Course Introduction
Financial Decision Making
Pre-Test Questions
Financial Decision Making explores the fundamental principles and analytical tools used to make informed financial decisions in both personal and organizational contexts. The course covers topics such as time value of money, risk and return analysis, budgeting, capital investment appraisal, financial statement interpretation, and the use of quantitative techniques for financial planning. Through case studies, real-world scenarios, and hands-on exercises, students develop skills to assess financial information, evaluate alternatives, and recommend viable solutions that align with strategic objectives. The course also examines the ethical and global dimensions of financial decisions, preparing students to navigate complex financial environments with confidence and integrity.
Recommended Textbook
Fundamentals of Corporate Finance 3rd Eition by Jonathan Berk
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Page 2
Chapter 1: Corporate Finance and the Financial Manager
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Sample Questions
Q1) What is the bid-ask spread on the stock shown above?
A)1 cent
B)3 cents
C)6 cents
D)12 cents
Answer: B
Q2) How much money would a stock exchange make from buying and selling 500 shares of the stock under the conditions shown above?
A)$250
B)$3,000
C)$5,875
D)$210,375
Answer: A
Q3) What are the main differences between a limited partnership and a limited liability corporation?
Answer: A limited partnership is required to have at least one general partner. A limited liability corporation is similar to a limited partnership but without the general partner.
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Chapter 2: Introduction to Financial Statement Analysis
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Q1) According to the text, did Enron and WorldCom follow Generally Accepted Accounting Principles (GAAP)in their financial reporting process?
Answer: Many of the problems of Enron and WorldCom were kept hidden from boards and shareholders, until it was too late. People felt that the accounting statements of these companies, while often remaining True to the letter of GAAP, did not present an accurate picture of the financial health of the company.
Q2) In general, a successful firm will have a market-to-book ratio that is substantially greater than 1.
A)True
B)False
Answer: True
Q3) Which ratio would you use to measure the financial health of a firm by assessing that firm's leverage?
A)debt-equity or equity multiplier ratio
B)market-to-book ratio
C)market debt-equity ratio
D)current or quick ratio
Answer: A
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Chapter 3: Time Value of Money: an Introduction
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Sample Questions
Q1) You have a used CD store. At an estate sale, you can purchase 230 compact discs for $356.5. You believe you could sell the CDs for an average of $3.05 each. What is the net benefit of buying the CDs at the estate sale and selling them in your store?
A)$445
B)$545
C)$645
D)$345
Answer: D
Q2) The Law of One Price states that if equivalent goods or securities are traded simultaneously in different competitive markets, they will trade for the same price in each market.
A)True
B)False
Answer: True
Q3) To enable costs and benefits to be compared, they are typically converted into cash value at the time the benefit is received.
A)True
B)False
Answer: False
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Page 5
Chapter 4: Time Value of Money: Valuing Cash Flow
Streams
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Sample Questions
Q1) Suppose that a young couple has just had their first baby and they wish to insure that enough money will be available to pay for their child's college education. They decide to make deposits into an educational savings account on each of their daughter's birthdays, starting with her first birthday. Assume that the educational savings account will return a constant 9%. The parents deposit $2400 on their daughter's first birthday and plan to increase the size of their deposits by 7% each year. Assuming that the parents have already made the deposit for their daughter's 18th birthday, then the amount available for the daughter's college expenses on her 18th birthday is closest to ________.
A)$80,232
B)$160,463
C)$112,324
D)$176,509
Q2) A perpetuity has a PV of $20,000. If the interest rate is 6%, how much will the perpetuity pay every year?
A)$600
B)$960
C)$1200
D)$720
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Chapter 5: Interest Rates
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Q1) A small business repairs its store. The builders charge them $130,000 which will be paid back in monthly installments over three years at 6.80% APR. The builders will reduce this rate to 6.30% APR if they pay $2600 up front. By approximately how much will this reduce the monthly loan repayments?
A)$109
B)$218
C)$164
D)$55
Q2) An investor buys a property for $608,000 with a 25-year mortgage and monthly payments at 8.10% APR. After 18 months the investor resells the property for $667,525. How much cash will the investor have from the sale, once the mortgage is paid off?
A)$57,216
B)$100,129
C)$71,521
D)$143,041
Q3) Is it possible to analyze cash flows that occur in time intervals that are not exactly equal to a year?
Q4) How are interest and return of principal handled in an amortizing loan payment?
