Business Finance
Exam Answer Key
Course Introduction
Business Finance explores the fundamental principles and practices involved in managing an organization's financial resources. The course examines key topics such as financial statement analysis, time value of money, risk and return, capital budgeting, working capital management, and sources of financing. Students will gain an understanding of how financial decisions impact firm value and performance, and develop practical skills in evaluating investment opportunities, managing short- and long-term finances, and making strategic financing decisions. Through case studies and real-world examples, learners will be equipped to apply financial concepts to business scenarios, preparing them for roles in corporate finance, banking, and financial planning.
Recommended Textbook
Essentials of Corporate Finance 7th Edition by Stephen A. Ross Westerfield
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2
Chapter 1: Introduction to Financial Management
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Sample Questions
Q1) In a general partnership, each partner is personally liable for:
A) the partnership debts that he or she created.
B) his or her proportionate share of all partnership debts regardless of which partner incurred that debt.
C) the total debts of the partnership, even if he or she was unaware of those debts.
D) the debts of the partnership up to the amount he or she invested in the firm.
E) all personal and partnership debts incurred by any partner, even if he or she was unaware of those debts.
Answer: C
Q2) Which one of the following functions should be assigned to the treasurer rather than the controller?
A) Data processing
B) Cost accounting
C) Tax management
D) Cash management
E) Financial accounting
Answer: D
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Chapter 2: Financial Statements, Taxes, and Cash Flow
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Sample Questions
Q1) Cash flow from assets is defined as:
A) the cash flow to shareholders minus the cash flow to creditors.
B) operating cash flow plus the cash flow to creditors plus the cash flow to shareholders.
C) operating cash flow minus the change in net working capital minus net capital spending.
D) operating cash flow plus net capital spending plus the change in net working capital.
E) cash flow to shareholders minus net capital spending plus the change in net working capital.
Answer: C
Q2) Which one of the following is the tax rate that applies to the next dollar of taxable income that a firm earns?
A) Average tax rate
B) Variable tax rate
C) Marginal tax rate
D) Absolute tax rate
E) Contingent tax rate
Answer: C
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Chapter 3: Working With Financial Statements
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Sample Questions
Q1) Freedom Health Centers has total equity of $861,300, sales of $1.48 million, and a profit margin of 5.2 percent. What is the return on equity?
A) 5.82 percent
B) 6.49 percent
C) 7.18 percent
D) 8.68 percent
E) 8.94 percent
Answer: E
Q2) The Blue Lantern has a return on equity of 17.8 percent, an equity multiplier of 1.9, and a total asset turnover of 1.45. What is the profit margin?
A) 2.76 percent
B) 3.57 percent
C) 4.90 percent
D) 5.28 percent
E) 6.46 percent
Answer: E
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Chapter 4: Introduction to Valuation: The Time Value of Money
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Sample Questions
Q1) You and your brother are planning a large anniversary party 3 years from today for your grandparents' 50<sup>th</sup> wedding anniversary. You have estimated that you will need $2,500 for this party. You can earn 3.5 percent compounded annually on your savings. How much would you and your brother have to deposit today in one lump sum to pay for the entire party?
A) $2,199.74
B) $2,254.86
C) $2,308.16
D) $2,334.90
E) $2,368.81
Q2) Your coin collection contains ten 1949 silver dollars. If your grandparents purchased them for their face value when they were new, how much will your collection be worth when you retire in 2050, assuming they appreciate at a 6.1 percent annual rate?
A) $3,550.61
B) $3,697.29
C) $3,728.54
D) $3,955.98
E) $4,197.29
Q3) Explain the Rule of 72.
Page 6
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Chapter 5: Discounted Cash Flow Valuation
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Sample Questions
Q1) The Good Life Store has a 6-year, interest-only loan at 9 percent interest. The firm originally borrowed $125,000. How much will the firm pay in total interest over the life of the loan?
