SMU Classification: Restricted

FNCE 101 Practice 2 Solutions

1. Canine Supply has sales of $2,200, total assets of $1,400, and a debt-equity ratio of 0.3. Its
return on equity is 15 percent. What is the net income?
A. $138.16
B. $141.41
C. $152.09
D. $156.67
E. $161.54
ROE = 0.15 = (Net income/$2,200)  ($2,200/$1,400)  (1 + 0.30)
Net income = $161.54

2. Lancaster Toys has a profit margin of 9.6 percent, a total asset turnover of 1.71, and a return on
equity of 21.01 percent. What is the debt-equity ratio?
A. 0.22
B. 0.28
C. 0.46
D. 0.72
E. 0.78

Equity multiplier = .2101/(.096  1.71) = 1.28

Debt-equity ratio = 1.28 - 1 = 0.28

3. Oscar's Dog House has a profit margin of 5.6 percent, a return on assets of 12.5 percent, and an
equity multiplier of 1.49. What is the return on equity?
A. 17.14 percent
B. 18.63 percent
C. 19.67 percent
D. 21.69 percent
E. 22.30 percent

Return on equity = 12.5 percent  1.49 = 18.63 percent, using the Du Pont Identity

4. A firm has total debt of $4,620 and a debt-equity ratio of 0.57. What is the value of the total
assets?
A. $6,128.05
B. $7,253.40
C. $9,571.95
D. $11,034.00
E. $12,725.26
Total equity = $4,620/0.57 = $8,105.26
Total assets = $4,620 + $8,105.26 = $12,725.26

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5. Which of the following can be used to compute the return on equity?

I. Profit margin  Return on assets
II. Return on assets  Equity multiplier
III. Net income/Total equity
IV. Return on assets  Total asset turnover
A. I and III only
B. II and III only
C. II and IV only
D. I, II, and III only
E. I, II, III, and IV

6. Shareholders probably have the most interest in which one of the following sets of ratios?
A. return on assets and profit margin
B. long-term debt and times interest earned
C. price-earnings and debt-equity
D. market-to-book and times interest earned
E. return on equity and price-earnings

ROE & PE ratio are both market ratios.

7. Over the past year, the quick ratio for a firm increased while the current ratio remained
constant. Given this information, which one of the following must have occurred? Assume all
ratios have positive values.
A. current assets increased
B. current assets decreased
C. inventory increased
D. inventory decreased
E. accounts payable increased

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8. High Mountain Foods has an equity multiplier of 1.55, a total asset turnover of 1.3, and a profit
margin of 7.5 percent. What is the return on equity?
A. 8.94 percent
B. 10.87 percent
C. 12.69 percent
D. 14.38 percent
E. 15.11 percent

Return on equity = .075  1.3  1.55 = 15.11 percent

9. Your grandmother has promised to give you $5,000 when you graduate from college. She is
expecting you to graduate two years from now. What happens to the present value of this gift if
you delay your graduation by one year and graduate three years from now?
A. remains constant
B. increases
C. decreases
D. becomes negative
E. cannot be determined from the information provided

Note: The more distant the CF, the lower the PV

10. You want to have $1 million in your savings account when you retire. You plan on investing a
single lump sum today to fund this goal. You are planning on investing in an account which will
pay 7.5 percent annual interest. Which of the following will reduce the amount that you must
deposit today if you are to have your desired $1 million on the day you retire?
I. Invest in a different account paying a higher rate of interest.
II. Invest in a different account paying a lower rate of interest.
III. Retire later.
IV. Retire sooner.
A. I only
B. II only
C. I and III only
D. I and IV only
E. II and III only

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11. Gerold invested $6,200 in an account that pays 5 percent simple interest. How much money will
he have at the end of ten years?
A. $8,710
B. $9,000
C. $9,300
D. $9,678
E. $10,099

Ending value = $6,200 + ($6,200  .05  10) = $9,300

12. What is the future value of $7,189 invested for 23 years at 9.25 percent compounded annually?
A. $22,483.60
B. $27,890.87
C. $38,991.07
D. $51,009.13
E. $54,999.88
Use Financial calculator. 23 N; 9.25 I/Y; -7189 PV; CPT FV

13. You just received $225,000 from an insurance settlement. You have decided to set this money
aside and invest it for your retirement. Currently, your goal is to retire 25 years from today. How
much more will you have in your account on the day you retire if you can earn an average return
of 10.5 percent rather than just 8 percent?
A. $417,137
B. $689,509
C. $1,050,423
D. $1,189,576
E. $1,818,342

