UT FIN 357 - Review Test 1Solutions (16 pages)

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Review Test 1Solutions



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Review Test 1Solutions

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Pages:
16
School:
University of Texas at Austin
Course:
Fin 357 - Business Finance

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Review Test 1 Questions created by Mary Lou Poloskey for another text can be used as part of your review for test 1 Solution Why is value maximization superior to profit maximization as a goal for management While profit maximization appears to be a logical goal at first glance it has some serious drawbacks First since profit is the difference between revenues and expenses it can be distorted by some creative accounting measures Second accounting profits are quite different from cash flows Cash flows are the focus of investors and therefore managers Third profit maximization does not recognize when cash flows occur Finally profit maximization as a goal ignores the risk involved in generating the cash flows To determine the value of a firm s stock consider 1 the size of the expected cash flows 2 the timing of the cash flows and 3 the riskiness of the cash flows Thus value maximization as a goal overcomes all the shortcomings of profit maximization as a goal 2 Which of the following is are advantages of the corporate form of organization a Reduced start up costs b Greater access to capital markets c Unlimited liability d Single taxation Solution b Shares in a corporation can be sold to raise capital from investors who are not involved in the business This greatly increases the amount of capital that can be raised to fund the business 3 Drayton Inc has current assets of 256 312 and total assets of 861 889 It also has current liabilities of 141 097 common equity of 200 000 and retained earnings of 133 667 How much long term debt does the firm have Solution Assets Total current Liabilities and Equity 256 312 00 Total current liabilities Long term debt 141 097 00 assets 387 125 00 Total assets Common stock 200 000 00 Retained earnings 133 667 00 861 889 00 stockholders Total liabilities and 861 889 00 equity 861 889 141 097 200 000 133 667 387 125 long term debt 4 Ellicott Testing Company produced revenues of 745 000 in 2011 It had expenses excluding depreciation of 312 640 depreciation of 65 000 and interest expense of 41 823 It pays an average tax rate of 34 percent What was the firm s net income after taxes Solution Amount Revenues Costs EBITDA Depreciation EBIT Interest 745 000 00 312 640 00 432 360 00 65 000 00 367 360 00 41 823 00 EBT 5 325 537 00 Taxes 34 110 682 58 Net income 214 854 42 What is the difference between book value balance sheets and market value balance sheets Which provides better information to investors and management Solution Book value balance sheets are accounting statements that use historical information Market value statements contain current information and show what line items are worth today Although market values can be harder to identify they provide better economic information than book value 6 What are agency costs Explain Solution Agency costs are the costs that



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