Financial Decision Making Practice
Questions
Course Introduction
Financial Decision Making introduces students to the fundamental concepts, tools, and techniques that underpin effective financial choices in business and personal contexts. The course explores key areas such as the time value of money, risk and return, capital budgeting, financial statement analysis, and the evaluation of investment alternatives. Students examine theoretical frameworks and apply quantitative methods to real-world scenarios, enabling them to assess financial performance, allocate resources efficiently, and make informed decisions aligned with strategic goals. Emphasis is placed on developing analytical skills and critical thinking necessary for navigating the complexities of today's financial environment.
Recommended Textbook
Corporate Finance The Core 4th Edition by Jonathan Berk
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Page 2
Chapter 1: The Corporation
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Q1) Explain the main differences between the NYSE and NASDAQ stock markets.
Answer: Key points: NYSE has physical location - NASDAQ is an electronic market. NYSE has one specialist in each stock and his role is to match buyers and sellers. NASDAQ has multiple market makers (dealers)in each stock who stand ready to trade on their own accounts.
Q2) The most senior financial manager in a corporation is usually called:
A)the chief executive officer.
B)the chief financial officer.
C)the chief operating officer.
D)the chairman of the board.
Answer: B
Q3) How much would you have to pay to purchase 100 shares of XYZ stock on November 18th?
A)$2520
B)$2525
C)$2593
D)$2600
Answer: D
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Chapter 2: Introduction to Financial Statement Analysis
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Q1) Luther Corporation's stock price is $39 per share and the company has 20 million shares outstanding.Its Debt -Capital Ratio for 2009 is closest to:
A)0.696
B)0.37
C)1.89
D)0.654
Answer: A
Q2) The firm's equity multiplier measures:
A)the value of assets held per dollar of shareholder equity.
B)the return the firm has earned on its past investments.
C)the firm's ability to sell a product for more than the cost of producing it.
D)how efficiently the firm is utilizing its assets to generate sales.
Answer: A
Q3) Which of the following balance sheet equations is INCORRECT?
A)Assets - Liabilities = Shareholders' Equity
B)Assets = Liabilities + Shareholders' Equity
C)Assets - Current Liabilities = Long Term Liabilities
D)Assets - Current Liabilities = Long Term Liabilities + Shareholders' Equity
Answer: C
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Page 4
Chapter 3: Financial Decision Making and the Law of One
Price
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Sample Questions
Q1) Assuming that the film maker issues the new security,the NPV for this project is closest to what amount? Should the film maker make the investment?
A)$1.7 million; Yes
B)$1.7 million; No
C)$2.7 million; Yes
D)$2.7 million; No
Answer: C
Q2) Suppose a risky security pays an average cash flow of $100 in one year.The risk-free rate is 5%,and the expected return on the market index is 13%.If the returns on this security are high when the economy is strong and low when the economy is weak,but the returns vary by only half as much as the market index,what risk premium is appropriate for this security?
A)4%
B)6.5%
C)9%
D)11%
Answer: A
Q3) The price per share of the ETF in a normal market is:
Answer: Value of ETF = 2 × 121.57 + 3 × 36.59 + 3 × 3.15 = $362.36
Page 5
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Chapter 4: The Time Value of Money
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Sample Questions
Q1) Which of the following is NOT a valid time value of money function in Excel?
A)PMT
B)NPER
C)I
D)FV
Q2) The British government has a consol bond outstanding that pays 100 in interest each year.Assuming that the current interest rate in Great Britain is 5% and that you will receive your first interest payment one year from now,then the value of the consol bond is closest to:
A) 1000
B) 1100
C) 2100
D) 2000
Q3) The amount of money that your great aunt Matilda originally put in the account is closest to:
A)$600
B)$800
C)$1000
D)$1200
Q4) Draw a timeline detailing the cash flows from investment "A."
Page 6
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Chapter 5: Interest Rates
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Q1) If your income tax rate is 30%,then the after-tax EAR for your home equity loan is closest to:
A)6.0%
B)5.9%
C)8.6%
D)5.8%
Q2) The effective annual rate (EAR)for a loan with a stated APR of 10% compounded quarterly is closest to:
A)9.65%
B)10.00%
C)10.38%
D)12.50%
Q3) If your income tax rate is 30%,then the after-tax return you receive on your money market fund is closest to:
A)3.7%
B)5.1%
C)3.6%
D)4.2%
Q4) What is the effective after-tax rate of each instrument,expressed as an EAR?
Q5) Should you purchase the delivery truck or lease it? Why?
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Chapter 6: Valuing Bonds
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Q1) Consider a bond that pays annually an 8% coupon with 20 years to maturity.The amount that the price of the bond will change if its yield to maturity increases from 5% to 7% is closest to:
A)-$270
B)-$225
C)-$310
D)-$250
Q2) Which of the following statements is FALSE?
A)Bonds are a securities sold by governments and corporations to raise money from investors today in exchange for promised future payments.
B)By convention the coupon rate is expressed as an effective annual rate.
C)Bonds typically make two types of payments to their holders.
D)The time remaining until the repayment date is known as the term of the bond.
