Review for Exam 3. Instructions: Please read carefully

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1 Review for Exam 3 Instructions: Please read carefully The exam will have 25 multiple choice questions and 5 work problems. Questions in the multiple choice section will be either concept or calculation questions. The calculation questions will be similar to those in the homework and review. However, the concept questions will be related to any topic we have covered in the class. The concept questions in the review are only some sample questions. You should NOT study only topics in the review. For the work problems, you need to solve the problems without knowing the possible answers. The questions will be similar to those in the homework and the review except that the possible solutions are not given. You can bring a formula sheet to the exam. Final Exams for Classes Meeting Tu-Th at 3:30pm Tuesday, May 19 11:30 AM - 2:30 PM Chapter 11

2 1. Assume the U.S. government was to decide to increase its budget deficit. This will cause to increase. A) interest rates B) the output of the economy C) both a and b D) neither a nor b 2. A big increase in government spending is an example of. A) a demand shock B) a supply shock C) an unsurprising shock D) none of the above 3. If you expect a larger interest rate increase than other market participants do, you would A) buy long-term bonds B) buy short-term bonds C) buy long-term government bonds only D) buy short-term government bonds only 4. Which of the following would not be considered a supply shock? A) a change in the price of imported oil B) frost damage to the orange crop C) a change in the level of education of the average worker D) an increase in the level of government spending 5. A trough is. A) a transition from an expansion in the business cycle to the start of a contraction B) a transition from a contraction in the business cycle to the start of an expansion C) only something used by farmers to feed pigs and is not a term in investments D) none of the above 6. The stage of the business cycle would be a good time to invest in firms engaged in natural resource extraction and processing such as minerals and petroleum. A) Peak B) Contraction C) Trough D) Expansion 7. the ratio of the number of people classified as unemployed to the total labor force.

3 A) The capacity utilization rate is B) The participation rate is C) The unemployment rate is D) None of the above are 8. An analyst starts by examining the broad economic environment and then considers the implications of the outside environment on the industry in which the firm operates. Finally, the firm's position within the industry is examined. This is called analysis. A) bottom-up B) outside-inside C) top-down D) upside-down Chapter is defined as the present value of all cash proceeds to the investor in the stock. A) dividend payout ratio B) intrinsic value C) market capitalization rate D) plow-back ratio 10. are analysts who use information concerning current and prospective profitability of a company to assess its fair market value. A) credit analysts B) fundamental analysts C) systems analysts D) technical analysts 11. You wish to earn a return of 10% on each of two stocks, A and B. Each of the stocks is expected to pay a dividend of $4 in the upcoming year. The expected growth rate of dividends is 6% for stock A and 5% for stock B. Using the constant growth DDM, the intrinsic value of stock A. A) will be higher than the intrinsic value of stock B B) will be the same as the intrinsic value of stock B C) will be less than the intrinsic value of stock B D) more information is necessary to Answer this question 12. The market capitalization rate on the stock of Aberdeen Wholesale Company is 10%. Its expected ROE is 12% and its expected EPS is $5.00. If the firm's plow-

4 back ratio is 40%, its P/E ratio will be. A) 8.33 B) C) D) Rose Hill Trading Company is expected to have EPS in the upcoming year of $6.00. The expected ROE is 18.0%. An appropriate required return on the stock is 14%. If the firm has a plowback ratio of 60%, its growth rate of dividends should be. A) 2.5% B) 4.0% C) 8.4% D) 10.8% 14. Grott and Perrin, Inc. has expected earnings of $3 per share for next year. The firm's ROE is 20% and its earnings retention ratio is 70%. If the firm's market capitalization rate is 15%, what is the present value of its growth opportunities? A) $20 B) $70 C) $90 D) $ Cache Creek Manufacturing Company is expected to pay a dividend of $4.20 in the upcoming year. Dividends are expected to grow at the rate of 8% per year. The riskfree rate of return is 4% and the expected return on the market portfolio is 14%. Investors use the CAPM to compute the market capitalization rate on the stock, and the constant growth DDM to determine the intrinsic value of the stock. The stock is trading in the market today at $ Using the constant growth DDM and the CAPM, the beta of the stock is. A) 1.4 B) 0.9 C) 0.8 D) Westsyde Tool Company is expected to pay a dividend of $2.00 in the upcoming year. The risk-free rate of return is 6% and the expected return on the market

