University of Rio Grande Fall 2010

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1 University of Rio Grande Fall 2010 Financial Management (Fin 20403) Practice Questions for Midterm 1 Answers the questions. (Or Identify the letter of the choice that best completes the statement if there are multiple choices) 1. During the last year Alpha Co had Net Income of $150, paid $20 in dividends, and sold new stock for $40. Beginning equity for the year was $700. Ending Equity was 2. Three years ago a piece of equipment was purchased for $10,000. Assuming an eight-year life and straight-line depreciation, financial statements for the third year will show: a. depreciation expense of $3,000 on the income statement, and accumulated depreciation of $3,000 b. depreciation expense of $1,250 on the income statement, and accumulated depreciation of $3,000 c. depreciation expense of $1,250 on the income statement, and accumulated depreciation of $3,750 d. depreciation expense of $1,250 on the income statement, and accumulated depreciation of $1, Selected accounts are listed below. How much is the firm's operating income? Accrued payroll $ 2,000 Sales 45,000 Cost of goods sold 26,000 Interest expense 1,000 Expenses (other than interest) 8, Wessel Corp. plans to sell 1,000 units in 2002 at an average sale price of $45 each. Cost of goods sold will be 40% of the sale price. Depreciation expense will be $3,000, interest expense $2,500, and other expenses will be $4,000. Wessel's tax rate is 20%. What will Wessel Corp's net income be for 2002? 5. Albert Corp. bought a machine for $10,000 thirteen years ago. It has been depreciated on a straight line basis over a 20 year life with no salvage value. The firm just sold the machine for $6,000. How much gain/loss should be reported on the sale. 6. The following items are components of a firm's balance sheet. How much is the firm's working capital (net working capital)? Cash $ 2,000 Long-term debt 10,000 Inventory 12,000 Owners' equity 62,000 Accounts payable 8,000 Accruals 1,500 Accumulated depreciation 6,000 Accounts receivable 14, The following items are components of a traditional balance sheet. How much are the total assets of the firm? Plant and equipment $ 42,000 Common stock 15,000 Cash 8,000 Inventory 21,000 Bad debt reserve 6,000 Paid in excess 6,000 Accumulated depreciation 28,000 Accounts receivable 22, Belvedere, Inc. has an annual payroll of $250,000. The firm pays employees every two weeks on Friday afternoon. Last month, the books were closed on the Thursday after payday. How much is the payroll accrual at the end of the month? (Round to nearest $)

2 9. The Johnson Company bought a truck costing $60,000 2 years ago. The truck's estimated life was six years at the time of purchase. It was accounted for by using straight line depreciation with zero salvage value. If the truck was sold yesterday for $65,000, what is the capital gain that must be reported on the sale of the truck? 10. The following items provide information about an individual for the past year. What is the individual's ending cash balance? Purchase of a new car $25,000 Cash used on living expenses 30,000 Beginning cash balance 8,000 Net worth, beginning 22,000 Unpaid utility and rent bills 2,000 Car loan proceeds 20,000 Sale of old car 1,000 Annual net pay from job 44,000 Car loan payment 1, Given the following selected information on McMillen's Chocolate, Inc., calculate Cash Flow from Operating Activities for Last Year This Year EAT $ 600,000 $ 750,000 Depreciation Exp. 100, ,000 Dividends 400, ,000 Accounts Receivable 1,500,000 2,000,000 Inventory 3,500,000 2,000,000 Accts. Payable/Accr. 350, ,000 Long-Term Debt 2,300,000 3,000,000 Common Stock 2,200,000 2,500,000 Retained Earnings 6,150,000 6,350, You have just won a $5 million lottery to be received in twenty annual equal payments of $250,000. What will happen to the present value of your winnings if the interest rate increases. 13. How much must be invested today to have $1,000 in two years if the interest rate is 5%? 14. Find the present value of $100 to be received at the end of two years if the discount rate is 12% compounded monthly. 15. Your bank balance is exactly $10,000. Three years ago you deposited $7,938 and have not touched the account since. What annually compounded rate of interest has the bank been paying? 16. $3,947 deposited four years ago has grown to $5,000. What semiannually compounded rate of interest has the bank been paying? 17. You purchased a piece of property for $30,000 nine years ago and sold it today for $83,190. What was the annual rate of return on your investment? 18. Suppose you put $100 into a savings account today, the account pays 8% compounded semiannually, and you withdraw $50 one year after your initial deposit. What would your ending balance be 20 years after the initial $100 deposit was made, assuming that you make no additional deposits? 19. A bank has agreed to loan you $10,000 at 11% for 5 years. You are required to make equal, annual, endof-year payments that include both principal and interest on the outstanding balance. Determine the amount of these annual payments (to the nearest dollar). 20. Many IRA funds argue that investors should invest at the beginning of the year rather than at the end. What is the difference to an investor who invests $2,000 per year at 11 percent over a 30-year period? 21. What present amount is equivalent to $100 received at the end of each year for 8 years, given an opportunity cost of 20%

