View Product website:

https://selldocx.com/docx/ch13-shareholder-wealth-management-test-bank-10th-1148

Chapter 13

Managing for Shareholder Wealth

True/False

1. Market value added (MVA) measures how much wealth a firm has created at a particular moment in time.

Difficulty: Easy

Keywords: market value added

2. MVA is calculated by deducting invested capital from firm value.

Difficulty: Easy

Keywords: market value added

3. A firm’s invested capital represents the amount of equity invested in a firm by its shareholders.

Difficulty: Easy

Keywords: market value added

4. In determining MVA, firm value meanswer the sum of a firm’s outstanding debt and equity securities.

Difficulty: Moderate

Keywords: market value added

5. The accounting model of determining shareholder value consists of discounting future free cash flows to the present.

Difficulty: Moderate

Keywords: accounting mode

6. The accounting model of determining shareholder value requires applying a price-earnings ratio to reported earnings.

Difficulty: Moderate

Keywords: accounting model

7. The accounting model of determining shareholder value requires applying a market to book ratio to reported free cash flows.

Difficulty: Moderate

Keywords: accounting model

8. The calculation of free cash flow includes interest expense.

Difficulty: Moderate

Keywords: free cash flow

9. The free cash-flow model evaluates a firm for a finite period of time through utilizing a terminal value.

Difficulty: Moderate

Keywords: free cash flow

10. The free cash flow method requires a projection of future free cash flows, which are discounted at a firm’s cost of capital.

Difficulty: Easy

Keywords: free cash flow method

11. The free cash flow method does not require a forecast of expected new investment in working capital.

Difficulty: Moderate

Keywords: free cash flow method

12. According to the free cash flow method, an increase in the cost of capital will decrease a firm’s value.

Difficulty: Moderate

Keywords: free cash flow method

13. Projected gross profit margin is one of the most significant valuation "drivers.”

Difficulty: Moderate

Keywords: value drivers

14. The cost of capital is not important in the determination of firm value when using the free cash flow model of valuation.

Difficulty: Moderate

Keywords: free cash flow

15. Economic value added (EVA) is the difference in a firm’s net operating profit after taxes and the capital charge for the period.

Difficulty: Moderate

Keywords: economic value added

16. A firm’s capital charge is the product of the firm’s cost of capital and its interest expense.

Difficulty: Moderate

Keywords: capital charge

17. Return on invested capital is the ratio of net operating assets divided by the firm’s invested capital.

Difficulty: Moderate

Keywords: return on invested capital

18. An unbounded incentive compensation plan has a minimum, but no maximum, performance target.

Difficulty: Moderate

Keywords: unbounded incentive compensation

19. A bounded incentive compensation plan places both lower and upper limits on levels of firm performance for which incentive compensation will be awarded to employees.

Difficulty: Moderate

Keywords: bounded incentive compensation

20. An unbounded incentive compensation plan places no lower or upper limits on levels of firm performance for which incentive compensation will be awarded to employees.

Difficulty: Moderate

Keywords: unbounded incentive compensation

Multiple Choice

21. What does the term "firm value" refer to?

a. Common stockholders’ equity minus preferred stockholders’ equity

b. Goodwill

c. The market value of the firm’s outstanding debt and equity securities

d. Net book value

Difficulty: Moderate

Keywords: firm value

22. How is MVA computed?

a. Current market price of common stock minus book value

b. Firm value minus invested capital

c. Current year market price of common stock minus last year market price of common stock

d. Total assets minus total liabilities

Difficulty: Moderate

Keywords: market value added

23. What does the accounting model of business valuation focus on?

a. Book value

b. The market’s valuation of a firm’s reported book value of common stock as reflected in the market-to-book ratio

c. Operating Income (EBIT) plus net profit after tax (NPAT) minus taxes

d. The market’s valuation of reported earnings as reflected in the price earnings ratio

Difficulty: Moderate

Keywords: accounting model

24. What does the free cash flow method of business valuation focus on?

a. Discount market value added to the present

b. Discount current year earnings to the present

c. Discount current year cash flows to the present

d. Discount projected future cash flows to the present

Difficulty: Moderate

Keywords: free cash flow method

25. Market Basket has 15 million shares of common stock outstanding. Investors apply a P/E ratio of 21.0 to the stock. The firm’s current year sales were $2.5 billion from which Market Basket earned a net profit of $25 million. Use the accounting model to determine the market value per share of the common stock.

