Business Finance
Test Preparation
Course Introduction
Business Finance explores the fundamental concepts and practices involved in managing the financial resources of business organizations. The course covers key topics such as financial statement analysis, time value of money, risk and return, capital budgeting, cost of capital, and working capital management. Students will learn how financial decisions impact business operations and overall corporate strategy, while gaining practical skills in evaluating investment opportunities, structuring financing options, and optimizing the financial performance of an organization. Through case studies and real-world applications, the course prepares students to make informed financial decisions in a dynamic business environment.
Recommended Textbook
Intermediate Financial Management 12th Edition by Eugene F. Brigham
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32 Chapters
1966 Verified Questions
1966 Flashcards
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Page 2
Chapter 1: An Overview of Financial Management and the Financial Environment
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Sample Questions
Q1) The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to
A)Maximize the stock price per share over the long run, which is the stock's intrinsic value.
B)Maximize the firm's expected EPS.
C)Minimize the chances of losses.
D)Maximize the firm's expected total income.
E)Maximize the stock price on a specific target date.
Answer: A
Q2) One drawback of switching from a partnership to the corporate form of organization is the following:
A)It subjects the firm to additional regulations.
B)It cannot affect the amount of the firm's operating income that goes to taxes.
C)It makes it more difficult for the firm to raise additional capital.
D)It makes the firm's investors subject to greater potential personal liabilities.
E)It makes it more difficult for the firm's investors to transfer their ownership interests.
Answer: A
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Chapter 2: Risk and Return: Part I
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Sample Questions
Q1) The two stocks in your portfolio,X and Y,have independent returns,so the correlation between them,r<sub>XY</sub> is zero.Your portfolio consists of $50,000 invested in Stock X and $50,000 invested in Stock Y.Both stocks have an expected return of 15%,betas of 1.6,and standard deviations of 30%.Which of the following statements best describes the characteristics of your 2-stock portfolio?
A)Your portfolio has a standard deviation less than 30%, and its beta is greater than 1.6.
B)Your portfolio has a beta equal to 1.6, and its expected return is 15%.
C)Your portfolio has a beta greater than 1.6, and its expected return is greater than 15%.
D)Your portfolio has a standard deviation greater than 30% and a beta equal to 1.6.
E)Your portfolio has a standard deviation of 30%, and its expected return is 15%.
Answer: B
Q2) The slope of the SML is determined by the value of beta.
A)True
B)False
Answer: False
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Page 4
Chapter 3: Risk and Return: Part Ii
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Sample Questions
Q1) If you plotted the returns of Selleck & Company against those of the market and found that the slope of your line was negative,the CAPM would indicate that the required rate of return on Selleck's stock should be less than the risk-free rate for a well-diversified investor,assuming that the observed relationship is expected to continue in the future.
A)True
B)False
Answer: True
Q2) You hold a portfolio consisting of a $5,000 investment in each of 20 different stocks.The portfolio beta is equal to 1.12.You have decided to sell a coal mining stock (b = 1.00)at $5,000 net and use the proceeds to buy a like amount of a mineral rights company stock (b = 2.00).What is the new beta of the portfolio?
A)1.1139
B)1.1700
C)1.2311
D)1.2927
E)1.3573
Answer: B
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Page 5
Chapter 4: Bond Valuation
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Sample Questions
Q1) Bond A has a 9% annual coupon,while Bond B has a 7% annual coupon.Both bonds have the same maturity,a face value of $1,000,and an 8% yield to maturity.Which of the following statements is CORRECT?
A)Bond A trades at a discount, whereas Bond B trades at a premium.
B)If the yield to maturity for both bonds remains at 8%, Bond A's price one year from now will be higher than it is today, but Bond B's price one year from now will be lower than it is today.
C)If the yield to maturity for both bonds immediately decreases to 6%, Bond A's bond will have a larger percentage increase in value.
D)Bond A's current yield is greater than that of Bond B.
E)Bond A's capital gains yield is greater than Bond B's capital gains yield.
