Financial Management basics

Chapter 1: The Role of Financial Management

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1. "Shareholder wealth" in a firm is represented by:

the number of people employed in the firm.

the book value of the firm's assets less the book value of its liabilities.

the amount of salary paid to its employees.

the market price per share of the firm's common stock.

2. The long-run objective of financial management is to:

maximize earnings per share.

maximize the value of the firm's common stock.

maximize return on investment.

maximize market share.

3. What are the earnings per share (EPS) for a company that earned $100,000 last year in after-tax profits, has 200,000 common shares outstanding and $1.2 million in retained earning at the year end?

$100,000

$6.00

$0.50

$6.50

4. A(n) would be an example of a principal, while a(n) would be an example of an agent.

shareholder; manager

manager; owner

accountant; bondholder

shareholder; bondholder

5. The market price of a share of common stock is determined by:

the board of directors of the firm.

the STOCK EXCHANGE on which the stock is listed.

the president of the company.

individuals buying and selling the stock.

6. The focal point of financial management in a firm is:

the number and types of products or services provided by the firm.

the minimization of the amount of taxes paid by the firm.

the creation of value for shareholders.

the dollars profits earned by the firm.

7. The decision function of financial management can be broken down into the decisions.

financing and investment

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investment, financing, and asset management

financing and dividend

capital budgeting, cash management, and credit management

8. The controller's responsibilities are primarily in nature, while the treasurer's responsibilities are primarily related to .

operational; financial management

financial management; accounting

accounting; financial management

financial management; operations

9. In the US, the has been given the power to adopt auditing, quality control, ethics, and disclosure standards for public companies and their auditors as well as investigate and discipline those involved.

American Institute of Certified Public Accountants (AICPA)

Financial Accounting Standards Board (FASB)

Public Company Accounting Oversight Board (PCAOB)

Securities and Exchange Commission (SEC)

10. A company's is (are) potentially the most effective instrument of good corporate governance.

common stock shareholders

board of directors

top executive officers

11. The Sarbanes-Oxley Act of 2002 (SOX) was largely a response to:

a series of corporate scandals involving Enron, WorldCom, Global Crossing, Tyco and numerous others.

a dramatic rise in the US trade deficit.

charges of excessive compensation to top corporate executives.

rising complaints by investors and security analysts over the financial accounting for stock options.

The following item is NEW to the 13th edition.

12. ___________ refers to meeting the needs of the present without compromising the ability of future generations to meet their own needs.

Corporate Social Responsibility (CSR)

Sustainability

Convergence

Green EconomicsChapter 4: The Valuation of Long-Term Securities MCQs solvedChapter 4: The Valuation of Long-Term Securities MCQs solved

Multiple-Choice QuizChapter 4: The Valuation of Long-Term SecuritiesJust click on the button next to each answer and you'll get immediate feedback.

1. What's the value to you of a $1,000 face-value bond with an 8% coupon rate when your

required rate of return is 15 percent?

More than its face value.

Less than its face value.

$1,000.

True.

2. If the intrinsic value of a stock is greater than its market value, which of the following is a

reasonable conclusion?

The stock has a low level of risk.

The stock offers a high dividend payout ratio.

The market is undervaluing the stock.

The market is overvaluing the stock.

3. When the market's required rate of return for a particular bond is much less than its

coupon rate, the bond is selling at:

a premium.

a discount.

cannot be determined without more information.

face value.

4. If an investor may have to sell a bond prior to maturity and interest rates have risen since

the bond was purchased, the investor is exposed to

the coupon effect.

interest rate risk.

a perpetuity.

an indefinite maturity.

5. Virgo Airlines will pay a $4 dividend next year on its common stock, which is currently

selling at $100 per share. What is the market's required return on this investment if the dividend

is expected to grow at 5% forever?

4 percent.

5 percent.

7 percent.

9 percent. Correct!

ke = (D1/P0) + g

ke = ($4/$100) + .05 = .09

6. If a bond sells at a high premium, then which of the following relationships hold true?

(P0 represents the price of a bond and YTM is the bond's yield to maturity.)

P0 < par and YTM > the coupon rate.

P0 > par and YTM > the coupon rate.

P0 > par and YTM < the coupon rate.

