Financial Decision Making
Exam Materials
Course Introduction
Financial Decision Making is a course designed to provide students with foundational knowledge and practical tools for making effective financial choices in business and personal contexts. The course covers key concepts such as time value of money, capital budgeting, risk and return analysis, financial statement interpretation, and the evaluation of investment opportunities. Through a combination of theoretical frameworks and real-world case studies, students learn to identify financial alternatives, assess the potential outcomes, and make informed decisions that align with organizational or individual goals. The course also emphasizes ethical considerations and the impact of financial decisions on stakeholders.
Recommended Textbook
Intermediate Financial Management 13th Edition by Eugene F. Brigham
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Page 2
Chapter 1: An Overview of Financial Management and the Financial Environment
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Sample Questions
Q1) Which of the following statements is CORRECT
A) most businesses (by number and total dollar sales) are organized as partnerships or proprietorships because it is easier to set up and operate in one of these forms rather than as a corporation. however, if the business gets very large, it becomes advantageous to convert to a corporation, mainly because corporations have important tax advantages over proprietorships and partnerships.
B) due to limited liability, unlimited lives, and ease of ownership transfer, the vast majority of u.s. businesses (in terms of number of businesses) are organized as corporations.
C) most business (measured by dollar sales) is conducted by corporations in spite of large corporations' often less favorable tax treatment, due to legal considerations related to ownership transfers and limited liability.
D) large corporations are taxed more favorably than sole proprietorships.
E) corporate stockholders are exposed to unlimited liability.
Answer: C
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Chapter 2: Risk and Return-Part I
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Q1) In portfolio analysis, we often use ex post (historical) returns and standard deviations, despite the fact that we are really interested in ex ante (future) data.
A)True
B)False
Answer: True
Q2) You observe the following information regarding Companies X and Y: Company X has a higher expected return than Company Y. Company X has a lower standard deviation of returns than Company Y. Company X has a higher beta than Company Y.
Given this information, which of the following statements is CORRECT
A) company x has a lower coefficient of variation than company y.
B) company x has less market risk than company y.
C) company x's returns will be negative when y's returns are positive.
D) company x's stock is a better buy than company y's stock.
E) company x has more diversifiable risk than company y.
Answer: A
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4
Chapter 3: Risk and Return-Part II
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Q1) A stock with a beta equal to -1.0 has zero systematic (or market) risk.
A)True
B)False
Answer: False
Q2) If the returns of two firms are negatively correlated, then one of them must have a negative beta.
A)True
B)False
Answer: True
Q3) The SML relates required returns to firms' systematic (or market) risk. The slope and intercept of this line can be influenced by managerial actions.
A)True
B)False Answer: False
Q4) It is possible for a firm to have a positive beta, even if the correlation between its returns and those of another firm are negative.
A)True
B)False Answer: True
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Chapter 4: Bond Valuation
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Q1) Listed below are some provisions that are often contained in bond indentures. Which of these provisions, viewed alone, would tend to reduce the yield to maturity that investors would otherwise require on a newly issued bond?
1) Fixed assets are used as security for a bond.
2) A given bond is subordinated to other classes of debt.
3) The bond can be converted into the firm's common stock.
4) The bond has a sinking fund.
5) The bond has a call provision.
6) The indenture contains covenants that prevent the use of additional debt.
A) 1, 4, 6
B) 1, 2, 3, 4, 6
C) 1, 2, 3, 4, 5, 6
D) 1, 3, 4, 5, 6
E) 1, 3, 4, 6
Q2) The desire for floating-rate bonds, and consequently their increased usage, arose out of the experience of the early 1980s, when inflation pushed interest rates up to very high levels and thus caused sharp declines in the prices of outstanding bonds.
A)True
B)False
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Page 6
Chapter 5: Financial Options
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Q1) Which of the following statements is CORRECT?
A) call options generally sell at a price less than their exercise value.
B) if a stock becomes riskier (more volatile), call options on the stock are likely to decline in value.
C) call options generally sell at prices above their exercise value, but for an in-the-money option, the greater the exercise value in relation to the strike price, the lower the premium on the option is likely to be.
D) because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock.
E) if the underlying stock does not pay a dividend, it makes good economic sense to exercise a call option as soon as the stock's price exceeds the strike price by about 10%, because this permits the option holder to lock in an immediate profit.
Q2) An option is a contract that gives its holder the right to buy or sell an asset at a predetermined price within a specified period of time.