Q2) As a general rule,a company's debentures have higher required interest rates than its mortgage bonds because mortgage bonds are backed by specific assets while debentures are unsecured.
A)True
B)False
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Chapter 5: Financial Options
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Q1) As the price of a stock rises above the strike price,the value investors are willing to pay for a call option increases because both (1)the immediate capital gain that can be realized by exercising the option and (2)the likely exercise value of the option when it expires have both increased.
A)True
B)False
Q2) 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
Q3) BLW Corporation is considering the terms to be set on the options it plans to issue to its executives.Which of the following actions would decrease the value of the options,other things held constant?
A)The exercise price of the option is increased.
B)The life of the option is increased, i.e., the time until it expires is lengthened.
C)The Federal Reserve takes actions that increase the risk-free rate.
D)BLW's stock price becomes more risky (higher variance).
E)BLW's stock price suddenly increases.
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Chapter 6: Accounting for Financial Management
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Sample Questions
Q1) On the balance sheet,total assets must always equal total liabilities and equity.
A)True
B)False
Q2) Below is the common equity section (in millions)of Fethe Industries' last two year-end balance sheets: \[\begin{array} { l r r } & 2015 & 2014 \\
\text { Common stock } & \$ 2,000 & \$ 1,000 \\
\text { Retained earnings } & 2,000 & 2,340 \\
\text { Total common equity } &\underline{ \$ 4,000 }& \underline{\$ 3,340}
\end{array}\] The company has never paid a dividend to its common stockholders.Which of the following statements is CORRECT?
A)The company's net income in 2014 was higher than in 2015.
B)The company issued common stock in 2015.
C)The market price of the company's stock doubled in 2015.
D)The company had positive net income in both 2014 and 2015, but the company's net income in 2014 was lower than it was in 2015.
E)The company has more equity than debt on its balance sheet.
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Page 8
Chapter 7: Analysis of Financial Statements
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Sample Questions
Q1) A firm wants to strengthen its financial position.Which of the following actions would increase its quick ratio?
A)Issue new common stock and use the proceeds to acquire additional fixed assets.
B)Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2) lead to an increase in accounts receivable.
C)Issue new common stock and use the proceeds to increase inventories.
D)Speed up the collection of receivables and use the cash generated to increase inventories.
E)Use some of its cash to purchase additional inventories.
Q2) Stewart Inc.'s latest EPS was $3.50,its book value per share was $22.75,it had 215,000 shares outstanding,and its debt-to-assets ratio was 46%.How much debt was outstanding?
A)$3,393,738
B)$3,572,356
C)$3,760,375
D)$3,958,289
E)$4,166,620
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Page 9
Chapter 8: Basic Stock Valuation
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Sample Questions
Q1) If D<sub>1</sub> = $1.50,g (which is constant)= 6.5%,and P<sub>0</sub> = $56,what is the stock's expected capital gains yield for the coming year?
A)6.50%
B)6.83%
C)7.17%
D)7.52%
E)7.90%
Q2) Projected free cash flows should be discounted at the firm's weighted average cost of capital to find the value of its operations.
A)True
B)False
Q3) The free cash flow valuation model cannot be used unless a company doesn't pay dividends.
A)True
B)False
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Chapter 9: Corporate Valuation and Financial Planning
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Sample Questions
Q1) The AFN equation assumes that the ratios of assets and liabilities to sales remain constant over time.However,this assumption can be relaxed when we use the forecasted financial statement method.Three conditions where constant ratios cannot be assumed are economies of scale,lumpy assets,and excess capacity.
A)True
B)False
Q2) Refer to the Judd Enterprises financial statements.If Judd does not plan on issuing new stock or additional long-term debt,then what is the additional net financing needed for the projected year?
A)$30
B)$33
C)$37
D)$339
E)$396
Q3) A rapid build-up of inventories normally requires additional financing,unless the increase is matched by an equally large decrease in some other asset.
A)True
B)False
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11
Chapter 10: Corporate Governance
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Sample Questions
Q1) Two important issues in corporate governance are (1)the rules that cover the board's ability to fire the CEO and (2)the rules that cover the CEO's ability to remove members of the board.
