FINANCIAL MANAGEMENT OBJS

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

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

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

Ans. maximize the value of the firm's common stock.

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?
Ans. $0.50

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

an agent.
Ans. shareholder; manager

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

Ans. individuals buying and selling the stock.

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

Ans. the creation of value for shareholders.

7. The decision function of financial management can be broken down into the ......decisions.
Ans. investment, financing, and asset management

8. The controller's responsibilities are primarily in nature, while the treasurer's responsibilities
are primarily related to .
Ans. accounting; financial management
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.

Ans. Public Company Accounting Oversight Board (PCAOB)

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

11. The Sarbanes-Oxley Act of 2002 (SOX) was largely a response to:
Ans. a series of corporate scandals involving Enron, WorldCom, Global Crossing, Tyco and
numerous others.

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)
Ans. Sustainability

13. Which of the following enjoys limited liability?

Ans. A corporation.

14. Michael Cohn is a "member" (a type of owner) of a marine supply business. Michael's
business is
Ans. a limited liability company.

15. The Counting House, Inc., purchased 5-year property class equipment for $60,000. It uses
the MACRS method of depreciation. What is tax depreciation for the second year of the
asset's life?
Ans. $19,200
16. A corporation in which you are a shareholder has just gone bankrupt. Its liabilities are far
in excess of its assets. You will be called on to pay:
Ans. nothing.

17. A 30-year bond issued by Gary's Plaid Pants Warehouse, Inc., in 1997 would now trade
in the
Ans. secondary capital market.

18. A major advantage of the corporate form of organization is:

Ans. limited owner liability.

19. Money market mutual funds

Ans. enable individuals and small businesses to invest indirectly in money-market
instruments.

20. The purpose of financial markets is to:

Ans. allocate savings efficiently.

21. Which of the following is NOT an example of a financial intermediary?

Ans. International Business Machines, Inc. (IBM).

22. How are funds allocated efficiently in a market economy?

Ans. The economic unit that is willing to pay the highest expected return
receives the funds.

23. Assume that a "temporary" additional (US federal tax related) first-year bonus
depreciation of 50 percent applies to a new, $100,000 piece of equipment purchased by
Bellemans Chocolatier, Inc. The asset has a $10,000 estimated final salvage value. If this
asset is fully depreciated for tax purposes over its useful life, the overall amount that
Bellemans will have depreciated for tax purposes is .
Ans. $100,000
24. 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
Ans. $39,272.

25. With continuous compounding at 10 percent for 30 years, the future value of an initial
investment of $2,000 is closest to
Ans. $40,171.

26. 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
Ans. fall.

27. Assume that the interest rate is greater than zero. Which of the following cash-inflow
streams should you prefer?
Year1 Year2 Year3 Year4
Ans. $400 $300 $200 $100

28. 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?
Ans. 9 percent.

29. To increase a given present value, the discount rate should be adjusted
Ans. downward.

30. 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
Ans. 10 percent.
31. 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
Ans. $3,741.

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

33. (1 + i)n
Ans. FVIF

34. 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 .
Ans. the Rule of 72

35. In a typical loan amortization schedule, the dollar amount of interest paid each
period .
Ans. decreases with each payment

36. In a typical loan amortization schedule, the total dollar amount of money paid each
period .
Ans. remains constant with each payment.

37. 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?
Ans. Less than its face value.

38. If the intrinsic value of a stock is greater than its market value, which of the following is a
reasonable conclusion?
Ans. The market is undervaluing the stock.

39. When the market's required rate of return for a particular bond is much less than its
coupon rate, the bond is selling at:
Ans. a premium.

40. 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
Ans. interest rate risk.

41. 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?
Ans. 9 percent.

42. 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.)
Ans. P0 > par and YTM < the coupon rate.

43. Interest rates and bond prices

Ans. move in opposite directions.

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

Ans. the expected price appreciation yield from a common stock.

45. In the United States, most bonds pay interest........a year, while many European bonds pay
interest..........a year.
Ans. twice; once

46. The expected rate of return on a bond if bought at its current market price and held to
maturity.
Ans. yield to maturity.

47. This type of risk is avoidable through proper diversification.

Ans. unsystematic risk
48. A statistical measure of the degree to which two variables (e.g., securities' returns) move
together.
Ans. covariance

49. An "aggressive" common stock would have a "beta"

Ans. greater than one.

50. A line that describes the relationship between an individual security's returns and returns
on the market portfolio.
Ans. characteristic line

51. According to the capital-asset pricing model (CAPM), a security's expected (required)
return is equal to the risk-free rate plus a premium
Ans. based on the systematic risk of the security.

52. The risk-free security has a beta equal to...................... while the market portfolio's beta is
equal to ............................
Ans. zero; one.

53 . Carrie has a "certainty equivalent" to a risky gamble's expected value that is less than the
gamble's expected value. Carrie shows
Ans. risk aversion.

54. Beta is the slope of

Ans. a characteristic line.