Q3) The price today of a three-year default-free security with a face value of $1000 and an annual coupon rate of 4% is closest to:
A)$1002.78
B)$1003.31
C)$1028.50
D)$1028.61
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Page 8
Chapter 7: Investment Decision Rules
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Sample Questions
Q1) Assuming that Dewey's cost of capital is 12% EAR,then the NPV of his retainer offer is closest to:
A)-$7500
B)-$7400
C)$6000
D)$7400
Q2) The IRR for this project is closest to:
A)18.9%
B)22.7%
C)34.1%
D)39.1%
Q3) Explain why the NPV decision rule might provide Larry with a different decision outcome than the IRR rule when evaluating Larry's three movie deal offer.
Q4) The payback period for this project is closest to:
A)2.1 years
B)3.0 years
C)2.0 years
D)2.2 years
Q5) If the discount rate for project B is 15%,then what is the NPV for project B?
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Chapter 8: Fundamentals of Capital Budgeting
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Q1) Which of the following statements is FALSE?
A)Because only the tax consequences of depreciation are relevant for free cash flow,we should use the depreciation expense that the firm will use for tax purposes in our free cash flow forecasts.
B)A firm generally identifies its marginal tax rate by determining the tax bracket that it falls into based on its overall level of pre-tax income.
C)Free Cash Flow = (Revenues - Costs)× (1 - <sub>c</sub>)- Capital ExpendituresNWC + <sub>c</sub> × Depreciation.
D)Net working capital is the difference between current liabilities and current assets.
Q2) Money that has been or will be paid regardless of the decision whether or not to proceed with the project is:
A)cannibalization.
B)considered as part of the initial investment in the project.
C)an opportunity cost.
D)a sunk cost.
Q3) Epiphany is worried about the reliability of the sales forecast.How sensitive is the project's NPV to a 10% change in sales?
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Page 10
Chapter 9: Valuing Stocks
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Sample Questions
Q1) Which of the following is NOT a situation where a trader is able to identify positive NPV trading opportunities in the securities markets?
A)An investor who has access to information known only to a few investors.
B)An investor who has lower trading costs than other market participants.
C)An investor who gets up really early in the morning so he can be the first to read and act upon the information contained in that day's Wall Street Journal.
D)An investor who has expertise in a highly complicated area for which a company has just released information.
Q2) Which of the following statements is FALSE?
A)We should use the general dividend discount model to value the stock of a firm with rapid or changing growth.
B)As firms mature,their growth slows to rates more typical of established companies.
C)The dividend discount model values the stock based on a forecast of the future dividends paid to shareholders.
D)The simplest forecast for the firm's future dividends states that they will grow at a constant rate,g,forever.
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11
Chapter 10: Capital Markets and the Pricing of Risk
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Sample Questions
Q1) What is the expected payoff for Little Cure's ten drugs?
A)$500 million
B)$100 million
C)$1 billion
D)$0
Q2) What is the excess return for the S&P 500?
A)5.7%
B)7.0%
C)0%
D)8.4%
Q3) The standard deviation of the overall payoff to Bank B is closest to:
A)$751,000
B)$2,179,000
C)$2,375,000
D)$21,794,000
Q4) What is the market portfolio?
Q5) Suppose that you want to use the 10 year historical average return on the Market to forecast the expected future return on the Market.Calculate the 95% confidence interval for your estimate of the expect return.
Page 12
Q6) Which pharmaceutical company faces less risk?
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Chapter 11: Optimal Portfolio Choice and the Capital Asset Pricing Model
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Q1) The Sharpe ratio for the efficient portfolio is closest to:
A)0.7
B)1.0
C)1.4
D)1.2
Q2) The Correlation between Stock X's and Stock Y's returns is closest to:
A)0.58
B)0.29
C)0.69
D)0.10
Q3) Which of the following statements is FALSE?
A)Dividing the covariance by the volatilities ensures that correlation is always between -1 and +1.
B)Volatility is the square root of variance.
C)The closer the correlation is to 0,the more the returns tend to move together as a result of common risk.
D)If two stocks move together,their returns will tend to be above or below average at the same time,and the covariance will be positive.
Q4) Will adding the precious metals fund improve your portfolio?
Page 13
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Chapter 12: Estimating the Cost of Capital
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Q1) Which of the following statements is FALSE?
A)Because very little trading is required to maintain it,an equal-weighted portfolio is called a passive portfolio.
B)If the number of shares in a value weighted portfolio does not change,but only the prices change,the portfolio will remain value weighted.
C)The CAPM says that individual investors should hold the market portfolio,a value-weighted portfolio of all risky securities in the market.
D)A price weighted portfolio holds an equal number of shares of each stock,independent of their size.
Q2) The equity cost of capital for "Miney" is closest to:
A)6.30%
B)7.50%
C)9.30%
D)9.75%
Q3) Assume that you have $250,000 to invest and you are interested in creating a value-weighted portfolio of these four stocks.How many shares of each of the four stocks will you hold? What percentage of the shares outstanding of each stock will you hold?
