Foundations of Financial Management, 13/e -...

Foundations of Financial Management, 13/e Solved MCQs

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Stanley B. Block, Texas Christian University Geoffrey A. Hirt, DePaul University

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Bartley R. Danielsen, North Carolina State University

The Goals and Functions of Financial Management

1 Which of the following are microeconomic variables that help define and explain the discipline of finance?

A) risk and return B) capital structure C) inflation D) all of the above

Explanation: All of the above are relevant in explaining finance.

2 One primary macroeconomic variable that helps define and explain the discipline of finance?

A) capital structure B) inflation C) technology D) risk

Explanation: Technology is very important in explaining the field of finance.

3 The money markets deal with .

A) securities with a life of more than one year B) short-term securities C) securities such as common stock D) none of the above

Explanation: The money markets are concerned with short-term securities, those with a life less than one year.


4 The ability of a firm to convert an asset to cash is called .

A) liquidity B) solvency C) return D) marketability

Explanation: Liquidity also means how close an asset is to cash.

5 Early in the history of finance, an important issue was:

A) liquidity B) technology C) capital structure D) financing options

Explanation: Maintaining liquidity was a major concern historically.

6 The is the most common form of business organization in the U.S.

A) corporation B) partnership C) sole proprietorship D) none of the above

Explanation: There are more sole proprietorships than any other form of business organization.

7 The has more sales in dollars than any other form of business organization.

A) sole proprietorship B) partnership C) corporation


D) none of the above

Explanation: The corporation is the most important in terms of dollars.

8 One major disadvantage of the sole proprietorship is .

A) simplicity of decision-making B) unlimited liability C) low operational costs D) none of the above

Explanation: The owners of a sole proprietorship are personally liable.

9 The appropriate firm goal in a capitalist society is .

A) profit maximization B) shareholder wealth maximization C) social responsibility D) none of the above

Explanation: The goal is to maximize the wealth of shareholders.

10 The agency problem will occur in a business firm if the goals of and shareholders do not agree.

A) investors B) the public C) management D) none of the above

Explanation: The goals of management may be different from those of shareholders.


Review of Accounting

1 The accounting statements that a firm is required to file include all but one of these.

A) Balance Sheet B) Statement of Accounts Receivable C) Income Statement D) Statement of Cash Flows

Explanation: The required statements include the income statement, balance sheet and statement of changes in cash flows. The statement of changes in owners equity (or retained earnings) is also required by Generally Accepted Accounting Principles but is not covered in this text.

2 The shows the firm's operating results over a period of time.

A) Income Statement B) Statement of Cash Flows C) Balance Sheet D) None of the above

Explanation: The Income Statement represents a moving picture of a firm's revenues and expenses.

3 All of the following except one are tax-deductible expenses.

A) interest expense B) depreciation C) common stock dividends D) income taxes

Explanation: Common stock dividends are not tax deductible to a firm.


4 All of the following are non-operating expenses except .

A) interest expense B) cost of goods sold C) preferred stock dividends D) taxes

Explanation: The cost of goods sold is an operating expense.

5 Bondholders receive from the business firm.

A) preferred dividend payments B) common stock payments C) interest payments D) royalties

Explanation: Bondholders are typically paid interest semi-annually.

6 The ratio of net income to common shares outstanding is called .

A) price/earnings ratio B) earnings per share C) dividends per share D) none of the above

Explanation: This is called the earnings per share (EPS).

7 Usually, firms with high price/earnings ratios are firms.

A) growth B) declining C) mature D) none of the above

Explanation: A high p/e ratio indicates a firm with strong growth prospects


8 One of the limitations of the is that it is based on historical costs.

A) income statement B) statement of cash flows C) balance sheet D) none of the above

Explanation: The balance sheet uses historical costs.

9 A source of funds is a:

A) decrease in a current asset B) decrease in a current liability C) increase in a current liability D) a and c above

Explanation: A decrease in current assets is equivalent to an increase in current liabilities.

10 Short-term financing for a business firm includes:

A) bonds B) accounts payable C) stockholder's equity D) mortgages

Explanation: The other three answers represent long-term financing


Financial Analysis

1 Trend analysis allows a firm to compare its performance to:

A) other firms in the industry B) other time periods within the firm C) other industries D) all of the above

Explanation: Trend analysis gives an analyst a long-term perspective. As a security analyst and a portfolio manager with Oppenheimer Capital, Dick Glasebrook spoke to a Senior Finance Managers’ Meeting at the Boeing Company on May 4, 1999. He said it is one thing to compare a firm’s performance against competitors within the same industry. But investors are not limited to specific industries. In fact, investors seek to diversify their investments across many different industries. So management should also compare performance to any well run company--both in and outside of their industry.

2 Ratio analysis allows a firm to compare its performance to:

A) other firms in the industry B) other time periods within the firm C) other industries D) all of the above

Explanation: Trend analysis gives an analyst a long-term perspective. As a security analyst and a portfolio manager with Oppenheimer Capital, Dick Glasebrook spoke to a Senior Finance Managers’ Meeting at the Boeing Company on May 4, 1999. He said it is one thing to compare a firm’s performance against competitors within the same industry. But investors are not limited to specific industries. In fact, investors seek to diversify their investments across many different industries. So management should also compare performance to any well run company--both in and outside of their industry.


3 Usually, a firm's suppliers are most interested in its ratios.

A) profitability B) debt C) asset utilization D) liquidity

Explanation: The suppliers are most interested in getting paid, as shown by the liquidity of the firm. http://vustudents.ning.com

4 would be most interested in a firm's debt utilization ratios.

A) bondholders B) stockholders C) short-term creditors D) Both A and B

Explanation: Debt is indicated by a firm issuing bonds but is also a function of the debt to equity relationship or the degree of financial leverage. Both bond holders and stockholders are interested in this relationship although frof opposing viewpoints.