55. A measure of "risk per unit of expected return."

Ans. coefficient of variation
56. The greater the beta, the................ of the security involved.
Ans. greater the unavoidable risk

57. Plaid Pants, Inc. common stock has a beta of 0.90, while Acme Dynamite Company
common stock has a beta of 1.80. The expected return on the market is 10 percent, and the
risk-free rate is 6 percent. According to the capital-asset pricing model (CAPM) and making
use of the information above, the required return on Plaid Pants' common stock should
be....... , and the required return on Acme's common stock should be...... .
Ans. 9.6 percent; 13.2 percent

58. Espinosa Coffee & Trading, Inc.'s common stock measured beta is calculated to be 0.75.
The market beta is, of course, 1.00 and the beta of the industry of which the company is a part
is 1.10. If Merrill Lych were to calculate an "adjusted beta" for Espinosa's common stock,
that adjusted beta would most likely be .
Ans. more than 0.75, but less than 1.10

59. Determine a firm's total asset turnover (TAT) if its net profit margin (NPM) is 5 percent,
total assets are $8 million, and ROI is 8 percent.
Ans. 1.60

60. Felton Farm Supplies, Inc., has an 8 percent return on total assets of $300,000 and a net
profit margin of 5 percent. What are its sales?
Ans. $480,000

61. Which of the following would NOT improve the current ratio?
Ans. Borrow short term to finance additional fixed assets.

62. The gross profit margin is unchanged, but the net profit margin declined over the same
period. This could have happened if
Ans. the U.S. Congress increased the tax rate.

63. Palo Alto Industries has a debt-to-equity ratio of 1.6 compared with the industry average
of 1.4. This means that the company
Ans. has greater than average financial risk when compared to other firms in its industry.
64. Kanji Company had sales last year of $265 million, including cash sales of $25 million. If
its average collection period was 36 days, its ending accounts receivable balance is closest
to....... (Assume a 365-day year.)
Ans. $23.7 million

65. A company can improve (lower) its debt-to-total assets ratio by doing which of the
following?
Ans. Sell common stock.

66. Which of the following statements (in general) is correct?

Ans. The lower the total debt-to-equity ratio, the lower the financial risk for a firm.

67. Retained earnings for the "base year" equals 100.0 percent. You must be looking at
Ans. an indexed balance sheet.

68. Krisle and Kringle's debt-to-total assets (D/TA) ratio is .4. What is its debt-to-equity
(D/E) ratio?
Ans. .667

69. A firm's operating cycle is equal to its inventory turnover in days (ITD)
Ans. plus its receivable turnover in days (RTD).

70. When doing an "index analysis," we should expect that changes in a number of the firm's
current asset and liabilities accounts (e.g., cash, accounts receivable, and accounts payable)
would move roughly together with.......... for a normal, well-run company.
Ans. net sales

71. The process of convergence of accounting standards around the world aims to........
Ans. Narrow or remove national accounting differences.

72. According to the accounting profession, which of the following would be considered a
cash-flow item from an "investing" activity?
Ans. cash outflow to acquire fixed assets.
73. According to the Financial Accounting Standards Board (FASB), which of the following
is a cash flow from a "financing" activity?
Ans. cash outflow to shareholders as dividends.

74. If the following are balance sheet changes:

$5,005 decrease in accounts receivable
$7,000 decrease in cash
$12,012 decrease in notes payable
$10,001 increase in accounts payable
a "use" of funds would be the:
Ans. $12,012 decrease in notes payable.

75. On an accounting statement of cash flows an "increase(decrease) in cash and cash

equivalents" appears as
Ans. none of the above.

76. Uses of funds include a (an):

Ans. increase in fixed assets.

77. Which of the following would be included in a cash budget?

Ans. dividends.

78. An examination of the sources and uses of funds statement is part of:
Ans. a funds flow analysis.

79. Which of the following is NOT a cash outflow for the firm?
Ans. depreciation.

80. Which of the following would be considered a use of funds?

Ans. an increase in cash.

81. The cash flow statement in the United States is most likely to appear using
Ans. an "indirect method."
82. For a profitable firm, total sources of funds will always ....... total uses of funds.
Ans. be equal to
83. According to the accounting profession, which of the following would be considered a
cash-flow item from an "investing" activity?
Ans. cash outflow to acquire fixed assets.

84. According to the Financial Accounting Standards Board (FASB), which of the following
is a cash flow from a "financing" activity?
Ans. cash outflow to shareholders as dividends.

85. If the following are balance sheet changes:

$5,005 decrease in accounts receivable
$7,000 decrease in cash
$12,012 decrease in notes payable
$10,001 increase in accounts payable
a "use" of funds would be the:
Ans. $12,012 decrease in notes payable.

86. On an accounting statement of cash flows an "increase(decrease) in cash and cash

equivalents" appears as
Ans. none of the above.

87. Uses of funds include a (an):

Ans. increase in fixed assets.

88. Which of the following would be included in a cash budget?

Ans. dividends.

89. An examination of the sources and uses of funds statement is part of:
Ans. a funds flow analysis.
90. Which of the following is NOT a cash outflow for the firm?
Ans. depreciation.

91. Which of the following would be considered a use of funds?

Ans. an increase in cash.

92. The cash flow statement in the United States is most likely to appear using
Ans. an "indirect method."

93. For a profitable firm, total sources of funds will always .............. total uses of funds.
Ans. be equal to

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

Ans. current assets.

95. Which of the following would be consistent with a more aggressive approach to financing
working capital?
Ans. Financing some long-term needs with short-term funds.

96. Which asset-liability combination would most likely result in the firm's having the
greatest risk of technical insolvency?
Ans. Reducing current assets, increasing current liabilities, and reducing long-term debt.

97. Which of the following illustrates the use of a hedging (or matching) approach to
financing?
Ans. Permanent working capital financed with long-term liabilities.

98. In deciding the appropriate level of current assets for the firm, management is confronted
with
Ans. a trade-off between profitability and risk.
99.. ......................varies inversely with profitability.
Ans. Liquidity.

100. Spontaneous financing includes

Ans. accounts payable.

101. Permanent working capital

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

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

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

103. Net working capital refers to

Ans. current assets minus current liabilities.

