Financial Decision Making
Chapter Exam Questions
Course Introduction
Financial Decision Making explores the principles and techniques vital for making informed financial choices in both personal and organizational contexts. The course covers key concepts such as budgeting, financial statement analysis, risk assessment, investment evaluation, and capital budgeting. Through real-world case studies and practical exercises, students develop the ability to analyze financial data, assess the impact of various financial decisions, and implement strategies that maximize value and support the long-term financial health of an organization or individual.
Recommended Textbook
Fundamentals of Corporate Finance 7th Edition by Richard
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Page 2
A. Brealey
Chapter 1: Goals and Governance of the Corporation
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Q1) Financial markets are used for trading:
A) both real assets and financial assets.
B) the goods and services produced by a firm.
C) securities, such as shares of IBM.
D) the raw materials used in manufacturing.
Answer: C
Q2) Ethical decision making by management has a payoff for shareholders in terms of:
A) improved capital structure.
B) enhanced reputation value.
C) increased managerial benefits.
D) higher dividend payments.
Answer: B
Q3) Which of the following would be considered a capital budgeting decision?
A) Planning to issue common stock rather than issuing preferred stock
B) Deciding to expand into a new line of products, at a cost of $5 million
C) Repurchasing shares of common stock
D) Issuing debt in the form of long-term bonds
Answer: B
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3
Chapter 2: Financial Markets and Institutions
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Q1) Like public companies,private companies can also use their stock price as a measure of performance.
A)True
B)False
Answer: False
Q2) The primary distinction between securities sold in the primary and secondary markets is the:
A) riskiness of the securities.
B) price of the securities.
C) previous issuance of the securities.
D) profitability of the issuing corporation.
Answer: C
Q3) The stocks of major corporations trade in many markets throughout the world on a continuous or near-continuous basis.
A)True
B)False
Answer: True
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Chapter 3: Accounting and Finance
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Q1) According to accrual accounting,when goods are not sold until the period after they were produced,then the cost of goods sold:
A) will be recognized in the first period.
B) will be recognized in the second period.
C) will be recognized when payment is received.
D)will be split between both periods
Answer: B
Q2) Discuss reasons why a market-value balance sheet may be distinctly different from a book-value balance sheet.
Answer: For some assets,depreciation expense is an accurate portrayal of reduction in market value.However,it is not at all uncommon for market value to be distinctly different from depreciated book value.This can be especially true for land,which is not depreciated but has often appreciated if it has been on the books for a long period of time.In a similar manner,liabilities may have a different market value if market interest rates on similar liabilities have changed sufficiently since the liability was issued.Finally,investors and analysts may have critical information about the future prospects for the firm that has not been incorporated into current generally accepted accounting principles.
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Chapter 5: The Time Value of Money
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Q1) An annuity due must have a present value at least as large as an equivalent ordinary annuity.
A)True
B)False
Q2) Would you prefer a savings account that paid 7% interest,compounded quarterly,over an account that paid 7.5% with annual compounding if you had $1,000 to deposit? Would the answer change if you had $100,000 to deposit?
Q3) Nominal dollars refer to the amount of purchasing power.
A)True
B)False
Q4) Why is it difficult and perhaps risky to evaluate financial projects based on APR alone?
Q5) Approximately how much should be accumulated by the beginning of retirement to provide a $2,500 monthly check that will last for 25 years,during which time the fund will earn 8% interest with monthly compounding?
A) $261,500.00
B) $323,800.00
C) $578,700.00
D) $690,000.00
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Chapter 6: Valuing Bonds
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Q1) Describe the process for calculating a yield to maturity for a bond,and tell what could cause the yield to maturity to change.
Q2) One-year Treasury bonds yield 5% while 2-year bonds yield 6%.You are quite confident that in 1 year's time 1-year bonds will yield 8%.Would the higher yield on 2-year bonds cause you to prefer them?
Q3) Bonds with a rating of Ba or below by Moody's are referred to as speculative grade,high-yield,or junk bonds.
A)True
B)False
Q4) Zero-coupon bonds are issued at prices below face value,and the investor's return comes from the difference between the purchase price and the payment of face value at maturity.
A)True
B)False
Q5) Which of the following bonds would be considered to be of investment grade?
A) A Caa-rated bond
B) A Ca-rated bond
C) A C-rated bond
D) A Baa-rated bond
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Chapter 7: Valuing Stocks
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Q1) When investors are not capable of making superior investment decisions on a continual basis based on past prices or public or private information,the market is said to be:
A) weak-form efficient.
B) semistrong-form efficient.
C) strong-form efficient.
D) fundamentally efficient.
Q2) Which of the following describes a seasoned offering?
A) An IPO of common stock for a well-known firm.
B) An IPO that is offered during the best buying season.