P0 < par and YTM < the coupon rate.

7. Interest rates and bond prices

move in the same direction.

move in opposite directions.

sometimes move in the same direction, sometimes in opposite directions.

have no relationship with each other (i.e., they are independent).

8. In the formula ke = (D1/P0) + g, what does g represent?

the expected price appreciation yield from a common stock.

the expected dividend yield from a common stock.

the dividend yield from a preferred stock.

the interest payment from a bond.

9. In the United States, most bonds pay interest a year, while many European bonds

pay interest a year.

once; twice

twice; once

once; once

twice; twice

10. The expected rate of return on a bond if bought at its current market price and held to

maturity.

yield to maturity

current yield

coupon yield

capital gains yieldChapter 3: The Time Value of Money MCQs solved

Multiple-Choice QuizChapter 3: The Time Value of MoneyJust click on the button next to each answer and you'll get immediate feedback.

1. You want to buy an ordinary annuity that will pay you $4,000 a year for the next 20 years.

You expect annual interest rates will be 8 percent over that time period. The maximum price you would be willing to pay for the annuity is closest to

$32,000.

$39,272. Correct!

PVA = $4,000 (PVIFA at 8% for 20 periods) PVA = $4,000 (9.818) = $39,272

$40,000.

$80,000.

2. With continuous compounding at 10 percent for 30 years, the future value of an initial

investment of $2,000 is closest to

$34,898.

$40,171. Correct!

FVA = $2,000 * e^(.10 * 30) FVA = $2,000 (20.0855) = $40,171

$164,500.

$328,282.

3. In 3 years you are to receive $5,000. If the interest rate were to suddenly increase, the

present value of that future amount to you would

fall.

rise.

remain unchanged.

cannot be determined without more information.

4. Assume that the interest rate is greater than zero. Which of the following cash-inflow

streams should you prefer? Year1 Year2 Year3 Year4

$400 $300 $200 $100

$100 $200 $300 $400

$250 $250 $250 $250

Any of the above, since they each sum to $1,000.

5. You are considering investing in a zero-coupon bond that sells for $250. At maturity in 16

years it will be redeemed for $1,000. What approximate annual rate of growth does this represent?

8 percent.

9 percent. Hint

$250 (FVIF at X% for 16 periods) = $1,000 (FVIF at approx. 9% for 16 periods) = $1,000/$250 = 4

OR -- noting that $250 doubles twice over 16 years to yield $1,000 we can use the Rule of 72 as follows: 72/(16/2) = 9 percent

12 percent.

25 percent.

6. To increase a given present value, the discount rate should be adjusted

upward.

downward.

True.

Fred.

7. For $1,000 you can purchase a 5-year ordinary annuity that will pay you a yearly payment

of $263.80 for 5 years. The compound annual interest rate implied by this arrangement is closest to

8 percent.

9 percent.

10 percent. Hint

$1,000 = $263.80 (PVIFA at X% for 5 periods) $1,000 / $263.80 = (PVIFA at X% for 5 periods) 3.791 = (PVIFA at 10% for 5 periods)

11 percent.

8. You are considering borrowing $10,000 for 3 years at an annual interest rate of 6%. The

loan agreement calls for 3 equal payments, to be paid at the end of each of the next 3 years. (Payments include both principal and interest.) The annual payment that will fully pay off (amortize) the loan is closest to

$2,674.

$2,890.

$3,741. Correct!

PVA = R (PVIFA at 6% for 3 periods) $10,000 = R (2.673) R = $10,000 / 2.673 = $3,741

$4,020.

9. When n = 1, this interest factor equals one for any positive rate of interest.

PVIF

FVIF

PVIFA

FVIFA

None of the above (you can't fool me!)

10. (1 + i)n

PVIF

FVIF

PVIFA

FVIFA

11. You can use to roughly estimate how many years a given sum of money must

earn at a given compound annual interest rate in order to double that initial amount .

Rule 415

the Rule of 72

the Rule of 78

Rule 144

12. In a typical loan amortization schedule, the dollar amount of interest paid each

period .

increases with each payment

decreases with each payment

remains constant with each payment

13. In a typical loan amortization schedule, the total dollar amount of money paid each

period .

increases with each payment

decreases with each payment

remains constant with each paymentChapter 13: Capital Budgeting TechniquesJust click on the button next to each answer and you'll get immediate feedback.