104. Marketable securities are primarily

Ans. short-term debt instruments.

105. Time consumed in clearing a check through the banking system.

Ans. Availability float

106. Commercial paper is essentially

Ans. a short-term unsecured corporate IOU.

107. Concentration banking

Ans. improves control over corporate cash.
108. Which would be an appropriate investment for temporarily idle corporate cash that will
be used to pay quarterly dividends three months from now?
Ans. Ninety-day commercial paper with a current annual yield of 6.2 percent.

109. Which of the following marketable securities is the obligation of a commercial bank?
Ans. Negotiable certificate of deposit

110. The movement of business data electronically in a structured, computer-readable format.

Ans. EDI

111. That portion of a firm's total marketable securities portfolio held to take care of probable
deficiencies in the firm's cash account.
Ans. Ready cash segment

112. The most basic requirement for a firm's marketable securities.

Ans. Safety

113. A non-negotiable check payable to a company account at a concentration bank

Ans. Depository transfer check (DTC)

114. According to the Bond Equivalent Yield (BEY) method, the yield on a $1,000, 13-week
US Treasury bill purchased for $960 would be closest to .......
Ans. 16.7 percent

115. US Treasury bills are now sold in minimum amounts of ....... and multiples
of ....... above the minimum.
Ans. $100; $100

116. Accounts receivable conversion (a.k.a., check conversion) is the conversion of a paper
check to .
Ans. an ACH debit transaction3
117. The US Federal National Mortgage Association (FNMA, "Fannie Mae") and the US
Federal Home Loan Mortgage Corporation (FHLMC, "Freddie Mac") are ...... Interest and
principal on debt securities that they issue ........ explicitly guaranteed by the US government.
Ans. government sponsored enterprises (GSEs); are not

118. A firm's inventory turnover (IT) is 5 times on a cost of goods sold (COGS) of $800,000.
If the IT is improved to 8 times while the COGS remains the same, a substantial amount of
funds is released from or additionally invested in inventory. In fact,
Ans. $60,000 is released.

119. Ninety-percent of Vogel Bird Seed's total sales of $600,000 is on credit. If its year-end
receivables turnover is 5, the average collection period (based on a 365-day year) and the
year-end receivables are, respectively:
Ans. 73 days and $108,000.

120. If EOQ = 360 units, order costs are $5 per order, and carrying costs are $.20 per unit,
what is the usage in units?
Ans. 2,592 units

121. Costs of not carrying enough inventory include:

Ans. all of these.

122. Which of the following relationships hold true for safety stock?
Ans. the higher the profit margin per unit, the higher the safety stock necessary.

123. Increasing the credit period from 30 to 60 days, in response to a similar action taken by
all of our competitors, would likely result in:
Ans. an increase in the average collection period.

124. The credit policy of Spurling Products is "1.5/10, net 35." At present 30% of the
customers take the discount, 62% pay within the net period, and the rest pay within 45 days
of invoice. What would receivables be if all customers took the cash discount?
Ans. Lower than the present level.
125. An increase in the firm's receivable turnover ratio means that:
Ans. it is collecting credit sales more quickly than before.

126. Receiving a required inventory item at the exact time needed.

Ans. JIT

127. EOQ is the order quantity that ....... over our planning horizon.
Ans. minimizes total inventory costs

128. A B2B exchange is a ...... Internet marketplace that matches supply and demand by real-
time auction bidding.
Ans. business-to-business

129. Under COD terms, the seller:

Ans. bears the risk of the buyer's refusing the goods shipped.

130. The type of business most likely to use trust receipt financing would be:
Ans. an automobile dealership.

131. The trade terms "2/15, net 30" indicate that:

Ans. a 2% discount is offered if payment is made within 15 days.

132. If credit terms of "2/10, net 40" are offered, the approximate cost of not taking the
discount and paying at the end of the credit period would be closest to which of the
following? (Assume a 365-day year.)
Ans. 24.8%

133. If a discount date is missed for some reason, when should a rational manager pay the
bill?
Ans. On the final due date.
134. If MetroPulse Media receives an invoice for purchases dated 10/21/X5 subject to credit
terms of "3/10, net 30 EOM," what is the last possible day the payment should be made (1) if
the discount is taken and (2) if the discount is not taken?
Ans. November 10 and November 30, respectively.

135. When a firm needs short-term funds for a specific purpose, the bank loan will likely be
a:
Ans. transaction loan.

136. Inventory is in the possession of a third party under which of the following methods?
Ans. Terminal warehouse receipts

137. The Houser Company has negotiated a $500,000 revolving credit agreement with
Chitwood National Bank. The agreement calls for an interest rate of 10% on fund used, a
15% compensating balance, and a commitment fee of 1% on the unused amount of the credit
line. Assuming that the compensating balance would not otherwise be maintained, the
effective annual interest cost if the firm borrows $200,000 for one year is closest to
Ans. 13.53 percent.

138. A formal, legal commitment to extend credit up to some maximum amount over a stated
period of time.
Ans. Revolving credit agreement

139. The type(s) of collateral generally used for a secured short-term loan is(are) .
Ans. inventory and/or receivables.

140. All of the following influence capital budgeting cash flows EXCEPT:
Ans. method of project financing used.

141. In proper capital budgeting analysis we evaluate incremental

Ans. cash flow.
142. The estimated benefits from a project are expressed as cash flows instead of income
flows because:
Ans. it is cash, not accounting income, that is central to the firm's capital budgeting decision.

143. In estimating "after-tax incremental operating cash flows" for a project, you should
include all of the following EXCEPT:
Ans. sunk costs.

