Solutions to Test 1

version B

25. After-tax returns

Equivalent pre-tax yield on corporate bond =

Answer: d

Diff: E

Answer: c

Diff: E

Answer: e

Diff: E

4.8%
(1 - 0.27)

26. Expected interest rates

= 6.58%.

IP3 = (3% + 4% + 5%)/3 = 4%. So k3 = k* + IP3 = 3% + 4% = 7%.

27. Expected inflation

kT4 = 8%. IP4 = 8% - 3% = 5%, which is the average inflation premium over the 4-year period. So, 5% = (3% +
4% + 5% + X)/4. So, X = 8%, or I4 = 8%.
28. Interest rates Answer: b Diff: M
29. Earnings per share

Answer: c Diff: M

The company paid a dividend of $0.80 per share.

paid was:

The total amount

$0.80 per share 1 million shares = $800,000.

The change in retained earnings (the amount of money the company
reinvests) is equal to NI - Div.
($6,000,000 - $5,000,000) = NI - $800,000
$1,000,000 + $800,000 = NI
$1,800,000 = NI.
EPS = NI/Shares
= $1,800,000/1,000,000
= $1.80.
30. Average inflation

Answer: b

Diff: M

We know kT5 = 5%, and kT10 = 6% (both given).

Since IP10 = 2.5%,
then kT10 = k* + 2.5%. (Since these are Treasuries DRP = LP = 0.)
Step 1:

Solve for the real risk-free rate:

kT10 = k* + 2.5%
6% = k* + 2.5%
3.5% = k*.

Step 2:

Solve for average inflation over next 5 years:

kT5 = k* + IP5
5% = 3.5% + IP5

IP5 = 1.5%.
31. ROA

Answer: d

Diff: E

Answer: c

Diff: E

Answer: d

Diff: M

Net income = 0.15($20,000,000) = $3,000,000.

ROA = $3,000,000/$22,500,000 = 13.3%.
32. Market/book ratio

M Price per share shares

B
BV
$80 shares
4.0
$40,000,000
$160,000,000 $80 shares
2,000,000 shares.
33. Operating income
EPS = NI/Shares
NI = EPS Shares
= $3.00 400,000 = $1,200,000.
EBT = NI/(1 - T) = $1,200,000/(1 - 0.4) = $2,000,000.
EBIT = EBT + Interest expense = $2,000,000 + $500,000 = $2,500,000.
34. Expected interest rates

Answer: a

Diff: E

If the 1-year rate in one year is X; (6% + X)/2 = 5.5%; X = 5%.

35. Profit margin

Answer: a

Diff: M

Equity multiplier = 1/(1 - 0.35) = 1.5385.

ROE = (Profit margin)(Assets utilization)(Equity multiplier)
15% = (PM)(2.8)(1.5385)
PM = 3.48%.
36. NOPAT

Answer: d

Diff: E

NOPAT02 = EBIT(1 - T)
= $450,000,000(0.6)
= $270,000,000.

37. Net operating working capital

Net operating
working capital02

Answer: b Diff: E

= $1,116,000,000 - $540,000,000 = $576,000,000.

38. Operating capital

Answer: e Diff: E

Total investor - supplied

operating capital02

$900,000,000

$576,000,000

$1,476,000,000.
39. Free cash flow

Answer: c Diff: M

NOWC01 = Current assets - Non-interest charging current liabilities

= $1,080,000,000 - $450,000,000 = $630,000,000.

Total investor-supplied
operating capital01

= Net plant & equipment + NOWC

=

$1,380,000,000.

$750,000,000

$630,000,000

FCF02 = NOPAT02 - Net investment in operating capital

=
$270,000,000
$1,476,000,000
$1,380,000,000
$174,000,000.

40. TIE ratio

TIE
7
7INT
6INT
INT

=
=
=
=
=

Answer: b

Diff: E

EBIT/INT
($300 + INT)/INT
$300 + INT
$300
$50.

41. EVA

Answer: b

Total investor-supplied

capital employed

EVA = EBIT (1 - T) -

Diff: M

After-tax
cost of capital .

Note that EBIT = Earnings before taxes plus interest expense.

Earnings before taxes = EBT =

$600,000
= $1,000,000.
0.6

EBIT = $1,000,000 + $200,000 = $1,200,000.

EVA = $1,200,000(0.6) - $9,000,000(0.10)
= -$180,000.

42. Equity multiplier

Answer: d

Equity multiplier = 4.0 = Total assets/Total equity = 4/1.

Assets = Debt + Equity
4 = Debt + 1

Diff: M

Debt = 3.
Debt/Assets = 3/4 = 0.75.
43. P/E ratio and stock price

Answer: e

Diff: E

EPS = $750,000/100,000 = $7.50.

P/E = Price/EPS = 8.
Thus, Price = 8 $7.50 = $60.00.
44. Debt ratio and Du Pont analysis

Answer: c

Diff: M

The Du Pont analysis of return on equity gives us:

ROE = ROA EM
14% = 10% EM
1.4 = EM.
From the equity multiplier (A/E), we can calculate the debt ratio:
1.4 = A/E
E/A = 1/1.4
E/A = 0.7143.
D/A = 1 E/A
D/A = 1 0.7143
D/A = 0.2857 = 28.57%.
45. Profit margin and Du Pont analysis

Answer: a

Diff: E

Using the Du Pont analysis again, we can calculate the profit

margin.
ROE
14%
14%
2%

=
=
=
=

PM TATO EM
PM 5 1.4
PM 7
PM.

46. Expected interest rates

Answer: d

Diff: E

The pure expectations hypothesis allows us to say that a long-term

security yield is comprised of a weighted average of securities
with shorter maturities.
6.5%
32.5%
27.0%
6.75%
47. ROE

=
=
=
=

(5.5% + 4X)/5
5.5% + 4X
4X
X.

(Sales per day)(DSO) = A/R

(Sales/365)(60) = $150,000
Sales = $912,500.
Profit margin = Net income/Sales.

Answer: c

Diff: M

Net income = 0.04($912,500) = $36,500.

Debt ratio = 0.64 = Total debt/$3,000,000.
Total debt = $1,920,000.
Total equity = $3,000,000 - $1,920,000 = $1,080,000.
ROE = $36,500/$1,080,000 = 3.38% 3.4%.

48. Net cash flow

Answer: d

Diff: M

NCF = NI + Depreciation and Amortization.

NI = EBIT - I - Taxes
= $700 - $200 - Taxes
= $500 ($500 40%)
= $500 - $200
= $300 million.
EBIT = EBITDA Depreciation and Amortization
$700 = $850 - DA
$150 million = DA.
So, depreciation and amortization totals $150 million.
NCF = NI + DEP and AMORT
= $300 + $150
= $450 million.
49. Du Pont equation

Answer: a

Diff: E

First, calculate the profit margin, which equals NI/Sales:

ROA = NI/TA = 0.04.
Sales/Total assets = S/TA = 2.
PM = (NI/TA)(TA/S) = 0.04(0.5) = 0.02. [TA/S = 1/2 = 0.5.]
Next, find the debt ratio by finding the equity ratio:
E/TA = (E/NI)(NI/TA). [ROE = NI/E and ROA = NI/TA.]
E/TA = (1/ROE)(ROA) = (1/0.06)(0.04) = 0.667, or 66.7% equity.
Therefore, D/TA must be 0.333 = 33.3%.
50. Inflation rate
IP5 = (5% + 6% + 9% + 13% + 12%)/5 = 9%.

Answer: d

Diff: E