1. A profitability index of .85 for a project means that:

the present value of benefits is 85% greater than the project's costs.

the project's NPV is greater than zero.

the project returns 85 cents in present value for each current dollar invested.

the payback period is less than one year.

2. BackInSoon, Inc., has estimated that a proposed project's 10-year annual net cash benefit,

received each year end, will be $2,500 with an additional terminal benefit of $5,000 at the end of

the tenth year. Assuming that these cash inflows satisfy exactly BackInSoon's required rate of

return of 8 percent, calculate the initial cash outlay. (Hint: With a desired IRR of 8%, use the IRR

formula: ICO = discounted cash flows.)

$16,775

$19,090 Correct!

($2,500)(PVIFA at 8% for 10 periods) + ($5,000)(PVIF at 8% for 10 periods) = ($2,500)

(6.710) + ($5,000)(.463) = $19,090

$25,000

$30,000

3. Woatich Windmill Company is considering a project that calls for an initial cash outlay of

$50,000. The expected net cash inflows from the project are $7,791 for each of 10 years. What

is the IRR of the project? [(Hint: The cash f lows from the project are an annuity so you can

solve for i in the equation PVA = R(PVIFAi,10).]

6 percent

7 percent

8 percent

9 percent Correct!

$50,000 = $7,791(PVIFA at i% for 10 periods)

$50,000/$7,791 = 6.418

From the PVIFA table in the book, 6.418 is the PVIFA at 9% for 10 periods.

4. Which of the following statements is correct?

If the NPV of a project is greater than 0, its PI will equal 0.

If the IRR of a project is 0%, its NPV, using a discount rate, k, greater than 0, will be 0.

If the PI of a project is less than 1, its NPV should be less than 0.

If the IRR of a project is greater than the discount rate, k, its PI will be less than 1 and its

NPV will be greater than 0.

5. Assume that a firm has accurately calculated the net cash flows relating to an investment

proposal. If the net present value of this proposal is greater than zero and the firm is not under

the constraint of capital rationing, then the firm should:

calculate the IRR of this investment to be certain that the IRR is greater than the cost

of capital.

compare the profitability index of the investment to those of other possible investments.

calculate the payback period to make certain that the initial cash outlay can be recovered

within an appropriate period of time.

accept the proposal, since the acceptance of value-creating investments should increase

shareholder wealth.

6. A project's profitability index is equal to the ratio of the of a project's future cash flows

to the project's .

present value; initial cash outlay

net present value; initial cash outlay

present value; depreciable basis

net present value; depreciable basis

7. The discount rate at which two projects have identical is referred to as Fisher's rate of

intersection.

present values

net present values

IRRs

profitability indexes

8. Two mutually exclusive investment proposals have "scale differences" (i.e., the cost of the

projects differ). Ranking these projects on the basis of IRR, NPV, and PI methods give

contradictory results.

will never

will always

may

will generally

9. If capital is to be rationed for only the current period, a firm should probably first consider

selecting projects by descending order of .

net present value

payback period

internal rate of return

profitability index

10. The method provides correct rankings of mutually exclusive projects, when the

firm is not subject to capital rationing.

net present value

internal rate of return

payback period

profitability index

11. In an NPV sensitivity graph, a steep sensitivity line for a particular input variable means

that a in that variable results in a in NPV.

small percentage change; large change

large percentage change; small change

12. One potential problem with sensitivity analysis is that it generally looks at sensitivity

"one variable at a time." However, one way to judge the sensitivity of results to simultaneous

changes in two variables, at least, is to construct an .

NPV profile

NPV sensitivity matrix

NPV sensitivity graph

Multiple-Choice QuizChapter 15: Required Returns and the Cost of CapitalJust click on the button next to each answer and you'll get immediate feedback.

1. A single, overall cost of capital is often used to evaluate projects because:

it avoids the problem of computing the required rate of return for each investment proposal.

it is the only way to measure a firm's required return.

it acknowledges that most new investment projects have about the same degree of risk.

it acknowledges that most new investment projects offer about the same expected return.