Future value = $225,000  (1 + .105)25 = $2,730,483

Future value = $225,000  (1 + .08)25 = $1,540,907
Difference = $2,730,483 - $1,540,907 = $1,189,576

14. Your father invested a lump sum 26 years ago at 4.25 percent interest. Today, he gave you the
proceeds of that investment which totaled $51,480.79. How much did your father originally
invest?
A. $15,929.47
B. $16,500.00
C. $17,444.86
D. $17,500.00
E. $17,999.45

Present value = $51,480.79  [1/(1 + .0425)26] = $17,444.86

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15. A year ago, you deposited $30,000 into a retirement savings account at a fixed rate of 5.5
percent. Today, you could earn a fixed rate of 6.5 percent on a similar type account. However,
your rate is fixed and cannot be adjusted. How much less could you have deposited last year if
you could have earned a fixed rate of 6.5 percent and still have the same amount as you
currently will when you retire 38 years from today?
A. $2,118.42 less
B. $3,333.33 less
C. $5,417.09 less
D. $7,274.12 less
E. $9,234.97 less

Future value = $30,000  (1 + .055)38+1 = $242,084.61

Present value = $242,084.61  [1/(1 + .065)38+1] = $20,765.03
Difference = $30,000 - $20,765.03 = $9,234.97

16. Sixteen years ago, Alicia invested $1,000. Eight years ago, Travis invested $2,000. Today, both
Alicia's and Travis' investments are each worth $2,400. Assume that both Alicia and Travis
continue to earn their respective rates of return. Which one of the following statements is
correct concerning these investments?
A. Three years from today, Travis' investment will be worth more than Alicia's.
B. One year ago, Alicia's investment was worth less than Travis' investment.
C. Travis earns a higher rate of return than Alicia.
D. Travis has earned an average annual interest rate of 3.37 percent.
E. Alicia has earned an average annual interest rate of 6.01 percent.

Alicia: $2,400 = $1,000  (1 + r)16; r = 5.62 percent (or use financial calculator)
Travis: $2,400 = $2,000  (1 + r)8; r = 2.31 percent

Since both Alicia and Travis have equal account values today and since Alicia earns the higher rate of
return, her account had to be worth less than Travis' account one year ago.

17. Some time ago, Julie purchased eleven acres of land costing $36,900. Today, that land is valued
at $214,800. How long has she owned this land if the price of the land has been increasing at
10.5 percent per year?
A. 13.33 years
B. 16.98 years
C. 17.64 years
D. 19.29 years
E. 21.08 years

$214,800 = $36,900  (1 + .105)t; t = 17.64 years

Financial calculator: 10.5 I/Y; -36900 PV; 214800 FV; CPT N

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18. In 1895, the winner of a competition was paid $110. In 2006, the winner's prize was $70,000.
What will the winner's prize be in 2040 if the prize continues increasing at the same rate?
A. $389,400
B. $421,122
C. $479,311
D. $505,697
E. $548,121

$70,000 = $110  (1 = r)111; r = 5.988466 percent

FV = $70,000  (1 + .05988466)34 = $505,697
Financial calculator: 111 N; -110 PV; 70000 FV; CPT I/Y
34 N; 5.988466 I/Y; 70000 PV; CPT FV

19. You are comparing two annuities which offer quarterly payments of $2,500 for five years and
pay 0.75 percent interest per month. Annuity A will pay you on the first of each month while
annuity B will pay you on the last day of each month. Which one of the following statements is
correct concerning these two annuities?
A. These two annuities have equal present values but unequal futures values at the end of year
five.
B. These two annuities have equal present values as of today and equal future values at the end
of year five.
C. Annuity B is an annuity due.
D. Annuity A has a smaller future value than annuity B.
E. Annuity B has a smaller present value than annuity A.

