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Fire 520 Exam 1

On my honor, I have neither given nor received aid on this assignment, and I pledge that I am in compliance with the VCU Honor System.

Name Signature

: ______________________________ : ______________________________

Questions i through viii are worth 5 points each and question ix is worth 10 points.

i.

Wells Water Systems recently reported $8,250 of sales, $4,500 of operating costs other than depreciation, and $950 of depreciation. The company had no amortization charges, it had $3,250 of outstanding bonds that carry a 6.75% interest rate, and its federal-plus-state income tax rate was 35%. In order to sustain its operations and thus generate sales and cash flows in the future, the firm was required to spend $750 to buy new fixed assets and to invest $250 in net operating working capital. How much free cash flow did Wells generate? a. b. c. d. e. $1,770.00 $1,858.50 $1,951.43 $2,049.00 $2,151.45

ii.

Tibbs Inc. had the following data for the year ending 12/31/07: Net income = $300; Net operating profit after taxes (NOPAT) = $400; Total assets = $2,500; Short-term investments = $200; Stockholders' equity = $1,800; Total debt = $700; and Total operating capital = $2,300. What was its return on invested capital (ROIC)? a. b. c. d. e. 14.91% 15.70% 16.52% 17.39% 18.26%

iii.

The CFO of Shalit Industries plans to have the company issue $300 million of new common stock and use the proceeds to pay off some of its outstanding bonds. Assume that the company, which does not pay any dividends, takes this action, and that total assets, operating income (EBIT), and its tax rate all remain constant. Which of the following would occur? a. b. c. d. e. The companys taxable income would fall. The companys interest expense would remain constant. The company would have less common equity than before. The companys net income would increase. The company would have to pay less taxes.

iv.

Other things held constant, which of the following actions would increase the amount of cash on a companys balance sheet? a. b. c. d. e. The company repurchases common stock. The company pays a dividend. The company issues new common stock. The company gives customers more time to pay their bills. The company purchases a new piece of equipment.

v.

Its retained earnings is the actual cash that the firm has generated through operations less the cash that has been paid out to stockholders as dividends. Retained earnings are kept in cash or near cash accounts and, thus, these cash accounts, when added together, will always be equal to the firm's total retained earnings.

a. b. vi.

True False

Money markets are markets for a. b. c. d. e. Foreign stocks. Consumer automobile loans. U.S. stocks. Short-term debt securities. Long-term bonds.

vii.

Which of the following is a primary market transaction? a. b. c. d. e. You sell 200 shares of IBM stock on the NYSE through your broker. IBM issues 2,000,000 shares of new stock and sells them to the public through an investment banker. You buy 200 shares of IBM stock from your brother. The trade is not made through a broker--you just give him cash and he gives you the stock. One financial institution buys 200,000 shares of IBM stock from another institution. An investment banker arranges the transaction. You invest $10,000 in a mutual fund, which then uses the money to buy $10,000 of IBM shares on the NYSE.

viii.

Which of the following factors would be most likely to lead to an increase in interest rates in the economy? a. b. c. d. e. Households reduce their consumption and increase their savings. The Federal Reserve decides to try to stimulate the economy. There is a decrease in expected inflation. The economy falls into a recession. Most businesses decide to modernize and expand their manufacturing capacity, and to install new equipment to reduce labor costs.

ix Describe how Collateralized Debt Obligations contributed to the financial market collapse of Fall 2008. (Use the reverse side of the page to answer.)

i.

Answer: a Bonds Interest rate Tax rate Required addition to net operating working capital Required capital expenditures (fixed assets) Sales Operating costs excluding depr'n Depreciation Operating income (EBIT) FCF = EBIT(1 T) + Depr'n Cap Ex Net Op WC FCF = $1,820 + $950 $750 $250 FCF = $1,770.00 $3,250.00 6.75% 35% $250.00 $750.00 $8,250.00 $4,500.00 $950.00 $2,800.00

ii.

Answer: d NOPAT Total operating capital $400 $2,300

ROIC = NOPAT/Total operating capital ROIC = $400/$2,300 ROIC = 17.39% iii. iv. v. vi. vii. Answer: d Answer: c Answer: b Answer: d Answer: b Statement b is a primary market transaction, since the money and the security pass directly between the issuing firm and the investor.

viii. Answer: e An increase in the demand for capital by businesses will increase interest rates in the economy.

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