Test Prep Test Prep Certifications BUSINESS-ENVIRONMENT-AND-CONCEPTS Questions & Answers

• Question 161:

  The amount of inventory that a company would tend to hold in stock would increase as the:

  A. Cost of carrying inventory decreases.

  B. Variability of sales decreases.

  C. Cost of running out of stock decreases.

  D. Length of time that goods are in transit decreases.

  Correct Answer: A

  Choice "a" is correct. The amount of inventory that a company would tend to hold in stock would increase

  as the cost of carrying inventory decreases.

  The amount of inventory that a company would tend to hold in stock would decrease as the:

  B. Variability of sales decreases.

  C. Cost of running out of stock decreases.

  D. Length of time that goods are in transit decreases.

• Question 162:

  Spotech Co.'s budgeted sales and budgeted cost of sales for the coming year are $212,000,000 and $132,500,000 respectively. Short-term interest rates are expected to average 5 percent. If Spotech could increase inventory turnover from its current 8 times per year to 10 times per year, its expected cost savings in the current year would be:

  A. $165,625

  B. $331,250

  C. $81,812

  D. $250,000

  Correct Answer: A

  Choice "a" is correct. $165,625 expected cost savings by increasing inventory turnover from its current 8 times to 10 times per year.

  

• Question 163:

  A company uses the following formula in determining its optimal level of cash.

  

  Where: b = Fixed cost per transaction i = Interest rate on marketable securities T = Total demand for cash over a period of time

  This formula is a modification of the Economic Order Quantity (EOQ) formula used for inventory management. Assume that the fixed cost of selling marketable securities is $10 per transaction, and the interest rate on marketable securities is 6 percent per year. The company estimates that it will make cash payments of $12,000 over a one-month period. What is the average cash balance (rounded to the nearest dollar)?

  A. $1,000

  B. $2,000

  C. $3,464

  D. $6,928

  Correct Answer: C

  Choice "c" is correct. Like the EOQ, this formula represents the amount of cash brought in by the sale of marketable securities. Also like the EOQ, this cash goes to zero (or the safety level) over time. The average cash (like the average inventory) is one half of the amount collected. Remember also to convert the interest rate to a per month figure of 0.5%

  

  Choices "a", "b", and "d" are incorrect, per above.

• Question 164:

  Which of the following factors is inherent in a firm's operations if it utilizes only equity financing?

  A. Financial risk.

  B. Business risk.

  C. Interest rate risk.

  D. Marginal risk.

  Correct Answer: B

  Choice "b" is correct. Business risk represents the risk associated with the unique circumstances of a particular company, as they might affect the shareholder value of that company. If an entity purely uses its own cumulative earnings in capitalizing its operations, it is exposed to the risks of its own unique circumstances. Choice "a" is incorrect. Financial risk, also called default risk, relates to the exposure of lenders to the failure of borrowers to repay principal and interest on debt. An entity using its own cumulative earnings in capitalizing its operations is not exposed to default risk. Choice "c" is incorrect. A business that exclusively uses equity capitalization would not be exposed to the risk that the value of its financial instruments will change as a result of changes in interest rates. Choice "d" is incorrect. Incremental changes in risk would be limited if a firm exclusively used its own equity financing to capitalize its operations.

• Question 165:

  Capital investments require balancing risk and return. Managers have a responsibility to ensure that the investments that they make in their own firms increase shareholder value. Managers have met that responsibility if the return on the capital investment:

  A. Exceeds the rate of return associated with the firm's beta factor.

  B. Is less than the rate of return associated with the firm's beta factor.

  C. Is greater than the prime rate of return.

  D. Is less than the prime rate of return.

  Correct Answer: A

  Choice "a" is correct. A capital investment whose rate of return exceeds the rate of return associated with the firm's beta factor will increase the value of the firm. Choice "b" is incorrect. A capital investment whose rate of return is less than the rate of return associated with the firm's beta factor will decrease the value of the firm. Choice "c" is incorrect. The return on a capital investment in relation to the prime rate of return will not necessarily indicate if the investment increases or decreases the value of the company without knowing the relative risk of the firm in relation to the market and its relationship to the prime rate. Choice "d" is incorrect. The return on a capital investment in relation to the prime rate of return will not necessarily indicate if the investment increases or decreases the value of the company without knowing the relative risk of the firm in relation to the market and its relationship to the prime rate.