A)True
B)False
Q2) Which of the following is NOT normally regarded as being a barrier to hostile takeovers?
A)Targeted share repurchases.
B)Shareholder rights provisions.
C)Restricted voting rights.
D)Poison pills.
E)Abnormally high executive compensation.
Q3) ESOPs were originally designed to help improve worker productivity,but today they are also used to help prevent hostile takeovers.
A)True
B)False
Q4) A poison pill is also known as a corporate restructuring.
A)True
B)False
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Chapter 11: Determining the Cost of Capital
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Sample Questions
Q1) Your consultant firm has been hired by Eco Brothers Inc.to help them estimate the cost of common equity.The yield on the firm's bonds is 8.75%,and your firm's economists believe that the cost of common can be estimated using a risk premium of 3.85% over a firm's own cost of debt.What is an estimate of the firm's cost of common from reinvested earnings?
A)12.60%
B)13.10%
C)13.63%
D)14.17%
E)14.74%
Q2) Suppose you are the president of a small,publicly-traded corporation.Since you believe that your firm's stock price is temporarily depressed,all additional capital funds required during the current year will be raised using debt.In this case,the appropriate marginal cost of capital for use in capital budgeting during the current year is the after-tax cost of debt.
A)True
B)False
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Chapter 12: Capital Budgeting: Decision Rules
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Sample Questions
Q1) One advantage of the payback method for evaluating potential investments is that it provides information about a project's liquidity and risk.
A)True
B)False
Q2) The NPV and IRR methods,when used to evaluate two independent and equally risky projects,will lead to different accept/reject decisions and thus capital budgets if the projects' IRRs are greater than their cost of capital.
A)True
B)False
Q3) Both the regular and the modified IRR (MIRR)methods have wide appeal to professors,but most business executives prefer the NPV method to either of the IRR methods.
A)True
B)False
Q4) The internal rate of return is that discount rate that equates the present value of the cash outflows (or costs)with the present value of the cash inflows.
A)True
B)False
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14
Chapter 13: Cash Flow Estimation and Risk Analysis
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Sample Questions
Q1) Which of the following statements is CORRECT?
A)An example of an externality is a situation where a bank opens a new office, and that new office causes deposits in the bank's other offices to increase.
B)The NPV method automatically deals correctly with externalities, even if the externalities are not specifically identified, but the IRR method does not. This is another reason to favor the NPV.
C)Both the NPV and IRR methods deal correctly with externalities, even if the externalities are not specifically identified. However, the payback method does not.
D)Identifying an externality can never lead to an increase in the calculated NPV.
E)An externality is a situation where a project would have an adverse effect on some other part of the firm's overall operations. If the project would have a favorable effect on other operations, then this is not an externality.
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15
Chapter 14: Real Options
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Sample Questions
Q1) The option to abandon a project is a real option,but a call option on a stock is not a real option.
A)True
B)False
Q2) Which of the following is most CORRECT?
A)Real options change the risk, but not the size, of projects' expected cash flows.
B)Real options are likely to reduce the cost of capital that should be used to discount a project's expected cash flows.
C)Very few projects actually have real options.
D)Real options are less valuable when there is a lot of uncertainty about the true values future sales and costs.
E)Real options change the size, but not the risk, of projects' expected cash flows.
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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Chapter 15: Distributions to Shareholders: Dividends and Repurchases
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Sample Questions
Q1) Brinkley Resources stock has increased significantly over the last five years,selling now for $175 per share.Management feels this price is too high for the average investor and wants to get the price down to a more typical level,which it thinks is $25 per share.What stock split would be required to get to this price,assuming the transaction has no effect on the total market value? Put another way,how many new shares should be given per one old share?
A)6.65
B)6.98
C)7.00
D)7.35
E)7.72
Q2) Stock dividends and stock splits should,at least conceptually,have the same effect on shareholders' wealth.
A)True
B)False
Q3) A reverse split reduces the number of shares outstanding.
