Business Finance
Exam Practice Tests
Course Introduction
Business Finance is an introductory course that examines the fundamental principles and practices of financial management in the context of a modern business enterprise. The course covers essential topics such as time value of money, financial analysis and planning, management of working capital, capital budgeting, risk and return, and financial markets. Students will develop an understanding of how businesses make investment and financing decisions, the role of financial statements in evaluating performance, and how financial tools and techniques are used to maximize organizational value. The course equips students with practical skills for analyzing financial data and making informed financial decisions critical to business success.
Recommended Textbook
Contemporary Financial Management 12th Edition by R. Charles Moyer
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Chapter 1: The Role and Objective of Financial Management
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Sample Questions
Q1) Financial management draws heavily on the following related disciplines:
A) accounting
B) macroeconomics
C) microeconomics
D) all of the above
Answer: D
Q2) An advantage that the corporate form of business has over either the sole proprietorship or partnership is the:
A) ability to raise capital
B) ease of changing ownership
C) limited liability
D) elimination of double taxes
Answer: D
Q3) The existence of divergent objectives between owners and managers is one example of a class of problems arising from ____.
A) social responsibility concerns
B) age differences between managers and owners
C) agency relationships
D) union-management relations
Answer: C
Page 3
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Chapter 2: The Domestic and International Financial Marketplace
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Sample Questions
Q1) Insider trading is defined as
A) an individual using proper trading rules
B) an individual buying or selling using non-SEC disclosure rules
C) an individual buying or selling on the basis of material nonpublic information
D) a zero-plus game
Answer: C
Q2) There are highly publicized hedge fund problems, for example Julian Robertson's Tiger fund or Long Term Capital Management. The impact that this has had on hedge funds is:
A) minimal. They have continued to grow in size and number.
B) huge. Hedge funds are being discontinued.
C) being felt in the overall reallocation of hedge funds into bonds.
D) inconsequential and irrelevant. Investors may rely on the due diligence of the fund managers.
Answer: A
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Chapter 3: Evaluation of Financial Performance
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Sample Questions
Q1) Flash In The Pan Cooking School is considering the issuance of additional long-term debt to finance expansion. At the present time the company has $160 million of 10% debentures outstanding. Its after-tax net income is $48 million, and the company's (marginal) income tax rate is 40%. The company is required by the debenture holders to maintain its coverage ratio at 4.0 or greater. Determine Flash's present coverage ratio.
A) 3.33
B) 2.78
C) 5.00
D) 6.00
Answer: D
Q2) Deferred taxes may occur due to the use of
A) different tax schedules
B) different depreciation methods for taxes and financial reporting
C) long-term equipment
D) different cash flow methods
Answer: B
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Chapter 4: Financial Planning and Forecasting
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Sample Questions
Q1) In preparing a statement of cash flows, the ____ method involves adjusting net income to reconcile it to net cash flows from operating activities.
A) direct
B) indirect
C) accrual
D) none of the above
Q2) In developing a firm's financial plan, the firm develops a strategic plan and an operational plan. What is the difference between a strategic plan and an operational plan?
Q3) ____ is the statistical technique that helps the analyst classify observations (firms) into two or more predetermined groups based on certain characteristics of the observation.
A) Deterministic analysis
B) Sensitivity analysis
C) Discriminant analysis
D) Optimization
Q4) Why would a firm experience cash flow difficulties immediately after a good sales period?
Q5) Explain the cash flow generation process:
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Chapter 5: The Time Value of Money
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Sample Questions
Q1) Using the "Rule of 72," about how long will it take a sum of money to double in value if the annual interest rate is 9 percent?
A) 9 years
B) 7 years
C) 8 years
D) 10 years
Q2) Your grandparents put $1,000 into a savings account for you when you were born 20 years ago. This account has been earning interest at a compound rate of 7 percent. What is its value today?