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Page 7
Chapter 6: Bonds
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Q1) Which of the following bonds will be least sensitive to a change in interest rates?
A)a ten-year bond with a $2,000 face value whose yield to maturity is 5.8% and coupon rate is 5.8% APR paid semiannually
B)a 15-year bond with a $5,000 face value whose yield to maturity is 7.4% and coupon rate is 6.2% APR paid annually
C)a 20-year bond with a $3,000 face value whose yield to maturity is 6.0% and coupon rate is 5.4% APR paid semiannually
D)a 30-year bond with a $1,000 face value whose yield to maturity is 5.5% and coupon rate is 6.4% APR paid annually
Q2) The above information is for a corporate bond issued by the Markel Corporation. What sort of bond is this?
A)a high-risk bond
B)an investment grade bond
C)a speculative bond
D)a high-yield bond
Q3) How can the financial calculator be used to calculate the price of a coupon bond from its yield to maturity?
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Chapter 7: Stock Valuation
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Q1) Which of the following models directly values all of the firm's equity, rather than a single share?
I. Dividend-discount model
II. Total payout model
III. Discounted cash flow model
A)I only
B)II only
C)III only
D)II and III
Q2) Which of the following statements is FALSE?
A)As firms mature, their earnings exceed their investment needs and they begin to pay dividends.
B)Total return equals earnings multiplied by the dividend payout rate.
C)Cutting the firm's dividend to increase investment will raise the stock price if, and only if, the new investments have a positive net present value (NPV).
D)We cannot use the constant dividend growth model to value the stock of a firm with rapid or changing growth.
Q3) What is a major assumption about growth rate in the dividend-discount model?
Q4) Can the dividend-discount model handle negative growth rates?
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Chapter 8: Investment Decision Rules
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Sample Questions
Q1) Under what situation can the net present value (NPV)profile be upward sloping?
Q2) A delivery service is buying 600 tires for its fleet of vehicles. One supplier offers to supply the tires for $80 per tire, payable in one year. Another supplier will supply the tires for $20,000 down today, then $45 per tire, payable in one year. What is the difference in PV between the first and the second offer, assuming interest rates are 8.1%?
A)-$860
B)-$229
C)-$574
D)$860
Q3) Most corporations measure the value of a project in terms of which of the following?
A)discount value
B)discount factor
C)future value (FV)
D)present value (PV)
Q4) What is a safe method to use when confronted with mutually exclusive projects?
Q5) Should personal preferences for cash today versus cash tomorrow play a role in the net present value (NPV)decision-making process?
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Page 10
Chapter 9: Fundamentals of Capital Budgeting
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Q1) Which of the following best explains why is it sensible for a firm to use an accelerated depreciation schedule such as MACRS rather than straight-line depreciation?
A)The firm will substantially decrease its depreciation tax shield across all of the depreciation timeline.
B)The firm can decide over how many years an item may be depreciated, thus allowing it full control of its depreciation expenses.
C)The firm will have substantially fewer depreciation expenses later in the depreciation timeline.
D)The firm will receive greater benefits to its cash flow earlier in the depreciation timeline and thus increase net present value (NPV).
Q2) The cash flow effect from a change in Net Working Capital is always equal in size and opposite in sign to the changes in Net Working Capital.
A)True B)False
Q3) How are the taxes paid under MACRS different from that paid under straight-line depreciation?
Q4) What is the most important function of sensitivity analysis?
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Chapter 10: Stock Valuation: a Second Look
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Q1) On a particular date, the above information concerning Office Depot, Incorporated, was given on Google Finance. Its competitor, Staples Incorporated, had a stock price of $24.33. Which of the following is closest to the EPS of Staples Incorporated if it is estimated using valuation multiples based on price-earnings ratios?
A)$1.58
B)$1.84
C)$2.63
D)$14.15
Q2) Praetorian Industries will pay a dividend of $2.50 per share this year and has an equity cost of capital of 8%. Praetorian's stock is currently trading at $84 per share. By comparing Praetorian with similar firms, an investor expects that its dividends will grow by up to 5% per year. What is the best next step that the investor should take regarding Praetorian's stock?
A)Sell any Praetorian stock that she owns.
B)Short Praetorian's stock.
C)Revise Praetorian's equity cost of capital.
D)Revise her estimate of Praetorian's dividend growth.
Q3) Which is the best valuation technique when using comparables?
