D364 Financial Management - Set 3 - Part 2

Correct Answer: A company issues new shares in an initial public offering (IPO)

Primary market transactions involve the sale of new securities directly from the issuer to investors, such as an IPO. Secondary market transactions involve trading between investors.

Correct Answer: EPS increases

When a company repurchases shares, the number of outstanding shares decreases, which increases the earnings per share, assuming net income remains constant.

Correct Answer: 5%

ROA is calculated as Profit Margin Total Asset Turnover. Rearranging the formula, Profit Margin = ROA / Total Asset Turnover. In this case: 10% / 2 = 5%.

Correct Answer: 40%

Gross profit margin is calculated as (Sales - COGS) / Sales. In this case: ($1,000,000 - $600,000) / $1,000,000 = 40%.

Correct Answer: It breaks down Return on Equity (ROE) into three components

The DuPont identity decomposes ROE into three parts: profit margin, total asset turnover, and equity multiplier, helping identify the drivers of ROE.

Correct Answer: The companys WACC will decrease

Increasing leverage (debt) typically lowers WACC because debt is cheaper than equity, especially if the cost of debt is lower than the cost of equity.

Correct Answer: $500,000

Equity is calculated as Total Assets - Total Liabilities. In this case: $800,000 - $300,000 = $500,000.

Correct Answer: Paying wages to employees

Operating activities include cash flows from a companys core business operations, such as paying wages. Repaying debt and issuing dividends are financing activities, while purchasing equipment is an investing activity.

Correct Answer: The bond is selling at a discount

A bond selling for less than its face value is priced at a discount, typically because its coupon rate is lower than current market interest rates.

Correct Answer: It increases ROE

Financial leverage increases ROE because it allows a company to use debt to finance assets and potentially generate higher returns for equity holders, though it also increases risk.

Correct Answer: To hedge interest rate or currency exchange risk

A swap contract is used to exchange cash flows in the future, often to hedge against interest rate or currency exchange risks. It is not typically used for speculation.

Correct Answer: Higher risk is generally associated with higher returns

In general, higher-risk investments offer the potential for higher returns, but they also come with the possibility of greater losses.

Correct Answer: $6.00

Book value per share is calculated as (Total Assets - Total Liabilities) / Number of Shares Outstanding. In this case: ($1,000,000 - $600,000) / 100,000 = $4.00.

Correct Answer: It reduces unsystematic risk

Diversification reduces unsystematic (company-specific) risk by spreading investments across different assets. However, it does not eliminate market risk.

Correct Answer: 7.5%

The SGR is calculated as ROE (1 - Payout Ratio). In this case: 15% (1 - 0.40) = 9.0%.

Correct Answer: $1,000,000

Debt-to-equity ratio is calculated as Total Debt / Total Equity. Rearranging the formula, Total Equity = Total Debt / Debt-to-Equity Ratio. In this case: $750,000 / 0.75 = $1,000,000.

Correct Answer: To determine the present value of future cash flows

The time value of money recognizes that a dollar today is worth more than a dollar in the future due to the potential earning capacity. It is used to calculate the present value of future cash flows.

Correct Answer: $60

The stock price is calculated as P/E ratio EPS. In this case: 20 $3 = $60.

Correct Answer: To measure how quickly a company can convert its inventory into cash

The CCC measures the time taken to turn a companys inventory into cash by tracking the time it takes to sell inventory, collect receivables, and pay payables.

Correct Answer: $500,000

Inventory turnover is calculated as COGS / Average Inventory. Rearranging the formula: COGS = Inventory Turnover Average Inventory. In this case: 5 $100,000 = $500,000.