Essentials of Financial Management Practice Questions
Course Introduction
Essentials of Financial Management introduces students to the fundamental principles and practices of financial decision-making within organizations. The course covers key topics including financial analysis, planning and control, time value of money, capital budgeting, risk and return analysis, cost of capital, and working capital management. Emphasis is placed on understanding the critical role financial managers play in ensuring organizational sustainability and growth, as well as the impact of financial decisions on business operations and value creation. Through real-world examples and problem-solving exercises, students will develop skills essential for evaluating financial information and making sound business decisions.
Recommended Textbook
CFIN 3 3rd Edition by Scott Besley
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Chapter 1: An Overview of Managerial Finance
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Sample Questions
Q1) Which of the following is a reason why companies move into international operations?
A) To take advantage of lower production costs in regions of inexpensive labor.
B) To develop new markets for their finished products.
C) To better serve their primary customers.
D) Because important raw materials are located abroad.
E) All of the above.
Answer: E
Q2) Normal profits are those that result in rates of return that are just sufficient to attract new capital in financial markets.
A)True
B)False
Answer: True
Q3) No firm can take cost-increasing,socially responsible actions in a competitive marketplace and expect to continue to compete,even if those cost-increasing actions yield significant benefits to the firm.
A)True
B)False
Answer: False
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Page 3
Chapter 2: Analysis of Financial Statements
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Sample Questions
Q1) If a firm has high current and quick ratios,this always is a good indication that a firm is managing its liquidity position well.
A)True
B)False
Answer: False
Q2) The current ratio and inventory turnover ratio measure the liquidity of a firm.The current ratio measures the relation of a firm's current assets to its current liabilities and the inventory turnover ratio measures how rapidly a firm turns its inventory back into a "quick" asset or cash.
A)True
B)False
Answer: False
Q3) All of the following represent cash outflows to the firm except A) Taxes.
B) Interest payments.
C) Dividends.
D) Purchase of plant and equipment.
E) Depreciation.
Answer: E
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Page 4
Chapter 3: The Financial Environment: Markets, institutions, and Investment Banking
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Sample Questions
Q1) One of the benefits from financial intermediation is risk diversification in that the pool of funds collected can be spread across a variety of investments.
A)True
B)False
Answer: True
Q2) If a corporation that has been in business for many years (for example IBM)wants to raise funds by issuing new common stock,its stock will be sold in the __________ market.
A) primary
B) secondary
C) debt
D) money
E) In this case, the stock can be sold in more than one of the above markets.
Answer: A
Q3) American depository receipts are foreign stocks that sell in American stock exchanges and are denominated in dollar prices.
A)True
B)False
Answer: False
Page 5
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Chapter 4: The Time Value of Money
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Sample Questions
Q1) You want to buy a Nissan 350Z on your 27th birthday.You have priced these cars and found that they currently sell for $30,000.You believe that the price will increase by 5 percent per year until you are ready to buy.You can presently invest to earn 14 percent.If you just turned 20 years old,how much must you invest at the end of each of the next 7 years to be able to purchase the Nissan in 7 years?
A) $4,945.57
B) $3,933.93
C) $7,714.72
D) $3,450.82
E) $6,030.43
Q2) When a loan is amortized,the largest portion of the periodic payment goes to reduce principal in the early years of the loan such that the accumulated interest can be spread out over the life of the loan.
A)True
B)False
Q3) The coupon rate is the rate of return you could earn on alternative investments of similar risk.
A)True
B)False
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Page 6
Chapter 5: The Cost of Money
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Sample Questions
Q1) Treasury securities that mature in 6 years currently have an interest rate of 8.5%.Inflation is expected to be 5% each of the next three years and 6% each year after the third year.The maturity risk premium is estimated to be 0.1%(t - 1),where t is equal to the maturity of the bond (i.e.,the maturity risk premium of a one-year bond is zero).The real risk-free rate is assumed to be constant over time.What is the real risk-free rate of interest?
A) 0.25%
B) 0.50%
C) 1.00%
D) 1.75%
E) 2.50%
Q2) The expectations theory postulates that the term structure of interest rates is based on expectations regarding future inflation rates.
A)True
B)False
Q3) During or near peaks of business activity,yield curves that are flat or downward sloping (possibly with humps)often are prevalent.
A)True
B)False
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Page 7
Chapter 6: Bonds Debt-Characteristics and Valuation
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Sample Questions
Q1) S.Claus & Company is planning a zero coupon bond issue.The bond has a par value of $1,000,matures in 2 years,and will be sold at a price of $826.45.The firm's marginal tax rate is 40 percent.What is the annual after-tax cost of debt to the company on this issue?
A) 4.0%
B) 6.0%
C) 8.0%
D) 10.0%
E) 12.0%
Q2) All else equal,a zero-coupon bond's price is more sensitive to changes interest rates than a bond with a 10% annual coupon.