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12
Chapter 11: Risk and Return in Capital Markets
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Q1) If returns on stock A are more volatile than the returns on stock B, the geometric average return of stock A will be ________ the geometric average return of stock B when their arithmetic average returns are same.
A)same as B)higher than C)lower than D)always same as
Q2) What is the diversification achieved by an investor if he invests in Exxon Mobil, Dell, and Bank of America?
Q3) The risk premium of a stock is NOT affected by its ________.
A)undiversifiable risk
B)market risk
C)systematic risk
D)unsystematic risk
Q4) When looking at investment portfolios historically, was there a pattern between returns and volatility?
Q5) Comment on the accuracy of the statement that as we put more stocks in a portfolio, its risk gets eliminated to zero.
Q6) Which type of investment has historically had the lowest volatility?
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Chapter 12: Systematic Risk and the Equity Risk Premium
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Q1) The beta of the market portfolio is ________.
A)0
B)-1
C)2
D)1
Q2) What diversification, if any, is achieved if two stocks in a portfolio are perfectly positively correlated?
Q3) Since total risk is greater than systematic risk, should standard deviation be always greater than beta?
Q4) The volatility of Home Depot Share prices is 50% and that of General Motors shares is 50%. When I hold both stocks in my portfolio and the stocks returns have zero correlation, the overall volatility of returns of the portfolio is ________.
A)more than 25%
B)less than 50%
C)more than 50%
D)less than 25%
Q5) While we are using historic return to estimate a stock's beta, why can't we use historic data to forecast the expected return for the stock?
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Chapter 13: The Cost of Capital
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Q1) A firm has $3 million market value and it sells preferred stock with a par value of $100. If the coupon rate on the preferred stock is 8% and the preferred stock trades at $92, what is the cost of preferred stock capital?
A)8.26%
B)8.70%
C)9.13%
D)9.57%
Q2) IBM expects to pay a dividend of $2 next year and expects these dividends to grow at 9% a year. The price of IBM is $80 per share. What is IBM's cost of equity capital?
A)9.20%
B)10.35%
C)10.93%
D)11.50%
Q3) What is the difference between the effective cost of debt and the cost of debt?
Q4) A firm's cost of debt is the rate of interest it would have to pay to refinance its existing debt.
A)True
B)False
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Chapter 14: Raising Equity Capital
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Q1) In a best-efforts IPO, the underwriter guarantees that all stock will be sold.
A)True
B)False
Q2) Convex Incorporated sells 10 million shares of stock in an SEO-8 million being primary shares issued by the company and 2 million being secondary shares sold by investors in the company. At the time of the sale, Convex's stock was selling at $8.00. If the underwriter charges 4% of the gross proceeds as a fee, how much money was raised in the sale?
A)$61.44 million
B)$64.51 million
C)$98.30 million
D)$104.45 million
Q3) The cost of issuing an IPO in the U.S. is higher than most other security issuance fees. A typical spread is ________.
A)5%
B)6%
C)7%
D)8%
Q4) What are angel investors?
Q5) How do the transaction costs of IPO puzzle financial economists?
Page 16
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Chapter 15: Debt Financing
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Q1) What are callable bonds?
Q2) Which of the following statements is FALSE?
A)By including more covenants, issuers increase their costs of borrowing.
B)Once bonds are issued, equity holders have an incentive to increase dividends at the expense of debt holders.
C)Covenants may restrict the level of further indebtedness and specify that the issuer must maintain a minimum amount of working capital.
D)If the covenants are designed to reduce agency costs by restricting management's ability to take negative-NPV actions that exploit debt holders, then the reduction in the firm's borrowing cost can more than outweigh the cost of the loss of flexibility associated with covenants.
Q3) Which of the following will have the greatest need of strong bond covenants if it is to receive a high bond rating?
A)a debenture
B)a mortgage bond
C)an asset-backed bond
D)a foreign bond
Q4) What is an original issue discount bond?
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Chapter 16: Capital Structure
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Q1) In general, the gain to investors from the tax deductibility of interest payments is referred to as the interest rate tax shield.
A)True
B)False
Q2) The Tradeoff Theory suggests that ________.
A)a firm should choose a debt level where the tax savings from increasing leverage are just offset by the increased probability of incurring the costs of financial distress
B)with higher costs of financial distress, it is optimal for a firm to choose higher leverage
C)differences in the magnitude of financial distress costs and the volatility of cash flows cannot explain the differences in the use of leverage across industries
D)there is no rational explanation for why firms choose debt levels that are too low to fully exploit the debt tax shield
Q3) What are some implications of market imperfections?
