1) The true owners of the corporation are the:
- holders of debt issues of the firm.
- preferred stockholders.
- Answer: common stockholders.
- board of directors of the firm.
2) In terms of organizational costs, which of the following sequences is correct, moving from lowest to highest cost?
- Corporation, limited partnership, general partnership, sole proprietorship
- General partnership, sole proprietorship, limited partnership, corporation
- Answer: Sole proprietorship, general partnership, limited partnership, corporation
- Sole proprietorship, general partnership, corporation, limited partnership
3) Which of the following best describes the goal of the firm?
- Answer: The maximization of the total market value of the firm’s common stock]
- Profit maximization
- Risk minimization
- None of the above
4)____ is a method of offering securities to a limited number of investors.
- Public offering
- Initial public offering
- Answer: Private placement
- Syndicated underwriting
5) Money market instruments include:
- corporate bonds
- Answer: bankers’ acceptances.
- preferred stock.
- common stock.
6) When public corporations decide to raise cash in the capital markets, what type of financing vehicle is most favored?
- Common stock
- Retained earnings
- Preferred stock
- Answer: Corporate bonds
7) According to the agency problem, ____ represent the principals of a corporation.
- Answer: shareholders
8) Difficulty in finding profitable projects is due to:
- ethical dilemmas.
- social responsibility.
- Answer: competitive markets.
- opportunity costs.
9) Which of the following is NOT a principle of basic financial management?
- Efficient capital markets
- Risk/return tradeoff
- Incremental cash flow counts
- Answer: Profit is king
10) Marshall Networks, Inc. has a total asset turnover of 2.5% and a net profit margin of 3.5%. The firm has a return on equity of 17.5%. Calculate Marshall’s debt ratio.
- Answer: 50%
11) The accounting rate of return on stockholders’ investments is measured by:
- return on assets.
- Answer: return on equity.
- realized rate of inflation.
- operating income return on investment.
12) Which of the following financial ratios is the best measure of the operating effectiveness of a firm’s management?
- Current ratio
- Gross profit margin
- Answer: Return on investment
- Quick ratio
13) Northwest Bank pays a quoted annual (nominal) interest rate of 4.75%. However, it pays interest (compouned) daily using a 365-day year. What is the effective annual rate of return (APY)?
- Answer: 4.86%
14) Suppose that you wish to save for your child's college education by opening up an educational IRA. You plan to deposit $100 per month into the IRA for the next 18 years. Assume that you will be able to earn 10%, compounded monthly, on your investment. How much will you have accumulated at the end of 18 years?
- Answer: $60,056
15) You have $10,000 to invest. You do not want to take any risk, so you will put the funds in a savings account at the local bank. Of the following choices, which one will produce the largest sum at the end of 22 years?
- An account that compounds interest annually
- Answer: An account that compounds interest daily
- An account that compounds interest monthly
- An account that compounds interest quarterly
16) The primary purpose of a cash budget is to:
- Answer: provide a detailed plan of future cash flows.
- determine the level of investment in current and fixed assets.
- determine accounts payable.
- determine the estimated income tax for the year.
17) Which of the following is NOT a basic function of a budget?
- Answer: Budgets compare historical costs of the firm with its current cost performance.
- Budgets indicate the need for future financing.
- Budgets provide the basis for corrective action when actual figures differ from the budgeted figures.
- Budgets allow for performance evaluation.
18) Which of the following statements about the percent-of-sales method of financial forecasting is true?
- Answer: It involves estimating the level of an expense, asset, or liability for a future period as a percent of the forecast for sales revenues.
- It is the least commonly used method of financial forecasting.
- It is a much more precise method of financial forecasting than a cash budget would be.
- It projects all liabilities as a fixed percentage of sales.
19) Which of the following is a non-cash expense?
- Packaging costs
- Answer: Depreciation expenses
- Interest expense
- Administrative salaries
20) A plant can remain operating when sales are depressed:
- in an effort to cover at least some of the variable cost.
- Answer: if the selling price per unit exceeds the variable cost per unit.
- to help the local economy.
- unless variable costs are zero when production is zero.