A) $3,870
B) $1,967
C) $3,026
D) $3,583
Q3) What is the effective rate of interest on a CD that has a nominal rate of 9.5 percent with interest compounded monthly?
A) 9.92%
B) 9.74%
C) 10.02%
D) 9.86%
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Chapter 6: Fixed Income Securities: Characteristics and Valuation
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Sample Questions
Q1) A Treasury bill with 182 days to maturity is quoted at 5.62 bid, 5.60 asked, and an asked yield of 5.84. How much would you pay for this security?
A) $9,440
B) $9,720
C) $9,708
D) $9,438
Q2) What is the value of an MDI $2.67 perpetual preferred stock to an investor who requires a 7% annual rate of return? Assume the par value is $60.00.
A) $85.71
B) $38.14
C) $59.33
D) $60.00
Q3) Which of the following is the highest risk debt issue?
A) senior debt
B) mortgage bond
C) equipment trust certificate
D) debenture
Q4) What is the collateral used in collateral trust bonds and who is its primary user?
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Chapter 7: Common Stock: Characteristics, Valuation, and Issuance
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Sample Questions
Q1) The book value of an asset represents A) the market value
B) the discounted cash flow value
C) the historic acquisition cost of the asset
D) stockholders' acquisition value
Q2) What is the current value of the common stock of Clump Dump Kitty Litter, Limited if you know the current dividend yield is 6.14%, the PE is 16, and the annual dividend is $1.35?
A) $21.60
B) $21.99
C) $8.29
D) $98.24
Q3) Quantum, Inc. has 5.4 million shares outstanding and the firm's charter provides for cumulative voting. The company has a twelve-member board of directors, all of whom are up for reelection. What is the minimum number of shares needed to ensure the election of one director?
A) 450,001
B) 415,386
C) 431,251
D) 425,421
Page 9
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Chapter 8: Analysis of Risk and Return
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Sample Questions
Q1) Why is risk an increasing function of time?
Q2) The term structure of interest rates is related to the ____.
A) default risk premium
B) seniority risk premium
C) marketability risk premium
D) maturity risk premium
Q3) Which of the following statements regarding risk is/are correct?
I. A portfolio of two negatively correlated assets has less risk than either of the individual assets and risk could be further reduced to 0 or below.
II. There is no case where creating a portfolio of assets will result in greater risk than that of the riskiest asset included in the portfolio.
A) I only
B) II only
C) Both I and II
D) Neither I nor II
Q4) What is an efficient portfolio?
Q5) Explain marketability risk and marketability premium.
Q6) List types of events that influence systematic (non-diversifiable) risk.
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Chapter 9: Capital Budgeting and Cash Flow Analysis
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Sample Questions
Q1) Raider Productions has to decide whether to build its warehouse in Dallas or Houston. This decision falls into the class of:
A) independent projects
B) mutually exclusive projects
C) contingent projects
D) marginal projects
Q2) There is neither a gain or a loss on the sale of a depreciable asset for an amount exactly equal to its ____.
A) acquisition cost
B) tax book value
C) opportunity cost
D) historical cost
Q3) Which of the following is a basic principle when estimating a project's cash flows?
A) cash flows should be measured on a pretax basis
B) cash flows should ignore depreciation because it is a non-cash charge
C) only direct effects of a project should be included in cash flow calculations
D) cash flows should be measured on an incremental basis
Q4) Why should sunk costs not be considered when evaluating a project?
Q5) List the steps that a firm uses in the capital budgeting process:
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Chapter 10: Capital Budgeting: Decision Criteria and Real Option Considerations
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Sample Questions
Q1) The profitability index is the ratio of the ____ to the ____.
A) net present value, net investment
B) net investment, net present value
C) present value of future net cash flows, net investment
D) net investment, present value of future net cash flows
Q2) One weakness of the internal rate of return approach is that:
A) it does not directly consider the timing of the cash flows from a project
B) it fails to provide a straightforward decision-making criterion
C) it implicitly assumes that the firm is able to reinvest the interim cash flows from a project at the firm's cost of capital.