Q4) What are the issues in determining the optimal leverage for a firm?
Q5) What role do industries play in the capital structure choice for a firm?
Q6) What are the issues in determining the present value (PV)of financial distress?
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Chapter 17: Payout Policy
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Q1) Share repurchases have a tax advantage over dividends because ________.
A)dividend payments are tax deductible
B)share repurchases increase the value of debt
C)capital gains can be deferred by long-term investors
D)repurchases are associated with increased customer loyalty
Q2) A firm has $300 million of assets that includes $40 million of cash and 8 million shares outstanding. The firm uses $30 million of its cash to pay dividends. If an investor has 1000 shares, how many shares must he sell to create a homemade dividend of $6,575?
A)67 shares
B)100 shares
C)84 shares
D)117 shares
Q3) Tax rates on dividends and capital gains differ across investors for a variety of reasons including ________.
A)income
B)investment horizon
C)tax jurisdiction
D)all of the above
Q4) What are the ways in which a firm can pay out its free cash flow?
Page 19
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Chapter 18: Financial Modeling and Pro Forma Analysis
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Q1) The amount of net working capital for Ideko in 2011 is closest to ________.
A)$30,510
B)$22,750
C)$28,170
D)$35,195
Q2) Using the percent of sales method, and assuming 20% growth in sales and no change in interest expense, estimate Billy's Burgers' Pretax Income for 2011.
A)$23.28 million
B)$35.76 million
C)$24.84 million
D)$38.16 million
Q3) What is the free cash flow to equity holders for a firm with free cash flow of $11,000, after-tax interest expense of $2,000, and an increase in debt of $2,000?
A)$7,000
B)$8,000
C)$9,000
D)$11,000
Q4) Why is EBITDA multiple used for valuation rather than sales or earnings?
Q5) What is common starting point for forecasting?
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Chapter 19: Working Capital Management
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Q1) What is the meaning of the term 2/10 net 30?
A)If the invoice is paid within 10 days, a 2% discount can be taken. If the invoice is paid between 11 and 29 days, a 1% discount can be taken. After 30 days, the full invoice is due.
B)If the invoice is paid within 2 days, a 10% discount can be taken; otherwise the full invoice is due in 30 days.
C)If the invoice is paid within 2 days, a 10% discount can be taken; otherwise a 2% discount can be taken if the invoice is paid in 30 days.
D)If the invoice is paid within 10 days, a 2% discount can be taken; otherwise the full invoice is due in 30 days.
Q2) A firm offers its customers 3/5 net 25. What is the cost of trade credit to a customer who chooses to pay on day 25?
A)32.3%
B)65.5%
C)68.4%
D)74.3%
Q3) What are the costs of holding inventory?
Q4) What is cash discount?
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Chapter 20: Short-Term Financial Planning
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Q1) What are loan origination fees and what effect does it have on the loan?
Q2) Firms need short-term financing to deal with seasonal working capital requirements, negative cash flow shocks, or positive cash flow shocks.
A)True
B)False
Q3) What is single, end-of-period payment loan?
Q4) In a single, end-of-period payment loan ________.
A)pay no interest on the loan and pay back the principal in one lump sum at the beginning of the loan
B)pay no interest on the loan and pay back the principal in one lump sum at the end of the loan
C)pay interest on the loan and pay back the principal in one lump sum in the beginning of the loan
D)pay interest on the loan and pay back the principal in one lump sum at the end of the loan
Q5) What is permanent working capital?
Q6) What is the average and maximum maturity of commercial paper?
Q7) What do we understand by positive cash flow shocks?
Q8) What are commitment fees and what effect does it have on the loan?
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Chapter 21: Option Applications and Corporate Finance
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Q1) For every owner of a call option there is also an option writer, the person who takes the other side.
A)True
B)False
Q2) The Black-Scholes formula is notable because it does not require us to know
A)the expected return on a stock
B)the risk-free rate
C)the volatility of the stock
D)the dividend rate on the stock
Q3) When the exercise price of a call option is lower than the current price of the stock, the option is said to be ________.
A)at-the-money
B)in-the-money
C)out-of-the-money
D)none of the above
Q4) What are European options?
Q5) What are American options?
Q6) When is an option at-the-money?
Q7) What is a put option?
