Business Finance
Exam Review
Course Introduction
Business Finance explores the fundamental principles and practices involved in managing the financial resources of businesses. The course covers key topics such as financial statement analysis, working capital management, budgeting, capital structure, investment decisions, and risk management. Students will gain an understanding of how financial data drives decision-making and value creation within organizations. Through practical examples and case studies, learners develop skills to analyze financial performance, assess funding options, and apply financial tools to solve real-world business challenges.
Recommended Textbook
Intermediate Financial Management 13th Edition by Eugene F. Brigham
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2031 Verified Questions
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Chapter 1: An Overview of Financial Management and the Financial Environment
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Sample Questions
Q1) Cheers Inc. operates as a partnership. Now the partners have decided to convert the business into a regular corporation. Which of the following statements is CORRECT
A) assuming cheers is profitable, less of its income will be subject to federal income taxes.
B) cheers will now be subject to fewer regulations.
C) cheers' shareholders (the ex-partners) will now be exposed to less liability.
D) cheers' investors will be exposed to less liability, but they will find it more difficult to transfer their ownership.
E) cheers will find it more difficult to raise additional capital.
Answer: C
Q2) The major advantage of a regular partnership or a corporation as a form of business organization is the fact that both offer their owners limited liability, whereas proprietorships do not.
A)True
B)False
Answer: False
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3
Chapter 2: Risk and Return-Part I
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Q1) Nystrand Corporation's stock has an expected return of 12.25%, a beta of 1.25, and is in equilibrium. If the risk-free rate is 5.00%, what is the market risk premium?
A) 5.80%
B) 5.95%
C) 6.09%
D) 6.25%
E) 6.40%
Answer: A
Q2) Which of the following statements is CORRECT
A) the slope of the security market line is beta.
B) any stock with a negative beta must in theory have a negative required rate of return, provided rrf is positive.
C) if a stock's beta doubles, its required rate of return must also double.
D) if a stock's returns are negatively correlated with returns on most other stocks, the stock's beta will be negative.
E) if a stock has a beta of to 1.0, its required rate of return will be unaffected by changes in the market risk premium.
Answer: D
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Chapter 3: Risk and Return-Part II
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Q1) If the returns of two firms are negatively correlated, then one of them must have a negative beta.
A)True
B)False
Answer: True
Q2) The CAPM is a multi-period model which takes account of differences in securities' maturities, and it can be used to determine the required rate of return for any given level of systematic risk.
A)True
B)False Answer: False
Q3) A stock with a beta equal to -1.0 has zero systematic (or market) risk.
A)True
B)False
Answer: False
Q4) The slope of the SML is determined by the value of beta.
A)True
B)False Answer: False
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Chapter 4: Bond Valuation
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Q1) Bonds A and B are 15-year, $1,000 face value bonds. Bond A has a 7% annual coupon, while Bond B has a 9% annual coupon. Both bonds have a yield to maturity of 8%, which is expected to remain constant for the next 15 years. Which of the following statements is CORRECT?
A) one year from now, bond a's price will be higher than it is today.
B) bond a's current yield is greater than 8%.
C) bond a has a higher price than bond b today, but one year from now the bonds will have the same price.
D) both bonds have the same price today, and the price of each bond is expected to remain constant until the bonds mature.
E) bond b has a higher price than bond a today, but one year from now the bonds will have the same price.
Q2) There is an inverse relationship between bonds' quality ratings and their required rates of return. Thus, the required return is lowest for AAA-rated bonds, and required returns increase as the ratings get lower.
A)True
B)False
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Page 6
Chapter 5: Financial Options
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Q1) Because of the time value of money, the longer before an option expires, the less valuable the option will be, other things held constant.
A)True B)False
Q2) The current price of a stock is $22, and at the end of one year its price will be either $27 or $17. The annual risk-free rate is 6.0%, based on daily compounding. A 1-year call option on the stock, with an exercise price of $22, is available. Based on the binomial model, what is the option's value?(Hint: Use daily compounding.)