5 The ratio indicates the return firm shareholders are earning.

A) return on assets B) return on investment C) return on equity D) net profit margin

Explanation: The shareholders represent equity, or ownership in the firm.


6 Which of the following is an example of a profitability ratio?

A) Quick ratio B) Average collection period C) Return on equity D) Times interest earned

Explanation: This is the only profitability ratio that is listed. All profitability ratios have net income in the denominator.

7 Total asset turnover will indicate if there is a problem with the ratio.

A) debt to assets B) times interest earned C) fixed asset turnover D) current

Explanation: Fixed asset turnover is part of total asset turnover.

8 All of the following are asset utilization ratios except:

A) average collection period B) inventory turnover C) receivables turnover D) return on assets

Explanation: Return on assets is a profitability ratio. Any ratio with net income in the denominator is a profitability ratio.

9 If a firm's debt ratio is 55%, this means of the firm's assets are financed by equity financing.

A) 55% B) 50% C) 45% D) not enough information to answer question


Explanation: The equity portion plus the debt portion must add up to 100%.

10 All of the following can present problems for ratio analysis except:

A) inflation B) inventory accounting methods C) disinflation D) all of the above

Explanation: These all may cause problems.




Financial Forecasting

1 Planning for future growth is called:

A) capital budgeting B) working capital management C) financial forecasting D) none of the above

Explanation: This involves looking ahead to the future.

2 Which one of the following is NOT a tool of financial forecasting?

A) cash budget B) capital budget C) pro forma balance sheet D) pro forma income statement

Explanation: The other three are all tools used by an analyst.

3 The first step in developing a pro forma income statement is to:

A) build a sales forecast B) determine the production schedule C) determine cost of goods sold D) none of the above

Explanation: A sales forecast begins the process.


4 Pro forma statements are statements.

A) actual B) projected C) a previous year's D) none of the above

Explanation: Pro forma statements are based on estimates or projections.

5 All of the following compose cost of goods sold except .

A) raw material B) labor C) overhead D) all of the above are part of cost of goods sold

Explanation: The cost of good sold involves all three of these items.

6 Financial managers use the to plan for monthly financing needs.

A) capital budget B) cash budget C) pro forma income statement D) none of the above

Explanation: The cash budget allows for planning cash needs.

7 The payments that a firm collects from its customers are called .

A) cash disbursements B) cash outflows C) cash receipts D) none of the above

Explanation: Cash receipts represent cash coming into the firm.


8 Examples of cash disbursements are all but .

A) payment for materials purchased B) collection of accounts receivable C) payment of dividends D) payment of taxes

Explanation: The collection of accounts receivable is an example of a cash receipt, not a cash disbursement.

9 In developing the pro forma balance sheet, we get common stock from .

A) the firm's previous balance sheet B) the firm's cash budget C) the firm's income statement D) none of the above

Explanation: Common stock appears on the balance sheet.

10 The percent of sales method of financial forecasting shows us the relationship between and financing needs.

A) changes in the level of liabilities B) changes in the level of assets C) changes in debt D) changes in the level of sales

Explanation: It compares the relationship between balance sheet items and sales.



Operating and Financial Leverage

1 An example of a semi-variable cost is:

A) rent B) raw material C) depreciation D) utilities

Explanation: The other three represent fixed or variable costs.

2 is the point at which firm profit is equal to zero.

A) breakeven B) operating breakeven C) financial leverage D) combined breakeven

Explanation: This is the point where the firm's revenues equal its expenses.

3 In breakeven analysis, if fixed costs rise, then the breakeven point will .

A) fall B) rise C) stay the same D) none of the above

Explanation: This implies that a larger quantity will have to be sold in order to break even.


4 In the breakeven formula, Price - Variable Cost is called the .

A) breakeven point B) leverage C) contribution margin D) none of the above

Explanation: This implies that a larger quantity will have to be sold in order to cover the additional fixed costsand still break even.

5 Which of the following types of firms may operate with high operating leverage?

A) a doctor's office B) an auto manufacturing facility C) a mental health clinic D) none of the above would have high operating leverage

Explanation: This implies a high break-even point and high operating expenses.

6 The is the percentage change in operating income that results from a percentage change in sales.

A) degree of financial leverage B) breakeven point C) degree of operating leverage D) degree of combined leverage

Explanation: This is called the degree of operating leverage (DOL).


7 If interest expenses for a firm rise, we know that firm has taken on more .

A) financial leverage B) operating leverage C) fixed assets D) none of the above

Explanation: Financial leverage refers to interest expense on debt.

8 The is the percentage change in earnings per share that results from a percentage change in operating income.

A) degree of combined leverage B) degree of financial leverage C) breakeven point D) degree of operating leverage

Explanation: This is known as the degree of financialleverage (DFL).

9 Combined leverage is the percentage change in relationship between sales and .

A) operating income B) operating leverage C) earnings per share D) breakeven point

Explanation: This combines operating leverage and financial leverage.

10 A highly leveraged firm is risky than its peers.

A) less B) more C) the same D) none of the above

Explanation: Leverage is equivalent to risk, because it implies a higher level of fixed costs.


Working Capital and the Financing Decision

1 Working capital management involves the financing and management of the assets of the firm.

A) fixed B) total C) current D) none of the above

Explanation: Working capital management deals with the financing and management of current assets.

2 An asset sold at the end of a specified time period is called a asset.

A) temporary current B) self-liquidating C) current D) permanent current

Explanation: A self-liquidating asset is one that will be sold after a certain amount of time.

3 Fixed assets are usually financed with funds.

A) long-term B) short-term C) permanent D) none of the above

Explanation: Fixed assets are by definition long-term assets.