C) An additional equity issue from a publicly traded firm.
D) Any shares traded in the secondary market are seasoned offerings.
Q3) What is the value of the expected dividend per share for a stock that has a required return of 16%,a price of $45,and a constant-growth rate of 12%?
A) $1.80
B) $3.60
C) $4.50
D) $7.20
Q4) How does competition among investors lead to efficient markets?
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Chapter 8: Net Present Value and Other Investment Criteria
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Q1) A project's opportunity cost of capital is:
A) the forgone return from investing in the project.
B) the return earned by investing in the project.
C) equal to the average return on all company projects.
D) designed to be less than the project's IRR.
Q2) Soft capital rationing is imposed upon a firm from _____ sources,while hard capital rationing is imposed from _____ sources.
A) internal; external
B) internal; internal
C) external; internal
D)external; external
Q3) Which of the following is incorrect for a borrowing project?
A) Its NPV graph rises as discount rates increase.
B) Its cash flow at time zero is typically an inflow.
C) Its NPV is positive.
D)It's acceptable if IRR exceeds cost of capital.
Q4) The IRR is the rate of return on the cash flows of the investment,also known as the opportunity cost of capital.
A)True
B)False
Page 10
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Chapter 9: Using Discounted Cash-Flow Analysis to Make Investment Decisions
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Q1) Calculate the NPV for the following capital budgeting proposal: $100,000 initial cost,to be depreciated straight-line over 5 years to an expected salvage value of $5,000,35% tax rate,$45,000 additional annual revenues,$15,000 additional annual expense,$8,000 additional investment in working capital,and 11% cost of capital.
Q2) Calculate the present value of the depreciation tax shield for an asset in the 3-year class life costing $100,000.Three-year class percentages are 33.33%,44.45%,14.81%,and 7.41%,respectively for years 1 through 4.The firm has a 35% tax rate and a 10% cost of capital.Compare this present value to that calculated for straight-line depreciation with no salvage value.
Q3) Which of the following statements regarding calculating cash flow from operations is incorrect?
A) Cash flow from operations = revenues - cash expenses - taxes paid
B) Cash flow from operations = net profit + depreciation
C) Depreciation tax shield = depreciation * (1 -tax rate)
D) Cash flow from operations = (revenues - cash expenses) * (1 - tax rate) + (depreciation * tax rate)
Q4) How is the company's tax bill affected by depreciation and how does this affect project value?
Page 11
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Chapter 10: Project Analysis
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Q1) The economic break-even level of sales will be higher than the accounting break-even level.
A)True
B)False
Q2) Managers that accept projects that only break even on an accounting basis are helping their shareholders.
A)True
B)False
Q3) The capital budget should be consistent with the firm's:
A) growth in sales.
B) strategic plans.
C) current level of debt.
D) dividend policy.
Q4) Which of the following techniques may be more appropriate to analyze projects with interrelated variables?
A) Sensitivity analysis
B) Scenario analysis
C) Break-even analysis
D) DOL analysis
Q5) Define DOL and discuss what affects it and how to interpret it.
Page 12
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Chapter 11: Introduction to Risk,Return,and the Opportunity
Cost
of Capital
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Q1) Average returns on high-risk assets are higher than those on low-risk assets.
A)True
B)False
Q2) Market interest rates have risen substantially in the 5 years since an investor purchased Treasury bonds that were offering a 7% return.If the investor sells now he or she is likely to receive:
A) greater than a 7% total return.
B) less than a 7% total return.
C) a 7% total rate of return.
D) a 7% nominal return but less than a 7% real return.
Q3) Most of the beneficial effects of diversification will have been received by the time a portfolio of common stocks contains _____ stocks.
A) 2
B) 5
C) 20
D) 50
Q4) How is the standard deviation of returns for individual common stocks or for a stock portfolio calculated?
Q5) Why does diversification reduce risk?
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Chapter 12: Risk,Return,and Capital Budgeting
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Q1) The CAPM provides a model of determining expected security returns that is:
A) precise in its calculations of risk premiums.
B) imprecise, but generally an acceptable guideline.
C) excellent for high beta stocks.
D) excellent for well-diversified portfolios.
Q2) Which of the following is most likely correct for a diversified stock portfolio that exhibits a higher standard deviation than the market index?
A) The portfolio contains fairly aggressive stocks.
B) The portfolio's stock plot below the security market line.
C) The portfolio's beta is less than 1.0.
D) The portfolio contains a significant amount of unique risk.
Q3) The required risk premium for any investment is given by the security market line.
A)True
B)False
Q4) What effect might operating leverage be expected to have on a project's beta?
A) Beta will increase.
B) Beta will decrease.
C) Beta will not be affected.
D) The effect depends on the market risk premium.