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Chapter 22: Mergers and Acquisitions
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Q1) Consider two firms, Bob Company and Cat Enterprises, both with earnings of $10 per share and 5 million shares outstanding. Cat is a mature company with few growth opportunities and a stock price of $25 per share. Bob is a new firm with much higher growth opportunities and a stock price of $40 per share. Assume Bob acquires Cat using its own stock and the takeover adds no value. In a perfect capital market, how many shares must Bob offer Cat's shareholders in exchange for their shares?
A)1 share of new company after takeover for each share of Cat Enterprises.
B)0.625 shares of new company after takeover for each share of Cat Enterprises.
C)1.6 shares of new company after takeover for each share of Cat Enterprises.
D)0.3846 shares of new company after takeover for each share of Cat Enterprises.
Q2) Assume that Martin pays no premium to acquire Luther. Calculate Martin's price-earnings (P/E)ratio both pre and post merger.
Q3) On average, when a bid is announced, the stock price of the target drops.
A)True
B)False
Q4) What is a white knight?
Q5) If Martin pays no premium to acquire Luther, what will the earnings per share be after the merger?
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Chapter 23: International Corporate Finance
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Q1) Suppose the domestic cost of capital for a U.S.-based company is 9%. Also, the U.S. interest rate is 5% and the European interest rate is 5%. What is the foreign denominated cost of capital for the company?
A)7%
B)8%
C)9%
D)10%
Q2) If a firm hedges a future purchase of euros by purchasing a call option, the firm ________ the potential cost but will benefit if the euro ________.
A)fixes, depreciates
B)fixes, appreciates
C)caps, depreciates
D)caps, appreciates
Q3) What are the timings of the foreign exchange market?
Q4) Firms that have a considerable amount of earnings abroad do not face any risk from changes in exchange rates.
A)True
B)False
Q5) What are internationally integrated capital markets?
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Chapter 24: Leasing
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Q1) Which of the following statements regarding leases and taxes is FALSE?
A)In a nontax lease, the lessee can deduct the interest portion of the lease payments as an interest expense.
B)In a true tax lease, the lease payments are treated as revenue for the lessor.
C)In a true tax lease, the lessee receives the depreciation deductions associated with the ownership of the asset.
D)The IRS separates leases into two broad categories: true tax leases and nontax leases.
Q2) Which of the following is considered an unfair comparison?
A)FMV lease versus $1.00-out lease
B)$1.00-out lease versus true tax lease
C)lease versus buy
D)lease versus borrow
Q3) A lease where the lessee can purchase the asset at the minimum of its fair market value and a fixed price is called a ________.
A)$1.00-out lease
B)fixed price lease
C)fair market value lease
D)fair market value cap lease
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Chapter 25: Insurance and Risk Management
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Q1) The risk that the firm will not have, or be able to raise, the cash required to meet the margin calls on its hedges is called ________.
A)liquidity risk
B)basis risk
C)commodity price risk
D)speculation risk
Q2) A steel maker needs 5,000,000 tons of coal next year. The current market price for coal is $70.00 per ton. At this price, the firm expects its EBIT to be $500 million. What will the firm's EBIT if the firm enters into a supply contract for coal for a fixed price of $72.00 per ton?
A)$500 million
B)$510 million
C)$490 million
D)$350 million
Q3) What are some of the disadvantages of long-term supply contracts?
Q4) Assuming that your firm will purchase insurance, what is the minimum-size deductible that would leave your firm with an incentive to implement the new safety policies?
Q5) What is the actuarially fair cost of full insurance?
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Chapter 26: Corporate Governance
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Q1) Which of the following statements is FALSE?
A)Increasing the pay-for-performance sensitivity comes with the added benefit of reducing managers' risk.
B)Stock and option grants give managers a direct incentive to increase the stock price to make their stock or options as valuable as possible.
C)By tying compensation to performance, the shareholders effectively give the manager an ownership stake in the firm.
D)During the 1990s, most companies adopted compensation policies that more directly gave managers an ownership stake by including grants of stock or stock options to executives.
Q2) Having a founder and top executive also be a major shareholder ________.
A)always results in agency conflicts that are bad for minority shareholders
B)can sometimes have benefits that outweigh the costs
C)is illegal in the U.S. and most other industrialized countries
D)is never beneficial to employees
Q3) Describe the "stakeholder" model of corporate governance.
Q4) Describe the main requirements of the Sarbanes-Oxley Act of 2002.
Q5) How does a pyramid structure work?
Q6) What is corporate governance?
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