4 is usually used to finance self-liquidating assets.

A) Long-term financing B) Short-term financing C) Permanent financing D) none of the above

Explanation: These are short-term or temporary assets. http://vustudents.ning.com

5 Short-term interest rates, in a normal economy, are generally than long-term rates.

A) higher B) the same C) lower D) none of the above

Explanation: Long-term interest rates are normally higher than short-term interest rates to compensate for uncertainty or risk.

6 The expectations hypothesis says that interest rates are a function of interest rates.

A) short-term; long-term B) long-term; short-term C) short-term; short-term D) none of the above

Explanation: This theory says that long-term interest rates reflect the average of short-term expected rates.


7 Insurance companies would tend to invest in securities.

A) short-term B) intermediate term C) long-term D) not enough information to answer

Explanation: An insurance company would prefer long-term securities because they are more conservative or safer.

8 The theory says that investors must be paid a premium to hold long-term securities.

A) expectations hypothesis B) time value theory C) segmentation D) liquidity premium

Explanation: This is the liquidity premium.

9 Short-term financing plans with high liquidity have:

A) high return and high risk B) moderate return and moderate risk C) low profit and low risk D) none of the above

Explanation: This is known as a "middle-of-the-road" approach.

10 Long-term financing plans with low liquidity have:

A) high return and high risk B) moderate return and moderate risk C) low return and low risk D) none of the above

Explanation: This is also known as a "middle-of-the-road" approach.


Current Asset Management

1 The transaction motive for holding cash is for

A) a safety cushion B) daily operating requirements C) compensating balance requirements D) none of the above

Explanation: This is money for everyday transactions.

2 Which of the following motives for holding cash is required by the bank before loaning money?

A) compensating balance motive B) transactions motive C) precautionary motive D) none of the above

Explanation: This can be considered a form of collateral.

3 The difference between the cash balance on the firm's books and the balance shown on the bank's books is called:

A) the compensating balance B) float C) a safety cushion D) none of the above

Explanation: Float implies that it takes time for checks to clear.


4 Electronic funds transfer has the use of float.

A) reduced B) increased C) had no effect on D) none of the above

Explanation: Electronic funds transfer (EFT) has moved cash more quickly and reduced float.

5 The most utilized marketable security by most firms is the:

A) Treasury bond B) Agency security C) Certificate of Deposit D) Treasury bill

Explanation: Treasury bills (T-Bills) are very safe, popular investments.

6 Of the following marketable securities, which are guaranteed by the Federal government?

A) agency securities B) negotiable certificates of deposit C) banker's acceptances D) none of the above

Explanation: None of these are backed by the government.

7 The 5 C's of credit include:

A) conditions B) collateral C) character D) all of the above

Explanation: The other two C's of credit are capacity and capital.


8 The use of safety stock by a firm will:

A) reduce inventory costs B) increase inventory costs C) have no effect on inventory costs D) none of the above

Explanation: Safety stock is extra inventory a firm keeps in case of unforseen circumstances.

9 All of these factors are used in credit policy administration except:

A) credit standards B) terms of trade C) dollar amount of receivables D) collection policy

Explanation: The other three choices are the primary policy variables to consider.

10 Firms aim to hold cash balances since cash is a non-interest earning asset.

A) low B) average C) high D) none of the above

Explanation: A firm does not want to keep too much cash on hand because it will lose interest (by not keeping the money in a bank). http://vustudents.ning.com


Sources of Short-Term Financing

1 The largest provider of short-term credit for a business is:

A) banking organizations B) suppliers to the firm C) commercial paper D) Eurodollars

Explanation: This is also known as trade credit.

2 The number of days until the firm is past due to a supplier is called the:

A) discount period B) term to credit C) payment period D) none of the above

Explanation: The payment period is the number of days a firm has to pay its bill.

3 If a firm is given trade credit terms of 2/10, net 30, then the cost of the firm failing to take the discount is:

A) 2% B) 30% C) 36.72% D) 10%

4 The interest rate given by a bank to its most creditworthy customers is the:

A) prime rate B) LIBOR rate C) federal funds rate D) discount rate

Explanation: This is the "best" interest rate charged to people with excellent credit.


5 Which of the following types of bank loans generally have the highest effective rate of interest?

A) simple interest loan B) discount interest loan C) loan with a compensating balance D) installment loan

Explanation: Installment loans tend to be the most expensive.

6 If a firm needs to borrow $100,000, at 8% interest, to finance working capital needs and a 20% compensating is required, then the firm should borrow .

A) $100,000 B) $80,000 C) $125,000 D) $108,000

Explanation: The formula to calculate this is: amount needed/(1-c), where c = the compensating balance percentage.

7 If a bank offers a firm a simple interest loan of $1000 for 120 days at a cost of $60 interest, what is the effective rate of interest on the loan?

A) 18.00% B) 6.00% C) 20.00% D) none of the above

Explanation: This is calculated by using formula 8-2 in this chapter.

8 If a company raises money to finance short-term needs by selling its accounts receivable to another party, this is called .

A) pledging B) warehousing C) factoring D) none of the above

Explanation: Factoring means selling the accounts receivable outright.


9 The most restrictive policy for using inventory as collateral for short-term borrowing is called:

A) blanket inventory lien B) warehousing inventory C) trust receipt D) factoring

Explanation: This is a complex method of inventory financing wherein the lender takes control of the inventory.

10 A type of accounts receivable financing where a firm uses its receivables as collateral is called:

A) pledging B) securitization C) factoring D) warehousing

Explanation: Pledging means using accounts receivable as collateral.


The Time Value of Money

1 Both the future and present value of a sum of money are based on:

A) interest rate B) number of time periods C) both a and b D) none of the above

Explanation: These two factors are used in time value of money calculations.