2. The cost of equity capital is all of the following EXCEPT:

the minimum rate that a firm should earn on the equity-financed part of an investment.

a return on the equity-financed portion of an investment that, at worst, leaves the market

price of the stock unchanged.

by far the most difficult component cost to estimate.

generally lower than the before-tax cost of debt.

3. In calculating the proportional amount of equity financing employed by a firm, we should

use:

the common stock equity account on the firm's balance sheet.

the sum of common stock and preferred stock on the balance sheet.

the book value of the firm.

the current market price per share of common stock times the number of shares

outstanding.

4. To compute the required rate of return for equity in a company using the CAPM, it is

necessary to know all of the following EXCEPT:

the risk-free rate.

the beta for the firm.

the earnings for the next time period.

the market return expected for the time period.

5. In calculating the costs of the individual components of a firm's financing, the corporate tax

rate is important to which of the following component cost formulas?

common stock.

debt.

preferred stock.

none of the above.

6. The common stock of a company must provide a higher expected return than the debt of

the same company because

there is less demand for stock than for bonds.

there is greater demand for stock than for bonds.

there is more systematic risk involved for the common stock.

there is a market premium required for bonds.

7. A quick approximation of the typical firm's cost of equity may be calculated by

adding a 5 percent risk premium to the firm's before-tax cost of debt.

adding a 5 percent risk premium to the firm's after-tax cost of debt.

subtracting a 5 percent risk discount from the firm's before-tax cost of debt.

subtracting a 5 percent risk discount from the firm's after-tax cost of debt.

8. Market values are often used in computing the weighted average cost of capital because

this is the simplest way to do the calculation.

this is consistent with the goal of maximizing shareholder value.

this is required in the U.S. by the Securities and Exchange Commission.

this is a very common mistake.

9. For an all-equity financed firm, a project whose expected rate of return plots should

be rejected.

above the characteristic line

above the security market line

below the security market line

below the characteristic line

10. Some projects that a firm accepts will undoubtedly result in zero or negative returns. In

light of this fact, it is best if the firm

adjusts its hurdle rate (i.e., cost of capital) upward to compensate for this fact.

adjusts its hurdle rate (i.e., cost of capital) downward to compensate for this fact.

does not adjust its hurdle rate up or down regardless of this fact.

raises its prices to compensate for this fact.

11. The Tchotchke Knick-Knack Company relies on preferred stock, bonds, and common

stock for its long-term financing. Rank in ascending order (i.e., 1 = lowest, while 3 = highest) the

likely after-tax component costs of the Tchotchke Company's long-term financing.

1 = bonds; 2 = common stock; 3 = preferred stock.

1 = bonds; 2 = preferred stock; 3 = common stock.

1 = common stock; 2 = preferred stock; 3 = bonds.

1 = preferred stock; 2 = common stock; 3 = bonds.

12. Lei-Feng, Inc.'s $100 par value preferred stock just paid its $10 per share annual

dividend. The preferred stock has a current market price of $96 a share. The firm's marginal tax

rate (combined federal and state) is 40 percent, and the firm plans to maintain its current capital

structure relationship into the future. The component cost of preferred stock to Lei-Feng, Inc. would be closest to .

6 percent

6.25 percent

10 percent

10.4 percent Correct!

$10/$96 = .1042

Remember, dividends are not a tax deductible expense so we do NOT multiply $10 by one

minus the tax rate before continuing our calculation.

13. David Ding is evaluating two conventional, independent capital budgeting projects (X

and Y) by making use of the risk-adjusted discount rate (RADR) method of analysis. Projects X

and Y have internal rates of return of 16 percent and 12 percent, respectively. The RADR

appropriate to Project X is 18 percent, while Project Y's RADR is only 10 percent. The company's overall, weighted-average cost of capital is 14 percent. David should .

accept Project X and accept Project Y.

accept Project X and reject Project Y.

reject Project X and accept Project Y. Correct!

The IRR of Project X (16%) is less than its RADR (18%), therefore reject.

The IRR of Project Y (12%) is greater than its RADR (10%), therefore

accept

reject Project X and reject Project Y.

14. One way to visualize the RADR approach is to make (new) use of an "old friend,"

the .

Security Market Line (SML)

characteristic line

NPV profile CORRECT!