• Question 166:

  The Frame Supply Company has just acquired a large account and needs to increase its working capital by $100,000. The controller of the company has identified a source of funds which is given below:

  Pay a factor to buy the company's receivables, which average $125,000 per month and have an average collection period of 30 days. The factor will advance up to 80 percent of the face value of receivables at 10 percent and charge a fee of 2 percent on all receivables purchaseD. The controller estimates that the firm would save $24,000 in collection expenses over the year. Assume the fee and interest are not deductible in advance. Assume a 360-day year in all of your calculations. The cost of factoring is:

  A. 12.0 percent.

  B. 14.8 percent.

  C. 16.0 percent.

  D. 20.0 percent.

  Correct Answer: C

  Choice "c" is correct.

  

• Question 167:

  Bander Co. is determining how to finance some long-term projects. Bander has decided it prefers the benefits of no fixed charges, no fixed maturity date and an increase in the credit-worthiness of the company. Which of the following would best meet Bander's financing requirements?

  A. Bonds.

  B. Common stock.

  C. Long-term debt.

  D. Short-term debt.

  Correct Answer: B

  Choice "b" is correct. Common stock is an equity security that conveys ownership. Common stock does not require any payment, it does not mature and, because it increases equity while having no effect on debt, it decreases the debt equity ratio and increases the credit-worthiness of the firm. Choice "a" is incorrect. Bonds are debt instruments that require specific fixed payments, mature at a specific time and increase debt. Immediately after issue, increases in debt increase the debt equity ratio and decrease credit worthiness. Choice "c" is incorrect. Long-term debt requires specific fixed payments, includes maturity at a specific time and (by definition), increases debt. Immediately after issue, increases in debt increase the debt equity ratio and decrease credit worthiness. Choice "d" is incorrect. Short-term debt requires specific fixed payments, includes maturity at a specific time and, by definition, increase debt. Immediately after issue, increases in debt increase the debt equity ratio and decrease credit worthiness.

• Question 168:

  Which of the following formulas should be used to calculate the economic rate of return on common stock?

  A. (Dividends + change in price) divided by beginning price.

  B. (Net income - preferred dividend) divided by common shares outstanding.

  C. Market price per share divided by earnings per share.

  D. Dividends per share divided by market price per share.

  Correct Answer: A

  Choice "a" is correct. The economic rate of return on common stock measures the dividend income and capital growth in relation to the initial investment, the beginning price of the stock. Choice "b" is incorrect. The proposed solution is earnings per share, a ratio generally computed as the earnings available to common shareholders (net income after payment of preferred shares) divided by the common shares outstanding. Choice "c" is incorrect. Market price per share divided by earnings per share is the price/ earnings or P/E ratio, not the economic rate of return on common stock. Choice "d" is incorrect. The dividends per share divided by the market price per share does not represent the economic rate of return on common stock, the ratio includes change in stock value in the denominator rather than the numerator of the equation.

• Question 169:

  A company has two divisions. Division A has operating income of $500 and total assets of $1,000. Division B has operating income of $400 and total assets of $1,600. The required rate of return for the company is 10%. The company's residual income would be which of the following amounts?

  A. $0

  B. $260

  C. $640

  D. $900

  Correct Answer: C

  Choice "c" is correct. Residual income is the difference between net income and the required return. The required return is net book value (total assets) times the hurdle rate (required rate of return). The calculations are as follows:

  

  Choice "a" is incorrect. Residual income would certainly not be $0 in this question because the operating

  income is greater than the required return for both Division A and Division B.

  Choice "b" is incorrect. The $260 is the total required return, not the total residual income.

  Choice "d" is incorrect. The $900 is the total operating income, not the total residual income.

• Question 170:

  At the beginning of year 1, $10,000 is invested at 8% interest, compounded annually. What amount of interest is earned for year 2?

  A. $800.00

  B. $806.40

  C. $864.00

  D. $933.12

  Correct Answer: C

  Choice "c" is correct. This question is a compound interest question because the interest is to be

  determined at the end of the second year. The calculation is as follows and uses different symbols than the

  SI = PIN formula in the text to show candidates the PRT formula as well (the CPA exam often uses

  different terminology):

  Interest = PRT (for the first year)

  Interest = $1,000 x .08 x 1 = $800 and adding the $800 to the beginning principal

  Interest = PRT (for the second year)

  Interest = $1,800 x .08 x 1 = $864

  It is obvious from the answer that the interest earned in year 2 is interest earned on the original principal

  ($10,000 x .08 = $800) plus interest on the year 1 interest ($800 x .08 = $64).

  Choice "a" is incorrect. This answer is interest only on the original principal, and not on the year 1 interest.

  Choice "b" is incorrect. This answer has a decimal point error in calculating the year 2 interest on year 1

  interest.

  Choice "d" is incorrect. This answer is apparently made up. It is sometimes difficult to come up with 3

  decent wrong answers, especially with simple questions.