2 An annuity is .

A) more than one payment B) a series of unequal but consecutive payments C) a series of equal and consecutive payments D) a series of equal and non-consecutive payments

Explanation: An annuity is a stream of equal payments to be received in the future.

3 If you have $1000 and you plan to save it for 4 years with an interest rate of 10%, what is the future value of your savings?

A) $1464.00 B) $1000.00 C) $1331.00 D) cannot be determined

4 Time value of money is an important finance concept because:

A) it takes risk into account B) it takes time into account C) it takes compound interest into account D) all of the above

Explanation: Time value of money incorporates all of these concepts.


5 The present value of a dollar to be received in the future is:

A) more than a dollar B) equal to a dollar C) less than a dollar D) none of the above

Explanation: The reason is because you can earn interest on the money.

6 The future value of a dollar that you invest today is:

A) more than a dollar B) equal to a dollar C) less than a dollar D) none of the above

Explanation: Again, the reason is because the money can earn interest.

7 The future value of an annuity is:

A) less than each annuity payment B) equal to each annuity payment C) more than each annuity payment D) none of the above

Explanation: The reason has to do with compound interest (or interest earning more interest).

8 The concepts of present value and future value are:

A) directly related to each other B) not related to each other C) proportionately related to each other D) inversely related to each other

Explanation: They are essentially opposite sides of a coin.



9 If you win the lottery and you choose to have your proceeds distributed to you over a twenty-year time period, with the first payment coming to you one year from today, which calculation would you use to calculate the worth of those proceeds to you today?

A) future value of a lump sum B) future value of an annuity

C) present value of a lump sum D) present value of an annuity

Explanation: This is shown by formula 9-4 in this chapter. But this is not a typical situation. Most lotteries (let’s say $1 Million over 20 years), will pay you the first payment today and $50,000 each year for the next 19 years. This is actually an “annuity due” which is not covered in this text. You’d have to calculate the present value of the annuity for 19 years and add the initial $50,000 you received today.

10 You have $1000 you want to save. If four different banks offer four different compounding methods for interest, which method should you choose to maximize your $1000?

A) compounded daily B) compounded quarterly C) compounded semi-annually D) compounded annually

Explanation: The more often interest is compounded the faster it will grow because you will begin to earn interest on the interest sooner.



Valuation and Rates of Return

1 In valuing a financial asset, you use these variables:

A) present value of future cash flows B) discount rate C) required rate of return D) all of the above

Explanation: All of these are needed in order to value an asset.

2 The principal amount of a bond at issue is called:

A) par value B) coupon value C) present value of an annuity D) present value of a lump sum

Explanation: This is also known as the face value or stated value.

3 If a bond's value rises above its par value during its life, interest rates have:

A) gone up B) gone down C) stayed the same D) there is no correlation with interest rates

Explanation: There is an inverse relationship between bond prices and interest rates (or yields).


4 The basic "rent" that you are charged when you borrow money is called:

A) inflation premium B) risk premium C) real rate of return D) none of the above

Explanation: This is known as the opportunity cost in economics.

5 As time to maturity draws near, a bond's value approaches:

A) zero B) par C) the coupon payment D) none of the above

Explanation: The bond price gets closer to its face value the closer it is to maturity (see figure 10-2 in this chapter).

6

One characteristic of preferred stock is that:

A) it has no maturity date B) it is a hybrid security with characteristics of both common stock

and debt C) it pays a fixed dividend payment D) all of the above

Explanation: Preferred stock is described by all of the above characteristics.

7 Common stock that has no growth in dividends is valued as if it were:

A) preferred stock B) a bond C) an option D) none of the above

Explanation: It is treated the same as preferred stock.


8 A high price/earnings ratio usually indicates that a firm is a:

A) value stock B) growth stock C) convertible security D) constant security

Explanation: A high p/e ratio indicates a stock that is growing and has positive future expectations.

9 A low price/earnings ratio usually means that a firm:

A) is a growth stock B) has positive expectations for the future C) is a mature firm D) is doomed in the marketplace.

Explanation: This is the opposite of a growth stock.

10 The premium to compensate an investor for the eroding effect of rising prices is called the:

A) risk premium B) inflation premium C) real rate of return D) none of the above

Explanation: This is compensation for inflation or the loss of purchasing power



Cost of Capital

1 A firm's cost of capital is the:

A) cost of borrowing money B) cost of issuing stock C) cost of bonds D) overall cost of financing to the firm

Explanation: This is also called the weighted average cost of capital (WACC).

2 The cost of debt financing is generally the cost of preferred or common equity financing.

A) less than B) more than C) equal to D) not enough information to tell

Explanation: This is because there is less risk to the lender than if he/she were to buy stock and because interest payments on debt are tax deductible to a firm.

3 The cost of preferred stock is usually more than the cost of debt because of:

A) low dividends B) tax deductibility of interest payments on debt C) high stock price D) none of the above

Explanation: Preferred stock is not tax deductible and there is slightly more risk associated with preferred stock than with bonds.


4 The cost of issuing new stock is called:

A) the cost of equity B) flotation costs C) marginal cost of capital D) none of the above

Explanation: Flotation costs are the selling or distribution costs associated with a new issue of stock.

5 The cost of retained earnings does not consider in the equation.

A) flotation costs B) the dividend in the next time period C) the value of the common equity D) the growth rate of dividends

Explanation: When a company retains its earnings there are no flotation costs incurred.

6 The most expensive source of financing for a firm is:

A) debt B) preferred stock C) retained earnings D) new common stock

Explanation: This is because of flotation costs, as described above.