A)True
B)False
Q3) Because junk bonds are such high-risk instruments,the returns on such bonds aren't very high and the existence of this market detracts from social welfare.
A)True
B)False
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8
Chapter 7: Stocks Equity-Characteristics and Valuation
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Sample Questions
Q1) DAA's stock is selling for $15 per share.The firm's income,assets,and stock price have been growing at an annual 15 percent rate and are expected to continue to grow at this rate for 3 more years.No dividends have been declared as yet,but the firm intends to declare a dividend of D3 = $2.00 at the end of the last year of its supernormal growth.After that,dividends are expected to grow at the firm's normal growth rate of 6 percent.The firm's required rate of return is 18 percent.The stock is
A) Undervalued by $3.03.
B) Overvalued by $3.03.
C) Correctly valued.
D) Overvalued by $2.25.
E) Undervalued by $2.25.
Q2) The last dividend on Spirex Corporation's common stock was $4.00,and the expected growth rate is 10 percent.If you require a rate of return of 20 percent,what is the highest price you should be willing to pay for this stock?
A) $44.00
B) $38.50
C) $40.00
D) $45.69
E) $50.00
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Page 9
Chapter 8: Risk and Rates of Return
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Sample Questions
Q1) Stock Q has a beta ( )equal to 1.6 and Stock P has a beta equal to 0.8.Based on this information,according to the capital asset pricing model (CAPM),which of the following statements is correct?
A) The required rate of return for Stock Q, r<sub>Q</sub>, should be 1.6 times greater than the required rate of return for Stock P, r<sub>P</sub>.
B) The risk premium associated with Stock Q, RP<sub>Q</sub>, should be 1.6 times greater than the risk premium associated with Stock P, RP<sub>P</sub>.
C) The required rate of return for Stock Q, r<sub>Q</sub>, should be two times greater than the required rate of return for Stock P, r<sub>P</sub>.
D) The risk premium associated with Stock Q, RP<sub>Q</sub>, should be two times greater than the risk premium associated with Stock P, RP<sub>P</sub>.
E) None of the above is a correct answer.
Q2) The expected rate of return of an asset will always equal one of the possible rates of return for that asset.
A)True
B)False
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Chapter 9: Capital Budgeting Techniques
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Sample Questions
Q1) Which of the following statements is correct?
A) The modified internal rate of return (MIRR) of a project increases as the discount rate increases.
B) The internal rate of return (IRR) of a project increases as the required rate of return increases.
C) Both IRR and MIRR can produce the multiple rates of return.
D) When comparing two projects, the project with the higher IRR will also have the higher MIRR.
E) Both a and c are correct.
Q2) The internal rate of return is that discount rate which equates the present value of the cash outflows (or costs)with the present value of the cash inflows.
A)True
B)False
Q3) Under certain conditions,a particular project may have more than one IRR.One condition under which this situation can occur is if,in addition to the initial investment at time = 0,a negative cash flow occurs at the end of the project's life.
A)True
B)False
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11
Chapter 10: Project Cash Flows and Risk
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Sample Questions
Q1) In theory,the decision maker should view market risk as being of primary importance.However,within-firm,or corporate,risk is relevant to a firm's
A) Well-diversified stockholders, because it may affect debt capacity and operating income.
B) Management, because it affects job stability.
C) Creditors, because it affects the firm's credit worthiness.
D) All of the above are correct.
E) Only answers a and c are correct.
Q2) Which of the following cash flows are incremental cash flows that need to be considered when evaluating a capital project?
A) Interest expenses on the financing of the project.
B) Sunk costs of engineering study to determine the feasibility of the project.
C) Opportunity cost of land being used for project that the firm already owns.
D) Both a and b are correct.
E) None of the above.
Q3) When calculating the cash flows for a project,you should include interest payments.
A)True
B)False
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12
Chapter 11: The Cost of Capital
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Sample Questions
Q1) Since 70 percent of preferred dividends received by a corporation is excluded from taxable income,the component cost of equity for a company which pays half of its earnings out as common dividends and half as preferred dividends should,theoretically,be
Cost of equity = r<sub>s</sub>(0.30)(0.50)+ r<sub>s</sub>(1 - T)(0.70)(0.50).
A)True
B)False
Q2) Estimating the cost of common equity using the discounted cash flow approach may be difficult to evaluate because
A) the dividend yield is extremely difficult to estimate.
B) the proper growth rate is difficult to establish.
C) the current price of the common equity is always changing making it difficult to determine.
D) all of the above are difficult to estimate.
Q3) Flotation costs associated with issuing new equity cause the cost of external equity to be lower than the cost of retained earnings.
A)True B)False
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Chapter 12: Capital Structure
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Sample Questions
Q1) Which of the following statements is correct?
A) As a rule, the optimal capital structure is found by determining the debt-equity mix that maximizes expected EPS.
B) The optimal capital structure simultaneously maximizes EPS and minimizes the WACC.