A) $2.43
B) $2.70
C) $2.99
D) $3.29
E) $3.62
Q3) Since investors tend to dislike risk and like certainty, the more volatile a stock, the less valuable will be an option to purchase the stock, other things held constant.
A)True B)False
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Chapter 6: Accounting for Financial Management
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Q1) Which of the following statements is CORRECT?
A) depreciation and amortization are not cash charges, so neither of them has an effect on a firm's reported profits.
B) the more depreciation a firm reports, the higher its tax bill, other things held constant.
C) people sometimes talk about the firm's net cash flow, which is shown as the lowest entry on the income statement, hence it is often called "the bottom line."
D) depreciation reduces a firm's cash balance, so an increase in depreciation would normally lead to a reduction in the firm's net cash flow.
E) net cash flow (ncf) is often defined as follows:net cash flow = net income + depreciation and amortization charges.
Q2) The fact that 70% of the interest income received by a corporation is excluded from its taxable income encourages firms to use more debt financing than they would in the absence of this tax law provision.
A)True
B)False
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Chapter 7: Analysis of Financial Statements
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Q1) If the CEO of a large, diversified, firm were filling out a fitness report on a division manager (i.e., "grading" the manager), which of the following situations would be likely to cause the manager to receive a better grade? In all cases, assume that other things are held constant.
A) the division's dso (days' sales outstanding) is 40, whereas the average for its competitors is 30.
B) the division's basic earning power ratio is above the average of other firms in its industry.
C) the division's total assets turnover ratio is below the average for other firms in its industry.
D) the division's debt ratio is above the average for other firms in the industry.
E) the division's inventory turnover is 6, whereas the average for its competitors is 8.
Q2) A decline in a firm's inventory turnover ratio suggests that it is managing its inventory more efficiently and also that its liquidity position is improving, i.e., it is becoming more liquid.
A)True
B)False
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Page 9
Chapter 8: Basic Stock Valuation
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Q1) Judd Corporation has a weighted average cost of capital of 10.25%, and its value of operations is $57.50 million. Free cash flow is expected to grow at a constant rate of 6.00% per year. What is the expected year-end free cash flow, FCF1 in millions?
A) $2.20
B) $2.44
C) $2.69
D) $2.96
E) $3.25
Q2) The projected cash flow for the next year for Minesuah Inc. is $100,000, and FCF is expected to grow at a constant rate of 6%. If the company's weighted average cost of capital is 11%, what is the value of its operations?
A) $1,714,750
B) $1,805,000
C) $1,900,000
D) $2,000,000
E) $2,100,000
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Chapter 9: Corporate Valuation and Financial Planning
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Q1) Which of the following statements is CORRECT?
A) the afn equation for forecasting funds requirements requires only a forecast of the firm's balance sheet. although a forecasted income statement may help clarify the results, income statement data are not essential because funds needed relate only to the balance sheet.
B) dividends are paid with cash taken from the accumulated retained earnings account, hence dividend policy does not affect the afn forecast.
C) a negative afn indicates that retained earnings and spontaneous liabilities are far more than sufficient to finance the additional assets needed.
D) if the ratios of assets to sales and spontaneous liabilities to sales do not remain constant, then the afn equation will provide more accurate forecasts than the forecasted financial statements method.
E) any forecast of financial requirements involves determining how much money the firm will need, and this need is determined by adding together increases in assets and spontaneous liabilities and then subtracting operating income.
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Chapter 10: Corporate Governance
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Sample Questions
Q1) Which one of the following statements is TRUE?
A) an example of an agency relationship is when the board of directors hires a ceo to run a company.
B) an example of an agency relationship is when the ceo nominates a slate of candidates to be on the board of directors.
C) an example of an agency relationship is when a supervisor hires a forklift operator.
D) the supervisor-employee relation between a production line supervisor and a production line operator is an example of an agency relationship.
E) an agency cost is the wage required to pay someone who is hired to perform a service.
Q2) Which one of the following statements is TRUE?
A) a classified board is one in which the board members have staggered terms.
B) one tool of corporate governance is a company's tax avoidance strategy.
C) one tool of corporate governance is choosing a good investment banker.
D) a classified board is one in which the board members serve anonymously.
