Finance Exam

MULTIPLE CHOICE

1.   Which of the following factors tend to encourage management to pursue stock price maximization as a goal?
a. shareholders link management's compensation to company performance
b. managers' reactions to the threats of firing and takeover
c. managers do not have goals other than stock price maximization
d. statements a and b are both correct
e. statements a, b, and c are all correct

2.   Capital market instruments include
a. negotiable certificates of deposit
b. corporate equities
c. commercial paper
d. treasury bills

3.   Activities of the investment banker include
a. assuming the risk of selling a security issue
b. selling new securities to the ultimate investors
c. providing advice to firms issuing securities
d. all of the above

4.   Savings are generally transferred to the business firms by
a. direct transfer of funds
b. indirect transfer using the investment banker
c. indirect transfer using the financial intermediary
d. all of the above

5.   Kingsbury Associate's current assets are as follows:
Cash $3,000
Accounts Receivable $4,500
Inventories $8,000

If Kingsbury has a current ratio of 3.2, what is its quick ratio?
a. 2.07
b. l.55
c. .48
d. none of the above

6.   Which of the following represents an attempt to measure the earnings of the firm's operations over a given time period?
a. balance sheet
b. cash flow statement
c. income statement
d. none of the above

7.   The debt ratio is a measure of a firm's
a. leverage
b. profitability
c. liquidity
d. coverage

8.   You just purchased a parcel of land for $10,000. If you expect a 14% annual rate of return on your investment, how much will you sell the land for in 10 years?
a. $25,000
b. $31,060
c. $37,072
d. $34,310
e. $45,000

9.   Loren Billingsley bought a yacht for $60,000 paying $15,000 down and agreeing to pay the balance in ten equal annual installments that include both principal and 9% interest on the declining balance. How big would the annual payment be?
a. $5,000
b. $7,000
c. $9,000
d. $11,000

10.You bought a painting 10 years ago as an investment. You originally paid $85,000 for it. If you sold it for $484,050, what was your annual return on investment?
a. 47%
b. 4.7%
c. 12.8%
d. 19%

11.Bobby's grandmother deposited $100 in a savings account for him when he was born. The money has been earning an annual rate of 12% interest, compounded quarterly for the last 25 years. He is getting married and would like to take his new bride on a fabulous honeymoon. How much does he have in this account to use?
a. $4,165
b. $1,700
c. $5,051
d. $1,922

12.Choose the most correct answer for the following: (1) Which is the measure of risk for choosing an asset which is to be held in isolation? (2) Which is the measure of risk for choosing an asset to be held as part of a well-diversified portfolio?
a. Variance; variance.
b. Standard deviation; beta.
c. Beta; beta.
d. Standard deviation; standard deviation.

13.Huit Industries' common stock has an expected return of 12.8% and a beta of 1.2. If the expected risk-free rate is 8%, what is the expected return for the market?
a. 8.8%
b. 9.5%
c. 12.0%
d. 13.8%

14.The appropriate measure for risk according to the capital asset pricing model is
a. the standard deviation of a firm's cash flows
b. the coefficient of variation of a firm's cash flows
c. the beta coefficient
d. none of the above

15.The risk-return relationship for each financial asset is shown on
a. the capital market line
b. the security market line
c. the New York Stock Exchange market line
d. none of the above

16.The yield to maturity on a bond
a. is fixed in the indenture
b. is lower for higher risk bonds
c. is the required return on the bond
d. is generally equal to the coupon interest rate

17.Cassel Corp. bonds pays an annual coupon rate of 10%. If investors' required rate of return is now 8% on these bonds, they will be priced at
a. par value
b. a premium to par value
c. a discount to par value
d. cannot be determined from information given

18. The discount rate used to value a bond is
a. the coupon interest rate
b. determined by the issuing company
c. fixed for the life of the bond
d. the market rate of interest

19. UVP preferred stock pays an annual dividend of 5%. Par value of UVP's preferred stock is $100 per share. If your required rate of return is 13%, how much will you be willing to pay for one share?
a. $ 38.46
b. $ 26.26
c. $ 65.46
d. $100.00

20. Which of the following is false?
a. preferred stock has some characteristics of both common stock and bonds
b. common stockholders are essentially creditors of the firm
c. the pre-emptive right on common stock protects the shareholder from dilution in ownership and value

21. Which of the following statements about NPV and IRR is/are false?
a. the NPV will be positive if the IRR is less than the cost of capital
b. any independent project acceptable by the NPV method will also be acceptable by the IRR method (if the multiple IRR problem does not exist)
c. when IRR = k, NPV = 0
d. both a and b above are false
e. both b and c above are false

22. The calculation of differential cash flows over a project's life should include
a. labor and material savings
b. additional revenue
c. interest to bondholders
d. a and b

23. The internal rate of return is
a. the discount rate that makes the NPV positive
b. the discount rate that equates the present value of the cash inflows with the present value of the cash outflows
c. the discount rate that makes NPV negative
d. the rate of return that makes the NPV positive

24. You are considering investing in a project with the following year-end after tax cash flows
Year l: $5,000
Year 2: $3,200
Year 3: $7,800