144. A capital investment is one that

Ans. has the prospect of long-term benefits.

145. Taxing authorities allow the fully installed cost of an asset to be written off for tax
purposes. This amount is called the asset's
Ans. depreciable basis.

146.. Adam Smith is considering automating his pin factory with the purchase of a $475,000
machine. Shipping and installation would cost $5,000. Smith has calculated that automation
would result in savings of $45,000 a year due to reduced scrap and $65,000 a year due to
reduced labor costs. The machine has a useful life of 4 years and falls in the 3-year property
class for MACRS depreciation purposes. The estimated final salvage value of the machine is
$120,000. The firm's marginal tax rate is 34 percent. The incremental cash outflow at time
period 0 is closest to
Ans. $480,000.

147. (See information in Question #7 above.) The "cost" of this asset that, by law, may be
written off over time "for tax purposes" is closest to
Ans. $480,000.

148. In general, if a depreciable asset used in business is sold for more than its depreciated
(tax) book value, any amount realized in excess of book value but less than the asset's
depreciable basis is considered a
Ans. "recapture of depreciation" and is taxed at the firm's ordinary income tax rate.
149. Under the Modified Accelerated Cost Recovery System (MACRS), an asset in the "5-
year property class" would typically be depreciated over........... years.
Ans. six

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

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

151. 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.)
Ans. $19,090

152. 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).]
Ans. 9 percent

153. Which of the following statements is correct?

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

154. 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:
Ans. accept the proposal, since the acceptance of value-creating investments should increase
shareholder wealth.

155. A project's profitability index is equal to the ratio of the .......of a project's future cash
flows to the project's.......... .
Ans. present value; initial cash outlay
156. The discount rate at which two projects have identical ......... is referred to as Fisher's
rate of intersection.
Ans. net present values

157. 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.
Ans. May

158. If capital is to be rationed for only the current period, a firm should probably first
consider selecting projects by descending order of .
Ans. profitability index

159. The ......... method provides correct rankings of mutually exclusive projects, when the
firm is not subject to capital rationing.
Ans. net present value

160. 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.
Ans. small percentage change; large change

161. 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 .
Ans. NPV sensitivity matrix.

162. The investment proposal with the greatest relative risk would have
Ans. the highest coefficient of variation of net present value.

163. Probability-tree analysis is best used when cash flows are expected to be
independent over time.
Ans. related to the cash flows in previous periods.
164. You are considering two mutually exclusive investment proposals, project A and project
B. B's expected value of net present value is $1,000 less than that for A and A has less
dispersion. On the basis of risk and return, you would say that
Ans. Project A dominates project B.

165. If two projects are completely independent (or unrelated), the measure of correlation
between them is:
Ans. 0

167. Managerial options can be viewed as

Ans. opportunities for altering management decisions in the future.

168.. A managerial option, in effect,

Ans. limits the downside risk of an investment project.

169. When using a probability tree approach, we discount the various cash flows to their
present value at
Ans. the risk-free rate.

170. The presence of managerial, or real, options ....... the worth of an investment project.
Ans. Increases.

171. A single, overall cost of capital is often used to evaluate projects because:
Ans. it avoids the problem of computing the required rate of return for each investment
proposal.

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

Ans. generally lower than the before-tax cost of debt.

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

should use:
Ans. the current market price per share of common stock times the number of shares
outstanding.
174. 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:
Ans. the earnings for the next time period.

175. 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?
Ans. debt.

176. The common stock of a company must provide a higher expected return than the debt of
the same company because
Ans. there is more systematic risk involved for the common stock.

177. A quick approximation of the typical firm's cost of equity may be calculated by
Ans. adding a 5 percent risk premium to the firm's before-tax cost of debt.

178. Market values are often used in computing the weighted average cost of capital because
Ans. this is consistent with the goal of maximizing shareholder value.

179. For an all-equity financed firm, a project whose expected rate of return
plots........... should be rejected.
Ans. below the security market line

180. 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
Ans. does not adjust its hurdle rate up or down regardless of this fact.

181. 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.
Ans. 1 = bonds; 2 = preferred stock; 3 = common stock.

182. 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........
Ans. 10.4 percent

183. 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 .
Ans. reject Project X and accept Project Y.

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

185. 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:
Ans. the Aaa bond would have the lower yield.

186. A firm's degree of operating leverage (DOL) depends primarily upon its
Ans. closeness to its operating break-even point.

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

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

188. EBIT is usually the same thing as:

Ans. operating profit.

189. 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:
Ans. fall.

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

Ans. if sales rise by 1%, EBIT will rise by 5%.

191. This statistic can be used as a quantitative measure of relative "financial risk."
Ans. (CV EPS – CV EBIT)
192. A firm's degree of total leverage (DTL) is equal to its degree of operating
leverage .......... its degree of financial leverage (DFL).
Ans. multiplied by

193. The further a firm operates above its operating break-even point, the closer its degree of
operating leverage (DOL) measure approaches
minus one.
Ans. one.

194. The term "capital structure" refers to:

Ans. long-term debt, preferred stock, and common stock equity.

195. A critical assumption of the net operating income (NOI) approach to valuation is:
Ans. that dividends increase at a constant rate.

196. The traditional approach towards the valuation of a company assumes:

Ans. that there is an optimum capital structure.

197. Two firms that are virtually identical except for their capital structure are selling in the
market at different values. According to M&M
Ans. This will not continue because arbitrage will eventually cause the firms to sell at the
same value.

198. The cost of monitoring management is considered to be a (an):

Ans. agency cost.

