods sold = 3.2 $437,500 = $1,400,000

Descriptive Question (2 points)

Discuss the difference between book values and market values and explain which one is more

important to the financial manager and why.

The accounts on the balance sheet are generally carried at historical cost, not market values.

Although the book value of the current assets and the liabilities may closely approximate market

values, the same cannot be said for the rest of the balance sheet accounts. Market values are more

relevant as they reflect today's values whereas the balance sheet reflects historical costs as adjusted

by various accounting methods. To determine the current value of a firm, and its worth to the

shareholders, financial managers must monitor market values.

Bonus Question (4 points) Show your work

Gladstone Pavers has a long-term debt ratio of 0.6 and a current ratio of 1.3. Current liabilities are

$700, sales are $4,440, the profit margin is 9.5 percent, and the return on equity is 19.5 percent.

How much does the firm have in net fixed assets?

Current assets = 1.3 $700 = $910

Net income = .095 $4,440 = $421.80

Total equity = $421.80/.195 = $2,163.0769

0.6 = Long term debt/(Long-term debt + $2,163.0769); Long-term debt = $3,244.6153

Total debt = $700 + $3,244.6153 = $3,944.6153

Total assets = $3,944.6153 + $2,163.0769 = $6,107.6922

Net fixed assets = $6,107.6922 - $910 = $5,197.69