D) none of the above
Q3) In comparing the techniques of net present value and internal rate of return:
A) The npv and irr techniques will generate the same accept-reject decision provided the projects have conventional cash flows.
B) The differences between the underlying assumptions of npv and irr can cause them to rank projects differently.
C) Both a and b
D) Neither a nor b
Q4) List the advantages and disadvantages of the payback method.
Page 12
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Chapter 11: Capital Budgeting and Risk
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Sample Questions
Q1) The risk-adjusted discount rate approach is preferable to the weighted cost of capital approach when
A) all projects have the same risk characteristics
B) the risk-free rate is known with certainty
C) the projects under consideration have different risk characteristics
D) the firm is unlevered
Q2) In a simulation analysis, a model is simulated on a computer program and run through several iterations. The results of these iterations are used to
A) plot a required rate of return value profile
B) compute a mean and a standard deviation of returns
C) provide the decision maker with a measure of beta risk
D) plot the coefficient of variation of the annual net cash flows
Q3) The use of sensitivity analysis requires that
A) a model of a project's cash flows be developed
B) probability distributions of the determinants of a project's cash flows be estimated
C) the firms have access to a very large computer
D) the firm is greatly interested in the portfolio risk reduction characteristics of a project
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Chapter 12: The Cost of Capital
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Sample Questions
Q1) The cost of debt must account for all of the following inputs EXCEPT:
A) Bond ratings.
B) Issuance costs.
C) flotation costs.
D) The tax rate.
Q2) A firm can raise up to $700 million for investment from a mixture of debt, preferred stock and retained equity. Above $700 million, the firm must issue new common stock. Assuming that debt costs and preferred stock costs remain unchanged, the marginal cost of capital for amounts up to $700 million will be ____ the marginal cost of capital for amounts over $700 million.
A) less than
B) equal to
C) greater than
D) cannot be determined from the information given
Q3) How is the marginal cost of the various component capital sources determined?
Q4) The total return to stockholders, k<sub>e</sub>, is composed of the
A) opportunity cost plus a risk premium
B) dividend yield plus the price appreciation of the security
C) opportunity cost plus an inflation premium
D) dividend yield minus the risk premium
Page 14
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Chapter 13: Capital Structure Concepts
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Sample Questions
Q1) There are many factors that influence a firm's business risk. List them.
Q2) What is the annual tax shield to a firm that has a capital structure consisting of $100 million of debt and $180 million of equity, if the average interest rate on debt is 9%, the return on equity is 13%, and the marginal tax rate is 40%?
A) $9.0 million
B) $5.4 million
C) $9.36 million
D) $3.6 million
Q3) Agency costs
A) increase as the debt/total assets ratio decreases
B) affect the present value of the tax shield
C) decrease as financial distress increases
D) reduce the market value of the levered firm
Q4) As more debt is added to the capital structure of a firm, the cost of debt capital
A) initially rises slowly, then falls beyond some point
B) increases at a steady rate throughout the entire range
C) beyond some point, becomes greater than the cost of equity
D) initially rises slowly, then increases rapidly beyond some point
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Chapter 14: Capital Structure Management in Practice
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Sample Questions
Q1) There are three categories of costs: fixed costs, variable costs and semi-variable costs. Which of the following is a semi-variable cost?
A) depreciation
B) labor costs
C) raw materials
D) management salaries
Q2) Chemex has a cash and marketable securities balance of $200 million. Management expects free cash flows of $320 million during the coming year. If management is considering a restructuring of its capital structure that would add an additional $350 million of annual fixed financial charges, what is the expected cash balance at the end of the year?
A) -$30 million
B) $170 million
C) $230 million
D) $470 million
Q3) Explain the difference between short-run costs and long-run costs.
Q4) List the five steps developed to assist financial managers in making capital structure decisions.
Q5) In what way does management's willingness to assume risk impact the firm?