7 The cost of capital at the retained earnings breakpoint is the:

A) weighted average cost of capital B) marginal cost of capital C) cost of new stock D) none of the above

Explanation: The marginal cost of capital is the cost of the last dollar of funds raised.


8 The cost of each component of a firm's capital structure multiplied by its weight in the capital structure is called the:

A) marginal cost of capital B) cost of debt C) weighted average cost of capital D) none of the above

Explanation: This represents the overall cost of financing to the firm.

9 When establishing their optimal capital structure, firms should strive to:

A) minimize the weighted average cost of capital B) minimize the amount of debt financing used C) maximize the marginal cost of capital D) none of the above

Explanation: This means the least expensive cost to the firm.

10 The overall cost of financing for the firm is called the:

A) weighted average cost of capital B) cost of preferred stock C) retained earnings breakpoint D) none of the above

Explanation: This is the weighted average cost of capital (WACC).


The Capital Budgeting Decision

1 focuses on long-term decision-making regarding the acquisition of projects.

A) Working Capital Management B) Capital Budgeting C) Cash Budgeting D) none of the above

Explanation: Capital budgeting deals with long-term financial decisions occuring in the future.

2 Since capital budgeting uses cash flows instead of accounting flows, the financial manager must add back to the analysis.

A) the cost of fixed assets B) the cost of accounts payable C) investments D) depreciation

Explanation: Since depreciation is a non-cash expenditure it must be added back to determine cash flow.

3 Which of the following capital budgeting methods focuses on firm liquidity?

A) payback method B) net present value C) internal rate of return D) none of the above

Explanation: The payback method determines how quickly the cash investment is recouped.



4 When faced with mutually exclusive option, which project should be accepted under the payback method?

A) The one with the longest payback period. B) The one with the shortest Payback period.

C) It doesn’t matter because the payback method is not theoretically correct.

D) None of the above. Explanation: The payback method emphasizes liquidity, so the one with the shortest payback period is preferable.

5 If the Net Present Values of two, mutually exclusive options are both greater than zero, which option should be selected if the firm uses the Net Present Value method?

A) The one with the largest Net Present Value. B) The one with the smallest Net Present Value. C) Either one. Both are greater than the cost of capital. D) None of the above

Explanation: The one with the largest Net Present Value adds the most value to the firm.

6

If the Internal Rates of Return of two, mutually exclusive options are both greater than the cost of capital, which option should be selected under the Internal Rate of Return method?

A) The one with the largest Internal Rate of Return. B) The one with the smallest Internal Rate of Return. C) The one with the highest Net Present Value at the firm’s cost of

capital. D) None of the above

Explanation: The Internal Rate of Return is not reliable for decisions involving mutually exclusive options. The Net Present Value method should be used to select between mutually exclusive options.


7 If two projects are independent, that means that _.

A) Selection of one precludes selection of the other. B) You should analyze the projects independently. C) Both a and b D) none of the above

Explanation: In other words, one or both projects could be selected.

8 According to the reinvestment rate assumption, which method of capital budgeting assumes cash flows are reinvested at the project's rate of return?

A) payback period B) net present value C) internal rate of return D) none of the above

Explanation: The internal rate of return method assumes that the rate of reinvestment will be equal to the actual internal rate of return.

9 When a firm places a budgetary constraint on the projects it invests in, this is called:

A) capital rationing B) working capital management C) cash budgeting D) none of the above

Explanation: This means there is a limit to the amount of funds available.

10 Which of the following capital budgeting methods states the return of a project as a percentage?

A) payback period B) net present value C) internal rate of return D) none of the above

Explanation: The internal rate of return is an interest rate.


Risk and Capital Budgeting 1 Because investors dislike uncertainty, they will require rates of return from risky investments.

A) higher B) lower C) the same D) none of the above

Explanation: This is to compensate them for risk.

2 is the variability of possible outcomes from a given investment.

A) Beta B) Return C) Risk D) Variance

Explanation: Risk is a measure of uncertainty.

3 Generally, the larger the standard deviation of an investment's expected outcomes, the the risk.

A) higher B) lower C) less volatile D) none of the above

Explanation: A smaller standard deviation implies less risk.


4 When stocks are held in a portfolio instead of individually, which measure of risk is appropriate?

A) standard deviation B) beta C) coefficient of variation D) none of the above

Explanation: The coefficient of variation is used to measure more than one stock.

5 If an individual stock's beta is higher than 1.0, that stock is:

A) exactly as risky as the market. B) riskier than the market. C) less risky than the market D) none of the above

Explanation: A beta less than 1.0 means a stock is less risky than the overall market.

6 The component of the risk-adjusted discount rate that is derived from the risk of Treasury securities is:

A) risk premium B) cost of capital C) call premium D) risk-free rate

Explanation: Treasury securities are safe, risk-free investments.

7 The component of the risk-adjusted discount rate that compensates the investor for holding risky assets is the:

A) risk-free rate B) cost of capital C) risk premium D) none of the above

Explanation: The risk premium is a compensation for risk.


8 The standard deviation measures:

A) portfolio risk B) the risk of an individual security C) the risk of two securities, with different expected returns,

compared to each other D) none of the above

Explanation: Risk is measured by the standard deviation.

9 Coefficient of variation measures:

A) portfolio risk B) the risk of an individual security C) the degree of risk per unit of expected return. D) none of the above

Explanation: The coefficient of variation is used to compare more than one security, with differing expected returns and levels of risk.

10 The automobile industry and the heavy manufacturing industry probably have expected returns with a correlation.

A) positive B) perfect positive C) negative D) slightly negative

Explanation: A positive correlation is associated with industries that are related to each other.


Capital Markets

1 The U.S. capital markets are composed of securities with maturities of .

A) less than one year B) one year C) one year and greater D) none of the above

Explanation: The capital markets deal with long-term securities.

