Financial Management - Other Flashcards
Assume the following values for an investment:
Risk-free rate of return = 2%
Expected rate of return = 9%
Beta = 1.4
Which one of the following is the required rate of return for the investment? A. 9.0% B. 9.8% C. 11.8% D. 12.6%
C. 11.8%
The required rate of return for the investment is 11.8% calculated as:
Required rate = Risk-free rate + Beta(Expected rate - Risk-free rate), or
Required rate = .02 + 1.4(.09 - .02), or
Required rate = .02 + 1.4(.07), or
Required rate = .02 + .098, or
Required rate = .118, or 11.8%
Nexco, Inc. is considering factoring its accounts receivable. Factorco, Inc. has offered the following terms for accounts receivable due in 30 days:
Value of receivables to be held in reserve for contingencies 10%
Following costs are deducted at time accounts are factored:
Interest rate on amounts provided 12%
Factor fee on total receivables factored 2%
If Nexco factors $200,000 of its accounts receivable due in 30 days with Factorco and, during that 30 days, $10,000 of those accounts receivable are reversed because the related goods were return or allowances were granted, which one of the following is the amount that Nexco will receive from Factorco at the end of the 30 day period? A. $ -0- (no amount) B. $ 9,800 C. $10,000 D. $19,600
C. $10,000
The amount held in reserve was .10 x $200,000, or $20,000. During the 30-day period of the factor agreement, $10,000 of the accounts receivable factored had to be reversed because of sales returns and allowances. Therefore, at the end of the 30-day period, Factorco would pay Nexco the remaining $10,000 ($20,000 reserve - $10,000 reversed = $10,000).
Which one of the following is a form of inventory secured loan in which the inventory is placed under the control of an independent third party? A. Floating lien agreement. B. Chattel mortgage agreement. C. Field warehouse agreement. D. Recourse loan agreement.
C. Field warehouse agreement.
In a field warehouse agreement, the inventory that serves as security for a borrowing remains with the borrower, but is place under the control of an independent third party. (Also, in a terminal warehouse agreement, the inventory is moved to a public warehouse and placed under the control of an independent third party.)
Nexco, Inc. is considering factoring its accounts receivable. Factorco, Inc. has offered the following terms for accounts receivable due in 30 days:
Value of receivables to be held in reserve for contingencies 10%
Following costs are deducted at time accounts are factored:
Interest rate on amounts provided before deducting interest (annual rate) 12%
Factor fee on total receivables factored 2%
If Nexco plans to factor $200,000 of accounts receivable due in 30 days, which one of the following is the amount it will receive from Factorco at the time the accounts are factored? A. $154,880 B. $174,240 C. $176,000 D. $196,000
B. $174,240
The amount provided would be $200,000 accounts receivable - $20,000 reserve - $4,000 factor fee = $176,000, for which interest would be charged for 30 days, or 1% (i.e., 1/12 of 12%). Therefore, the correct amount received would be $176,000 - ($176,000 x .01) = $176,000 - $1,760 = $174,240.
Which of the following statements concerning long-term financing is/are correct?
I. Long-term financing consists of sources that constitute capital structure.
II. Long-term financing consists of sources on which the weighted-average cost of capital is based.
III. Long-term financing consists only of equity sources of capital. A. I only. B. I and II, only. C. I and III, only. D. I, II, and III.
B. I and II, only.
Statements I and II are correct; Statement III is not correct. Long-term financing consists of sources that constitute capital structure (as opposed to financial structure). These are the sources of financing that are used to calculate the weighted-average cost of capital (Statements I and II, respectively). Statement III is not correct because long-term financing includes long-term debt, as well as equity.
Which one of the following would not be considered a means of long-term financing? A. Financial lease. B. Common stock. C. Trade accounts payable. D. Bonds payable.
C. Trade accounts payable
The use of trade accounts payable (a current liability) is a means of short-term financing, not long-term financing.
What impact will the issuing of new preferred stock have on the following for the issuing entity?
Long-Term Debt Debt-to-Equity Ratio
Increase Increase
Increase Decrease
No Change Increase
No Change Decrease
No Change Decrease
Since preferred stock is not debt, there will be no effect on long-term debt; however, since preferred stock is equity, the debt-to-equity ratio will decrease.
Bander Co. is determining how to finance some long-term projects. Bander has decided it prefers the benefits of no fixed charges, no fixed maturity date, and an increase in the credit-worthiness of the company. Which of the following would best meet Bander's financing requirements? A. Bonds. B. Common stock. C. Long-term debt. D. Short-term debt.
B. Common stock.
Issuing common stock to finance its projects would best meet Bander’s financing strategy. Specifically, issuing common stock would (1) not result in fixed charges, since dividends are at the discretion of the Board of Directors, (2) not result in a fixed maturity date, since common stock does not mature, and (3) would likely increase the credit-worthiness of the company because the issuance of additional common stock would reduce its debt to equity ratio by increasing equity.