21) The break-even model enables the manager of a firm to:
- determine the quantity of output that must be sold to cover all operating costs.
- calculate the minimum price of common stock for certain situations.
- set appropriate equilibrium thresholds.
- determine the optimal amount of debt financing to use.
22) How long will it take $750 to double at 8% compounded annually?
- Answer: 9 years
- 6.5 years
- 48 months
- 12 years
23) Which of the following is the formula for compound value?
- Answer: FVn = P(1+i)n
- FVn = (1+i)/P
- FVn = P(1+i)-n
- FVn = P/(1+i)n
24) The present value of a single future sum:
- increases as the number of discount periods increase.
- is generally larger than the future sum.
- increases as the discount rate increases.
- Answer: depends upon the number of discount periods.
25) Which of the following is NOT considered a permanent source of financing?
- Corporate bonds
- Common stock
- Answer: Commercial paper
- Preferred stock
26) A toy manufacturer following the hedging principle will generally finance seasonal inventory build-up prior to the Christmas season with:
- common stock.
- selling equipment.
- preferred stock.
- Answer: trade credit.
27) Which of the following is considered to be a spontaneous source of financing?
- Operating leases
- Accounts receivable
- Answer: Accounts payable
28) We compute the profitability index of a capital-budgeting proposal by:
- multiplying the IRR by the cost of capital.
- dividing the present value of the annual after-tax cash flows by the cost of capital.
- multiplying the cash inflow by the IRR.
- Answer: dividing the present value of the annual after-tax cash flows by the cost of the project.
29) Your company is considering a project with the following cash flows: Initial outlay = $1,748.80 Cash flows Years 1–6 = $500 Compute the IRR on the project.
- Answer: 18%
30) For the NPV criteria, a project is acceptable if the NPV is____, while for the profitability index, a project is acceptable if the profitability index is ___.
- greater than one, greater than zero
- less than zero, greater than the required return
- greater than zero, less than one
- Answer: greater than zero, greater than one
31) You have been asked to analyze a capital investment proposal. The project’s cost is $2,775,000. Cash inflows are projected to be $925,000 in Year 1; $1,000,000 in Year 2; $1,000,000 in Year 3; $1,000,000 in Year 4; and $1,225,000 in Year 5. Assume that your firm discounts capital projects at 15.5%. What is the project’s MIRR?
- Answer: 19.99%
32) Which of the following is considered to be a deficiency of the IRR?
- It fails to utilize the time value of money.
- It fails to properly rank capital projects.
- It is not useful in accounting for risk in capital budgeting.
- Answer: It could produce more than one rate of return.
33) Most firms use the payback period as a secondary capital-budgeting technique, which, in a sense, allows them to control for risk.
34) ABC Service can purchase a new assembler for $15,052 that will provide an annual net cash flow of $6,000 per year for five years. Calculate the NPV of the assembler if the required rate of return is 12%. (Round your answer to the nearest $1.)
- Answer: $6,577
35) The firm should accept independent projects if:
- the IRR is positive.
- the payback is less than the IRR.
- the NPV is greater than the discounted payback.
- Answer: the profitability index is greater than 1.0.
36) The NPV assumes cash flows are reinvested at the:
- real rate of return.
- Answer: cost of capital.
37) The average cost associated with each additional dollar of financing for investment projects is:
- the incremental return.
- Answer: the marginal cost of capital.
- risk-free rate.
38) The most expensive source of capital is:
- preferred stock.
- Answer: new common stock.
- retained earnings.
39) PepsiCo uses 30-year Treasury bonds to measure the risk-free rate because:
- these bonds are essentially free of business risk.
- Answer: they capture the long-term inflation expectations of investors associated with investments in long-term assets.
- these bonds are essentially free of interest rate risk.
- none of the above.
40) Shawhan Supply plans to maintain its optimal capital structure of 30% debt, 20% preferred stock, and 50% common stock far into the future. The required return on each component is: debt–10%; preferred stock–11%; and common stock–18%. Assuming a 40% marginal tax rate, what after-tax rate of return must Shawhan Supply earn on its investments if the value of the firm is to remain unchanged?