A) $42,189.84
B) $53,666.67
C) $67,500.00
D) $69,000.00
E) $74,500.00
Q2) Jodie's Fashions has just signed a $2.2 million contract. The contract calls for a payment of $0.6 million today, $0.8 million one year from today, and $0.8 million two years from today. What is this contract worth today if the firm can earn 7.2 percent on its money?
A) $2,038,616.67
B) $2,042,414.79
C) $2,108,001.32
D) $2,124,339.07
E) $2,202,840.91
Q3) Explain the similarities and differences among an ordinary annuity, an annuity due, and a perpetuity.
Q4) Identify 4 ways that you can use annuity computations in your everyday life.
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Chapter 6: Interest Rates and Bond Valuation
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Sample Questions
Q1) The Road House would like to issue some semiannual coupon bonds at par. Comparable bonds have a current yield of 8.16 percent, an effective annual yield of 8.68 percent, and a yield to maturity of 8.50 percent. What coupon rate should The Road House set on its bonds?
A) 8.00 percent
B) 8.16 percent
C) 8.50 percent
D) 8.68 percent
E) 9.00 percent
Q2) The price at which an investor can purchase a bond from a dealer is called the _____ price.
A) asked
B) coupon
C) call
D) face
E) bid
Q3) Explain what a mortgage backed security (MBS) is and how it functions. Also, explain why these securities were such a problem during 2008.
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Chapter 7: Equity Markets and Stock Valuation
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Sample Questions
Q1) The Printing Company stock is selling for $32.60 a share based on a 14 percent rate of return. What is the amount of the next annual dividend if the dividends are increasing by 2.5 percent annually?
A) $3.48
B) $3.52
C) $3.57
D) $3.66
E) $3.75
Q2) Pluto, Inc., has an issue of preferred stock outstanding that pays a $4.50 dividend every year, in perpetuity. If this issue currently sells for $82.30 per share, what is the required return?
A) 5.47 percent
B) 6.89 percent
C) 7.70 percent
D) 8.23 percent
E) 8.98 percent
Q3) How is the stated value of a preferred stock utilized?
Q4) How are preferred stock dividends treated for tax purposes by the issuer, an individual shareholder, and a corporate shareholder?
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Chapter 8: Net Present Value and Other Investment Criteria
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Sample Questions
Q1) An investment has conventional cash flows and a profitability index of 1.0. Given this, which one of the following must be true?
A) The internal rate of return exceeds the required rate of return.
B) The investment never pays back.
C) The net present value is equal to zero.
D) The average accounting return is 1.0.
E) The net present value is greater than 1.0.
Q2) The reinvestment approach to the modified internal rate of return:
A) individually discounts each separate cash flow back to the present.
B) reinvests all the cash flows, including the initial cash flow, to the end of the project.
C) discounts all negative cash flows to the present and compounds all positive cash flows to the end of the project.
D) discounts all negative cash flows back to the present and combines them with the initial cost.
E) compounds all of the cash flows, except for the initial cash flow, to the end of the project.
Q3) Explain why the net present value is considered to be the best method of analyzing an investment.
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Page 10
Chapter 9: Making Capital Investment Decisions
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Sample Questions
Q1) Aaron's Market is implementing a project that will initially increase accounts payable by $3,600, increase inventory by $4,800, and decrease accounts receivable by $800. All net working capital will be recouped when the project terminates. What is the cash flow related to the net working capital for the last year of the project?
A) -$2,000
B) -$400
C) $400
D) $1,200
E) $2,000
Q2) The net working capital invested in a project is generally:
A) a sunk cost.
B) an opportunity cost.
C) recouped in the first year of the project.
D) recouped at the end of the project.
E) depreciated to a zero balance over the life of the project.
Q3) Explain the difference between scenario analysis and sensitivity analysis and identify the purpose of each.
Q4) Explain the difference between a sunk cost and an opportunity cost and give an example of each.
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Chapter 10: Some Lessons From Capital Market History
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Sample Questions
Q1) Which one of the following is the most apt to have the largest risk premium in the future based on the historical record for 1926-2008?