A)True
B)False
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Chapter 6: Accounting for Financial Management
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Q1) Which of the following factors could explain why Regal Industrial Fixtures had a negative net cash flow last year, even though the cash on its balance sheet increased?
A) the company repurchased 20% of its common stock.
B) the company sold a new issue of bonds.
C) the company made a large investment in new plant and equipment.
D) the company paid a large dividend.
E) the company had high amortization expenses.
Q2) DeYoung Devices Inc., a new high-tech instrumentation firm, is building and equipping a new manufacturing facility. Assume that currently its equipment must be depreciated on a straight-line basis over 10 years, but Congress is considering legislation that would require the firm to depreciate the equipment over 7 years. If the legislation becomes law, which of the following would occur in the year following the change?
A) the firm's reported net income would increase.
B) the firm's operating income (ebit) would increase.
C) the firm's taxable income would increase.
D) the firm's net cash flow would increase.
E) the firm's tax payments would increase.
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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 current ratio?
A) use cash to increase inventory holdings.
B) reduce the company's days' sales outstanding to the industry average and use the resulting cash savings to purchase plant and equipment.
C) use cash to repurchase some of the company's own stock.
D) borrow using short-term debt and use the proceeds to repay debt that has a maturity of more than one year.
E) issue new stock and then use some of the proceeds to purchase additional inventory and hold the remainder as cash.
Q2) Which of the following would indicate an improvement in a company's financial position, holding other things constant?
A) the current and quick ratios both increase.
B) the inventory and total assets turnover ratios both decline.
C) the debt ratio increases.
D) the profit margin declines.
E) the ebitda coverage ratio declines.
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Chapter 8: Basic Stock Valuation
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Q1) Founders' shares are a type of classified stock where the shares are owned by the firm's founders, and they generally have more votes per share than the other classes of common stock.
A)True
B)False
Q2) A company's free cash flow was just FCF0 = $1.50 million. The weighted average cost of capital is WACC = 10.1%, and the constant growth rate is g = 4.0%. What is the current value of operations?
A) $23.11 million
B) $23.70 million
C) $24.31 million
D) $24.93 million
E) $25.57 million
Q3) The cash flows associated with common stock are more difficult to estimate than those related to bonds because stock has a residual claim against the company versus a contractual obligation for a bond.
A)True
B)False
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10
Chapter 9: Corporate Valuation and Financial Planning
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Q1) One of the necessary steps in the financial planning process is a forecast of financial statements under each alternative version of the operating plan in order to analyze the effects of different operating procedures on projected profits and financial ratios.
A)True
B)False
Q2) Firms with high capital intensity ratios have found ways to lower this ratio permitting them to achieve a given level of growth with fewer assets and consequently less external capital. For example, just-in-time inventory systems, multiple shifts for labor, and outsourcing production are all feasible ways for firms to reduce their capital intensity ratios.
A)True
B)False
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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Q1) Which one of the following statements is TRUE?
A) one tool of corporate governance is how the company's charter affects the likelihood of a takeover.
B) one tool of corporate governance is stock repurchases.
C) one tool of corporate governance is a company's tax avoidance strategy.
D) one tool of corporate governance is choosing a good investment banker.
E) creditors have a claim on a firm's earning stream through the dividend payments they receive.
Q2) Which one of the following statements is TRUE?
A) a manager avoiding a positive npv but risky project is an example of a manager-shareholder conflict.
B) management is said to be entrenched when the company is doing badly and is "stuck in a rut."
C) a quarter-end bonus is an example of a nonpecuniary benefit.
D) a company's matching contribution to a retirement plan is a nonpecuniary benefit.
E) company sponsorship of a local charity is an example of a nonpecuniary benefit.
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Chapter 11: Determining the Cost of Capital
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Q1) For capital budgeting and cost of capital purposes, the firm should always consider reinvested earnings as the first source of capital-i.e., use these funds first because reinvested earnings have no cost to the firm.
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) The cost of debt is equal to one minus the marginal tax rate multiplied by the interest rate on new debt.
A)True
B)False
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Page 13
Chapter 12: Capital Budgeting: Decision Criteria
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Sample Questions
Q1) Nichols Inc. is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's IRR can be less than the cost of capital or negative, in both cases it will be rejected. \(\begin{array}{cccccccc}
\text { Year } & 0 & 1 & 2 & 3 & 4 & 5 \\ \text { Cash flows }& -\$ 1250 & \$ 325 & \$ 325 & \$ 325 & \$ 325 & \$ 325 \end{array}\)
A) 9.43%
B) 9.91%
C) 10.40%
D) 10.92%
E) 11.47%
Q2) Because "present value" refers to the value of cash flows that occur at different points in time, a series of present values of cash flows should not be summed to determine the value of a capital budgeting project.