20. You just won the grand prize in a national writing contest! As your prize, you will receive $2,000
a month for ten years. If you can earn 7 percent on your money, what is this prize worth to you
today?
A. $172,252.71
B. $178,411.06
C. $181,338.40
D. $185,333.33
E. $190,450.25

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21. You are the beneficiary of a life insurance policy. The insurance company informs you that you
have two options for receiving the insurance proceeds. You can receive a lump sum of $200,000
today or receive payments of $1,400 a month for 20 years. You can earn 6 percent on your
money. Which option should you take and why?
A. You should accept the payments because they are worth $209,414 to you today.
B. You should accept the payments because they are worth $247,800 to you today.
C. You should accept the payments because they are worth $336,000 to you today.
D. You should accept the $200,000 because the payments are only worth $189,311 to you
today.
E. You should accept the $200,000 because the payments are only worth $195,413 to you today.

22. You need some money today and the only friend you have that has any is your miserly friend. He
agrees to loan you the money you need, if you make payments of $25 a month for the next six
months. In keeping with his reputation, he requires that the first payment be paid today. He also
charges you 1.5 percent interest per month. How much money are you borrowing?
A. $134.09
B. $138.22
C. $139.50
D. $142.68
E. $144.57

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23. Nadine is retiring at age 62 and expects to live to age 85. On the day she retires, she has
$348,219 in her retirement savings account. She is somewhat conservative with her money and
expects to earn 6 percent during her retirement years. How much can she withdraw from her
retirement savings each month if she plans to spend her last penny on the morning of her
death?
A. $1,609.92
B. $1,847.78
C. $1,919.46
D. $2,116.08
E. $2,329.05

24. You just received an insurance settlement offer related to an accident you had six years ago. The
offer gives you a choice of one of the following three offers:

You can earn 7.5 percent on your investments. You do not care if you personally receive the
funds or if they are paid to your heirs should you die within the settlement period. Which one of
the following statements is correct given this information?
A. Option A is the best choice as it provides the largest monthly payment.
B. Option B is the best choice because it pays the largest total amount.
C. Option C is the best choice because it is has the largest current value.
D. Option B is the best choice because you will receive the most payments.
E. You are indifferent to the three options as they are all equal in value.

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Option A has a present value of $90,514.16 at 7.5 percent.

Option B has a present value of $85,255.68 at 7.5 percent.
Option C has a present value of $100,000.
Option C is the best choice since it has the largest present value.

25. Your father helped you start saving $20 a month beginning on your 5th birthday. He always made
you deposit the money into your savings account on the first day of each month just to "start
the month out right." Today completes your 17th year of saving and you now have $6,528.91 in
this account. What is the rate of return on your savings?
A. 5.15 percent
B. 5.30 percent
C. 5.47 percent
D. 5.98 percent
E. 6.12 percent

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26. A fund was established to provide scholarships for worthy students. The first scholarships will be
granted one year from now for a total of $35,000. Annually thereafter, the scholarship amount
will be increased by 5.5 percent to help offset the effects of inflation. The scholarship fund will
last indefinitely. What is the value of this gift today at a discount rate of 8 percent?
A. $437,500
B. $750,000
C. $1,200,000
D. $1,400,000
E. $1,450,750

27. Your parents have made you two offers. The first offer includes annual gifts of $10,000, $11,000,
and $12,000 at the end of each of the next three years, respectively. The other offer is the
payment of one lump sum amount today. You are trying to decide which offer to accept given
the fact that your discount rate is 8 percent. What is the minimum amount that you will accept
today if you are to select the lump sum offer?
A. $28,216
B. $29,407
C. $29,367
D. $30,439
E. $30,691

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28. You are considering changing jobs. Your goal is to work for three years and then return to school
full-time in pursuit of an advanced degree. A potential employer just offered you an annual
salary of $41,000, $44,000, and $46,000 a year for the next three years, respectively. All salary
payments are made as lump sum payments at the end of each year. The offer also includes a
starting bonus of $2,500 payable immediately. What is this offer worth to you today at a
discount rate of 6.75 percent?
A. $112,406
B. $115,545
C. $117,333
D. $121,212
E. $134,697

29. One year ago, Deltona Motor Parts deposited $16,500 in an investment account for the purpose
of buying new equipment three years from today. Today, it is adding another $12,000 to this
account. The company plans on making a final deposit of $20,000 to the account one year from
today. How much will be available when it is ready to buy the equipment, assuming the account
pays 5.5 interest?
A. $53,408
B. $53,919
C. $56,211
D. $56,792
E. $58,021

30. A preferred stock pays an annual dividend of $2.60. What is one share of this stock worth today
if the rate of return is 11.75 percent?
A. $18.48
B. $20.00
C. $22.13
D. $28.80
E. $30.55

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