A) U.S. Treasury bills
B) Large-company stocks
C) Long-term government debt
D) Small-company stocks
E) Long-term corporate debt
Q2) The lower the standard deviation of returns on a security, the _____ the expected rate of return and the _____ the risk.
A) lower; lower
B) lower; higher
C) higher; lower
D) higher; higher
E) You cannot determine anything about the expected rate of return from the standard deviation.
Q3) There are regulations that prohibit "insider trading", which is the use of non-public information about a security to earn abnormal profits from trading that security. Which form of market efficiency would make these laws unnecessary? Explain why.
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12
Chapter 11: Risk and Return
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Sample Questions
Q1) A stock has a beta of 1.56 and an expected return of 17.3 percent. A risk-free asset currently earns 5.1 percent. If a portfolio of the two assets has a beta of 1.06, what are the portfolio weights?
A) Stock weight = 0.28; risk-free weight = 0.72
B) Stock weight = 0.032; risk-free weight = 0.68
C) Stock weight = 0.44; risk-free weight = 0.56
D) Stock weight = 0.68; risk-free weight = 0.32
E) Stock weight = 0.72; risk-free weight = 0.28
Q2) Which one of the following portfolios will have a beta of zero?
A) A portfolio that is equally as risky as the overall market.
B) A portfolio that consists of a single stock.
C) A portfolio comprised solely of U. S. Treasury bills.
D) A portfolio with a zero variance of returns.
E) No portfolio can have a beta of zero.
Q3) Which one of the following best exemplifies unsystematic risk?
A) Unexpected economic collapse
B) Unexpected increase in interest rates
C) Unexpected increase in the variable costs for a firm
D) Sudden decrease in inflation
E) Expected increase in tax rates
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Chapter 12: Cost of Capital
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Sample Questions
Q1) Bob's is a retail chain of specialty hardware stores. The firm has 21,000 shares of stock outstanding that are currently valued at $68 a share and provide a 13.2 percent rate of return. The firm also has 500 bonds outstanding that have a face value of $1,000, a market price of $1,068, and a 7 percent coupon. These bonds mature in 6 years and pay interest semiannually. The tax rate is 35 percent. The firm is considering expanding by building a new superstore. The superstore will require an initial investment of $12.3 million and is expected to produce cash inflows of $1.1 million annually over its 10-year life. The risks associated with the superstore are comparable to the risks of the firm's current operations. The initial investment will be depreciated on a straight line basis over the life of the project. At the end of the 10 years, the firm expects to sell the superstore for $6.7 million. Should the firm accept or reject the superstore project and why?
A) Accept; The project's NPV is $1.27 million.
B) Accept; The NPV is $4.89 million.
C) Reject; The NPV is $1.06 million
D) Reject; The NPV -$3.27 million.
E) Reject; The NPV is -$5.71 million.
Q2) Explain the concept of the subjective approach to assigning a required return to a project.
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Page 14
Chapter 13: Leverage and Capital Structure
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Sample Questions
Q1) Which one of the following supports the theory that the value of a firm increases as the firm's level of debt increases?
A) M&M Proposition I, without taxes
B) M&M Proposition II, without taxes
C) M&M Proposition I, with taxes
D) Static theory of capital structure
E) No theory suggests this.
Q2) Which one of the following is correct based on the static theory of capital structure?
A) A firm receives the greatest benefit from debt financing when its tax rate is relatively low.
B) A debt-equity ratio of 1 is considered to be the optimal capital structure.
C) The costs of financial distress decrease the value of a firm.
D) The more debt a firm assumes, the greater the incentive to acquire even more debt until such time as the firm is financed with 100 percent debt.
E) At the optimal level of debt a firm also optimizes its tax shield on debt.
Q3) Explain how taxes affect the value of a firm based on M&M Proposition I.
Q4) Explain the primary difference between a Chapter 7 bankruptcy and a Chapter 11 bankruptcy.
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Page 15
Chapter 14: Dividends and Dividend Policy
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Sample Questions
Q1) On which one of the following dates is the determination made as to which shareholders will receive a dividend payment?