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Chapter 15: Dividend Policy
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Sample Questions
Q1) The passive residual dividend policy seems to be inconsistent with A) a world having significant transactions costs associated with new stock issues
B) a stable dividend policy
C) a policy of paying only stock dividends
D) a share-repurchase policy
Q2) A legal constraint that dividends must be paid out of a firm's present and past net earnings is known as the ____ restriction.
A) net earnings
B) net operating earnings
C) initial investment
D) earned capital
Q3) All of the following are arguments for the relevance of dividends except:
A) existence of issuance costs
B) reduction of agency costs
C) protection against dilution
D) risk aversion
Q4) What is the signaling effect of dividend payments?
Q5) What are the procedures for repurchasing stock?
Q6) Explain the "clientele effect".
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Chapter 16: Working Capital Policy and Short-term Financing
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Sample Questions
Q1) The aggressive approach to the financing of a firm's current assets uses a ____ proportion of short-term debt and a ____ proportion of long-term debt.
A) low, high
B) relatively high, relatively low
C) high interest, low interest
D) none of the above
Q2) Laserscope has an inventory conversion period of 45 days, a receivables conversion period of 42 days, and a payables deferral period of 51 days. What is the length of its cash conversion cycle?
A) 54 days
B) 36 days
C) 48 days
D) can determine with more information
Q3) A firm's net working capital position is a widely used measure of its ____.
A) leverage
B) profitability
C) risk
D) none of the above
Q4) Why is working capital so important to a firm's continued profitability?
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Chapter 17: The Management of Cash and Marketable Securities
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Sample Questions
Q1) Pronet has annual sales of $724 million from its 600 retail stores. Pronet can reduce its mail float by 2 days through the use of wire transfers. The annual cost of the wire transfers is expected to be $105,610. If Pronet's cost of short-term funds is 9.75 percent, should the change to wire transfers be made? Assume 365 days per year.
A) No, loss of $247,340
B) Yes, savings of $281,185
C) Yes, savings of $474,582
D) No, loss of $105,610
Q2) The primary components or sources of float include all the following except
A) check clearing float
B) collection float
C) processing float
D) mail float
Q3) Firms that have large multi-million dollar remittances use:
A) the Federal Reserve System
B) couriers
C) lockboxes
D) wire transfers
Q4) Name the three primary components (or sources) of float:
Page 19
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Chapter 18: Management of Accounts Receivable and Inventories
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Sample Questions
Q1) Relaxing (i.e., lowering) the firm's credit standards is likely to result in
A) lower sales
B) smaller bad-debt losses
C) a shorter average collection period
D) possible higher pre-tax profits
Q2) Haulsee Inc. builds 800,000 golf carts a year and purchases the electronic motors for these carts for $370 each. Ordering costs are $540 and Haulsee's inventory carrying costs average 14% of the inventory value. What is the total inventory costs?
A) $565,445
B) $224,331
C) $211,555
D) $21,155,120
Q3) Inventory related costs are all of the following EXCEPT:
A) Ordering costs
B) Product advertising costs
C) Carrying costs
D) Stockout costs
Q4) In trying to collect on past-due accounts, the firm may use several methods. List them.
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Chapter 19: Lease and Intermediate-term Financing
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Sample Questions
Q1) Prime Care has approached the leasing department of First City Bank to arrange lease financing for a $1.2 million CAT scanner. The economic life of the scanner is estimated to be 10 years. The estimated salvage value at the end of 10 years is $0. First City plans to depreciate the scanner on a straight-line basis over 10 years. If First City charges a beginning of the year lease payment of $255,395, what after-tax rate of return will the bank earn on the lease? Assume a marginal tax rate of 40%.
A) 4.7%
B) 16.8%
C) 13%
D) 40%
Q2) The contract period of an operating lease tends to
A) be somewhat less than the economic life of an asset
B) be equal to the economic life of the asset
C) be somewhat greater than the economic life of the asset
D) recover the full cost of the asset
Q3) In a leveraged lease, what items secure the mortgage bonds of the lender?