C) The optimal capital structure minimizes the cost of equity, which is a necessary condition for maximizing the stock price.
D) The optimal capital structure simultaneously minimizes the cost of debt, the cost of equity, and the WACC.
E) Each of the above statements is false.
Q2) Other things held constant,an increase in financial leverage will increase a firm's market (or systematic)risk as measured by its beta coefficient.
A)True
B)False
Q3) The fact that interest is tax deductible makes corporate debt less expensive than common of preferred stock.
A)True
B)False
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14
Chapter 13: Distribution of Retained Earnings: Dividends and Stock Repurchases
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Q1) Managers,on average,do not raise dividends unless they believe future earnings will be able to sustain the higher level dividends.
A)True
B)False
Q2) If the information content,or signaling,hypothesis is correct,then changes in dividend policy can be important with respect to firm value and capital costs.
A)True
B)False
Q3) Ducheyne Electric recently declared a 15 percent stock dividend.On the date of the stock dividend Ducheyne had 16 million shares outstanding priced at $46 per share in the market.An accounting entry was required on the balance sheet transferring some retained earnings to the common stock account.If retained earnings was $280 million prior to the transaction,what was the dollar amount of retained earnings after the transfer?
A) $280.0 million
B) $110.4 million
C) $234.0 million
D) $277.6 million
E) $169.6 million
Page 15
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Chapter 14: Working Capital Policy
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Sample Questions
Q1) The average length of time required to convert a firm's receivables into cash is called the __________.
A) cash conversion cycle
B) inventory conversion period
C) receivables collection period
D) payables deferral period
E) days sales outstanding
Q2) The fact that no explicit interest cost is paid on accruals and that the firm can exercise considerable control over their level makes accruals an attractive source of additional funding.
A)True
B)False
Q3) Working capital management is not important for new firms since they will be able to generate positive cash flows at some time in the future.
A)True
B)False
Q4) The sale of common stock for cash will increase the current assets for a firm.
A)True
B)False
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Chapter 15: Managing Short-Term Assets
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Sample Questions
Q1) Refer to Aberwald Corporation.If the lead time for placing an order is 5 days,and Aberwald holds a safety stock equal to a 30-day supply of chips,then at what inventory level should an order be placed?
A) 15,570
B) 3,175
C) 12,250
D) 13,675
E) 8,124
Q2) Refer to East Lansing Appliances.What would be the incremental cost of carrying receivables if this change were made?
A) $108,750
B) -$116,250 (carrying costs would decline)
C) $157,900
D) -$225,000 (carrying costs would decline)
E) $260,500
Q3) Exchange rates influence a multinational firm's inventory policy because changing currency values can affect the value of inventory.
A)True
B)False
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Page 17
Chapter 16: Managing Short-Term Liabilities Financing
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Q1) A line of credit can be either a formal or informal agreement between borrower and bank regarding the maximum amount of credit the bank will extend to the borrower subject to certain conditions.
A)True
B)False
Q2) Coverall Carpets Inc.is planning to borrow $12,000 from the bank.The bank offers the choice of a 12 percent discounted interest loan or a 10.19 percent add-on,one-year installment loan,payable in 4 equal quarterly payments.What is the approximate effective rate of interest on the 10.19 percent add-on loan?
A) 5.095%
B) 10.19%
C) 12.00%
D) 20.38%
E) 30.57%
Q3) A revolving credit agreement is a formal line of credit usually used by large firms.The firm will pay a fee on the unused balance of the committed funds to compensate the bank for the commitment to extend those funds.
A)True
B)False
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Page 18
Chapter 17: Financial Planning and Control
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Sample Questions
Q1) Financial planning involves the projection of sales,income,and assets as well as the determination of the resources needed to achieve these projections.
A)True
B)False
Q2) The higher the percentage of a firm's total costs that are fixed,the higher the degree of operating leverage and the lower the operating breakeven point.
A)True B)False
Q3) Everything else equal,if a firm shifts its capital structure to include more debt than before the shift,then the firm's business risk should
A) increase because the degree of financial leverage increases.
B) decrease because the degree of operating leverage decreases.
C) not change because capital structure decisions should affect the firm's financial risk, not its business risk.
D) not change because, although additional common stock will increase financial risk, the business risk should decrease by the same amount.
E) increase because the degree of financial leverage increases
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19
Chapter 18: project Cash Flows and Risk
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Sample Questions
Q1) Other things held constant,which of the following would increase the NPV of a project being considered?
A) A shift from MACRS to straight-line depreciation.
B) Making the initial investment in the first year rather than spreading it over the first 3 years.
C) A decrease in the discount rate associated with the project.
D) The sale of the old machine, in a replacement decision, at a capital loss rather than at book value.
E) An increase in required working capital.
Q2) The primary advantage of accelerated depreciation over straight line depreciation is that the total,undiscounted,depreciation tax savings over the life of the project are greater when an accelerated depreciation method is used.
A)True
B)False
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