5 portfolio is 12%. Analysts expect the price of Westsyde Tool Company shares to be $29 a year from now. The beta of Westsyde Tool Company's stock is Using a one-period valuation model, the intrinsic value of Westsyde Tool Company stock today is. A) $24.29 B) $27.39 C) $31.13 D) $ Ace Frisbee Corporation produces a good that is very mature in their product life cycles. Ace Frisbee Corporation is expected to pay a dividend in year 1 of $3.00, a dividend in year 2 of $2.00, and a dividend in year 3 of $1.00. After year 3, dividends are expected to decline at the rate of 2% per year. An appropriate required return for the stock is 8%. Using the multistage DDM, the stock should be worth today. A) $13.06 B) $13.38 C) $18.25 D) $ A firm is expected to produce $3.00 per share in earnings next year. If the firm plans to plow back 30% of those earnings at a reinvestment rate of 25%, what will be the expected growth in dividends? A) 7.50% B) 15.0% C) 25.0% D) 30.0% 19. Next year's earnings are estimated to be $5.00. The company plans to reinvest 20% of its earnings at 15%. If the cost of equity is 9%, what is the present value of growth opportunities? A) $9.09 B) $10.10 C) $11.11 D) $12,21

6 20. Janet Ludlow s firm requires all its analysts to use a two-stage DDM and the CAPM to value stocks. Using these measures, Ludlow has valued QuickBrush Company at $63 per share. She now must value SmileWhite Corporation. a. Calculate the required rate of return for SmileWhite using the information in the following table: (K) b. Ludlow estimates the following EPS and dividend growth rates for SmileWhite: (K) Estimate the intrinsic value of SmileWhite using the table above, and the twostage DDM. Dividends per share in 2007 were $1.72. Chapter Which of the following balance sheet items is not considered an asset? A) inventory B) accounts receivable C) accrued taxes D) All of the above are assets 22. A firm has a ROE of 20% and a market-to-book ratio of Its P/E ratio is. A) 8.40 B) C) D) Use the following to answer questions 32-41: The financial statements of Shuswap Lake Manufacturing Company are given below.

7 Note: The common shares are trading in the stock market for $160 each. 23. The firm's current ratio for 2005 is. A) 0.90 B) 1.44 C) 1.89 D) The firm's leverage ratio for 2004 is. A) 0.90 B) 1.56 C) 1.89 D) 3.13

8 25. The firm's fixed asset turnover ratio for 2005 is. Please keep in mind that when a ratio involves both income statement and balance sheet numbers, the balance sheet numbers for the beginning and end of the year must be averaged. A) 3.39 B) 3.60 C) 6.00 D) The firm's asset turnover ratio for 2005 is. Please keep in mind that when a ratio involves both income statement and balance sheet numbers, the balance sheet numbers for the beginning and end of the year must be averaged. A) 0.90 B) 1.56 C) 1.92 D) The net income of the company is $970. Taxes payable decrease by $120, depreciation is $85, and fixed assets are sold for $90. If the firm's inventories also decline by $65, what is the total change in cash for the firm for all activities? A) Increase of $970 B) Increase of $1090 C) Decrease of $970 D) Decrease of $ A firm has an ROE of 3%, a debt/equity ratio of 0.5, a tax rate of 40%, and the interest rate on its debt is 10%. Its ROA is. A) 4% B) 6% C) 6.67% D) 7.50% 29. A firm purchases goods on credit worth $150. The same firm pays off $100 in old credit purchases. An investment is made via the purchase of a new facility and equity is issued in the amount of $300 to pay for the purchase. What is the change in net cash provided by operations? A) $50 increase B) $100 increase C) $150 increase D) $250 increase

9 30. What ratio will definitely increase when a firm increases its annual sales with no corresponding increase in assets? A) Asset turnover B) Current ratio C) Liquidity ratio D) Quick ratio 31. Alumbat Corporation has $800,000 of debt outstanding, and it pays an interest rate of 10 percent annually on its bank loan. Alumbat's annual sales are $3,200,000; its average tax rate is 40 percent; and its net profit margin on sales is 6 percent. If the company does not maintain a TIE ratio of at least 4 times, its bank will refuse to renew its loan, and bankruptcy will result. What is Alumbat's current TIE ratio? a. 2.4 b. 3.4 c. 3.6 d. 4.0 e. 5.0 Chapter The Dow theory proposes that several forces simultaneously affect stock prices. Which of the following is not one of these forces? a. the primary trend b. contrary trends c. intermediate trends d. minor trends 33. When a stock's market price breaks through its moving average line from below, a technical analyst interprets this as a(n). a. bullish signal b. bearish signal c. hold recommendation d. uncertain signal requiring confirmation 34. Technical analysts. a. never incorporate fundamental information into their analysis b. do not deny the value of fundamental information c. believe that fundamental analysis must support their conclusions d. None of the above