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Chapter 13: The Weighted-Average Cost of Capital and Company Valuation
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Q1) A change in the company's capital structure will change the amount of taxes paid but will not change the WACC.
A)True
B)False
Q2) Why is debt financing said to include a tax shield for the company?
A) Taxes are reduced by the amount of the debt.
B) Taxes are reduced by the amount of the interest.
C) Taxable income is reduced by the amount of the debt.
D) Taxable income is reduced by the amount of the interest.
Q3) A company's CFO wants to maintain a target debt-to-equity ratio of 1/4.If the WACC is 18.6%,and the pretax cost of debt is 9.4%,what is the cost of common equity assuming a tax rate of 34%?
A) 19.90%
B) 20.90%
C) 21.70%
D) 22.73%
Q4) One way to check the correctness of the expected return on bonds is through the bond discount model.
A)True B)False
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Chapter 14: Introduction to Corporate Financing
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Q1) Junk bonds represent debt that was issued to:
A) finance the acquisition of used manufacturing equipment.
B) firms in countries with high rates of inflation.
C) offer higher yields and less security than other debt.
D) firms that have defaulted on their dividend payments.
Q2) Holders of callable bonds know that the company will wish to buy the issue back if interest rates fall,and therefore the price of the bond will not rise above the call price.
A)True
B)False
Q3) Additional paid-in capital refers to:
A) a firm's retained earnings.
B) a firm's treasury stock.
C) the difference between the issue price and the par value.
D) funds borrowed from a bank or bondholders.
Q4) Subordinated debt is an example of short-term debt for a firm.
A)True
B)False
Q5) What does it mean to say that financing is a zero-NPV transaction?
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Chapter 15: How Corporations Raise Venture Capital and Issue Securities
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Q1) The direct expense of a stock issue includes the:
A) cost of underpricing the stock.
B) underwriting spread and other expenses.
C) underwriting spread, other expenses, and cost of underpricing.
D) underwriting spread.
Q2) When a public company offers shares to the general public,it does so under a(n):
A) rights issue.
B) initial public offering.
C) shelf registration.
D) general cash offer.
Q3) The "winner's curse" is a reminder that:
A) successful bidders may often overpay for an object.
B) underwriters charge excessive fees.
C) stocks are much riskier than bonds.
D) underpricing an issue is a cost to existing owners.
Q4) Second-stage financing occurs:
A) prior to the initial public offering.
B) when company founders sell a portion of their shares.
C) after the best efforts of the underwriters.
D) when the IPO does not raise sufficient cash.
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Chapter 16: Debt Policy
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Q1) Calculate the firm's expected return on its assets if its expected return on debt is 10%,its expected return on equity is 20%,and its WACC is 14%.
A) 14%
B) 15%
C) 16%
D) Cannot be calculated
Q2) In the year ending October 2007,Walmart paid out $1,929 million as debt interest. How much more tax would Walmart have paid if the firm had been entirely equity-financed? What would be the present value of Walmart's interest tax shield if the company planned to keep its borrowing permanently at the 2007 level? Assume an interest rate of 6% and a corporate tax rate of 35%.
Q3) The interest tax shield is equal to the:
A) difference between interest expense and income taxes.
B) amount of interest paid in a given year.
C) product of the interest expense and the tax rate.
D) product of the debt principal and the interest rate on debt.
Q4) Discuss the trade-off theory of capital structure,including the determination of an optimal debt level.
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Chapter 17: Payout Policy
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Q1) Dividends are likely to shift up and down as earnings fluctuate so that managers can maintain a stable payout ratio.
A)True
B)False
Q2) You now own 84 shares of XYZ stock which is selling for $40 each,4 of which you just received from the XYZ corporation.XYZ has declared a:
A) stock dividend of 5%.
B) cash dividend of $4.
C) stock dividend of 4.76%.
D) cash dividend of $160.
Q3) Capital gains may be preferred by investors over dividends even if their tax rates are equal because:
A) taxes on dividends are withheld from paychecks.
B) taxes on capital gains are paid annually.
C) taxes on capital gains can be timed.
D) after-tax dividends are less certain than capital gains.
Q4) Why would payout decisions be used by management to signal the prospects of the firm?
Q5) What are the four main ways to implement stock repurchase?
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Chapter 18: Long-Term Financial Planning
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Q1) Which of the following statements is correct concerning the sustainable growth rate?
A) It increases as ROE decreases.
B) It increases as the payout ratio decreases.
C) It is maximized when the plowback ratio equals zero.
D) It is always less than the internal growth rate.
Q2) Sources and uses of funds are made equal through:
A) a balancing item.
B) pro forma financial statements.
C) borrowed cash.
D) additions to retained earnings.
Q3) Which of the following statements is not true regarding financial planning models?
A) They should include as much detail as possible.