A)True
B)False
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Chapter 13: Capital Budgeting-Estimating Cash Flows and Analyzing Risk
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Q1) Superior analytical techniques, such as NPV, used in combination with risk-adjusted cost of capital estimates, can overcome the problem of poor cash flow estimation and lead to generally correct accept/reject decisions.
A)True
B)False
Q2) When evaluating a new project, firms should include in the projected cash flows all of the following EXCEPT:
A) previous expenditures associated with a market test to determine the feasibility of the project, provided those costs have been expensed for tax purposes.
B) the value of a building owned by the firm that will be used for this project.
C) a decline in the sales of an existing product, provided that decline is directly attributable to this project.
D) the salvage value of assets used for the project that will be recovered at the end of the project's life.
E) changes in net working capital attributable to the project.
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15
Chapter 14: Real Options
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Sample Questions
Q1) Refer to the data for Nationwide Pharmaceutical Corporation (NPC). Calculate the effect of waiting on the project's risk, using the same data. By how much will delaying reduce the project's coefficient of variation? (Hint: Use the expected NPV.)
A) 2.23
Q2) 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
Q3) Real options are most valuable when the underlying source of risk is very low. A)True
B)False
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Page 16
Chapter 15: Distributions to Shareholders-Dividends and Repurchases
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Q1) Which of the following statements is correct?
A) one nice feature of dividend reinvestment plans (drips) is that they reduce the taxes investors would have to pay if they received cash dividends.
B) empirical research indicates that, in general, companies send a negative signal to the marketplace when they announce an increase in the dividend, and as a result share prices fall when dividend increases are announced. the reason is that investors interpret the increase as a signal that the firm has relatively few good investment opportunities.
C) if a company wants to raise new equity capital rather steadily over time, a new stock dividend reinvestment plan would make sense. however, if the firm does not want or need new equity, then an open market purchase dividend reinvestment plan would probably make more sense.
D) dividend reinvestment plans have not caught on in most industries, and today about 99% of all companies with drips are utilities.
E) under the tax laws as they existed in 2008, a dollar received for repurchased stock must be taxed at the same rate as a dollar received as dividends.
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Page 17
Chapter 16: Capital Structure Decisions
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Q1) Barette Consulting currently has no debt in its capital structure, has $500 million of total assets, and its basic earning power is 15%. The CFO is contemplating a recapitalization where it will issue debt at a cost of 10% and use the proceeds to buy back shares of the company's common stock, paying book value. If the company proceeds with the recapitalization, its operating income, total assets, and tax rate will remain unchanged. Which of the following is most likely to occur as a result of the recapitalization?
A) the roa would remain unchanged.
B) the basic earning power ratio would decline.
C) the basic earning power ratio would increase.
D) the roe would increase.
E) the roa would increase.
Q2) The Miller model begins with the MM model with corporate taxes and then adds personal taxes.
A)True
B)False
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 data for Kitto Electronics. Using the compressed adjusted present value model, what is Kitto's value of equity?
A) $1,492,000
B) $1,529,300
C) $1,567,533
D) $1,606,721
E) $1,646,889
Q2) If the firm uses the after-tax cost of new debt as the discount rate when analyzing a refunding decision, and if the NPV of refunding is positive, then the value of the firm will be maximized if it immediately calls the outstanding debt and replaces it with an issue that has a lower coupon rate.
A)True
B)False
Q3) In the compressed adjusted present value model, the appropriate discount rate for the tax shield is the unlevered cost of equity.
A)True
B)False
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Page 19
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Q1) The cost of meeting SEC and possibly additional state reporting requirements regarding disclosure of financial information, the danger of losing control, and the possibility of an inactive market and an attendant low stock price are potential disadvantages of going public.
A)True
B)False
Q2) Going public establishes a market value for the firm's stock, and it also ensures that a liquid market will continue to exist for the firm's shares. This is especially true for small firms that are not widely followed by security analysts.
A)True
B)False
Q3) Which of the following is generally NOT true and an advantage of going public?
A) increases the liquidity of the firm's stock.
B) makes it easier to obtain new equity capital.