A)True
B)False
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Chapter 16: Capital Structure Decisions
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Q1) Morales Publishing's tax rate is 40%,its beta is 1.10,and it uses no debt.However,the CFO is considering moving to a capital structure with 30% debt and 70% equity.If the risk-free rate is 5.0% and the market risk premium is 6.0%,by how much would the capital structure shift change the firm's cost of equity?
A)1.53%
B)1.70%
C)1.87%
D)2.05%
E)2.26%
Q2) Refer to Exhibit 16.2.What would the stock price be if VF issued the new debt and immediately used the proceeds to repurchase stock?
A)$49.43
B)$50.70
C)$52.00
D)$53.33
E)$56.00
Q3) Whenever a firm borrows money,it is using financial leverage.
A)True
B)False
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Page 18
Chapter 17: Dynamic Capital Structures and Corporate Valuation
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Q1) Refer to Exhibit 17.2.According to the MM extension with growth,what is the value of Kitto's tax shield?
A)$156,385
B)$164,616
C)$173,280
D)$182,400
E)$192,000
Q2) Which of the following statements concerning the MM extension with growth is NOT CORRECT?
A)The value of a growing tax shield is greater than the value of a constant tax shield.
B)For a given D/S, the levered cost of equity is greater than the levered cost of equity under MM's original (with tax) assumptions.
C)For a given D/S, the WACC is less than the WACC under MM's original (with tax) assumptions.
D)The total value of the firm increases with the amount of debt.
E)The tax shields should be discounted at the unlevered cost of equity.
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Chapter
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Q1) Refer to Exhibit 18.1.What will the after-tax annual interest savings for NWW be if the refunding takes place?
A)$664,050
B)$699,000
C)$768,900
D)$845,790
E)$930,369
Q2) Stanovich Enterprises has 10-year,12.0% semiannual coupon bonds outstanding.Each bond is now eligible to be called at a call price of $1,060.If the bonds are called,the company must replace them with new 10-year bonds.The flotation cost of issuing new bonds is estimated to be $45 per bond.How low would the yield to maturity on the new bonds have to be in order for it to be profitable to call the bonds today,i.e.,what is the nominal annual "breakeven rate"?
A)9.29%
B)9.78%
C)10.29%
D)10.81%
E)11.35%
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Chapter 19: Lease Financing
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Sample Questions
Q1) Stanley Inc.must purchase $6,000,000 worth of service equipment and is weighing the merits of leasing the equipment or purchasing.The company has a zero tax rate due to tax loss carry-forwards,and is considering a 5-year,bank loan to finance the equipment.The loan has an interest rate of 10% and would be amortized over 5 years,with 5 end-of-year payments.Stanley can also lease the equipment for 5 end-of-year payments of $1,790,000 each.How much larger or smaller is the bank loan payment than the lease payment? Note: Subtract the loan payment from the lease payment.
A)$177,169
B)$196,854
C)$207,215
D)$217,576
E)$228,455
Q2) Assume that a piece of leased equipment has a relatively high rather than low expected residual value.From the lessee's viewpoint,it might be better to own the asset rather than lease it because with a high residual value the lessee will likely face a higher lease rate.
A)True
B)False
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Page 21
Chapter
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Q1) Refer to Exhibit 20.1.What is the bond's conversion ratio?
A)27.14
B)28.57
C)30.00
D)31.50
E)33.08
Q2) 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
Q3) 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
Q4) The owner of a convertible bond owns,in effect,both a bond and a call option.
A)True
B)False
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Chapter 21: Supply Chains and Working Capital Management
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Q1) Buchholz Corporation follows a moderate current asset investment policy,but it is now considering a change,perhaps to a restricted or maybe to a relaxed policy.The firm's annual sales are $400,000; its fixed assets are $100,000; its target capital structure calls for 50% debt and 50% equity; its EBIT is $35,000; the interest rate on its debt is 10%; and its tax rate is 40%.With a restricted policy,current assets will be 15% of sales,while under a relaxed policy they will be 25% of sales.What is the difference in the projected ROEs between the restricted and relaxed policies?
