Other 2 - Financial Management Flashcards
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%
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.
Which of the following formulas should be used to calculate the historic economic rate of return on common stock?
A. (Dividends + change in price) divided by beginning price.
B. (Net income - preferred dividend) divided by common shares outstanding.
C. Market price per share divided by earnings per share.
D. Dividends per share divided by market price per share.
A. (Dividends + change in price) divided by beginning price.
For common stock, expected returns are from dividends and stock price appreciation. Thus, the rate of return on the common stock would be (dividends paid during the period + change in the stock price)/price of the stock at beginning of the period.
The optimal capitalization for an organization usually can be determined by the
A. Maximum degree of financial leverage.
B. Maximum degree of total leverage.
C. Lowest total weighted-average cost of capital.
D. Intersection of the marginal cost of capital and the marginal efficiency of investment.
C. Lowest total weighted-average cost of capital.
The optimal capitalization for an organization would be determined by the lowest total weighted-average cost of capital. The weighted-average cost of capital determines the average cost of a corporation’s capital by weighting each component, both debt and equity. The lowest total weighted-average cost of capital usually would be the optimal capitalization and would maximize the value of the firm’s stock.
Which one of the following sources of new capital usually has the lowest after-tax cost? A. Bonds. B. Preferred stock. C. Common stock. D. Retained earnings.
A. Bonds.
Bonds usually have the lowest after-tax cost of new capital because investors have less risk when investing in bonds than in equity, and because the interest payments to bondholders is deductible for tax purposes.
A cash management system should be concerned with the float associated with both cash receipts and cash disbursement.
Will efficient practices seek to increase or decrease receipt float and disbursement float?
Receipt Float Disbursement Float
Increase Increase
Increase Decrease
Decrease Increase
Decrease Decrease
Decrease Increase
C is correct.
Float is the length of time between the writing of a check (or other draft instrument) and the actual transfer of the funds. Receipt float is the time between the writing of a check (or other instrument) by a customer and when those funds become available to the party to which the check was made.
Disbursement float is the time between the writing of a check by a firm writes and removal of the funds from the firm’s account. Efficient cash management will seek to decrease receipt float and increase disbursement float.
By reducing receipt float, a firm has cash it is receiving available sooner than it would be available otherwise.
By increasing disbursement float, a firm has cash it is paying available longer than it otherwise would be available. Thus, decreasing receipt float and increasing disbursement float make more cash available to a firm.
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.
As a consequence of finding a more dependable supplier and adopting just-in-time inventory ordering, Dee Co. reduced its safety stock of raw materials inventory by 80%. Which one of the following would the reduction in safety stock have on Dee's economic order quantity? A. 80% decrease. B. 64% decrease. C. 20% increase. D. 0% change (no effect).
D. 0% change (no effect).
A change in safety stock does not affect a firm’s economic order quantity (but does affect its reorder point). The calculation of economic order quantity (EOQ) is:
Thus, the safety stock is not a factor in determining the economic order quantity, and a change (decrease) in safety stock would have no effect on Dee’s economic order quantity.
In managing its working capital, your firm tries to follow the hedging principle of finance. Which one of the following would be too aggressive to be consistent with that principle as applied to working capital?
A. Financing short-term needs with long-term funds.
B. Financing long-term needs with short-term funds.
C. Financing seasonal needs with short-term funds.
D. Financing a permanent build-up in inventory with long-term debt.
B. Financing long-term needs with short-term funds.
Under the hedging principle of finance, assets are acquired with financing that matches the life of the asset. Thus, short-term assets would be financed with short-term liabilities and long-term assets would be financed with long-term liabilities or equity. The financing of long-term needs with short-term funds would be an aggressive approach to financing long-term needs that would not be consistent with the hedging principle.
Acid-test Ratio Formula
Acid-test Ratio = (Cash + (Net) Receivables + Marketable Securities) / Current Liabilities