C) establishes a market value for the firm.
D) makes it easier for owner-managers to engage in profitable self-dealings.
E) facilitates stockholder diversification.
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Page 20
Chapter 19: Lease Financing
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Q1) Operating leases often have terms that include
A) full amortization over the life of the lease.
B) very high penalties if the lease is canceled.
C) restrictions on how much the leased property can be used.
D) much longer lease periods than for most financial leases.
E) maintenance of the equipment by the lessor.
Q2) Heavy use of off-balance sheet lease financing will tend to
A) make a company appear less risky than it actually is because its stated debt ratio will appear lower.
B) affect a company's cash flows but not its degree of risk.
C) have no effect on either cash flows or risk because the cash flows are already reflected in the income statement.
D) affect the lessee's cash flows but only due to tax effects.
E) make a company appear more risky than it actually is because its stated debt ratio will be increased.
Q3) Under a sale and leaseback arrangement, the seller of the leased property is the lessee and the buyer is the lessor.
A)True
B)False
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Page 21
Chapter 20: Hybrid Financing Preferred Stock-Warrants and Convertibles
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Q1) Convertible debentures for Kulik Corporation were issued at their $1,000 par value in 2012. At any time prior to maturity on February 1, 2032, a debenture holder can exchange a bond for 25 shares of common stock. What is the conversion price, Pc?
A) $40.00
B) $42.00
C) $44.10
D) $46.31
E) $48.62
Q2) Corporations that invest surplus funds in floating-rate preferred stock benefit from getting a relatively stable price, which is desirable for liquidity portfolios, and they also benefit from the 70% tax exemption on preferred dividends received.
A)True
B)False
Q3) The owner of a convertible bond owns, in effect, both a bond and a call option.
A)True
B)False
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22
Chapter 21: Supply Chains and Working Capital Management
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Q1) Marshall Inc. recently hired your consulting firm to improve the company's performance. It has been highly profitable but has been experiencing cash shortages due to its high growth rate. As one part of your analysis, you want to determine the firm's cash conversion cycle. Using the following information and a 365-day year, what is the firm's present cash conversion cycle?
\(\begin{array}{lr}
\text { Average inventory }= & \$ 75,000 \\
\text { Annual sales }= & \$ 600,000 \\
\text { Annual cost of goods sold }= & \$ 360,000 \\
\text { Average accounts receivable }= & \$ 160,000 \\
\text { Average accounts payable }= & \$ 25,000
\end{array}\)
A) 120.6 days
B) 126.9 days
C) 133.6 days
D) 140.6 days
E) 148.0 days
Q2) The aging schedule is a commonly used method for monitoring receivables.
A)True B)False
Page 23
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Chapter 22: Providing and Obtaining Credit
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Questions
Q1) The primary reason to monitor aggregate accounts receivable is to see if customers, on average, are paying more slowly.
A)True
B)False
Q2) Refer to Exhibit Van Doren. What would be the cost to Van Doren of the discounts taken?
A) $116,750
B)$108,750
C) $155,000
D) $225,000
E) $260,500
Q3) 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
Q4) The collection process, although sometimes difficult, is a fairly inexpensive component of doing business.
A)True
B)False
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Chapter 23: Other Topics in Working Capital Management
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Q1) During times of inflation, which of these inventory accounting methods is best for cash flow?
A) lifo, because the most expensive goods are recorded as being sold first, resulting in a higher cost of goods sold and a lower reported net income.
B) specific identification, because it correctly identifies the actual item sold and so the actual cost is recorded on the income statement.
C) weighted average, because it smoothes the reported cost of goods sold over time.
D) it doesn't matter which you use since cash flow is unaffected by the choice of inventory identification method.
E) fifo, because the cheapest goods are recorded as being sold first, resulting in lower cost of goods sold and higher reported net income.
Q2) The cash balances of most firms consist of transactions, compensating, precautionary, and speculative balances. We can produce a total desired cash balance by calculating the amount needed for each purpose and then summing them together.
A)True
B)False
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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) Interest rate swaps allow a firm to exchange fixed for floating-rate payments, but a swap cannot reduce actual net interest expenses.
A)True
B)False
Q3) The two basic types of hedges involving the futures market are long hedges and short hedges, where the words "long" and "short" refer to the maturity of the hedging instrument. For example, a long hedge might use Treasury bonds, while a short hedge might use 3-month T-bills.