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Page 14
Chapter 13: Investor Behavior and Capital Market Efficiency
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Sample Questions
Q1) The alpha for the informed investors is closest to:
A)-2.4%
B)-0.9%
C)0.0%
D)3.6%
Q2) Using the FFC four factor model and the historical average monthly returns,the expected monthly return for Wal-Mart is closest to:
A)0.71%
B)0.53%
C)1.38%
D)0.79%
Q3) Which of the following stocks represent selling opportunities?
1.Taggart Transcontinental
2.Rearden Metal
3.Wyatt Oil
4.Nielson Motors
A)1 only
B)1 and 2 only
C)2 and 3 only
D)2 and 4 only
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Chapter 14: Capital Structure in a Perfect Market
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Q1) Suppose that to raise the funds for the initial investment,the project is sold to investors as an all-equity firm.The equity holders will receive the cash flows of the project in one year.The market value of the unlevered equity for this project is closest to:
A)$94,100
B)$90,000
C)$86,250
D)$98,600
Q2) Which of the following statements is FALSE?
A)As long as investors can borrow or lend at the same interest rate as the firm,homemade leverage is a perfect substitute for the use of leverage by the firm.
B)When investors use leverage in their own portfolios to adjust the leverage choice made by the firm,we say that they are using homemade leverage.
C)The value of the firm is determined by the present value of the cash flows from its current and future investments.
D)The investor can re-create the payoffs of unlevered equity by borrowing and using the proceeds to purchase the equity of the firm.
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Chapter 15: Debt and Taxes
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Q1) The value of Shepard Industries with leverage is closest to:
A)$64 million
B)$100 million
C)$135 million
D)$114 million
Q2) If Flagstaff currently maintains a .5 debt to equity ratio,then the value of Flagstaff as a levered firm is closest to:
A)$114 million
B)$100 million
C)$111 million
D)$140 million
Q3) Assume that investors hold Google stock in retirement accounts that are free from personal taxes.If Google were to issue sufficient debt to reduce its taxes by $600 million per year permanently,then the value that would be created is closest to:
A)$6.4 billion
B)$8.6 billion
C)$9.8 billion
D)$14.3 billion
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17
Chapter 16: Financial Distress,managerial Incentives,and Information
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Q1) List five general categories of indirect costs associated with bankruptcy.
Q2) Which of the following projects should Nielson Motors accept?
A)1 only
B)1,2,and 3 only
C)1 and 4 only
D)2,3,and 5 only
Q3) The cost of ________ is highest for firms that can easily increase the risk of their investments.
A)asset substitution
B)debt overhang
C)debt covenants
D)debt maturity
Q4) Which of the following is NOT an indirect cost of bankruptcy?
A)Loss of suppliers
B)Fire sales of assets
C)Costs of appraisers
D)Loss of employees
Q5) Suppose that MI has zero-coupon debt with a $140 million face value due next year.Calculate the value of levered equity,the value of debt,and the total value of MI with leverage.
Page 18
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Chapter 17: Payout Policy
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Q1) Calculate Rockwood's stock price following the market becoming aware of the new information regarding Rockwood's true value,if (1)Rockwood completed the repurchase prior to the market becoming aware of the information and (2)Rockwood completed the repurchase following the market becoming aware of the new information.
Q2) The effective dividend tax rate for an investor in Rearden Metal is closest to: A)0%
B)20%
C)25%
D)30%
Q3) The price per share of Iota if they use the $200 million to expand is closest to:
A)$13.75
B)$16.50
C)$19.00
D)$16.80
Q4) The effective dividend tax rate in 1999 is closest to: A)0%
B)20%
C)25%
D)30%
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Chapter 18: Capital Budgeting and Valuation With Leverage
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Q1) Which of the following is NOT a step in valuation using the flow to equity method?
A)Determine the equity cost of capital,r<sub>E</sub>.
B)Compute the equity value,E,by discounting the free cash flow to equity using the equity cost of capital.
C)Determine the free cash flow to equity of the investment.
D)Determine the before-tax cost of capital,r<sub>U</sub>.
Q2) Which of the following statements is FALSE?
A)In the flow-to-equity valuation method,the cash flows to equity holders are then discounted using the weighted average cost of capital.
B)In the WACC and APV methods,we value a project based on its free cash flow,which is computed ignoring interest and debt payments.
C)In the flow-to-equity (FTE)valuation method,we explicitly calculate the free cash flow available to equity holders taking into account all payments to and from debt holders.
D)The first step in the FTE method is to determine the project's free cash flow to equity (FCFE).
Q3) Calculate the NPV for Iota's new project.
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Chapter 19: Valuation and Financial Modeling: a Case Study
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Q1) If the risk-free rate of interest is 6% and the market risk premium has historically averaged 5%,then the cost of capital for Nike is closest to:
A)14.7%
B)10.2%
C)9.1%
D)13.5%
Q2) Ideko's Accounts Receivable Days is closest to:
A)84 days
B)95 days
C)90 days
D)75 days
Q3) Assuming that Ideko has a EBITDA multiple of 8.5,then the continuation unlevered P/E ratio of Ideko in 2010 is closest to:
A)17.6
B)16.4
C)14.5
D)19.0
Q4) What is the purpose of the sensitivity analysis?
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