2 The following can be classified as a capital market security:

A) banker's acceptance B) U.S. Treasury bills C) money market mutual fund D) common stock

Explanation: The other three answers represent short-term securities, which are traded in the money market.

3 The NAFTA agreement involved which two countries besides the U.S.?

A) Mexico and Canada B) Cuba and Mexico C) Panama and Cuba D) Canada and Cuba

Explanation: It is the North American Free Trade Agreement.


4 Which of the following types of securities are exempt from at least some taxes?

A) Federally sponsored agency securities B) Municipal bonds C) common stock D) preferred stock

Explanation: Municipal bonds are exempt from federal income taxes.

5 Which of the following financial markets is the largest in terms of dollar value?

A) derivatives market B) stock market C) bond market D) commercial paper market

Explanation: The bond market represents the largest dollar amount.

6 Which of the following is a source of internal capital for the business firm?

A) retained earnings B) depreciation C) common stock D) a and b above

Explanation: Common stock is a source of external capital for a firm.

7 Which of the following is not an organized exchange?

A) AMEX B) NASDAQ C) NYSE D) none of the above

Explanation: All of the above are organized exchanges.


8 Recently stock exchanges have moved toward share prices stated in .

A) fractions B) whole numbers C) decimals D) none of the above

Explanation: Historically they traded in fractions for many years.

9 The regulatory body for the New York Stock Exchange is _.

A) U.S. Treasury B) Securities and Exchange Commission C) National Association of Securities Dealers D) all of the above

Explanation: The Securities and Exchange Commission (SEC) is the "policeman" for the securities markets.

10 Which piece of legislation was enacted in order to establish a national securities market?

A) Securities Act of 1933 B) Securities Exchange Act of 1934 C) Securities Acts Amendments of 1975 D) none of the above

Explanation: The purpose of this legislation was to direct the SEC to supervise the development of a national securities market.



Investment Banking: Public and Private Placement

1 Investment bankers are intermediaries between business firms and .

A) banks B) securities dealers C) the investing public D) none of the above

Explanation: They are the "middlemen" between the two.

2 Leveraged buyouts rely on to purchase a firm.

A) Debt B) Equity C) Cash D) none of the above

Explanation: It involves issuing bonds or debt.

3 The Gramm-Leach-Bliley Act repealed the .

A) McFadden Act B) Securities Act of 1933 C) The Federal Reserve Act D) The Glass-Stegall Act

Explanation: This act broke down barriers between investment banking and commercial banking.


4 Which of the following pieces of legislation required that banks keep their commercial and investment functions separate?

A) McFadden Act B) Gramm-Leach-Bliley Act C) Glass-Steagall Act D) none of the above

Explanation: This act was repealed by the Gramm-Leach-Bliley Act.

5 An investment banker may engage in buying and selling a new issue of securities in order to ensure a liquid market. This function is called .

A) market making B) advising C) agency function D) underwriting

Explanation: The purpose of this is to make sure there is a liquid market for the security.

6 of earnings may occur after a new stock issue is made.

A) Maximization B) Dilution C) Termination D) Stabilization

Explanation: This means that earnings per share (EPS) may go down.

7 How long does an investment banker usually try to stabilize the market after an initial public offering?

A) 2-3 days B) 2-3 months C) 1 month D) none of the above

Explanation: A couple of days is the norm.


8 A disadvantage of being a public company is:

A) the ability to have greater access to the capital markets B) having the ability to engage in merger C) disclosure of information to the SEC D) all of the above are advantages

Explanation: Public companies open themselves up to public scrutiny.

9 is the most popular way of raising debt capital for most corporations.

A) Bank loans B) Public debt issues C) Private debt issues D) None of the above

Explanation: “…privately placed debt now exceeds 50% of all long term corporate debt outstanding.”

10 Which of the following are functions of an investment banker?

A) underwriter B) market maker C) advisor D) all of the above

Explanation: The investment banker provides all of these functions.


Long-Term Debt and Lease Financing

1 The principal value of a bond is called the:

A) the coupon rate B) the par value C) the maturity value D) none of the above

Explanation: It is also called the stated value or face value.

2 The is the stated interest rate at the time the bond was issued.

A) coupon rate B) effective rate C) yield to maturity D) internal rate of return

Explanation: This is the interest rate stated on the bond.

3 A is a long-term senior bond without collateral.

A) subordinated debenture B) debenture C) junior debenture D) indenture

Explanation: In other words, there is nothing to back up or secure the bond.

4 The method of bond repayment where bonds are paid off in installments over the life of the bond issue is called:

A) sinking fund provision B) call provision C) serial repayment D) conversion

Explanation: A serial repayment means the bond is paid off in installments over its life.


5 The method of bond repayment where debt is converted to shares of common stock in the company is called:

A) serial repayment B) conversion C) sinking fund provision D) call feature

Explanation: This allows the company to convert bonds into shares of stock.

6 Firms generally decide to call their bonds when interest rates:

A) rise B) drop C) remain the same D) there is no relationship between interest rates and the call

provision

Explanation: This way a firm will save money on interest expense.

7 The current yield on a bond worth $900 with a par value of $1000 and a coupon rate of 10% is:

A) 10% B) 11.11% C) 12.05% D) none of the above

Explanation: This is calculated by dividing the stated interest payment (10% x 1000) by the current price of the bond.

8 Zero coupon bonds:

A) are sold at par. B) pay no interest payment C) are sold at a deep discount. D) b and c above

Explanation: Zero coupon bonds have no interest payments and are sold at a discount from their face value.


9 An advantage of debt financing is:

A) interest payments are tax deductible B) the use of debt, up to a point, lowers the firm's cost of capital C) does not dilute owner's earnings D) all of the above

Explanation: All of these are advantages of using debt.