3 22. After watching "Who Wants to Be a Millionaire", you have decided you want to join the millionaire's club. Your goal is to have $1,000,000 in 35 years. If you can invest in a mutual fund that you project will earn a 10% return, how much must you invest each year to meet your goal? (Round to nearest $) 23. If you were to borrow $10,000 over five years at 12% compounded monthly, what would be your monthly payment? 24. You have borrowed $180,000 to buy a new home. You plan to make monthly payments over a 25-year period. The bank has offered you a 10% interest rate compounded monthly. Calculate the total amount of interest you will pay the bank over the life of the loan. 25. What is the effective rate of interest on a CD that has a nominal rate of 9.5 percent with interest compounded monthly? 26. 1st Bank offers you a car loan at an annual interest rate of 10% compounded monthly. What effective annual interest rate is the bank charging you? 27. Find the present value of a perpetuity of $1,500 per year, given a 20% opportunity cost. 28. Jim Luster wants to have saved enough money by the time he is 65 to invest it and earn a $60,000 annual income for the rest of his life. He wants to be able to leave that same amount to his heirs, no matter how long he lives. If he can earn 8% on invested money, how much does he need to have accumulated by the time he is 65? 29. You want to purchase a car for $40,000 when you graduate in two years. At that time you will take out a 5-year bank loan at 12% compounded monthly. Based on your estimated earnings, you think you'll be able to afford loan payments of $750 per month. You plan to save up the difference between the cost of the car and the amount you'll borrow by making quarterly deposits over the next two years in a bank account that pays 8% compounded quarterly. How large must those deposits be? (Round to the nearest dollar) 30. In six years, your daughter will be going to college. You wish to have a fund that will provide her with $10,000 at the end of each of her four years in college. How much must you deposit today if the money will earn10 percent in each of the 10 years? 31. Consider the timing of the following certain investment projects profits Profit L S Year 1 $0 $3,000 2 $3,000 $0 A) Project S is preferred to project L. B) Project L is preferred to project S. C) Projects S and L both have profits over the two years of $3,000 and are therefore equivalent. D) A goal of profit maximization would favor S over L. 32. Assume that GAR Corporation had sales of $15 million; its cost of goods sold was $9 million; and it incurred operating expenses of $4.5 million and an additional $300,000 in interest expense. In addition, it received interest income of $300,000 and dividend income of $400,000. Assume that the firm pays income taxes at the rate of 40 percent. What is GAR's income tax liability? 33. Assume that Wurst Corporation had sales of $85 million; its cost of goods sold was $60 million; and it incurred operating expenses of $13 million. In addition, it received interest income of $900,000 and dividend income of $750,000. Assume that the firm pays income taxes at the rate of 40 percent. What is Wurst's income tax liability? 34. Four Doors Down, Inc., has taxable income of $85,000. Use the following portion of a corporation tax table (surcharges do not apply) $0 - $50,000 15% $50,001 - $75,000 25% $75,001 - $100,000 34% What is Four Doors Down, Inc.'s marginal tax rate?

4 35. Venus, Inc., had sales in 2002 of $2 million dollars. The common stockholders received $400,000 in cash dividends and preferred stockholders were paid $200,000. Interest expense was $150,000 while operating expenses totaled $600,000, and cost of goods sold was $500,000. Dividends of $200,000 were received on the company's investment in Serena, Inc., What is the tax liability of Venus, Inc.? 36. Goodwin Enterprises had a gross profit of $2,500,000 for the year. Operating expenses and interest expense incurred in that same year were $595,000 and $362,000, respectively. Goodwin had 200,000 shares of common stock and 180,000 shares of preferred stock outstanding. Management declared a $2.50 dividend per share on the common and a $1.50 dividend per share on the preferred. Securities purchased at a cost of $37,500 in a previous year were resold at a price of $50,500. Compute the taxable income and the resulting tax liability for Goodwin Enterprises for the year. the following tax rates Income Tax rate 0-$50,000 15% 50,001-$75,000 25% 75,001-$100,000 34% $100,001-$335,000 39% over $335,001 34% 37. You are considering an investment in a U.S. Treasury bond but you are not sure what rate of interest it should pay. Assume that the real risk-free rate of interest is 1.0 percent; inflation is expected to be 2.0 percent; the maturity risk premium is 1.5 percent; and the default risk premium for AAA-rated corporate bonds is 3 percent. What rate of interest should the U.S. Treasury bond pay? 38. You are considering an investment in a U.S. corporate bond but you are not sure what rate of interest it should pay. Assume that the real risk-free rate of interest is 1.0 percent; inflation is expected to be 2.0 percent; the maturity risk premium is 1.5 percent; and, the default risk premium for AAA rated corporate bonds is 3 percent. What rate of interest should the U.S. corporate bond pay? 39. Given the anticipated rate of inflation (i) of 2.1 percent and the real rate of interest (R) of 2.7 percent, find the nominal rate of interest (r).

5 Answers to Mid 1- Practice Questions 1 $870 2 depreciation expense of $1,250 on the income statement, and accumulated depreciation of $3,750 on the balance sheet. 3 $11,000 4 $14,000 5 $2,500 gain 6 $18,500 7 $59,000 8 $3,846 9 $25, $19, $2,050, it will be worth less 13 $ $ % % 17 12% 18 $ $2, $43, $3, $ $310, % % 27 $7, $750, $ $17, A) Project S is preferred to project L. 32 $648, $5,250, % 35 Tax liability = 275, Tax liability = $529, % % 39 r = 4.86%

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