A)4.25%
B)4.73%
C)5.25%
D)5.78%
E)6.35%
Q2) Not taking cash discounts is costly,and as a result,firms that do not take them are usually those that are performing poorly and have inadequate cash balances.
A)True
B)False
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Page 23
Chapter 22: Providing and Obtaining Credit
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Q1) Credit standards refer to the financial strength and importance of a potential customer to the firm required in order to qualify for credit.
A)True
B)False
Q2) Danby Design Inc.has approached the bank with its plan to borrow $12,000.The bank offers the choice of a 12 percent discount interest loan or a 10.19 percent add-on,one-year installment loan,payable in 4 equal quarterly payments.What is the approximate (nominal)rate of interest on the 10.19 percent add-on loan?
A)5.10%
B)10.19%
C)12.00%
D)20.38%
E)30.57%
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: Advanced Issues in Cash Management and Inventory Control
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Q1) Refer to Exhibit 23.2.How many orders should Cartwright place during the year?
A)12
B)25
C)30
D)40
E)60
Q2) Halliday Inc.receives a $2 million payment once a year.Of this amount,$700,000 is needed for cash payments made during the next year.Each time Halliday deposits money in its account,a charge of $2.00 is assessed to cover clerical costs.If Halliday can hold marketable securities that yield 5 percent,and then convert these securities to cash at a cost of only the $2 deposit charge,what is the total cost for one year of holding the minimum cost cash balance according to the Baumol model?
A)$7,483
B)$187
C)$3,741
D)$374
E)$748
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25
Chapter 24: Enterprise Risk Management
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Q1) A commercial bank recognizes that its net income suffers whenever interest rates increase.Which of the following strategies would protect the bank against rising interest rates?
A)Entering into an interest rate swap where the bank receives a fixed payment stream, and in return agrees to make payments that float with market interest rates.
B)Purchase principal only (PO) strips that decline in value whenever interest rates rise.
C)Enter into a short hedge where the bank agrees to sell interest rate futures.
D)Sell some of the bank's floating-rate loans and use the proceeds to make fixed-rate loans.
E)Buying inverse floaters.
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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Chapter 25: Bankruptcy, reorganization, and Liquidation
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Q1) Even if a firm's cash flow projections indicate that it will soon be unable to meet its interest payments,a bankruptcy case cannot begin until the firm actually defaults on a scheduled payment.
A)True
B)False
Q2) Bankruptcy plays no role in settling labor disputes and product liability suits.Such issues are outside the bounds of bankruptcy law and are covered by other statutes.
A)True
B)False
Q3) A central question that must be addressed in bankruptcy proceedings is whether the firm's inability to meet scheduled interest payments results from a temporary cash flow problem or from a potentially permanent problem caused by falling asset values.
A)True
B)False
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Chapter 26: Mergers and Corporate Control
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Q1) Refer to Exhibit 26.1.What is the value of Glassmakers' equity to Best? (Round your answer to the closest thousand dollars.)
A)$16,019,000
B)$17,111,000
C)$18,916,000
D)$22,111,000
E)$22,916,000
Q2) Only if a target firm's value is greater to the acquiring firm than its market value as a separate entity will a merger be financially justified.
A)True
B)False
Q3) 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) Suppose a carton of hockey pucks sell in Canada for 105 Canadian dollars,and 1 Canadian dollar equals 0.71 U.S.dollars.If purchasing power parity (PPP)holds,what is the price of hockey pucks in the United States?
A)$14.79
B)$63.00
C)$74.55
D)$85.88
E)$147.88
Q2) When the value of the U.S.dollar appreciates against another country's currency,we may purchase more of the foreign currency with a dollar.
A)True
B)False
Q3) If an investor can obtain more of a foreign currency for a dollar in the forward market than in the spot market,then the forward currency is said to be selling at a discount to the spot rate.
A)True
B)False
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Chapter 28: Time Value of Money
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Q1) All other things held constant,the present value of a given annual annuity decreases as the number of periods per year increases.