- Answer: 13.0%
41) Bender and Co. is issuing a $1,000 par value bond that pays 9% interest annually. Investors are expected to pay $918 for the 10-year bond. Bender will have to pay $33 per bond in flotation costs. What is the cost of debt if the firm is in the 34% tax bracket?
- Answer: 7.23%
42) The XYZ Company is planning a $50 million expansion. The expansion is to be financed by selling $20 million in new debt and $30 million in new common stock. The before-tax required rate of return on debt is 9%, and the required rate of return on equity is 14%. If the company is in the 40% tax bracket, what is the marginal cost of capital?
- Answer: 10.6%
43) Zybeck Corp. projects operating income of $4 million next year. The firm’s income tax rate is 40%. Zybeck presently has 750,000 shares of common stock which have a market value of $10 per share, no preferred stock, and no debt. The firm is considering two alternatives to finance a new product: (a) the issuance of $6 million of 10% bonds, or (b) the issuance of 60,000 new shares of common stock. If Zybeck issues common stock this year, what will projected EPS be next year?
- Answer: $2.96
44) Lever Brothers has a debt ratio (debt to assets) of 40%. Management is wondering if its current capital structure is too conservative. Lever Brothers’s present EBIT is $3 million, and profits available to common shareholders are $1,560,000, with 342,857 shares of common stock outstanding. If the firm were to instead have a debt ratio of 60%, additional interest expense would cause profits available to stockholders to decline to $1,440,000, but only 228,571 common shares would be outstanding. What is the difference in EPS at a debt ratio of 60% versus 40%?
- Answer: $1.75
45) Lever Brothers has a debt ratio (debt to assets) of 20%. Management is wondering if its current capital structure is too conservative. Lever Brothers’s present EBIT is $3 million, and profits available to common shareholders are $1,680,000, with 457,143 shares of common stock outstanding. If the firm were to instead have a debt ratio of 40%, additional interest expense would cause profits available to stockholders to decline to $1,560,000, but only 342,857 common shares would be outstanding. What is the difference in EPS at a debt ratio of 40% versus 20%?
- Answer: $0.88
46) A bond sold simultaneously in several different foreign capital markets, but denominated in a currency different from the country in which the bond is issued, is called a(n):
- floating bond.
- Answer: Eurobond.
- international capital bond.
- world bond.
47) Which of the following statements about exchange rates is true?
- Exchange rates were fixed prior to establishing a floating-rate international currency system, and all countries set a specific parity rate for their currency relative either to the Canadian or to the U.S. dollar.
- Day-to-day fluctuations in exchange rates currently are caused by changes in parity rates.
- Answer: A floating-rate international currency system has been operating since 1973.
- All of the choices.
48) Capital markets in foreign countries:
- offer lower returns than those obtainable in the domestic capital markets.
- Answer: provide international diversification.
- in general are becoming less integrated due to the widespread availability of interest rate and currency swaps.
- all of the choices.
49) A spot transaction occurs when one currency is:
- exchanged for another currency at a specified price.
- traded for another at an agreed-upon future price.
- Answer: immediately exchanged for another currency.
- deposited in a foreign bank.
50) If the quote for a forward exchange contract is greater than the computed price, the forward contract is:
- a good buy.
- at equilibrium.
- Answer: overvalued.
51) The interplay between interest rate differentials and exchange rates such that both adjust until the foreign exchange market and the money market reach equilibrium is called the:
- Answer: interest rate parity theory.
- arbitrage markets theory.
- balance of payments quantum theory.
- purchasing power parity theory.
52) One reason for international investment is to reduce:
- Answer: portfolio risk.
- beta risk.
- price-earnings (P/E) ratios.
- advantages in a foreign country.
53) An important (additional) consideration for a direct foreign investment is:
- Answer: political risk.
- maximizing the firm’s profits.
- attaining a high international P/E ratio.
- all of the above.
54) Buying and selling in more than one market to make a riskless profit is called:
- profit maximization.
- cannot be determined from the above information.
- Answer: arbitrage.
- international trading.
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