Q4) Explain a leveraged lease.
Q5) What are the advantages of leasing?
Q6) What is a term loan?
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Chapter 20: Financing With Derivatives
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Q1) A debenture of the Allegro Company (par value $1,000) is convertible into the company's common stock at a price of $50 per share. The convertible bond has a coupon interest rate of 7% and matures in 10 years. Straight debt of equivalent risk and maturity is yielding 8%. The company's common stock is currently selling for $60 per share. Determine the conversion value and straight-bond value of Allegro Company's convertible bonds.
A) $1,200; $1,000
B) $1,000; $933
C) $1,200; $933
D) $1,000; $1,000
Q2) List some securities that have option features.
Q3) The difference between the market value of a convertible bond and the higher of its conversion or straight-bond value is the
A) exercise premium
B) investment premium
C) conversion premium
D) liquidation premium
Q4) Why would a company issue convertible securities instead of straight bonds?
Q5) What is the difference between a conversion price and a conversion ratio?
Q6) What variables affect the call option valuation?
Page 22
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Chapter 21: Risk Management
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Sample Questions
Q1) Firms work to diversify. All of the following are diversification methods that firms use EXCEPT:
A) Firms seek to expand the customer base.
B) Firms seek to obtain raw materials from a number of suppliers.
C) Firms seek to isolate their product by selling to a single niche market.
D) Firms seek to produce more than one product.
Q2) What is marking-to-market and how is this process guaranteed?
Q3) Forward contracts are said to possess ____ risk.
A) business risk
B) financial risk
C) performance risk
D) spot risk
Q4) List five hedging strategies for risk management
Q5) Which of the following is generally used to enforce rights under patents and copyrights?
A) Legal action
B) Takeover threats
C) Diversification
D) Retained earnings
Q6) What is a hedge?
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Chapter 22: International Financial Management
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Sample Questions
Q1) Which of the following is not a primary category of foreign exchange risk that multinational firms must consider?
A) economic exposure
B) operating exposure
C) translation exposure
D) transaction exposure
Q2) Today, short-term interest rates in Australia are 8.50% and the corresponding U.S. rate is 6.0%. The current discount on forward Australian dollars is 2.0%. Can a U.S. trader use covered interest arbitrage to take advantage of this situation? If so what is the net effect?
A) No. Lose 1/2%
B) No. Lose 2 1/2%
C) Yes. Gain 1/2%
D) Yes. Gain 2 1/2%
Q3) Basic hedging techniques include all of the following except
A) money market hedge
B) forward market hedge
C) primary market hedge
D) none, because all are basic hedging techniques
Q4) How do market forces support the relative purchasing power parity?
Page 24
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Chapter 23: Corporate Restructuring
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Q1) A form of business combination in which two (unaffiliated) companies contribute financial and/or physical assets, as well as personnel, to a new company to engage in some economic activity is known as a ____.
A) joint venture
B) conglomerate merger
C) merger
D) consolidation
Q2) What is a form of business combination in which a company purchases all or a controlling block of another company's common shares and the two companies become affiliated?
A) horizontal merger
B) vertical merger
C) conglomerate
D) holding company
Q3) Explain a form of business combination called a holding company and how the combination is achieved.
Q4) How does a joint venture differ from a holding company?
Q5) There are three methods for valuing merger candidates. Briefly explain each of them.
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Chapter 24: Continuous Compounding and Discounting
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Q1) What is the future value of $20,000 invested for 20 years at a nominal interest rate of 9 percent compounded continuously?
A) $112,088
B) $120,993
C) $108,894
D) $147,781
Q2) Moneybag Bank & Trust is offering loans at 5% compounded continuously. Before you decide to borrow using that interest rate, what payment would be required on a $200,000 loan for a 30 year loan?