10 35. A relatively low value of Barron's confidence index is a(n): a. bullish signal. b. bearish signal. c. hold recommendation. d. uncertain signal requiring further confirmation. 36. When stock price falls below a support level, technical analysts interpret this as a(n): a. bullish signal. b. bearish signal. c. hold recommendation. d. uncertain signal requiring further confirmation. 37. If stock advances exceed declines by a wide margin, then technical analysts perceive the market as. a. vulnerable to a sell-off b. likely to remain stable c. stronger because of the widespread movement d. weaker because of the widespread movement 38. The ratio of the price of a particular security to a price index for its industry is referred to as the. a. trin statistic b. primary trend c. breadth ratio d. relative strength 39. A high amount of short interest is typically considered as a and contrarians may consider it as a. a. Bearish signal; bullish signal b. Bullish signal; bearish signal c. Bearish signal; false signal d. Bullish signal; false signal

11 40. The Dow Theory is a technique that attempts to identify. a. Only long-term trends in stock market prices b. Only short-term trends in stock market prices c. Both long-term and short-term trends in stock market prices d. Trends in arbitrage trading opportunities 41. A support level is. a. A level beyond which the market is unlikely to rise b. A level below which the market is unlikely to fall c. An equilibrium price level justified by characteristics such as earnings and cash flows d. The peak of a market wave or cycle 42. Technical analysts consider a decrease in the put/call ratio as. a. A bearish signal b. A bullish signal c. A trend reversal signal d. A signal to enter the options market 43. On day 1, the stock price of Ford was $81 and the automotive stock index was 324. On day 2, the stock price of Ford was $85 and the automotive stock index was 335. Consider the ratio of Ford to the automotive stock index at day 1 and day 2. Ford is the automotive industry and technical analysts who follow relative strength would advise the stock. a. Outperforming, buying b. Outperforming, selling c. Underperforming, buying d. Underperforming, selling 44. On a particular day, there were 890 stocks which advanced on the NYSE and 723 which declined. The volume in advancing issues was 80,846,000 and the volume in declining issues was 70,397,000. The common measure of market breadth is. a. -10,449,000 b c. 167 d. 10,449,000

12 Answers 1. Answer: C 2. Answer: A 3. Answer: B 4. Answer: D 5. Answer: B 6. Answer: A 7. Answer: C 8. Answer: C 9. Answer: B 10. Answer: B 11. Answer: A 12. Answer: B Difficulty: Medium P 1.40 = = E.10.12(.40) 13. Answer: D ( ) g = = 14. Answer: B 15. Answer: B 16. Answer: B 17. Answer: A V =.08 PVGO = V (.02) (.02) k = (.7).2(.7 ) β = = = = = = = 70 V 0 = Answer: A g = 0.30 x 0.25 =.075 (.926) (.857) + ( )(.794) = Answer: C g =.20 x.15 =.03. P = 4.0 / ( ) = PVGO = (5/.09) = 11.11

13 20. a. k = r f + β [Ε(r M ) r f ] = 4.5% (14.5% 4.5%) = 16% b. Year Dividends 2007 $ $ = $ $ = $ $ = $ $ = $2.63 Present value of dividends paid in years 2008 to 2001: Year PV of Dividends 2008 $1.93/ = $ $2.16/ = $ $2.42/ = $1.55 Total: $4.82 D $2.63 = = k g P2010 = $37.57 PV (in 2007) of P 2010 = $37.57/( ) = $24.07 Intrinsic value of stock = $ $24.07 = $ Answer: C 22. Answer: B 23. Answer: B P E = 2.38 = ,150,000 CR = = , Answer: D 2,500,000 L = = , , Answer: A 5,000,000 FAT = = ,400, ,550, Answer: C

14 5,000,000 AT = 2,500, ,700, Answer: B cash flow = = 1090 = Answer: C 1.03 ROA = Answer: A 30. Answer: A (.10) = ANS: E TIE = EBIT/I, so find EBIT and I. Interest = $800, = $80,000. Net income = $3,200, = $192,000. Taxable income = EBT = $192,000/(1 T) = $192,000/0.6 = $320,000. EBIT = $320,000 + $80,000 = $400,000. TIE = $400,000/$80,000 = 5.0 times. 32. B 33. A 34. B 35. B 36. B 37. C 38. D 39. A 40. C 41. B 42. B 43. A 44. C