A)True
B)False
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Chapter 25: Bankruptcy-Reorganization and Liquidation
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Q1) Chapter 7 of the Bankruptcy Act is designed to do which of the following?
A) establish the rules of reorganization for firms with projected cash flows that eventually will be sufficient to meet debt payments.
B) ensure that the firm is viable after emerging from bankruptcy.
C) allow the firm to negotiate with each creditor individually.
D) provide safeguards against the withdrawal of assets by the owners of the bankrupt firm and allow insolvent debtors to discharge all of their obligations and to start over unhampered by a burden of prior debt.
E) protect shareholders against creditors.
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) 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
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Chapter 26: Mergers and Corporate Control
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Q1) A two-tier merger offer is one where the acquiring company offers to purchase the target company in a two-part transaction. Cash is paid to some stockholders, bonds are issued to others, but the total values of each part of the transaction are equal.
A)True
B)False
Q2) Synergistic benefits can arise from a number of different sources, including operating economies of scale, financial economies, and increased managerial efficiency.
A)True
B)False
Q3) A spin-off is a type of divestiture in which the assets of a division are sold to another firm.
A)True
B)False
Q4) Since managers' central goal is to maximize stock price, managerial control issues do not interfere with mergers that would benefit the target firm's stockholders.
A)True
B)False
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Chapter 27: Multinational Financial Management
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Q1) If the United States is running a deficit trade balance with China, then in a free market we would expect the value of the Chinese yuan to depreciate against the U.S. dollar.
A)True
B)False
Q2) The interest rate paid on Eurodollar deposits depends on the particular bank's lending rate and on rates available on U.S. money market instruments.
A)True
B)False
Q3) Suppose Stackpool Inc. had inventory in Britain valued at 240,000 pounds one year ago. The exchange rate for dollars to pounds was 1£ = 2 U.S. dollars. This year the exchange rate is 1£ = 1.82 U.S. dollars. The inventory in Britain is still valued at 240,000 pounds. What is the gain or loss in inventory value in U.S. dollars as a result of the change in exchange rates?
A) $240,000
B) $43,200
C) $0
D) $43,200.
E) $47,473
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Page 29
Chapter 28: Time Value of Money
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Q1) Your bank offers a savings account that pays 3.5% interest, compounded annually. How much will $500 invested today be worth at the end of 25 years?
A) $1,122.54
B) $1,181.62
C) $1,240.70
D) $1,302.74
E) $1,367.88
Q2) Midway through the life of an amortized loan, the percentage of the payment that represents interest could be equal to, less than, or greater than to the percentage that represents repayment of principal. The proportions depend on the original life of the loan and the interest rate.
A)True
B)False
Q3) Disregarding risk, if money has time value, it is impossible for the future value of a given sum to exceed its present value.
A)True
B)False
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Chapter 29: Basic Financial Tools: A review
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249 Verified Questions
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Sample Questions
Q1) Which of the following statements is CORRECT?
A) diversifiable risk can be reduced by forming a large portfolio, but normally even highly-diversified portfolios are subject to market (or systematic) risk.
B) a large portfolio of randomly selected stocks will have a standard deviation of returns that is greater than the standard deviation of a 1-stock portfolio if that one stock has a beta less than 1.0.
C) a large portfolio of stocks whose betas are greater than 1.0 will have less market risk than a single stock with a beta = 0.8.
D) if you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the market risk from the portfolio.
E) a large portfolio of randomly selected stocks will always have a standard deviation of returns that is less than the standard deviation of a portfolio with fewer stocks, regardless of how the stocks in the smaller portfolio are selected.
Q2) If the returns of two firms are negatively correlated, then one of them must have a negative beta.
A)True
B)False
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Page 31
Chapter 30: Pension Plan Management
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10 Verified Questions
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Sample Questions
Q1) 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
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) 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%
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32
Chapter 31: Financial Management in Not for Profit
Businesses
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Sample Questions
Q1) The primary goal of investor-owned firms is shareholder wealth maximization, while the primary goal of not-for-profit firms is typically stated in terms of some mission; for example, to provide health care services to the communities served.
A)True
B)False
Q2) Since not-for-profit firms do not pay taxes, they receive no tax benefits whatsoever from using debt financing.
A)True
B)False
Q3) Not-for-profit firms have fund capital in place of equity capital. Since fund capital does not have to provide a return to stockholders, the appropriate cost of fund capital in a cost of capital estimate is zero.
A)True
B)False
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