A) $1,089.59
B) $1,578.34
C) $1,183.92
D) $1,226.90
Q3) Determine the value of $10,000 at the end of 3 years invested at 8 percent assuming continuous compounding.
A)$12,712
B)$12,400
C)$32,460
D)$12,600
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Chapter 25: Mutually Exclusive Investments Having Unequal Lives
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Sample Questions
Q1) Casa Chica is considering replacing a piece of equipment. Alternative A costs $80,000, has an eight year life and would produce net cash flows of $18,000 in each of the eight years. Alternative B costs $65,000, has a six year life and would produce net cash flows of $18,000 in each of the six years. If Chica's cost of capital is 13 percent, which alternative should be chosen using the equivalent annual annuity method?
A) Project A
B) Project B
C) Indifferent between the two projects
D) Neither, because both projects have a negative NPV
Q2) The advantage(s) of the equivalent annual annuity method over the replacement chain technique in evaluating mutually exclusive investments having unequal lives include
A) the equivalent annual annuity method is often computationally simpler
B) the equivalent annual annuity method simplifies the handling of the time discrepancies that frequently arise in the replacement chain method
C) the equivalent annual annuity method is theoretically superior
D) a and b only
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Chapter 26: Breakeven Analysis
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Q1) In a graphic breakeven analysis, the point where total revenue is less than total cost indicates that the firm has:
A) net operating capital
B) cash flow from investing
C) a negative EBIT
D) a positive return on capital
Q2) The Foggy Futures Weather Network offers an annual almanac for sale each year with information about predicted weather patterns, severe storm safety tips and a tracking chart. The finished product sells for $35 with a variable cost per unit of $21. The company has operating costs of $1,050,000. Using 100,000 units as a base, what is the degree of operating leverage?
A) 6.2
B) 5.7
C) 7.9
D) 4.0
Q3) What are the possible uses for breakeven analysis?
Q4) Explain the composition of operating costs and why they can cause an inaccurate breakeven analysis.
Q5) How can a firm have more than one breakeven output point?
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Chapter 27: Bond Refunding Analysis
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Q1) Why would a corporation consider bond refunding?
Q2) In a bond refunding analysis, the principal benefit, or cash inflow, is the present value of the
A) pretax interest savings over the life of the issue
B) aftertax flotation cost savings
C) aftertax interest savings over the life of the issue
D) aftertax call premium
Q3) Wood River Power Company is considering refunding a $100 million 12% coupon debenture issue with a 9% coupon, 20-year debenture. The 12% issue also matures in 20 years and is now callable at 109% of par. The unamortized flotation cost on the old issue is $360,000 and the flotation cost of the new issue is 0.775%. Wood River estimated that there would be a 4 week period where both bonds would be outstanding. The company has a weighted cost of capital of 11% and a 40% marginal tax rate. Should Wood River sell the refunding issue? (Note: PVIFA<sub>0.054,20 </sub>= 12.050)
A) yes, NPV is approximately $15.21 million
B) yes, NPV is approximately $9.86
C) yes, NPV is approximately 6.485 million
D) No, NPV is negative $0.554 million
Q4) Why is the after-tax cost of debt used in bond refunding analysis?
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Chapter 28: Taxes
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Sample Questions
Q1) Corporate capital gains income is currently taxed at ____ ordinary income.
A) 80 percent of the marginal tax rate on B) the same marginal rate as C) 50 percent of the marginal tax rate on D) none of the above
Q2) A corporation's net operating loss may be carried ____ years and ____ years to offset taxable income in those years.
A) back 20, forward 2
B) back 3, forward 5
C) back 5, forward 15
D) back 2, forward 20
Q3) Last year Cell 2 had a net operating loss of $120,000 and a capital loss of $80,000. This year (2010) the firm has an operating income of $230,000 and a capital gain of $40,000. What is Cell 2's tax liability this year? Assume there are no other tax loss carry backs or carry forwards.
A) $4,500
B) $72,950
C) $26,150
D) $12,500
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