The market price of a bond issued at a premium is equal to the present value of its principal amount
A. Only, at the stated interest rate.
B. And the present value of all future interest payments, at the stated interest rate.
C. Only, at the market (effective) interest rate.
D. And the present value of all future interest payments, at the market (effective) interest rate.
D. And the present value of all future interest payments, at the market (effective) interest rate.
The market price of a bond, whether issued at par, at a premium, or at a discount, will be the present value of the principal amount plus the present value of future interest payments, all at the market (effective) rate of interest.
A company recently issued 9% preferred stock. The preferred stock sold for $40 a share, with a par of $20. The cost of issuing the stock was $5 a share. What is the company's cost of preferred stock? A. 4.5% B. 5.1% C. 9.0% D. 10.3%
B. 5.1%
The current cost of capital for newly issued preferred stock is computed as the net proceeds per share divided into the annual cost (dividends) of the newly issued shares. In this question, the net proceeds per share is given as $40 sales price less $5 per share issue cost, or $35 per share net proceeds. The annual cost of the newly issued shares is the par value, $20, multiplied by the preferred dividend rate, 9%, or $20 x .09 = $1.80 annual dividend per share. Therefore, the cost of capital for the newly issued preferred stock is $1.80/$35.00 = 5.1%.
Allen issues $100 par value preferred stock that is selling for $101 per share, on which the firm has to pay an underwriting fee of $5 per share sold. The stock is paying an annual dividend of $10 per share. Allen's tax rate is 40%. Which one of the following is the cost of preferred stock financing to Allen? A. 4.2% B. 6.2% C. 9.9% D. 10.4%
D. 10.4%
The correct calculation is the annual dividend divided by the net proceeds of the stock issuance. Therefore, the calculation would be $10 annual dividend/$101 selling price - $5 underwriter’s fee = $96 proceeds, or $10/$96 = 10.4%
The stock of Fargo Co. is selling for $85. The next annual dividend is expected to be $4.25 and is expected to grow at a rate of 7%. The corporate tax rate is 30%. What percentage represents the firm's cost of common equity? A. 12.0% B. 8.4% C. 7.0% D. 5.0%
A. 12.0%
The firm’s cost of common equity is the rate of return currently expected by potential investors in the firm’s common stock. When it is assumed that the dividends are expected to grow at a constant rate, that rate of return is calculated as:
Common Stock Expected Return (CSER) = (Dividend in 1st Year/Market Price) + Growth Rate
Using the values given: CSER = ($4.25/$85.00) + .07
CSER = .05 + .07 = .12 (or 12%)
The CSER of 12% is the cost of capital through common stock financing.
Which of the following considerations typically would be important in selecting investments for the temporary use of “excess” cash?
Safety of Principal Ready Marketability
Yes Yes
Yes No
No Yes
No No
Safety of Principal Ready Marketability
Yes Yes
In selecting short-term investments for “excess” cash, a firm would be concerned with (1) safety of principal, (2) price stability of the investment instrument, and (3) ability to readily convert the investment to cash without undue cost.
Moe’s Boat Service currently does not offer a discount to encourage its customers to pay early for services provided to them. Moe has discussed with his accountant the possibility of offering a 2% discount to improve its cash conversion cycle. Moe’s accountant determined the following:
Credit sales expected to remain unchanged at $1,000,000
The 2% discount is expected to be taken on 40% of accounts receivable balance amounts.
The average accounts receivable would likely decrease by $ 30,000
Moe has an opportunity cost of 15% associated with its use of cash.
Which one of the following is the dollar amount of net benefit or cost that Moe would obtain if the proposed 2% discount plan is implemented? A. $ 3,500 B. $ 4,500 C. $ 8,000 D. $20,000
A. $ 3,500
The benefits obtained would be the reduction in working capital required for carrying average accounts receivable of $30,000 multiplied by the opportunity cost of .15 = $4,500. The cost of the plan would be the reduced cash collected on accounts receivable of .02 times the 40% expected to take advantage of the discount (.02 x .40 = .008) times the credit sales, or .008 x $1,000,000 = $8,000. So, the net results would be an increase in cost of $4,500 - $8,000 = - $3,500. Although not clearly stated in the problem “facts,” the decrease is intended to be average accounts receivable. As this is an actual AICPA exam question, the wording has been left unchanged.
Which of the following inventory management approaches seeks to minimize total inventory costs by considering both the restocking (reordering) cost and the carrying costs? A. Economic order quantity. B. Just-in-time. C. Materials requirements planning. D. ABC.
A. Economic order quantity.
The economic order quantity model seeks to determine the order size that will minimize total inventory cost, both order cost and carrying costs.
While the question can be answered quite easily, because the economic order quantity answer choice is the only one that is concerned with minimizing total inventory cost by considering carrying cost and restocking cost (reordering costs), the wording of the question is ambiguous at best. It would have been better worded as “Which of the following inventory management approaches seeks to minimize total inventory costs by considering both the restocking (reordering) cost and the carrying costs?” Because it is an actual AICPA exam question, the wording has been left unchanged.