E) a classified board is one in which an announcement requesting applications for board members appears in the newspaper.
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Page 12
Chapter 11: Determining the Cost of Capital
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Sample Questions
Q1) The cost of capital used in capital budgeting should reflect the average cost of the various sources of long-term funds a firm uses to acquire assets.
A)True
B)False
Q2) Westbrook's Painting Co. plans to issue a $1,000 par value, 20-year noncallable bond with a 7.00% annual coupon, paid semiannually. The company's marginal tax rate is 40.00%, but Congress is considering a change in the corporate tax rate to 30.00%. By how much would the component cost of debt used to calculate the WACC change if the new tax rate was adopted?
A) 0.57%
B) 0.63%
C) 0.70%
D) 0.77%
E) 0.85%
Q3) If a firm's marginal tax rate is increased, this would, other things held constant, lower the cost of debt used to calculate its WACC.
A)True
B)False
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13
Chapter 12: Capital Budgeting: Decision Criteria
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Sample Questions
Q1) Yoga Center Inc. is considering a project that has the following cash flow and cost of capital (r) data. What is the project's NPV? Note that a project's expected NPV can be negative, in which case it will be rejected.
\(\begin{array} { l c c c c c }
r& 14.00 \% \\
\text { Year } &0& 1 & 2 & 3 & 4 \\
\text { Cash flowr } & - \$ 1,200 & 400 & 425 & 450 & 475 \end{array}\)
A) $41.25
B) $45.84
C) $50.93
D) $56.59
E) $62.88
Q2) The primary reason that the NPV method is conceptually superior to the IRR method for evaluating mutually exclusive investments is that multiple IRRs may exist, and when that happens, we don't know which IRR is relevant.
A)True
B)False
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Page 14
Chapter 13: Capital Budgeting-Estimating Cash Flows and Analyzing Risk
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Sample Questions
Q1) If debt is to be used to finance a project, then when cash flows for a project are estimated, interest payments should be included in the analysis.
A)True
B)False
Q2) The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is a standardized measure of the risk per unit of expected return.
A)True
B)False
Q3) Which of the following is NOT a relevant cash flow and thus should not be reflected in the analysis of a capital budgeting project?
A) shipping and installation costs.
B) cannibalization effects.
C) opportunity costs.
D) sunk costs that have been expensed for tax purposes.
E) changes in net working capital.
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Page 15
Chapter 14: Real Options
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Q1) Refer to the data for Drilling Experts, Incorporated. Since the project is considered to be quite risky, a 20% cost of capital is used. What is the project's expected NPV, in thousands of dollars?
A) $336.15
B) $373.50
C) $415.00
D) $461.11
E) $507.22
Q2) Refer to data for Steppingstone Incorporated. Based on the above information, what is the Z 90's expected net present value?
A)$6,678
B)$3,251
C) $15,303
D) $20,004
E) $45,965
Q3) Real options affect the size, but not the risk, of a project's expected cash flows.
A)True
B)False
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16
Chapter 15: Distributions to Shareholders-Dividends and Repurchases
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Sample Questions
Q1) MM's dividend irrelevance theory says that while dividend policy does not affect a firm's value, it can affect the cost of capital.
A)True
B)False
Q2) If the signaling, hypothesis (which is also called the information content hypothesis) is correct, then changes in dividend policy can have an important effect on the firm's value and capital costs.
A)True
B)False
Q3) Which of the following would be most likely to lead to a decrease in a firm's dividend payout ratio?
A) its access to the capital markets increases.
B) its r&d efforts pay off, and it now has more high-return investment opportunities.
C) its accounts receivable decrease due to a change in its credit policy.
D) its stock price has increased over the last year by a greater percentage than the increase in the broad stock market averages.
E) its earnings become more stable.
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Page 17
Chapter 16: Capital Structure Decisions
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Sample Questions
Q1) Which of the following statements is CORRECT?
A) the capital structure that maximizes the stock price is generally the capital structure that also maximizes earnings per share.
B) all else equal, an increase in the corporate tax rate would tend to encourage a company to increase its debt ratio.