199. What is the value of the tax shield if the value of the firm is $5 million, its value if
unlevered would be $4.78 million, and the present value of bankruptcy and agency costs is
$360,000?
Ans. $580,000

200. According to the concept of financial signaling, management behavior results in new
debt issues being regarded as " ....... news" by investors.
Ans. good
201. The cost of capital for a firm -- when we allow for taxes, bankruptcy, and agency costs
Ans. first declines and then ultimately rises with increasing levels of financial leverage.

202. When sequential long-term financing is involved, the choice of debt or equity influences
the future financial..................of the firm.
Ans. flexibility

203. Retained earnings are

Ans. the cumulative earnings of the company after dividends.

204. Which of the following is an argument for the relevance of dividends?

Ans. All of the above.

205. All of the following are true of stock splits EXCEPT:

Ans. retained earnings are changed.

206. If Ian O'Connor Enterprises, Inc., repurchased 50 percent of its outstanding common
stock from the open (secondary) market, the result would be
Ans. a decrease in total assets.

207. On May 7, Melbourne Mining declared a $.50-per-share quarterly dividend payable June
28 to stockholders of record on Friday, June 7. What is the latest date by which you could
purchase the stock and still get the recently declared dividend?
Ans. June 4

208. An offer by a firm to repurchase some of its own shares is known as

Ans. a self-tender offer.

209. If an individual stockholder reinvests dividends under a company's dividend

reinvestment plan, the reinvested dividends are
Ans. taxable to the shareholder.
210. The dividend payout ratio is equal to
Ans. dividends per share divided by earnings per share.

211. Letter stock is

Ans. privately placed common stock that cannot be immediately resold to the general public.

212. A preliminary prospectus is known as a

Ans. red herring.

213. If an investment banker has agreed to sell a new issue of securities on a best-efforts
basis, the issue
Ans. results in no assumption of underwriting risk by the investment banker.

214. The actual market value of a right will differ from its theoretical value for all of the
following reasons EXCEPT for:
Ans. the size of the firm's marginal tax rate.

215. In a common stock right offering the subscription price is generally:

Ans. set below the current market price of the stock.

216. When the investment banker bears the risk of not being able to sell a new security at the
established price, this is known as:
Ans. underwriting.

217. To say that there is "asymmetric information" in the issuing of common stock or debt
means that
Ans. management has more accurate information than investors have.

218. In calculating the value of one right when the stock is selling "rights-on," the analyst
needs to know the number of rights needed to buy one share of stock and:
Ans. the subscription price per share.
219. A best efforts offering is sometimes used in connection with a...........of new, long-term
securities.
Ans. public issue

220. ............ permits what is known as a shelf registration.

Ans. SEC Rule 415

221. A company can ensure the complete success of a rights offering by making use of a
Ans. standby arrangement.

221. The market price of K-T-Lew Corporation's common stock is $60 per share, and each
share gives its owner one subscription right. Four rights are required to purchase an
additional share of common stock at the subscription price of $54 per share. If the common
stock is currently selling "rights-on," the theoretical value of a right is closest to
Ans. $1.20

222. (See Question 12 above.) The theoretical value of one share of K-T-Lew common stock
when it goes "ex-rights" is closest to
Ans. $58.80

223. Financial intermediaries ...........

Ans. include insurance companies and pension funds

224. The Sarbanes-Oxley Act of 2002 (SOX) was largely a response to:
Ans. a series of corporate and accounting frauds involving Enron, Arthur Andersen,
WorldCom, and numerous others.

225. Because of US "Securities Offering Reform" ........can take advantage of a special

streamlined "shelf registration" process that provides for automatic effectiveness of a
registration statement upon filing with the SEC (i.e., no SEC review).
Ans. Only well-known seasoned issuers (WKSIs)

226. A bond issue may be retired by:

Ans. all of the above.

227. Protective covenants are:

Ans. to protect bondholders.

228. Which of the following bonds offer the investor the most protection?
Ans. First-mortgage bonds

229. A company refunds its bonds for any of the following reasons EXCEPT for:
Ans. to issue new bonds at higher rate of interest.

230. The call-option value of a callable bond is likely to be high when

Ans. interest rates are volatile.

231. Treasury stock is:

Ans. common stock that has been repurchased and is being held by the issuing company.

232. A call provision, a sinking fund, and/or conversion are used to retire
Ans. bonds and preferred stock.

233. Preferred shareholders' claims on assets and income of a firm come ......... those of
creditors......... those of common shareholders.
Ans. after; but before

234. Dual classes of .......... are common in new ventures where promotional........ usually
goes to the founders.
Ans. common stock; common stock

235. One difference between a financial lease and operating lease is that:
Ans. An operating lease is often cancellable by the lessee.

236. The principal reason for the existence of leasing is that:

Ans. Companies, financial institutions, and individuals derive different benefits from owning
assets.

237. A way to analyse whether debt or lease financing would be preferable is to:
Ans. Compare the net present values under each alternative, using the after-tax cost
of borrowing as the discount rate.

238. A conventional revolving credit agreement allows a firm:

Ans. to do all of the above.

239. The type of lease that includes a third party, a lender, is called a(n):
Ans. leveraged lease.

240. One advantage of a financial lease is that:

Ans. It provides a way to indirectly depreciate land.

241. Medium-term notes (MTNs) have maturities that range up to

Ans. thirty years (or more)

242. A direct lease, a sale and leaseback, and a leveraged lease are all examples of
Ans. financial leases.

243. A $500 par-value convertible debenture is selling at $520. If the conversion ratio is 20,
what is the conversion price?
Ans. $25.00

244. A company has just issued convertible bonds with $1,000 par value and a conversion
ratio of 40. Which of the following is most likely to be the market price per share of the
company's common stock at present?
Ans. Under $25.
245. If a warrant carries a right to buy one share of common stock and is exercisable at $20
per common share while the market price of a share is $30, the theoretical value of the
warrant is:
Ans. $20.