If the initial outlay for the project is $12,113, compute the project's internal rate of return.
a. 14%
b. 10%
c. 32%
d. 24%

25.Which of the following best describes why cash flows are utilized rather than accounting profits when evaluating capital projects?
a. cash flows have a greater present value than accounting profits
b. cash flows reflect the timing of benefits and costs more accurately than accounting profits
c. cash flows are more stable than accounting profits
d. cash flows improve the tax position of a firm more than accounting profits
e. none of the above

26. Which of the following is the best definition of an incremental cash inflow/outflow?
a. cash flows that are achieved by diverting sales from other projects of the firm
b. cash flows that are associated with the financing of a project
c. cash flows that occur a little at a time
d. what the cash flows will be if the project is undertaken versus what they will be if the project is not undertaken
e. none of the above

27. Increased depreciation expenses affect tax-related cash flows by
a. increasing taxable income, thus increasing taxes
b. decreasing taxable income, thus reducing taxes
c. decreasing taxable income, with no effect on cash flow since depreciation is a non-cash expense
d. none of the above

28. Current assets would usually not include
a. plant and equipment
b. marketable securities
c. accounts receivables
d. inventories

29. Which of the following is a disadvantage of the use of current liabilities to finance assets?
a. greater risk of illiquidity
b. less flexibility
c. higher interest cost
d. both a and b

30. In order to maximize firm value, management should invest in new assets
a. so long as a project's IRR is greater or equal to the firm's marginal cost of capital
b. so long as a project's IRR is positive
c. so long as a project's accounting rate of return is greater or equal to the firm's marginal cost of capital
d. b and c

31. Your company is considering an investment in a project which would require an initial outlay of $300,000 and produce expected cash flows in years 1-5 of $87,385 per year. You have determined that the current after-tax cost of the firm's capital (required rate of return) for each source of financing is as follows
Cost of Debt 8%
Cost of Preferred Stock 12%
Cost of Common Stock 16%
Long term debt currently makes up 20% of the capital structure, preferred stock 10%, and common stock 70%. What is the net present value of this project?
a. -$13,876
b. $0
c. $287,692
d. $1,568

32. Which of the following would be considered a component in calculating a firm's cost of capital?
a. accounts payable
b. inventory
c. accruals
d. accounts receivable
e. bonds

33. Given the following information on S & G Inc.'s capital structure, compute the company's weighted average cost of capital.

The company's marginal tax rate is 40%
a. 13.3%
b. 7.1%
c. 10.6%
d. 10%

34. According to the moderate view of capital costs and financial leverage, as the use of debt financing increases
a. the cost of capital continuously decreases
b. the cost of capital remains constant
c. the cost of capital continuously increases
d. there is an optimal level of debt financing

35. Operating leverage refers to
a. financing a portion of the firm's assets with securities bearing a fixed rate of return
b. the additional chance of insolvency borne by the common shareholder
c. the incurrence of fixed operating costs in the firm's income stream
d. none of the above

36. The Modigliani and Miller view (independence hypothesis) to capital structure puts forth that:
a. the value of the firm will be maximized at a debt-to-assets ratio of 40%.
b. the cost of capital increases with the increasing leverage
c. the value of the firm will be unaffected by increases or decreases in debt financing.
d. the total value of the firm falls with increasing leverage.

37. The inclusion of bankruptcy risk in firm valuation
a. acknowledges that a firm has an upper limit to debt financing
b. provides a rationale for a saucer-shaped cost of capital curve
c. is ignored in the Independence Hypothesis.
d. all of the above

38. Dividend policy is influenced by
a. a company's investment opportunities
b. a company's availability of internally generated funds
c. a & b

39. Exchange rate risk:
a. Exists when the contract is written in terms of the foreign currency
b. Arises from the fact that the spot exchange rate on a future date is a random variable
c. Can be hedged in the forward markets
d. All of the above

40. A cash flow statement can be used to answer a variety of questions. Which of the following would this statement not be likely to answer? 
a. Why was money borrowed?
b. Where did profits go?
c. What is the current level of inventory?
d. Were there any new investment activities?

TRUE/FALSE

41. The agency problem arises due to the separation of ownership and control in a firm. T F

42. An IPO (Initial Public Offering) is an example of secondary market transaction. T F

43. Market risk refers to the tendency of a stock to move with the general stock market. A stock with above-average market risk will tend to be more volatile than an average stock and it will also have a beta which is greater than 1.0. T F

44. Preferred stock has some characteristics of both common stock and bonds. T F

45. If the IRR > Required Rate of Return , a project generates an abnormally high rate of return that will increase shareholder wealth. T F

46. Financial leverage measures the responsiveness of the firm's earnings per share to fluctuations in EBIT. T F

47. Financial risk includes the probability of insolvency as well as the variability of earnings resulting from the use of fixed-charge (debt) securities in the capital structure. T F

48. The objective of capital-structure management can be viewed as the endeavor to find the financing mix that will minimize the firm's composite cost of capital and maximize the value of the stock. T F

49. The clientele effect suggests that firms can change their dividend policy frequently with no potential adverse effect on the firm. T F

50. After a stock split of 2:1, each investor will have one-half of the percentage ownership in the firm that he had before the split. T F