Financiad Economics ECN134 Midterm 1 Practice test Prof Farshid Mojaver 18 pts 1 Some Financial Terms and Ideas a What is securitization b What is financial engineering c What are financial derivatives d What are futures e What is Credit Default Swap CDS f How might CDS have contributed to the current financial crisis 15 pts 2 Calculating Total Cash Flows Schwert Corp shows the following information on its 2010 income statement sales 167 000 costs 91 000 other expenses 5 400 depreciation expense 8 000 interest expense 11 000 taxes 18 060 dividends 9 500 In addition you re told that the firm issued 7 250 in new equity during 2010 and redeemed 7 100 in outstanding long term debt a b c d What is the 2010 operating cash flow What is the 2010 cash flow to creditors What is the 2010 cash flow to stockholders If net fixed assets increased by 22 400 during the year what was addition to net working capital NWC Answer To find the OCF we first calculate net income Income Statement Sales 167 000 Costs 91 000 Depreciation 8 000 Other expenses 5 400 EBIT 62 600 Interest 11 000 Taxable income 51 600 Taxes 18 060 Net income 33 540 a Dividends 9 500 Additions to RE 24 040 OCF EBIT Depreciation Taxes 62 600 8 000 18 060 52 540 b CFC Interest Net new LTD 11 000 7 100 18 100 Note that the net new long term debt is negative because the company repaid part of its long term debt c CFS Dividends Net new equity 9 500 7 250 2 250 e Must solve for Change in NWC from CFA OCF Net capital spending Change in NWC But first need to solve for CFA and Change in NWC CFA CFC CFS 18 100 2 250 20 350 Net capital spending Increase in NFA Dep n 22 400 8 000 30 400 CFA OCF Net capital spending Change in NWC 20 350 52 540 30 400 Change in NWC Change in NWC 1 790 15 pts 3 Using Du Pont Identity Y3K Inc has sales of 3 100 total assets of 1 580 and a debt equity ratio of 1 20 If its return on equity is 16 percent what is its net income Answer This is a multi step problem involving several ratios The ratios given are all part of the Du Pont Identity The only Du Pont Identity ratio not given is the profit margin If we know the profit margin we can find the net income since sales are given So we begin with the Du Pont Identity ROE 0 16 PM TAT EM PM S TA 1 D E Solving the Du Pont Identity for profit margin we get PM ROE TA 1 D E S PM 0 16 1 1580 1 1 20 3 100 0371 Now that we have the profit margin we can use this number and the given sales figure to solve for net income PM 0371 NI S NI 0371 3 100 114 91 15 pts 4 EFN The most recent financial statement for Martin Inc are shown here Income Statement Sales Costs Taxable income Taxes 34 Net income 25 800 Balance Sheet Assets 113 000 Debt 16 500 9 300 3 162 6 138 20 500 Equity Total 113 000 Total 92 500 113 000 Assets and costs are proportional to sales Debt and equity are not A dividend of 1 841 was paid and Martin wishes to maintain a constant payout ratio Next year s sales are projected to be 30 960 What external financing is needed Answer An increase of sales to 30 960 is an increase of 30 960 25 800 25 800 20 or 20 Assuming costs and assets increase proportionally the pro forma financial statements will look like this Pro forma income statement Sales 30 960 00 Costs 19 800 00 EBIT 11 160 00 Pro forma balance sheet Assets 135 600 Debt Equity Total 135 600 Total 20 500 00 97 655 92 118 155 92 Taxes 34 3 794 40 Net income 7 365 60 The payout ratio is constant so the dividends paid this year is the payout ratio from last year times net income or Dividends 1 841 40 6 138 7 365 60 2 209 68 The addition to retained earnings is Addition to retained earnings 7 365 2 209 68 5 155 92 And the new equity balance is Equity 92 500 5 155 92 97 655 92 So the EFN is EFN Total assets Total liabilities and equity 135 600 118 155 92 17 444 08 11 pts 2 Derivation of the formula for Growing Annuity Show that the present value of a growing annuity that pays a stream of cash flows C and grows at a constant rate g for a fixed number of periods T can be simplified to PV C r g 1 g T 1 1 r 12 pts 3 Annuity Weak consumer spending has led automobile manufacturers to offer zero interest financing or cash back options to stimulate sales Suppose you can buy the car of your choice for its negotiated price of 16 200 less 500 cash back or you can finance the entire 16 200 car cost for 36 months at zero interest You have the cash necessary to pay for the car in an account that earns a stated annual interest rate of 4 compounded monthly You will either finance it or pay cash depending on which is the best deal a What is the cost of the financed car to you right now b Should you pay cash or finance the car and why c Now suppose the manufacturers offer 2 rather than zero percent financing Should you pay cash now or finance the car and why Answer a The monthly financed car payment with no interest is 16 200 36 450 PV C r 1 1 1 r T 450 1 1 36 0 04 0 04 1 12 12 PV 15 241 84 b Finance it By financing we will actually make profit of 458 16 15 700 15 241 84 c First we need to find monthly payment when price is 16 200 ND financing is 2 PV C ArmT PV 16 200 ArmT 1 1 34 9 1 36 0 02 12 1 02 12 1 1 1 mT A r m 1 r m C 16 200 34 913 464 01 Now we need to calculate the PV of a constant stream of income using SAIR of 4 This is the true value of the financing offer to us PV 464 1 1 0 04 12 1 04 12 36 15 716 34 This is 16 only better than the cash price I would be nearly indifferent between the two 6 pts 4 Annuity Pure Discount Bond Suppose that you have a pure discount bond that pays 1 000 at maturity with 6 years remaining until payoff in order to yield a 7 return a How would you price the bond b Suppose the day after you buy the bond interest rate …