D364 Financial Management - Set 3 - Part 1

Correct Answer: 12.5

The P/E ratio is calculated as Price per share / Earnings per share (EPS). EPS = $200,000 / 100,000 = $2.00. P/E ratio = $25 / $2 = 12.5.

Correct Answer: $150,000

Operating income is calculated as Gross Profit - Operating Expenses. In this case: $300,000 - $150,000 = $150,000.

Correct Answer: Issuing bonds

Issuing bonds is an external source of financing, as the company raises money from external investors. Retained earnings and reducing inventory are internal sources of funds.

Correct Answer: $500,000

The debt-to-equity ratio is calculated as Total Debt / Total Equity. In this case, 0.5 = Total Debt / $1,000,000, so Total Debt = $1,000,000 × 0.5 = $500,000.

Correct Answer: The cost of a feasibility study conducted last year

Sunk costs are costs that have already been incurred and cannot be recovered, like the cost of a past feasibility study. Future expenses, such as raw materials or salaries, are not considered sunk costs.

Correct Answer: $350,000

Net income is calculated as (EBIT - Interest) × (1 - Tax Rate). In this case: ($600,000 - $100,000) × (1 - 0.30) = $350,000.

Correct Answer: To assess a company’s financial health and performance

Financial ratio analysis is used to evaluate a company’s financial performance and condition by comparing various metrics, such as profitability, liquidity, and leverage ratios.

Correct Answer: It provides a single rate of return for easy comparison

IRR gives a single percentage return that can be compared with the company’s required rate of return to make investment decisions. It considers the time value of money.

Correct Answer: The company has more current liabilities than current assets

Net working capital is calculated as Current Assets - Current Liabilities. A negative value indicates that current liabilities exceed current assets, which may lead to liquidity issues.

Correct Answer: 7.37%

The current yield is calculated as Annual Coupon Payment / Current Price. In this case: ($1,000 × 7%) / $950 = 7.37%.

Correct Answer: Bond prices fall

There is an inverse relationship between interest rates and bond prices. When interest rates increase, the prices of existing bonds with lower coupon rates decrease.

Correct Answer: $60

The annual interest payment is calculated as Face Value × Coupon Rate. In this case: $1,000 × 6% = $60 per year.

Correct Answer: To determine the minimum return required on a company’s investments

WACC represents the average rate a company must pay to finance its assets, considering both debt and equity, and is used as a hurdle rate for investment decisions.

Correct Answer: Sales revenue

Operating leverage refers to the impact of fixed costs on a company’s profitability. A company with high operating leverage will experience greater fluctuations in profits as sales change.

Correct Answer: Common stockholders have a residual claim on assets, while preferred stockholders have priority over dividends

Preferred stockholders have priority in receiving dividends before common stockholders, but common stockholders have a residual claim on assets after debts and preferred shareholders are paid.

Correct Answer: 0.8

The debt-to-equity ratio is calculated as Total Debt / Total Equity. In this case: ($2,000,000 + $1,000,000) / $5,000,000 = 0.6.

Correct Answer: It determines a stock’s expected return based on its systematic risk

CAPM calculates the expected return of a stock based on its beta (systematic risk), the risk-free rate, and the expected market return.

Correct Answer: $2,000,000

The P/S ratio is calculated as Market Value / Sales. In this case: Market Value = 2.0 × $1,000,000 = $2,000,000.

Correct Answer: 12.5%

Using CAPM, Expected Return = Risk-Free Rate + Beta × (Market Return - Risk-Free Rate). In this case: 3% + 1.5 × (8% - 3%) = 12.5%.

Correct Answer: Cash available after all expenses, taxes, and reinvestments

FCFF represents the cash available to the company after operating expenses, taxes, and capital expenditures have been paid, available to both equity holders and debt holders.