The NPV profile for a project can be used to highlight the NPV for a project at any number of

alternative risk-adjusted discount rates -- including the weighted-average cost of capital (WACC)

for the firm.

Multiple-Choice QuizChapter 16: Operating and Financial LeverageJust click on the button next to each answer and you'll get immediate feedback.

1. If I believe in the basic principle of a risk-reward relationship, my conclusion regarding

security ratings and yields between an Aaa bond and a Baa bond would be that:

the Aaa bond would have the lower yield.

the Aaa bond would have the higher yield.

the Baa bond would have lower default risk.

default risks would differ but yields would be equal.

2. A firm's degree of operating leverage (DOL) depends primarily upon its

sales variability.

level of fixed operating costs.

closeness to its operating break-even point.

debt-to-equity ratio.

3. An EBIT-EPS indifference analysis chart is used for

evaluating the effects of business risk on EPS.

examining EPS results for alternative financing plans at varying EBIT levels.

determining the impact of a change in sales on EBIT.

showing the changes in EPS quality over time.

4. EBIT is usually the same thing as:

funds provided by operations.

earnings before taxes.

net income.

operating profit.

5. In the context of operating leverage break-even analysis, if selling price per unit rises and

all other variables remain constant, the operating break-even point in units will:

fall.

rise.

stay the same.

still be indeterminate until interest and preferred dividends paid are known.

6. If a firm has a DOL of 5 at Q units, this tell us that:

if sales rise by 5%, EBIT will rise by 5%.


if sales rise by 5%, EBIT will fall by 25%.


7. This statistic can be used as a quantitative measure of relative "financial risk."

coefficient of variation of earnings per share (CVEPS)

coefficient of variation of operating income (CVEBIT)

(CVEPS - CVEBIT)

(CVEPS + CVEBIT)

8. A firm's degree of total leverage (DTL) is equal to its degree of operating leverage its

degree of financial leverage (DFL).

plus

minus

divided by

multiplied by

9. The further a firm operates above its operating break-even point, the closer its degree of

operating leverage (DOL) measure approaches

minus one.

zero.

one.

infinity

Multiple-Choice QuizChapter 8: Overview of Working Capital ManagementJust click on the button next to each answer and you'll get immediate feedback.

1. In finance, "working capital" means the same thing as

total assets.

fixed assets.

current assets.

current assets minus current liabilities.

2. Which of the following would be consistent with a more aggressive approach to financing

working capital?

Financing short-term needs with short-term funds.

Financing permanent inventory buildup with long-term debt.

Financing seasonal needs with short-term funds.

Financing some long-term needs with short-term funds.

3. Which asset-liability combination would most likely result in the firm's having the greatest

risk of technical insolvency?

Increasing current assets while lowering current liabilities.

Increasing current assets while incurring more current liabilities.

Reducing current assets, increasing current liabilities, and reducing long-term debt.

Replacing short-term debt with equity.

4. Which of the following illustrates the use of a hedging (or matching) approach to financing?

Short-term assets financed with long-term liabilities.

Permanent working capital financed with long-term liabilities.

Short-term assets financed with equity.

All assets financed with a 50 percent equity, 50 percent long-term debt mixture.

5. In deciding the appropriate level of current assets for the firm, management is confronted

with

a trade-off between profitability and risk.

a trade-off between liquidity and marketability.

a trade-off between equity and debt.

a trade-off between short-term versus long-term borrowing.

6. varies inversely with profitability.

Liquidity.

Risk.

Blue.

False.

7. Spontaneous financing includes

accounts receivable.

accounts payable.

short-term loans.

a line of credit.

8. Permanent working capital

varies with seasonal needs.

includes fixed assets.

is the amount of current assets required to meet a firm's long-term minimum needs.

includes accounts payable.

9. Financing a long-lived asset with short-term financing would be

an example of "moderate risk -- moderate (potential) profitability" asset financing.

an example of "low risk -- low (potential) profitability" asset financing.

an example of "high risk -- high (potential) profitability" asset financing.

an example of the "hedging approach" to financing.

10. Net working capital refers to

total assets minus fixed assets.

current assets minus current liabilities.

current assets minus inventories.

current assets.

Financial Management basics

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