a. $21

b. $35

c. $25

d. $15

Difficulty: Moderate

Keywords: accounting model

26. Market Basket has 15 million shares of common stock outstanding. Investors apply a P/E ratio of 21.0 to the stock. The firm’s current year sales were $2.5 billion from which Market Basket earned a net profit of $25 million. Use the accounting model to determine the total market value of the firm’s common stock.

a. $265 million

b. $350 million

c. $415 million

d. $525 million

Difficulty: Moderate

Keywords: accounting model

27. Which of the following should be used to represent the income portion of the calculation of free cash flow?

a. Net profit after tax

b. Operating profit

c. Operating profit times capital costs

d. Net operating profit after tax plus depreciation

Difficulty: Moderate

Keywords: free cash flow

28. Which of the following should be deducted from the income portion of the calculation of free cash flow?

a. Expected additional investment in working capital

b. Expected depreciation

c. Expected additional investment in notes payable

d. Expected sale of new shares of common stock

Difficulty: Moderate

Keywords: free cash flow

29. Which of the following should be deducted from the income portion of the calculation of free cash flow?

a. Expected additional investment in marketable securities

b. Expected sale of new shares of preferred stock

c. Expected additional investment in capital expenditures

d. Expected additional investment in long-term bonds

Difficulty: Moderate

Keywords: free cash flow

30. Estima Corp. has sales of $850 million, cost of goods sold of $615 million, operating expenses of $119 million, depreciation expense of $31 million, interest expense of $15 million, and an income tax rate of 40%. What is Estima’s net operating profit after tax (NOPAT) for purposes of determining free cash flow?

a. $51 million

b. $63 million

c. $74 million

d. $88 million

Difficulty: Moderate

Keywords: free cash flow

31. Marshall Manufacturing, Inc. has estimated NOPAT at $10,000 for Year 1. Given the following forecasted information, calculate the free cash flow for Year 1.

Interest expense $1,000

Depreciation expense $2,000

Investment in net working capital $500

Investment in new capital (CAPEX) $3,000

a. $7,700

b. $8,500

c. $9,500

d. $10,500

Difficulty: Moderate

Keywords: free cash flow

32. Marjen, Inc. has estimated the following for free cash flows. They have determined that their weighted average cost of capital is 10%, and they have 5,000 shares of stock outstanding. Using the cash flows provided to estimate a terminal value, what is the share value of their stock? (Round to the nearest whole dollar.)

Year Free Cash Flow

1. $10,000
2. $12,000
3. $16,000

a. $20

b. $25

c. $30

d. $35

Difficulty: Moderate

Keywords: free cash flow

33. Which of the following should be added to a firm’s NOPAT in the calculation of the income portion for determining free cash flow?

a. Interest expense

b. Depreciation

c. Capital costs

d. Net working capital

Difficulty: Easy

Keywords: free cash flow, depreciation

34. Which of the following is NOT considered a value-enhancing strategy?

a. Negotiate stricter credit terms from suppliers.

b. Develop indirect sources of financing.

c. Initiate inventory control policies.

1. Both a and b.
2. All of the above.

Difficulty: Moderate

Keywords: value enhancing strategies

35. Which of the following is the most significant valuation "driver"?

a. Expected cash requirement

b. Interest expense

c. Projected sales

d. Accounts receivable

Difficulty: Moderate

Keywords: value driver

36. Nova Corp. has a weighted average cost of capital of 9.5%, sales of $1.450 billion, cost of goods sold of $985 million, operating expenses of $216 million, and an income tax rate of 40%. If the firm’s total invested capital at the beginning of the year was $560 million, what is Nova’s capital charge?

a. $63.8 million

b. $18.5 million

c. $53.2 million

d. $29.6 million

Difficulty: Moderate

Keywords: capital charge

37. What is a firm’s capital charge?

a. A firm’s addition to retained earnings

b. The difference in a firm’s NOPAT and the capital charge for the period

c. A firm’s weighted average cost of capital times the firm’s invested capital at the beginning of the period.