C) since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its wacc.
D) since debt is cheaper than equity, increasing a company's debt ratio will always reduce its wacc.
E) when a company increases its debt ratio, the costs of equity and debt both increase. therefore, the wacc must also increase.
Q2) The firm's target capital structure should be consistent with which of the following statements?
A) minimize the cost of debt (rd).
B) obtain the highest possible bond rating.
C) minimize the cost of equity (rs).
D) minimize the weighted average cost of capital (wacc).
E) maximize the earnings per share (eps).
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Chapter 17: Dynamic Capital Structures and Corporate Valuation
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Q1) In the compressed adjusted present value model, the appropriate discount rate for the tax shield is the after-tax cost of debt.
A)True
B)False
Q2) Palmer Company has $5,000,000 of 15-year maturity bonds outstanding. Each bond has a maturity value of $1,000, an annual coupon of 12.0%. The bonds can be called at any time with a premium of $50 per bond. If the bonds are called, the company must pay flotation costs of $10 per new refunding bond. Ignore tax considerations assume that the firm's tax rate is zero. The company's decision of whether to call the bonds depends critically on the current interest rate on newly issued bonds. What is the breakeven interest rate, the rate below which it would be profitable to call in the bonds?
A) 9.57%
B) 10.07%
C) 10.60%
D) 11.16%
E) 11.72%
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Page 19
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Q1) Which of the following statements concerning common stock and the investment banking process is NOT CORRECT?
A) if a firm sells 1,000,000 new shares of class b stock, the transaction occurs in the primary market.
B) listing a large firm's stock is often considered to be beneficial to stockholders because the increases in liquidity and reputation probably outweigh the additional costs to the firm.
C) stockholders have the right to elect the firm's directors, who in turn select the officers who manage the business. if stockholders are dissatisfied with management's performance, an outside group may ask the stockholders to vote for it in an effort to take control of the business. this action is called a tender offer.
D) the announcement of a large issue of new stock could cause the stock price to fall. this loss is called "market pressure," and it is treated as a flotation cost because it is a cost to stockholders that is associated with the new issue.
E) the preemptive right gives each existing common stockholder the right to purchase his or her proportionate share of a new stock issue.
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Page 20
Chapter 19: Lease Financing
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Q1) Delamont Transport Company (DTC) is evaluating the merits of leasing versus purchasing a truck with a 4-year life that costs $40,000 and falls into the MACRS 3-year class. If the firm borrows and buys the truck, the loan rate would be 10%, and the loan would be amortized over the truck's 4-year life, so the interest expense for taxes would decline over time. The loan payments would be made at the end of each year. The truck will be used for 4 years, at the end of which time it will be sold at an estimated residual value of $10,000. If DTC buys the truck, it would purchase a maintenance contract that costs $1,000 per year, payable at the end of each year. The lease terms, which include maintenance, call for a $10,000 lease payment (4 payments total) at the beginning of each year. DTC's tax rate is 40%. What is the net advantage to leasing? (Note: Assume MACRS rates for Years 1 to 4 are 0.3333, 0.4445, 0.15, and 0.07.)
A) $849
B) $896
C) $945
D) $999
E) $1,047
Q2) A sale and leaseback arrangement is a type of financial, or capital, lease.
A)True
B)False
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Page 21
Chapter 20: Hybrid Financing Preferred Stock-Warrants and Convertibles
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Q1) The problem of dilution of stockholders' earnings never results from the sale of call options, but it can arise if warrants are used.
A)True
B)False
Q2) Preferred stock can provide a financing alternative for some firms when market conditions are such that they cannot issue either pure debt or common stock at any reasonable cost.
A)True
B)False
Q3) Most convertible securities are bonds or preferred stocks that, under specified terms and conditions, can be exchanged for common stock at the option of the holder.
A)True
B)False
Q4) Unlike bonds, the cost of preferred stock to the issuing firm is the same on a before-tax and after-tax basis. This is because dividends on preferred stock are not tax deductible, whereas interest on bonds is deductible.
A)True
B)False
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Chapter 21: Supply Chains and Working Capital Management
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Q1) Which of the following statements is NOT CORRECT?