B) The results of a model are pro forma financial statements.
C) The plug variable maintains consistency.
D) Financial analysis is not used in financial planning.
Q4) A typical horizon for long-term planning is 5 years.
A)True
B)False
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Chapter 19: Short-Term Financial Planning
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Q1) Which of the following is not typically a characteristic of commercial paper borrowing?
A) Maturity is short-term.
B) Banks are not the lenders.
C) The loans are secured.
D) Borrowers have high credit quality.
Q2) A company that borrows $1 million long term and invests the proceeds in inventory will see a $1 million increase in its net working capital.
A)True
B)False
Q3) When a firm finances long-term assets with short-term sources of funding,it:
A) reduces the risk of cash shortage.
B) will have lower interest expense.
C) improves the leverage ratio.
D) ignores the principle of matched maturities.
Q4) A company that pays $5,000 previously owed to one of its suppliers will see a $5,000 decrease in cash.
A)True
B)False
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Chapter 12: Risk, Return, and Capital Budgeting
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Q1) In general,a firm's credit policy should grant the credit whenever the expected:
A) loss from default is less than the cost of the product.
B) profit from granting credit exceeds zero.
C) profit exceeds the price of the product.
D) probability of a loss is less than 50%.
Q2) A firm with ______ profit margin should extend credit to customers with a high probability of default.
A) high
B) average
C) low
D) zero
Q3) The decision to offer credit depends on the probability of payment.You should grant credit if the expected profit from doing so is greater than the profit from refusing.
A)True
B)False
Q4) The break-even probability of collection is positively related to the firm's percentage of profit margin.
A)True
B)False
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Chapter 21: Mergers, Acquisitions, and Corporate Control
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Q1) In which merger type would one be least likely to observe economies of scale?
A) Horizontal
B) Vertical
C) Conglomerate
D) All of these
Q2) Firms A and B are each worth $50 million,but generate a $20 million gain when merged.If the cost of the merger was $5 million,how much did firm A pay for firm B?
A) $50 million
B) $55 million
C) $60 million
D) $65 million
Q3) Firms with substantial amounts of free cash flow often discover that:
A) conglomerate mergers are the best use for the funds.
B) accounting profits are what truly matter.
C) they have become takeover targets.
D) their capital budgets have been too low.
Q4) Why is it stated that the safest way of evaluating the potential gains from a merger is to focus on the changes in cash flow that will transpire as a result of the merger?
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Chapter 22: International Financial Management
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Q1) Knowing the value of compounding,you consider the opportunity to invest for 10 years in a Japanese investment that will return 12% annually.The U.S.alternative for a 10-year investment appears to offer 7% annually.The spot exchange rate is ¥96/$.What other concern should you have?
Q2) Predict the expected spot exchange rate between the Japanese yen and U.S.dollar,given that inflation in Japan,at 8%,is 4% higher than in the United States and that the current spot rate is ¥107/$.
A) ¥102.72/$
B) ¥103.04/$
C) ¥111.12/$
D) ¥111.28/$
Q3) The difference in interest rates between countries is believed to be equal to the expected change in spot exchange rates.
A)True
B)False
Q4) What is the difference between spot and forward exchange rates?
Q5) How do we perform on NPV analysis for projects with cash flows in foreign currencies?
Q6) What are some simple strategies to protect the firm against exchange rate risk?
Page 24
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Chapter 23: Options
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Q1) Callable bonds give the option to the issuing firm and hence reduce the value of the bond.
A)True
B)False
Q2) Which of the following statements is correct for an investor who has purchased "portfolio insurance" by owning the stock and buying a put option on the stock?
A) The investor profits when the stock price declines.
B) Maximum profitability occurs when stock price equals strike price.
C) Value per share can decline no further than the strike price less the value of the option premium.
D) The option will certainly be exercised.
Q3) Stock options have been traded on exchanges since:
A) the founding of the New York Stock Exchange.
B) options were discovered in 1946.
C) the early part of the 1970s.
D) just before the stock market crash in 1987.
Q4) The value of a call option increases as the strike price increases.
A)True
B)False
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Chapter 24: Risk Management
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Q1) Under what conditions can the use of options actually be detrimental to the firm's profitability?
Q2) Real estate futures on the Chicago Mercantile Exchange were launched in 2006 and enable participants to protect themselves against changes in house prices in 10 U.S.cities.
A)True
B)False
Q3) Counterparties to an interest rate swap exchange both interest payments and principal amounts.
A)True
B)False
Q4) The swap is the arrangement by two counterparties to exchange one stream of cash flow for another.
A)True
B)False
Q5) Which of the following futures contract is written on a nondeliverable asset?
A) U.S. Treasury bills
B) Wheat
C) Standard and Poor's index
D) British pounds
26
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