Managerial Finance (6305) Practice Questions
Solution to Practice Questions: Unit 1
1. List and briefly describe the three general areas of responsibility for a financial manager.
1. capital budgeting: the identification of investment opportunities that have a positive net value
2. capital structure: the mix of long-term debt and equity used to finance a firm’s operations
3. working capital management: the daily control of a firm’s short-term assets and short-term liabilities
2. Describe the key advantages associated with the corporate form of organization.
The advantages of the corporate form of organization are :
the ease of transferring ownership
the owners’ limited liability for business debts
the ability to raise large amounts of capital
the potential for an unlimited life for the organization.
3. Why are so many businesses structured as sole proprietorships when the corporate form of
business offers more advantages?
A significant advantage of the sole proprietorship is that it is inexpensive and easy to form. If the sole
proprietor has limited capital to start with, it may not be desirable to spend part of that capital forming a
corporation.
Also, limited liability for business debts may not be a significant advantage if the proprietor has most of
his or her personal assets tied up in the business already.
Finally, for a typical small firm, having an unlimited life for the business has no real advantage since the
heart and soul of the business is the person who founded it, thereby effectively limiting the life of the
business to that of its founder.
4. From a liability point of view, what is the difference between investing in a sole proprietorship
and a general partnership?
Both a sole proprietor and a general partner have unlimited liability for the firm’s debts. However, as a
sole proprietor you should be totally aware of all the business dealings of the firm.
In a general partnership, you may or may not handle the financial transactions and thus are accepting the
responsibility for actions taken not only by yourself, but those of your partners.
5. Give some examples of ways in which manager’s goals can differ from those of shareholders.
The primary goal of a financial manager should be to maximize the current value of the outstanding
stock.
This goal focuses on enhancing the returns to stockholders who are the owners of the firm. However,
managers frequently are more concerned with their personal benefits from employment, the prestige of
their position, and the perks to which they feel entitled.
There are numerous examples, some of which are excessive compensation packages, large corporate
offices, excessive staffing, and first-class travel and conference locations, to name a few.
6. How do the actual effects of the Sarbanes-Oxley Act of 2002 compare to the initial intent of that
Act?
Some of the key requirements of Sarbanes-Oxley are:
the prohibition of personal loans from the company to its officers,
an annual report by management of the internal control and financial reporting within the firm
along with an independent auditor’s assessment of that report,
a review and sign off by the corporate officers of the annual financial statements, and the
responsibility for the accuracy of the financial reports placed directly on senior management of
the firm.
While firms that have opted to remain publicly-owned are complying with these requirements, they
are paying a cost to do so. This cost has caused other firms to “go dark” or to opt for listing on a
foreign exchange rather than a U.S. exchange. While some of the results do match the intent of the
Act, the costs, “going dark”, and foreign listings were most likely not intended by the supporters of
the Act.
7. Compare and contrast the NYSE with NASDAQ.
The NYSE is an auction market where sell orders are matched with buy orders. The NYSE has a
physical trading floor located on Wall Street in New York City.
NASDAQ is a dealer market which is solely electronic and therefore has no physical trading
floor. Dealers buy and sell for their own inventory.
The listing requirements of the NYSE are more stringent than those of NASDAQ and thus the
NYSE tends to list larger firms with smaller firms being listed on NASDAQ. Note however, that
larger firms can, and do, opt to remain on NASDAQ even though they qualify for NYSE listing.
Practice Questions: Unit 2
1. During 2009, RIT Corp. had sales of $565,600. Costs of goods sold, administrative and selling expenses,
and depreciation expenses were $476,000, $58,800, and $58,800, respectively. In addition, the company had an
interest expense of $112,000 and a tax rate of 35 percent. What is the operating cash flow for 2009? Ignore any tax
loss carry-back or carry-forward provisions.
$17,920
$21,840
$30,800
$52,600
$77,840
Earnings before interest and taxes = Net income = $565,600 – $476,000 –
$58,800 – $58,800 = -$28,000
Operating cash !ow = -$28,000 + $58,800 – $0 = $30,800
2. Suppose you are given the following information for Bayside Bakery: sales = $30,000; costs = $15,000;
addition to retained earnings = $4,221; dividends paid = $469; interest expense = $1,300; tax rate = 30 percent.
What is the amount of the depreciation expense?
4820
5500
7000
8180
9500
Net income = $469 + $4,221 = $4,690
Earnings before taxes = $4,690/(1 – .30) = $6,700
Earnings before interest and taxes = $6,700 + $1,300 = $8,000
Depreciation = $30,000 – $15,000 – $8,000 = $7,000
Net income = $469 + $4,221 = $4,690 Earnings before taxes = $4,690/(1 – .30) = $6,700 Earnings before interest
and taxes = $6,700 + $1,300 = $8,000 Depreciation = $30,000 – $15,000 – $8,000 = $7,000
3. Please define Net working capital and provide the formula to calculate it.
Current assets minus current
liabilities.
4. The percentage of the next dollar you earn that must be paid in taxes is referred to as the _____ tax rate.
Marginal
5. The cash flow of a firm which is available for distribution to the firm’s creditors and stockholders is called
the:
operating cash flow.
net capital spending.
