Corporate finance midterm exam solutions

A. TOTAL OPERATING EXPENSES

B. GROSS PROFIT

C. NET PROFIT

D. SALES (or REVENUES)

2. Net Working Capital (NWC) is defined as:

A. Book Value (BV) of current assets.

B. Cash Balance minus current liabilities.

C. Current Assets minus Current Liabilities.

D. Total Assets minus Liabilities

3. Which one of the following decreases a firm’s Net Income but does not decrease its Operating Cash Flow (OCF) if the firm owes no taxes for the current year?

A. Fixed Operating Expense

B. Variable Operating Expense

C. Depreciation Expense

E. Write Down of Accounts Receivable Account

4. Cash Flow From Assets (CFFA) is defined as:

A. Cash Flow to shareholders MINUS the cash flow to creditors.

B. Operating Cash Flow (OCF) PLUS Cash Flow to Creditors PLUS Cash Flow to Shareholders.

C. Operating Cash Flow (OCF) PLUS or MINUS the change (∆) in Net Working Capital (NWC) PLUS or MINUS Net Capital Spending.

D. Operating Cash Flow (OCF) PLUS Net Capital Spending PLUS the change (∆ )in Net Working Capital (NWC).

5. Which of the following category of standard financial ratios is related to a firm’s capital structure?

A. Short-term solvency or LIQUIDITY ratios

B. Long-term solvency or financial LEVERAGE ratios

C. Asset management or TURNOVER ratios

D. Profitability ratios (Return On)

E. Market value ratios

6. Which of the following IS NOT one of the THREE INDIVIUDAL RATIOS into which the DUPONT IDENTITY decomposes?

A. Return on Fixed Assets

B. Net Profit Margin

C. Equity Multiplier

D. Asset Turnover

7. ( TRUE or FALSE ) Generally, the DENOMINATOR in Turnover Ratios is the firm’s Sales (Revenues).

8. ( TRUE or FALSE ) A firm’s EARNING BEFORE TAXES (EBT) as shown on its Income Statement is the same thing as its TAXABLE INCOME on its federal Income Tax Return.

9. ( TRUE or FALSE ) Ratio Analysis of a firm’s financial statements is only meaningful if ratios are compared to an appropriate standard OR they are part of a trend analysis of firm activities over time. Those comparables are called BENCHMARKS.

10. ( TRUE or FALSE ) The goal of financial management is to MAXIMIZE the NET PROFIT which a company generates through effective and efficient use of its assets.

11. The two important and fundamental principles which we have said dominate all financial management decision-making are _____TVM________________ and

___Risk-Return Trade-Off_______.

12. The three potential sources of a company’s assets are BORROWING (Debt), CAPITAL CONTRIBUTIONS (Sale of Stock) and ____Earning/Profits/(will accept RE)___.

13. The three (3) categories into which corporate financial management decisions fall

are CAPITAL STRUCTURE, WORKING CAPITAL MANAGEMENT and ___CAPITAL BUDGETING___.

Part II (37 points)(SHOW AND LABEL YOUR WORK)