10 A capital lease: lease. A) is generally used by corporations more often than an operating

B) is placed on the balance sheet. C) is capitalized. D) all of the above

Explanation: All of these are true of a capital lease.


Common and Preferred Stock Financing 1 have a claim to the residual income of the firm.

A) Bondholders B) Preferred Stockholders C) Common Stockholders D) none of the above

Explanation: Common stockholders are the ultimate owners of a firm.

2 voting elects a member of the board of directors of a firm with a 51% vote.

A) Cumulative B) Preferred C) Majority D) none of the above

Explanation: Majority voting means over 50%.

3 Which of the following types of voting includes minority shareholders?

A) Cumulative B) Preferred C) Majority D) none of the above

Explanation: Cumulative voting allows those with less than a 50% interest to elect some of the board of directors.


4 If a corporate charter says that current stockholders must be given the first option to purchase new stock, then that is a rights offering.

A) Pre-emptive B) Rights-on C) Ex-rights D) none of the above

Explanation: Pre-emptiverights gives priority to the current stockholders.

5 When a rights offering is announced, the stock initially trades:

A) Ex-rights B) Rights-on C) No-rights D) Pre-emptive right

Explanation: Rights-on means that someone who purchases the stock will also receive a right toward a future purchase of the stock.

6 makes a firm unattractive in case of a takeover bid.

A) Rights offering B) Greenmail C) Poison Pill D) Black Knight

Explanation: This is an attempt to "poison" an attempted takeover.



7 are certificates that have a legal claim on an ownership interest in a foreign company's stock.

A) Stock certificates B) Preferred stock C) Bond indentures D) American Depository Receipts

Explanation: This is the definition of American Depository Receipts (ADRs).

8 Securities that have a mandatory dividend are:

A) bonds B) preferred stock C) common stock D) none of the above

Explanation: A firm is not obligated to pay a dividend on any security.

9 One provision of preferred stock is that they can participate in the firm's yield during good years. That provision is .

A) the call provision B) cumulative dividends C) the participation provision D) the conversion provision

Explanation: The participation provision means that the owners may receive more than the quoted yield if the firm is having a very good year.


10 Which of the following have ownership interest in the firm?

A) Common stockholders B) Preferred stockholders C) Bondholders D) All of the above

Explanation: Common stockholders are the ultimate owners of a firm.


Dividend Policy and Retained Earnings 1 The Board of Directors may do which of the following with net income?

A) put it in the cash account B) retain it C) pay it out as dividends D) B & C above

Explanation: Net income may be either retained by the company or paid out as dividends.

2 One desire of stockholders regarding dividend policy is:

A) stable dividends B) frequent dividends C) low dividends D) high dividends

Explanation: Stability of dividends is important to stockholders.

3 A stock dividend:

A) increases the value of stockholder's equity. B) decreases the value of stockholder's equity C) does not change the value of stockholder's equity. D) none of the above

Explanation: Owners' equity is not changed by a stock dividend.


4 The purpose of a stock split is usually to:

A) increase the investor's wealth B) bring down the stock price into a lower trading range. C) reduce of threat of takeover D) decrease the number of shares outstanding

Explanation: Stock splits are used when the price of a stock gets too high.

5 As a result of the Jobs and Growth Tax Relief Act of 2003, dividends and capital gains are taxed at a maximum rate of:

A) 38.6% B) 20% C) 15% D) none of the above

Explanation: This recent piece of legislation reduced the maximum capital gains tax rate to 15%.

6 Which of the following balance sheet accounts will be affected by a stock dividend but not by a stock split?

A) dividends in arrears B) cash C) common stock D) retained earnings

Explanation: A stock split will not affect a company's retained earnings account.


7 A firm may repurchase its own stock because:

A) it provides positive information about the firm. B) the firm has inadequate capital budgeting alternatives C) it will increase shareholder's wealth D) all of the above

Explanation: These are all reasons for a firm to repurchase its stock.

8 A stock split:

A) does not change the amount in the common stock account B) is treated by accountants just like a stock dividend C) reduces retained earnings D) none of the above

Explanation: A stock split doesn't change the total value of common stock, only the number of shares.

9 The ex-dividend date is the date:

A) on which recipients of the dividend are determined B) the dividend is declared C) which no longer includes dividend payments for stock

bought on that date. D) none of the above

Explanation: The ex-dividend date is also two business days before the holder-of-record date.

10 Individuals in a high tax bracket typically prefer for a firm to:

A) issue dividends B) retain earnings C) hold cash D) none of the above

Explanation: The reason is so they don't have to pay taxes on the dividends


Convertibles, Warrants, and Derivatives

1 The conversion ratio is the:

A) ratio of the conversion premium to market value of the convertible security.

B) price at which a convertible security is exchanged for common stock.

C) number of shares of common stock in to which the

convertible may be converted. D) none of the above

Explanation: The conversion ratio tells how many shares of stock will result from the conversion.

2 The floor value for a convertible bond is:

A) the conversion value B) the pure bond value C) the conversion price D) none of the above

Explanation: If the stock price falls below the conversion price, the conversion option becomes worthless and the value of the bond becomes simply the present value of the future interest and principal payments. This is the value of the bond without the conversion feature.

3 A convertible security is:

A) a security that can be converted into debt at the option of the owner.

B) a security that can be converted into preferred stock at the option of the owner.

C) a security that can be converted into common stock at the option of the owner.


Explanation: This allows one to exchange the security for common stock.

4 The conversion price is usually than the market price of the common stock at the time the bond issue is sold.

A) higher B) lower C) the same as D) none of the above

Explanation: The reason for this is to make the convertible security more desirable.