246. An exchangeable bond:

Ans. involves the common stock of another company.

247. The call price of a convertible bond is generally

Ans. greater than the face value of the bond.

248. A(n).........is a bond that may be exchanged for common stock of the same corporation.
Ans. convertible bond

249. A warrant is a relatively ............... option to purchase........... at a specified exercise price

over a specified period of time.
Ans. long-term; common stock

250. Some options have a current theoretical value ...............and yet ....................
Ans. of zero; sell for positive prices

251. Suppose that the market price of Company X is $45 per share and that of Company Y is
$30. If X offers three-fourths a share of common stock for each share of Y, the ratio of
exchange of market prices would be:
Ans. 1.125

252. The restructuring of a corporation should be undertaken if

Ans. the restructuring is expected to create value for shareholders.

253. The "information effect" refers to the notion that

Ans. a corporation's actions may convey information about its future prospects.
254. In the long run, a successful acquisition is one that:
Ans. increases the market price of the acquirer's stock over what it would have been without
the acquisition.

255. Bidding companies often pay too much for the acquired firm. The hubris hypothesis
explains this by suggesting that the bidders
Ans. have big egos and this impedes rational decision-making.

256. A tender offer is

Ans. a would-be acquirer's offer to buy stock directly from shareholders.

257. The public sale of common stock in a subsidiary in which the parent usually retains
majority control is called
Ans. an equity carve-out.

258. In the United States, goodwill charges arising from a current acquisition are generally
deductible for "tax purposes" over
Ans. 15 years.

259. Empirical evidence on acquisitions indicates...........excess returns on average to the

shareholders of the selling company, and...........excess returns on average to those of the
buying company.
Ans. substantial; no

260. One means for a company to "go private" is

Ans. the leveraged buyout (LBO).

261. Recent accounting changes in the US.......

Ans. eliminated the pooling-of-interests method, allowing only the purchase method for
mergers and acquisitions.
262. Which of the following is a legitimate reason for international investment?
Ans. There are possible benefits from international diversification.

263. Interest-rate parity refers to the concept that, where market imperfections are few,
Ans. there is an offsetting relationship between interest rate differentials and differentials
in the forward spot exchange market.

264. The forward market is especially well-suited to offer hedging protection against
Ans. transactions risk exposure.

265. Suppose that the Japanese yen is selling at a forward discount in the forward-exchange
market. This implies that most likely
Ans. interest rates are higher in Japan than in the United States.

266. Following FASB Statement No. 52, gains or losses from currency translation are shown:
Ans. on the balance sheet as an adjustment to owners' equity.

267. All of the following are hedges against exchange-rate risk EXCEPT
Ans. use of spot market.

268. A multinational can centralize cash management and attempt to reduce exchange rate
risk exposure through the use of
Ans. a reinvoicing center.

269. Forfaiting most closely resembles

Ans. export factoring.

270. The euro is the name for

Ans. a common European currency.

271. Assume that a Big Mac hamburger is selling for �1.99 in the United Kingdom, the
same hamburger is selling for $2.71 in the United States, and the actual exchange rate (to buy
$1.00 with British pounds) is 0.63. According to , the British pound is the US
dollar.
Ans. purchasing-power parity; overvalued

IA
Which one of the following increases cash?
a. purchasing inventory
b. purchasing new machinery
Ans c. accepting credit from a supplier
d. granting credit to a customer
e. making a payment on a bank loan

Which one of the following is the equity risk related to a firm's capital structure policy?
A financial
b extrinsic
c. business
d. systematic
e. market

The specified date on which the principal amount of a bond is payable is referred to as which
one of the following?
a. maturity
b. clean date
c. yield date
d. dirty date
e. coupon date

A firm is technically insolvent when:

a. it is unable to meet its financial obligations.
B. it has a negative book value.
c. it files for bankruptcy protection.
d. total debt exceeds total equity.
e. the market…

Which one of the following increases cash?

a. purchasing inventory
b. purchasing new machinery
c. accepting credit from a supplier
d. granting credit to a customer
e. making a payment on a bank loan

Which one of the following is the equity risk related to a firm's capital structure policy?
a. financial
b. extrinsic
c. business
d. systematic
e. market

The specified date on which the principal amount of a bond is payable is referred to as which
one of the following?
a. maturity
b. clean date
c. yield date
d. dirty date
e. coupon date

A firm is technically insolvent when:

A. it is unable to meet its financial obligations.
b. it has a negative book value.
c. it files for bankruptcy protection.
d. total debt exceeds total equity.
e. the market value of its stock is less than its book value.

Which one of the following is computed by dividing next year's annual dividend by the
current stock price?
a. capital gains yield
b. dividend yield
c. total yield
d. yield to maturity
e. growth rate

A call-protected bond is a bond that:

a. is guaranteed to be called.
b. is callable at any time.
c. can never be called.
d.is currently being called.
e. cannot be called during a certain period of time.

Which one of the following is the equity risk related to a firm's capital structure policy?
a. financial
b. extrinsic
c. business
d. systematic
e. market

The specified date on which the principal amount of a bond is payable is referred to as which
one of the following?
a. maturity
b. clean date
c. yield date
d. dirty date
e. coupon date

A firm is technically insolvent when:

a. it is unable to meet its financial obligations.
B. it has a negative book value.
c. it files for bankruptcy protection.
d. total debt exceeds total equity.
e. the market value of its stock is less than its book value.