A)True
B)False
Q2) At the end of 10 years,which of the following investments would have the highest future value? Assume that the effective annual rate for all investments is the same and is greater than zero.
A)Investment A pays $250 at the beginning of every year for the next 10 years (a total of 10 payments).
B)Investment B pays $125 at the end of every 6-month period for the next 10 years (a total of 20 payments).
C)Investment C pays $125 at the beginning of every 6-month period for the next 10 years (a total of 20 payments).
D)Investment D pays $2,500 at the end of 10 years (just one payment).
E)Investment E pays $250 at the end of every year for the next 10 years (a total of 10 payments).
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Chapter 29: Basic Financial Tools: a Review
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Sample Questions
Q1) Stock A's beta is 1.7 and Stock B's beta is 0.7.Which of the following statements must be true about these securities? (Assume market equilibrium.)
A)Stock B must be a more desirable addition to a portfolio than A.
B)Stock A must be a more desirable addition to a portfolio than B.
C)The expected return on Stock A should be greater than that on B.
D)The expected return on Stock B should be greater than that on A.
E)When held in isolation, Stock A has more risk than Stock B.
Q2) Your business has just taken out a 1-year installment loan for $72,500 at a nominal rate of 11.0% but with equal end-of-month payments.What percentage of the 2nd monthly payment will go toward the repayment of principal?
A)73.67%
B)77.55%
C)81.63%
D)85.93%
E)90.45%
Q3) A stock's beta measures its diversifiable risk relative to the diversifiable risks of other firms.
A)True
B)False
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Page 31
Chapter 30: Pension Plan Management
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Q1) Ms.Lloyd,who is 25 and expects to retire at age 60,has just been hired by the Chambers Corporation.Ms.Lloyd's current salary is $30,000 per year,but her wages are expected to increase by 5 percent annually over the next 35 years.Chambers has a defined benefit pension plan in which workers receive 2 percent of their final year's wages for each year of employment.Assume a world of certainty.Further,assume that all payments occur at year-end.What is Ms.Lloyd's expected annual retirement benefit,rounded to the nearest thousands of dollars?
A)$35,000
B)$57,000
C)$89,000
D)$116,000
E)$132,000
Q2) 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
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Q1) Which of the following statements about a not-for-profit firm's ownership is most correct?
A)The residual earnings (profits) of not-for-profit firms can be distributed to the firm's top managers.
B)Not-for-profit firms are exempt from federal taxes, but they must pay state and local taxes, including property taxes.
C)Upon liquidation of a not-for-profit firm, the proceeds from the sale of its assets are distributed, on a pro rata basis, to the firm's employees.
D)None of the profits are used for private inurement.
E)Not-for-profit firms are governed by a board of trustees whose members are elected by the community at large.
Q2) 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
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Chapter 32: a Values of the Areas Under the Standard
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Q1) There are 10,000,000 shares outstanding of O'Connell Co.'s stock,which now sells for $50 per share.The company plans to raise $100 million as new equity by selling common stock.Since the preemptive right is in the corporate charter,rights will be used.Management has decided that the rights should be worth $1 each: Such a price would assure that most stockholders would either exercise or sell their rights rather than just letting them expire,yet a careless failure to use the rights would not impose too severe a hardship on anyone.What subscription price should O'Connell set for its offering to obtain the desired price of the rights,and what will be the ex-rights stock price (M<sub>e</sub>),assuming the theoretical relationships hold? (Hint: N = Number of old shares/Number of new shares; Number of new shares = Dollars to be raised/Subscription price per share.) \(\text {Sub Price}\) \(\quad \) \(\text {Ex-rights}\)
a. \(\$ 39.65 \quad\quad \$ 42.50\)
b. \(\$ 40.25 \quad \quad\$ 43.50\)
c. \(\$ 42.65 \quad\quad \$ 47.50\)
d. \(\$ 44.55 \quad\quad \$ 49.00\)
e. \(\$ 46.65 \quad\quad \$ 50.00\)
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