A) Date of record
B) Ex-dividend date
C) Payment date
D) Declaration date
E) Public announcement date
Q2) The ex-dividend date is defined as _____ day(s) before the date of record.
A) three business
B) three
C) two business
D) two
E) one
Q3) Which one of the following would tend to favor a low dividend payout?
A) Higher tax rates on capital gains than on dividend income
B) High flotation cost for equity issues
C) Endowment fund investors who cannot spend principal
D) Investors' desire for a high dividend yield
E) Elimination of the tax-deferral on capital gains
Q4) What is the difference between a tender offer and a targeted repurchase?
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Chapter 15: Raising Capital
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Sample Questions
Q1) Which one of the following statements related to IPO underpricing is correct?
A) The IPOs of larger-sized firms tend to be more underpriced than the IPOs of smaller-sized firms.
B) IPO underpricing is limited to the U.S. markets.
C) The percent of underpricing remains stable over time in the U.S.
D) The only period in the U.S. when underpricing produced first day returns of 50 percent or more was during the tech bubble of 1999-2000.
E) Some of the greatest IPO underpricing has occurred in China.
Q2) Which one of the following is the name given to a registration of securities under SEC 415 which permits a firm to issue the securities over a two-year period?
A) Seasoned registration
B) Negotiated registration
C) Shelf registration
D) Extended registration
E) Delayed registration
Q3) Provide two arguments in favor of IPO underpricing and two arguments against IPO underpricing.
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Chapter 16: Short-Term Financial Planning
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Sample Questions
Q1) Which one of the following statements about the operating cycle is correct?
A) The operating cycle illustrates the sources and uses of cash.
B) The operating cycle is equal to the cash cycle plus the accounts receivable period.
C) The operating cycle begins when a product is sold to a customer.
D) The operating cycle is based on a 360-day year.
E) The operating cycle describes how a product moves through the current asset accounts.
Q2) You've worked out a line of credit arrangement that allows you to borrow up to $55 million at any time. The interest rate is 0.55 percent per month. In addition, 3 percent of the amount you borrow must be deposited in a noninterest-bearing account. Assume that your bank uses compound interest on its line-of-credit loans. Suppose you need $12 million today and you repay it in six months. How much interest will you pay?
A) $387,567
B) $413,902
C) $421,028
D) $441,414
E) $442,886
Q3) How can a firm benefit from preparing a short-term financial plan?
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Chapter 17: Working Capital Management
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Sample Questions
Q1) A firm uses the extended economic order quantity approach to inventory management. Which one of the following inventory levels is considered to be the minimum inventory level given this approach?
A) Zero inventory
B) Reorder point level
C) Safety stock level
D) 50 percent of the reorder quantity
E) Safety stock plus the reorder quantity
Q2) Which one of the following is a disbursement account into which funds are transferred only as needed to cover the demands for payment?
A) Master account
B) Controlled disbursement account
C) Bank controlled account
D) Investment account
E) Safety stock account
Q3) Explain the basic structure and workings of a disbursement system that utilizes zero-balance accounts.
Q4) Identify some of the specific costs firms incur if their current asset levels are either too high or too low.
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Chapter 18: International Aspects of Financial Management
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Sample Questions
Q1) Which one of the following occurs when interest rate parity exists between countries A and B?
A) Country A investors are indifferent between risk-free investments in countries A and B
B) Forward exchange rates for countries A and B must be equal for all time periods
C) Risk-free interest rates in countries A and B must be equal
D) Spot and forward exchange rates between the currencies of the two countries must be equal
E) Significant covered interest arbitrage opportunities between currencies A and B must exist
Q2) Currently, you can exchange 100 for $133. The inflation rate in Euroland is expected to be 2.5 percent. In one year, it is expected that 100 can be exchanged for $136. Assume relative purchasing power parity exists. What is the expected inflation rate in the U.S.?
A) 3.84 percent
B) 4.26 percent
C) 4.71 percent
D) 5.21 percent
E) 5.68 percent
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