A) accruals are "free" in the sense that no explicit interest is paid on these funds.
B) a conservative approach to working capital management will result in most, if not all, permanent current operating assets being financed with long-term capital.
C) the risk to a firm that borrows with short-term credit is usually greater than if it borrowed using long-term debt. this added risk stems from the greater variability of interest costs on short-term debt and possible difficulties with rolling over short-term debt.
D) bank loans generally carry a higher interest rate than commercial paper.
E) commercial paper can be issued by virtually any firm so long as it is willing to pay the going interest rate.
Q2) Which of the following items should a company report directly in its monthly cash budget?
A) cash proceeds from selling one of its divisions.
B) accrued interest on zero coupon bonds that it issued.
C) new shares issued in a stock split.
D) new shares issued in a stock dividend.
E) its monthly depreciation expense.
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Chapter 22: Providing and Obtaining Credit
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Questions
Q1) Suppose that you're planning a vacation and borrow $2,000 from a bank for one year at a stated annual interest rate of 14 percent, with interest prepaid (a discounted loan). Also, assume that the bank requires you to maintain a compensating balance equal to 20 percent of the initial loan value. What effective annual interest rate are you being charged?
A) 14.00%
B) 8.57%
C) 16.28%
D) 21.21%
E) 28.00%
Q2) The credit period is the amount of time it takes to do a credit search on a potential customer.
A)True
B)False
Q3) Cash discounts are mostly used to get new customers in the door since existing customers almost always use the delayed payment terms. A)True
B)False
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24
Chapter 23: Other Topics in Working Capital Management
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Q1) Gemini Inc.'s optimal cash transfer amount, using the Baumol model, is $60,000. The firm's fixed cost per cash transfer of marketable securities to cash is $180. In addition, the total estimated cash costs (transfers and carrying cost) for the firm, based on 16 transactions per year, are $5,760. On what opportunity cost of holding cash was this analysis based?
A) 19.2%
B) 10.4%
C) 6.3%
D) 12.1%
E) 9.6%
Q2) Refer to Exhibit Duckett Group. According to the Baumol model, what is the optimal transaction size for transfers from marketable securities to cash?
A) $7,071
B) $38,357
C) $70,711
D) $102,956
E) $87,000
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Chapter 24: Enterprise Risk Management
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Q1) Suppose the December CBOT Treasury bond futures contract has a quoted price of 80'07. If annual interest rates go up by 1.00 percentage point, what is the gain or loss on the futures contract?(Assume a $1,000 par value, and round to the nearest whole dollar.)
A) $78.00
B) $82.00
C) $86.00
D) $90.00
E) $95.00
Q2) One objective of risk management can be to reduce the volatility of a firm's cash flows.
A)True
B)False
Q3) In theory, reducing the volatility of its cash flows will always increase a company's value.
A)True
B)False
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26
Chapter 25: Bankruptcy-Reorganization and Liquidation
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Q1) What would be the priority of the claims as to the distribution of assets in a liquidation under Chapter 7 of the Bankruptcy Act? 1 is the highest claim, 5 is the lowest.
(1) Trustees' costs to administer and operate the firm.
(2) Common stockholders.
(3) General, or unsecured, creditors.
(4) Secured creditors, who have a claim to the proceeds from the sale of specific property pledged to secure a loan.
(5) Taxes due to federal and state governments.
A) 5, 4, 1, 3, 2
B) 4, 1, 5, 3, 2
C) 5, 1, 4, 2, 3
D) 1, 5, 4, 3, 2
E) 1, 4, 3, 5, 2
Q2) The primary test of feasibility in a reorganization is whether the firm's fixed charges after reorganization can be covered by its projected cash flows.
A)True
B)False
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Chapter 26: Mergers and Corporate Control
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Q1) In a financial merger, the relevant post-merger cash flows are simply the sum of the expected cash flows of the two companies, measured as if they were operated independently.
A)True
B)False
Q2) Although goodwill created in a merger may not be amortized for shareholder reporting purposes, it may be amortized for Federal tax purposes.