5 The interest rate on convertibles is generally the interest rate on nonconvertible securities.

A) greater than B) less than C) the same as D) none of the above

Explanation: Convertible securities are more desirable than nonconvertibles; therefore, they don't have to pay as high an interest rate.

6 The conversion premium will be large:

A) if investors think the price of the stock will rise. B) if interest rates decline C) when the stock price is falling D) none of the above

Explanation: If investors are optimistic about the prospects of the common stock, the conversion premium may be large.


7 The price of a convertible bond:

A) has upside and downside limits B) has only downside limits C) has only upside limits D) none of the above

Explanation: A convertible bond has only a floor or lowest value.

8 Warrants are:

A) investments whose value is directly related to the price of the underlying stock.

B) the same as call options C) the same as put options D) none of the above

Explanation: A warrant is an option to buy a stated number of shares of a stock at a specified price (the exercise price) over a given time period.

9 Which of the following is an advantage of a convertible bond?

A) downside protection is ineffectual if the bond is bought at a large premium over par value

B) conversion may be forced on the bondholder by call provisions on the convertible bond

C) there is downside risk for the investor D) none of the above

Explanation: This means that there is a lowest possible value (called the floor value) for the security.


10 A step-up in the conversion price refers to:

A) the ability of the company to step up the maturity of the bond to an earlier date.

B) a shorter time to call C) the provision that decreases the conversion ratio the longer

the bond is held D) none of the above

Explanation: A step-up in the conversion price means that the conversion ratio is decreasing and the conversion price is increasing.


External Growth through Mergers

1 Which of the following is NOT a potential benefit of merger?

A) Synergy B) Portfolio Effect C) Dilution of EPS D) tax loss carry forward

Explanation: The other three answers are all benefits of a merger.

2 A business combination where the two firms who are merging develop a new firm is called:

A) a horizontal merger B) a vertical merger C) a business consolidation D) none of the above

Explanation: The result of a business consolidation is a new firm.

3 The price that an acquiring company must pay for the acquired company is:

A) book value B) market value C) a higher price than market value D) none of the above

Explanation: This is known as the merger premium.


4 The typical merger premium is:

A) 20% B) 20-40% C) 40-60% D) none of the above

Explanation: The premium is generally 40-60%.

5 Merging with an unrelated company is called a merger.

A) conglomerate B) horizontal C) vertical D) none of the above

Explanation: This is a merger of totally unrelated companies.

6 A business combination where the resulting firm maintains the identity of the acquiring firm is called a:

A) conglomerate B) merger C) consolidation D) none of the above

Explanation: A merger occurs when the acquiring firm's original identity is kept with the new firm.


7 Which of the following is a tender offer that uses debt to buy the firm?

A) hostile takeover B) negotiated merger C) two-step buyout D) leveraged buyout

Explanation: A leveraged buyout involves bonds or debt.

8 The financial motives for merger include all of the following except:

A) the portfolio effect B) improved access to the capital markets C) tax loss carry forwards D) synergy

Explanation: All of these are financial motives for a merger.

9 The elimination of overlapping functions and the meshing of two firms' strong areas creates the managerial incentive for merger that is called:

A) pooling of interest B) purchase of assets C) synergy D) None of the above

Explanation: Synergy also occurs when the whole is greater than the sum of its parts.

10 Which of the following kinds of mergers lead to diversification benefits?

A) vertical B) conglomerate C) horizontal D) none of the above


Explanation: A conglomerate merger involves unrelated companies.

International Financial Management 1 What type of MNC produces a product domestically and ships it to a foreign market?

A) joint venture B) fully owned foreign subsidiary C) exporter D) importer

Explanation: An exporter sells a product to a foreign market.

2 When an MNC cannot produce an actual product in a foreign subsidiary due to political restrictions, it can export technology and knowledge through:

A) an exporter B) a joint venture C) an importer D) a licensing agreement

Explanation: A licensing agreement allows a multinational corporation (MNC) to export technology and knowledge.

3 Many MNCs prefer above all other methods of establishing a foreign presence.

A) exporting B) joint ventures C) fully owned foreign subsidiaries D) none of the above

Explanation: A joint venture has many pluses, including exposing the MNC


to the least amount of political risk.


4 What one currency is worth in terms of another currency is called a(n) .

A) euro B) exchange rate C) spot rate D) forward rate

Explanation: The exchange rate shows the price or value of one currency as compared to another.

5 Currency exchange rates tend to vary inversely with their .

A) interest rates B) cross rate C) purchasing power D) economic power

Explanation: This provides a similar purchasing power in each country and is known as purchasing power parity (PPP).

6 The system of government accounts that catalog the flow of economic transactions between the residents of one country and the residents of other countries is called .

A) a joint venture B) current account C) balance of payments D) balance of interest rates

Explanation: The balance of payments (BOP) shows the economic transactions between two countries.


7 The exchange rate that is paid for a currency for immediate delivery is the:

A) spot rate B) cross rate C) forward rate D) none of the above

Explanation: The spot rate is the price of a currency right now or "on the spot".

8 The exchange rate between two currencies outside the American dollar is called the:

A) forward rate B) cross rate C) spot rate D) none of the above

Explanation: The cross rate is the exchange rate for two currencies quoted against the U.S. dollar.

9 A multinational corporation may be defined as:

U.S.

A) a company that imports foreign products B) a company that hires foreign labor C) a company which carries on business activity outside the


Explanation: A multinational corporation (MNC) does business in more than one country.

10 A fully owned foreign subsidiary is a form of MNC in which:

A) the MNC owns and operates the firm by itself. B) the MNC has a partner in the foreign country. C) the foreign government is cooperative.



Explanation: A fully owned foreign subsidiary is owned and operated by the multinational corporation (MNC).

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