A. Consider the following information from the financial accounting records of Palmer, Inc. (17 points)

2012 2013

Sales $ 3,723 $ 4,027

Cost of Goods Sold 2,145 2,353

Depreciation 695 843

Interest 159 175

Dividends 199 223

Current Assets 1,953 2,170

Net Fixed Assets 6,505 6,835

Current Liabilities 888 1,121

Long Term Debt (LTD) 2,751 1,863

0. Prepare Comparative Balance Sheets for 2012 & 2013: (4)

2012 2013 2012 2013

Current Assets 1,953 2,170 Current Liabilities 888 1,121

Net Fixed Assets 6,505 6,835 Long Term Debt 2,751 1,863

Equity 4,819 6,021

Total Assets 8,458 9,005 Total L + E 8,458 9,005

1. Prepare Palmer’s Income Statement for 2013 (assume a 34% aggregate tax rate): (4)

Sales 4,027

Cost of Goods Sold 2,353

Depreciation 843

EBIT 831

Interest Expense 175

Taxable Income (EBT) 656

Taxes @ 34% 223

Net Income 433

Dividends 223

∆ Retained Earnings (+) 210

1. What was Palmer’s Operating Cash Flow (OCF) for 2013? (3)

EBIT + Depn - Taxes = 831 + 843 -- 223 = 1,451

1. What is Palmer’s Total Cash Flow (Cash Flow from Assets) for 2013? (4)

TCF = OCF +- ∆CAPEX +- ∆ (NWC

∆CAPEX = End NFA - Beg NFA + Depn = (6835 – 6505) + 843 = 1,173

∆NWC = End NWC - Beg NWC = (2170 - 1121) -- (1953 -- 888) = 1049 – 1065 = -16

TCF = 1451 - 1173 + 16 = 294

1. What was 2013 Cash Flow TO Creditors? (2)

CF to Creditors = Interest – Net New LTD = 175 -- (-888) = 1,063**

**Total payments to Creditors are Interest plus principal reduction (this is a cash outflow)

B. Your firm has Total Assets of $158,000 and a DEBT TO ASSETS RATIO of 35%. What is the firm’s DEBT TO EQUITY RATIO? (3)

D/E = .35/.65 = .5385

What is the DOLLAR AMOUNT of the Stockholder Equity Section of the firm’s Balance Sheet? (2)

E = .65 x 158,000 = $ 102,700

C. A company has Sales of $1,655,000; Operating Expenses of $593,000; Depreciation Expense of $194,000. The applicable tax rate is 35%. What is the firm’s Operating Cash Flow (OCF) in this period? (5)

OCF = EBITDA – TAXES (or EBIT + DEPN -- TAXES)

EBITDA = (1,655,000 -- 593,000) = 1,062,000

TAXES = (1,655,000 -- 593,000 -- 194,000)(.35) = 303,800

OCF = 1,062,000 -- 303,800 = $ 758,200

OR OCF = (Sales -- Operating Expenses)(1 – T) + (DEPN)(T)

(1,655,000 -- 593,000)(.65) + (194,000)(.35) = 758,200

D. Use the following Balance Sheet to assess the corporation’s financial condition using standard ratio analysis (6 points):

Cash 167,000 AP 236,000

AR 241,000 NP 176,000

Inv 498,000

Tot CA $906,000 Tot CL 412,000

Patents 818,000 LTD 913,000

NFA 4,700,000 Tot Liab 1,325,000

TA 6,424,000 CS 869,000

RE 4,230,000

Tot L&E 6,424,000

Comment on the firm liquidity position if industry standards for companies of similar size generally have Current Ratios of 2.55 and Quick Ratios of 1.38. What are possible explanations (or areas requiring further investigation) for any deviations from the standards which you calculate?

ANS: CA/CL = 906,000/412,000 = 2.2

ANS: (CA -- INV)/CL = (906,000 -- 498,000)/412,000 = .99

The company appears less liquid than you would expect. Explanations could be any area of WC management. Initial inquiry would probably be into the quality an saleability of inventory and various CA turnover ratios.

E. Howard Lumber has a current Accounts Receivable (AR) balance of $645,382, which was the approximate average balance throughout the current period. Total Sales for the year were $7,339,562.50, 80% of which were CREDIT SALES. What is the company’s Receivables Turnover Ratio? (2 points)

(7,339,562.5)(.8)/645,382 = 5,871,650/645,382 = 9.1 TIMES

(3) How many days (on average) did it take for Howard Lumber’s to collect on sales made on credit? (2 points)

ANS = 365/9.1 = 40.11 days

EXTRA CREDIT (2 points)(DO THIS LAST!!!!)

Holliday Products, Inc. has current liabilities of $ 365,000, a Quick Ratio of .85, Inventory Turnover of 5.8 times, and a Current Ratio of 1.4. What is the Cost of Goods Sold (CGS) for the company during the current period?

ANS: Total CA = (1.4)(365,000) = 511,000

INV = (1.4 -- .85)(CL) = (.55)(365,000) = 200,750

CGS = (INV)(5.8) = (200,750)(5.8) = 1,164,350

CHECK : QR = (511,000 – 200,750)/365,000 = .85