A)True
B)False
Q3) Any goodwill created in a merger must be amortized over its expected life, usually 40 years, for shareholder reporting purposes.
A)True
B)False
Q4) A company seeking to fight off a hostile takeover might employ the services of an investment banking firm to develop a defensive strategy.
A)True
B)False
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28
Chapter 27: Multinational Financial Management
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Q1) Which of the following statements is NOT CORRECT?
A) foreign bonds and eurobonds are two important types of international bonds.
B) foreign bonds are bonds sold by a foreign borrower but denominated in the currency of the country in which the issue is sold.
C) the term eurobond applies only to foreign bonds denominated in u.s. currency.
D) a foreign bond might pay a higher nominal interest rate than a u.s. bond.
E) any bond sold outside the country of the borrower is called an international bond.
Q2) If it takes $0.71 U.S. dollars to purchase one Swiss franc, how many Swiss francs can one U.S. dollar buy?
A) 0.50
B) 0.71
C) 1.00
D) 1.41
E) 2.81
Q3) The United States and most other major industrialized nations currently operate under a system of floating exchange rates.
A)True
B)False
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Chapter 28: Time Value of Money
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Sample Questions
Q1) Your uncle has $300,000 invested at 7.5%, and he now wants to retire. He wants to withdraw $35,000 at the end of each year, beginning at the end of this year. He also wants to have $25,000 left to give you when he ceases to withdraw funds from the account. What is the maximum number of $35,000 withdrawals that he can make and still have at least $25,000 left in the account? (Hint: If your solution for N is not an integer, round down to the nearest whole number.)
A) 12
B) 13
C) 14
D) 15
E) 16
Q2) As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or less than the nominal rate on the deposit (or loan).
A)True
B)False
Q3) Starting to invest early for retirement reduces the benefits of compound interest.
A)True
B)False
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Chapter 29: Basic Financial Tools: A review
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Sample Questions
Q1) A stock just paid a dividend of D0 = $1.50. The required rate of return is rs = 10.1%, and the constant growth rate is g = 4.0%. What is the current stock price?
A) $23.11
B) $23.70
C) $24.31
D) $24.93
E) $25.57
Q2) The greater the number of compounding periods within a year, then (1) the greater the future value of a lump sum investment at Time 0 and (2) the greater the present value of a given lump sum to be received at some future date.
A)True
B)False
Q3) Time lines cannot be constructed in situations where some of the cash flows occur annually but others occur quarterly.
A)True
B)False
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Chapter 30: Pension Plan Management
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Q1) Kumar Consulting operates several stock investment portfolios that are used by firms for investment of pension plan assets. Last year, one portfolio had a realized return of 12.6 percent and a beta coefficient of 1.15. The average T-bond rate was 7 percent and the realized rate of return on the S&P 500 was 12 percent. What was the portfolio's alpha?
A) $0.75%
B) $0.15%
C) 0%
D) 0.15%
E) 0.75%
Q2) From a pure cost standpoint, a firm with a defined contribution plan would be more likely to hire older workers than a firm with a defined benefit plan.
A)True
B)False
Q3) Under a defined contribution plan, employees agree to contribute some percentage of their salaries, up to 20 percent, to the firm's pension fund.
A)True
B)False
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Chapter 31: Financial Management in Not for Profit
Businesses
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Q1) The net present social value model formally recognizes that not-for-profit firms must consider the social value along with the financial value of proposed new projects.
A)True
B)False
Q2) Which of the following statements about a not-for-profit firm's cost of capital estimate is most correct?
A) the capital structure weights for a not-for-profit firm are set at 50/50, because such firms can raise $1 of debt financing for each dollar of retained earnings.
B) the cost of tax-exempt debt issued by not-for-profit firms is increased ("grossed up") by 1 t in the wacc estimate to reflect the fact that such firms do not pay taxes.
C) equity (fund) capital has a cost that is roughly equivalent to the cost of retained earnings to similar investor-owned companies.
D) not-for-profit firms have a zero cost of capital.
E) since a not-for-profit firm has no shareholders, its wacc estimate does not include a cost of equity (fund capital) estimate.
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