Which one of the following is computed by dividing next year's annual dividend by the
current stock price?
a. capital gains yield
b. dividend yield
c. total yield
d. yield to maturity
e. growth rate

A call-protected bond is a bond that:

a. is guaranteed to be called.
b. is callable at any time.
c. can never be called.
d. is currently being called.
e. cannot be called during a certain period of time.

Which of the following statements regarding the timeline is FALSE?

a. The $5000 below date 2 is the payment you will receive at the beginning of the second
year.
b. Date 1 is one year from now.
c. The $5000 below date 1 is the payment you will receive at the end of the first year.
d. Date 0 represents today.
Which of the following is NOT an advantage of a sole proprietorship?
a. Limited liability
b. No separation of ownership and control
c. Ease of setup
d. Single taxation

Mary just purchased a bond which pays $60 a year in interest. What is this $60 called?
a. face value
b. yield
c. call premium
d. discount
e. coupon

The average of a firm's cost of equity and after-tax cost of debt that is weighted based on the
firm's capital structure is called the:
a. weighted average cost of capital.
b. reward to risk ratio.
c. structured cost of capital.
d. weighted capital gains rate.
e. subjective cost of capital.

Which of the following is/are an advantage of incorporation?

a. Unlimited life
b. Limited liability
c. Access to capital markets
d. All of the above

Which one of the following is the primary determinant of a firm's cost of capital?
a. use of the funds
b. cost of debt
c. cost of equity
d. debt-equity ratio
e. applicable tax rate

If the current rate of interest is 8%, then the future value 20 years from now of an investment
that pays $1000 per year and lasts 20 years is closest to:
a. $9818
b. $93,219
c. $36,725
d. $45,762

Which of the following statements regarding limited partnerships is TRUE?

a. There is no limit on a limited partner's liability.
b. A general partner's liability is limited by the amount of their investment.
C. A limited partner's liability is limited by the amount of their investment.
d. A limited partner is not liable until all the assets of the general partners have been
exhausted.

If the current rate of interest is 8%, then the future value 20 years from now of an investment
that pays $1000 per year and lasts 20 years is closest to:
a. $9818
b. $93,219
c. $36,725
d. $45,762

Which one of the following best describes pro forma financial statements?
a. financial statements expressed in real dollars, given a stated base year
b. financial statements where all accounts are expressed as a percentage of last year's values
c. financial statements where the assets are expressed as a percentage of total assets and costs
are expressed as a percentage of sales
d. financial statements showing projected values for future time periods
e. financial statements expressed in a foreign currency
The length of time that elapses between the day a firm purchases an inventory item and the
day that item sells is called the:
a. inventory period.
b. accounts payable period.
c. cash cycle
d. operating cycle.
e. accounts receivable period.

Terry is calculating the present value of a bonus he will receive next year. The process he is
using is called:
a. accumulating.
b. growth analysis.
c. discounting.
d. reducing.
e. compounding.

Butter & Jelly reduced its taxes last year by $350 by increasing its interest expense by
$1,000. Which of the following terms is used to describe this tax savings?
a. tax-loss interest
b. current tax yield
c. financing shield
d. interest credit
e. interest tax shield

The aftertax cost of debt:

a. will generally exceed the cost of equity if the relevant tax rate is zero.
b. has a greater effect on a firm's cost of capital when the debt-equity ratio increases.
c. will generally equal the cost of preferred if the tax rate is zero.
d. varies inversely to changes in market interest rates.
e. is unaffected by changes in the market rate of interest.

A firm should select the capital structure that:

a. maximizes the value of the firm.
b. produces the highest cost of capital.
c. equates the value of debt with the value of equity.
d. minimizes taxes.
e.is fully unlevered.

Bert owns a bond that will pay him $75 each year in interest plus a $1,000 principal payment
at maturity. What is the $1,000 called?
a. discount
b. dirty price
c. yield
d. face value
e. coupon

There are two distinct discount rates at which a particular project will have a zero net present
value. In this situation, the project is said to:
a. have operational ambiguity.
b. produce multiple economies of scale.
c. create a mutually exclusive investment decision.
d. have multiple rates of return.
e. have two net present value profiles

A bond that has only one payment, which occurs at maturity, defines which one of the
following?
a. floating-rate
b. zero coupon
c. debenture
d. junk
e. callable

Which one of the following is an example of a sunk cost?

a. $1,800 increase in comic book sales if a store commences selling puzzles
b. $1,200 paid to repair a machine last year
c. $4,500 reduction in current shoe sales if a store commences selling sandals
d. $20,000 project that must be forfeited if another project is accepted
e. $1,500 of lost sales because an item was out of stock

A firm is technically insolvent when:

A it has a negative book value.
b. it is unable to meet its financial obligations.
c. the market value of its stock is less than its book value.
d. it files for bankruptcy protection.
e. total debt exceeds total equity.

There are two distinct discount rates at which a particular project will have a zero net present
value. In this situation, the project is said to:
A have two net present value profiles.
b. have operational ambiguity.
c. produce multiple economies of scale.
d. create a mutually exclusive investment decision.
e. have multiple rates of return.