d. The difference between a firm’s return on assets (ROA) and its weighted average cost of capital

Difficulty: Moderate

Keywords: capital charge

38. Nova Corp. has a weighted average cost of capital of 9.5%, sales of $1.450 billion, cost of goods sold of $985 million, operating expenses of $216 million, and an income tax rate of 40%. If the firm’s total invested capital at the beginning of the year was $560 million, what is Nova’s EVA?

a. $66.8 million

b. $71.5 million

c. $83.1 million

d. $96.2 million

Difficulty: Moderate

Keywords: economic value added

39. Busing Electronics has sales of $1.115 billion, cost of goods sold of $822 million, operating expenses of $198 million, and an income tax rate of 40%. The firm’s total invested capital at the beginning of the year was $450 million. Calculate Busing’s EVA assuming a weighted average cost of capital of 11%.

a. $6.8 million

b. $7.5 million

c. $8.3 million

d. $9.4 million

Difficulty: Moderate

Keywords: economic value added

40. What is EVA?

a. A firm’s addition to retained earnings

b. The difference in a firm’s NOPAT and the capital charge for the period

c. A firm’s weighted average cost of capital times total equity divided by NOPAT.

d. The difference between a firm’s ROA and its weighted average cost of capital.

Difficulty: Moderate

Keywords: economic value added

41. What is return on invested capital?

a. The ratio of net operating income after tax for the period divided by the firm’s invested capital at the end of the previous period

b. The free cash flow for the period divided by the firm’s equity capital at the end of the previous period

c. The ratio of net sales for the period divided by the firm’s total assets at the end of the previous period

d. The ratio of gross profit for the period divided by the firm’s equity capital at the end of the previous period

Difficulty: Moderate

Keywords: return on invested capital

42. How can the agency conflict between management and shareholders be lessened?

a. Grant higher salaries to senior management.

b. Give greater authority to senior managers.

c. Link firm performance to senior management compensation.

d. Offer lifetime contracts to senior managers.

Difficulty: Moderate

Keywords: agency conflict, compensation

43. Which of the following is the most direct and common method of aligning the interests of the firm’s employees with those of shareholders?

a. Bonus payments

b. Base pay

c. Performance-based salary

d. Stock options

Difficulty: Moderate

Keywords: direct compensation

44. An unbounded incentive pay program consists of which of the following elements?

a. Upper but no lower limit on performance targets

b. Lower but no upper limit on performance targets

c. Upper and lower limits on performance targets

d. No upper or lower limits on performance targets

Difficulty: Moderate

Keywords: unbounded incentive pay program

45. A bounded incentive pay program consists of which of the following elements?

a. Upper but no lower limit on performance targets

b. Lower but no upper limit on performance targets

c. Upper and lower limits on performance targets

d. No upper or lower limits on performance targets

Difficulty: Moderate

Keywords: bounded incentive pay program

Short Answer

46. Compare and contrast short-term versus long-term incentive plans. Give an example of each.

Difficulty: Moderate

Keywords: short-term incentive pay plans, long-term incentive pay plans

47. Given the following estimates, calculate the free cash flow value of the firm. Assume a tax rate of 40%, a weighted average cost of capital of 10%, and that all taxes are paid with cash.

Year 1 2 3

Sales $30,000 $50,000 $70,000

Depreciation expense 3,000 4,000 5,000

EBIT 9,500 12,000 22,500

NWC investments 300 400 500

New CAPEX investments 2,000 2,500 4,500

Year 1 2 3

EBIT $9,500 $12,000 $22,500

Taxes (40%) (3,800) (4,800) (9,000)

Plus: Deprec. 3,000 4,000 5,000

NWC inv. (300) (400) (500)

CAPEX inv. (2,000) (2,500) (4,500)

Free cash flow 6,400 8,300 13,500

Terminal CF = $13,500/.10 = $135,000

Firm value:

Calculator steps:

0 CFj

6400 CFj

8300 CFj

13500 + 135000 CFj

10 I/YR

Function NPV = $124,248

Difficulty: Hard

Keywords: free cash flow method