Financial Questions Practice, Exercises for Finance

Financial Questions Practice, Exercises for Finance

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Financial Management I – Online

Assignment #1

Chapters 1-3, 5-7

/80 marks

Name: __________________________ Date: _____________

1. Provide at least three examples each of real and financial assets that might appear on the balance

sheet of General Motors. (3 marks)

2. Distinguish between a firm's capital budgeting decision and financing decision. (3 marks)

3. Why are secondary market transactions of importance to corporations? (3 marks)

4. What are the functions of financial markets? (2 marks)

5. Why do non-financial corporations need modern financial markets and institutions? (2 marks)

6. If depreciation is a method of allocating cost rather than an actual cash flow, discuss how

depreciation impacts the income statement and overall cash flows. (2 marks)

7. Determine the net income and also the cash flow from operations for the following firm: $500,000

sales, $10,000 cash dividends, $300,000 cost of goods sold, $20,000 administrative expense, $20,000

depreciation expense, $40,000 interest expense, and a tax rate of 34 percent. (4 marks)

8. What is the change in cash balance for a firm with: $10,000 cash flow from operations, $1,600 cash

used for new investment, a reduction in the level of debt of $2,000, $1,000 in cash dividends, and $200

in depreciation expense? (3 marks)

9. Compute the total tax liability, the average tax rate, and the marginal tax rate for the following

corporation: $1,000,000 in taxable income; 15 percent tax up to $50,000, 25 percent up to $75,000, 34

percent up to $100,000, and 39 percent over $100,000. (3 marks)

10. If four years of college is expected to cost $150,000 18 years from now, how much must be

deposited now into an account that will average 8 percent annually in order to save the $150,000? By

how much would your answer change if you expected 11 percent annually? Explain the difference. (4


11. After reading the fine print in your credit card agreement, you find that the “low” interest rate is

actually an 18 percent APR, or 1.5 percent per month. Now, to make you feel even worse, calculate the

effective annual interest rate. (3 marks)

12. Discuss the statement, “Money has a time value.” (4 marks)

13. Explain the difference between a regular annuity and an annuity due. (2 marks)

14. Mrs. Brown is considering setting up a college fund for her grandson. Mrs. Brown wants to pay her

grandson's tuition fees of $5,000 each year for four years. Assume that she saves an equal amount each

year, and the first deposit is made one year from now. Interest rates will remain constant at 8 percent.

How much must Mrs. Brown save each year? Assume her grandson will go to college in 18 years and

tuition fees are paid once a year at the beginning of the year. (5 marks)

15. Lincoln and Donovan's will pay a dividend of $5 per share in year 1. It sells at $60 a share, and firms

in the same industry provide an expected rate of return of 14 percent. What must be the expected

growth rate of the company's dividend? (2 marks)

16. Show numerically that investment horizon has no bearing on current stock price. For your illustration

assume investment horizons of three versus five years and the following facts: the stock is correctly

priced at $40.00, has a required return of 17 percent, a growth rate of 7 percent, and has just paid a

$3.74 dividend. (4 marks) Page 3

17. Lincoln wants to buy a new Mercedes-Benz Jeep. He will need to borrow $20,000 to go with his

down payment in order to afford this car. If car loans are available at a 6 percent annual interest rate,

what will Lincoln's monthly payment be on a four-year loan? (3 marks)

18. Determine the current yield, yield to maturity, and price of the following bond as of the date of

purchase and on each anniversary date of its purchase until maturity: three-year bond with a 12 percent

coupon and a purchase price of $1,100. (4 marks)

19. Why are long-term bonds more sensitive to changes in interest rates than short-term bonds? (3


20. What is meant by “default risk” in bonds, and how do investors respond to it? (2 marks)

21. Why do investors pay attention to bond ratings and demand a higher interest rate for bonds with

low ratings? (2 marks)

22. A stock offers an expected dividend of $3.50, has a required return of 14 percent, and has

historically exhibited a growth rate of 6 percent. Its current price is $35.00 and shows no tendency to

change. How can you explain this price based on the constant growth dividend discount model? (5


23. Develop a current stock value for a firm that is expected to have extraordinary growth of 25 percent

for four years (from today), after which it will face more competition and slip into a constant growth

rate of 5 percent. Its required return is 14 percent and next year's dividend is expected to be $5.00. (5


24. For a firm that expects earnings next year of $10.00 per share, has a plowback ratio of 35 percent, a

return on equity of 20 percent, and a required return of 15 percent, show the current stock value and

next year's expected stock value, assuming that growth is to be constant. (5 marks)

25. Lincoln Thomas believes that the Harris Group will pay a dividend of $4 on its common stock next

year. Thereafter, you expect dividends to grow at a rate of 12 percent a year in perpetuity. If Lincoln

requires a return of 24 percent on his investment, how much should he be willing to pay for the stock?

(2 marks)

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