Mary just purchased a bond which pays $60 a year in interest. What is this $60 called?
A coupon
b. call premium
c. yield
d. discount
e. face value
Bert owns a bond that will pay him $75 each year in interest plus a $1,000 principal payment
at maturity. What is the $1,000 called?
A discount
b. face value
c. dirty price
d. yield
e. coupon

Tony currently owns 12,000 shares of GL Tools. He has just been notified that the firm is
issuing additional shares of stock and that he is being given a chance to purchase some of
these shares prior to the shares being offered to the general public. What is this type of offer
called?
A priority offer
b. best efforts offer
c. general cash offer
d. firm commitment offer
e. rights offer

A call-protected bond is a bond that:

A is guaranteed to be called.
b. is currently being called.
c. can never be called.
d. cannot be called during a certain period of time.
e. is callable at any time.

The stand-alone principle advocates that project analysis should be based solely on which one
of the following costs?
A fixed
b. variable
c. sunk
d. total
e. incremental

Soup Galore is a partnership that was formed three years ago for the purpose of creating,
producing, and distributing healthy soups in a dried form. The firm has been extremely
successful thus far and has decided to incorporate and offer shares of stock to the general
public. What is this type of an equity offering called?
A venture capital offering
b. shelf offering
c. seasoned equity offering
d. private placement
e. initial public offering

Textile Mills borrows money at a rate of 13.5 percent. This interest rate is referred to as the:
A current yield.
b. cost of capital.
c. compound rate.
d. cost of debt.
e. capital gains yield.

A business firm ceases to exist as a going concern as a result of which one of the following?
A. liquidation
b. share repurchase
c. divestiture
d. capital restructuring
e. reorganization

Butter & Jelly reduced its taxes last year by $350 by increasing its interest expense by
$1,000. Which of the following terms is used to describe this tax savings?
A. interest tax shield
b. interest credit
c. financing shield
d. tax-loss interest
e. current tax yield

Which of the following is NOT an advantage of a sole proprietorship?

A. No separation of ownership and control
b. Single taxation
c. Ease of setup
d. Limited liability

Which one of the following states that the value of a firm is unrelated to the firm's capital
structure?
A. Efficient Markets Hypothesis
b. M&M Proposition II
c. Capital Asset Pricing Model
d. Law of One Price
e. M&M Proposition I

If the current rate of interest is 8%, then the future value 20 years from now of an investment
that pays $1000 per year and lasts 20 years is closest to:
A. $9818
b. $93,219
c. $45,762
d. $36,725

A bond that has only one payment, which occurs at maturity, defines which one of the
following?
A. debenture
b. floating-rate
c. callable
d. junk
e. zero coupon
The depreciation tax shield is best defined as the:
A. amount of tax that is due when an asset is sold.
b. amount by which the aftertax depreciation expense lowers net income.
c. amount of tax that is saved when an asset is purchased.
d. amount of tax that is saved because of the depreciation expense.
e. tax that is avoided when an asset is sold as salvage.

The aftertax cost of debt:

a. will generally equal the cost of preferred if the tax rate is zero.
b. varies inversely to changes in market interest rates.
c. is unaffected by changes in the market rate of interest.
d. has a greater effect on a firm's cost of capital when the debt-equity ratio increases.
e. will generally exceed the cost of equity if the relevant tax rate is zero.

Which one of the following is a type of equity security that has a fixed dividend and a priority
status over other equity securities?
a. common stock
b. warrant
c. senior bond
d. preferred stock
e. debenture

Which of the following statements regarding limited partnerships is TRUE?

a. A limited partner's liability is limited by the amount of their investment.
b. A limited partner is not liable until all the assets of the general partners have been
exhausted.
c. A general partner's liability is limited by the amount of their investment.
d. There is no limit on a limited partner's liability.
Which of the following is/are an advantage of incorporation?
a. Unlimited life
b. Access to capital markets
c. Limited liability
d. All of the above

Which one of following is the rate at which a stock's price is expected to appreciate?
A coupon rate
b. dividend yield
c. total return
d. current yield
e. capital gains yield

Which one of the following is an example of a sunk cost?

a. $4,500 reduction in current shoe sales if a store commences selling sandals
b. $1,500 of lost sales because an item was out of stock
c. $1,800 increase in comic book sales if a store commences selling puzzles
d. $20,000 project that must be forfeited if another project is accepted
e. $1,200 paid to repair a machine last year

Which one of the following is the equity risk that is most related to the daily operations of a
firm?
a. systematic risk
b. financial risk
c. market risk
d. extrinsic risk
e. business risk
The length of time that elapses between the day a firm purchases an inventory item and the
day that item sells is called the:
a. cash cycle
b. operating cycle.
c. accounts payable period.
d. inventory period.
e. accounts receivable period.

Which of the following statements regarding the timeline is FALSE?

a. Date 0 represents today.
b. Date 1 is one year from now.
c. The $5000 below date 2 is the payment you will receive at the beginning of the second
year.
d. The $5000 below date 1 is the payment you will receive at the end of the first year.

Terry is calculating the present value of a bonus he will receive next year. The process he is
using is called:
a. compounding.
b. reducing.
c. discounting.
d. growth analysis.
e. accumulating.

Which one of the following is computed by dividing next year's annual dividend by the
current stock price?
a. yield to maturity
b. growth rate
c. total yield
d. dividend yield
e. capital gains yield
The average of a firm's cost of equity and after-tax cost of debt that is weighted based on the
firm's capital structure is called the:
a. weighted capital gains rate.
b. weighted average cost of capital.
c. subjective cost of capital.
d. reward to risk ratio.
e. structured cost of capital.

A firm should select the capital structure that:

a. is fully unlevered.
b. maximizes the value of the firm.
c. minimizes taxes.
d. produces the highest cost of capital.
e. equates the value of debt with the value of equity.

The specified date on which the principal amount of a bond is payable is referred to as which
one of the following?
a. dirty date
b. maturity
c. clean date
d. coupon date
e. yield date