Course Introduction
Financial Decision Making
Test Questions
Financial Decision Making is a comprehensive course designed to equip students with the analytical tools and conceptual frameworks necessary to make informed financial choices in business and personal contexts. The course covers foundational topics such as time value of money, risk and return analysis, capital budgeting, financial statement interpretation, and cost of capital. Students will also examine decision-making under uncertainty, explore techniques for evaluating investment projects, and consider ethical implications in financial choices. Through case studies, problem-solving sessions, and real-life scenarios, learners develop practical skills in assessing financial alternatives, optimizing asset allocation, and crafting effective financial strategies. This course is ideal for those seeking to enhance their financial literacy and decision-making proficiency in both professional and everyday settings.
Recommended Textbook
Introduction to Corporate Finance 4th Edition by Sean Cleary
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Page 2
Chapter 1: An Introduction to Finance
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Q1) Why is the secondary market important?
Answer: The secondary market is where investors trade previously issued securities.It is important because it provides liquidity to investors.If an efficient secondary market did not exist,investors would be very reluctant to hold securities with longer maturities.If they are not willing to buy these securities,then securities in the primary market will become more difficult to sell.Hence,the secondary market is necessary for the proper functioning of the primary market.
Q2) Human capital is
A) based on only the current skills, but not the education, of a country's citizens.
B) based on only the education, but not the current skills, of a country's citizens. C) based on the skills and capital of citizens and should be included in a country's wealth.
D) difficult to measure and should therefore not be included in a country's wealth.
Answer: C
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3
Chapter 2: Business Corporatefinance
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Q1) Why are externalities a necessary consideration when conducting business,especially for large corporations?
A) Externalities always cost money, and those costs hurt a firm's bottom line.
B) Forgetting to account for externalities is against tax laws in Canada.
C) The actions a large firm makes can have a significant impact on other firms, and those actions may not necessarily be in Canada's best interests.
D) all of the above
Answer: C
Q2) Which of the following is NOT a reason why the market for corporate control is the most effective mechanism to give managers the incentive to act like shareholders?
A) The government imposes significant lawsuits and penalties for managers not acting in the best interests of shareholders.
B) The threat of acquisition keeps managers focused on achieving good performance and a high stock price.
C) A low stock price makes a firm a good target for acquisition.
D) It allows the best managers the chance to manage assets.
Answer: A
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Chapter 3: Financial Statements
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Sample Questions
Q1) "Crediting" an account
A) I only
B) II only
C) I and II only
D) II and III only
I.increases an asset account.
II.increases a liability account.
III.could increase both an equity account and a liability account.
Answer: D
Q2) Five years ago,J.Hi Corp.bought a paper cup making machine for $50,000.Assume the machine is the only asset in its class.The company has just sold the machine for $35,000.The UCC of the asset class just before the sale is $15,000.What are the tax consequences of this sale?
A) There is zero tax consequence since the machine was sold for less than its acquisition cost.
B) A capital loss of $15,000.
C) A CCA recapture of $20,000.
D) A terminal loss of $20,000.
Answer: C
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Page 5
Chapter 4: Financial Statement Analysis and Forecasting
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Sample Questions
Q1) Alberta High Skies Company has net income of $3 million.It issued 500,000 shares two years ago at an issue price of $20 per share,and the stock is now trading at $35 per share.What is Alberta High Skies' price-earnings ratio?
A) 1.75
B) 3.33
C) 5.83
D) 9.17
Q2) On the balance sheet,a company reports total assets of $8 million,common shares (book value)of $4 million,and retained earnings of $2 million.The debt-to-asset ratio is:
A) 0.25
B) 0.50
C) 0.75
D) None of the above
Q3) What is the major implication of the adoption of IFRS standards globally?
Q4) Discuss three issues that make the comparison of companies within the same industry group difficult.
Q5) Discuss some difficulties when comparing the ratios of similar corporations from different countries.
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Chapter 5: Time Value of Money
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Q1) Why is a dollar today always worth at least a dollar in the future?
A) because of the risk involved with investing
B) because of the opportunity cost of money
C) because of inflation
D) all of the above
Q2) As interest rates rise,future values
A) increase.
B) decrease.
C) stay the same.
D) cannot be determined, need compounding frequency.
Q3) You have been offered four different financing schemes for a $30,000 car.Which one should you choose?
A) $5,000 down with the rest paid in equal monthly payments of $624.70 per month for 48 months
B) $0 down with equal monthly payments of $960 per month for 36 months
C) $15,000 down and a final payment of $18,550 two years from now
D) have it financed with a bank loan at a quoted rate of 9.5% with loan repayments made monthly
Q4) Explain the difference between simple interest and compound interest.
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Chapter 6: Bond Valuation and Interest Rates
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Q1) Explain the difference between the coupon rate and the current yield.
Q2) Sam has put aside C$5,000 for his travel to Japan in a year from now.He could invest the money in Canada and earn 4.5 percent,and then convert it to Japanese yen when he leaves.Alternatively,Sam could convert the funds to Japanese yen (JY)and earn a 4.85 percent return on a Japanese investment today.Which approach should he take if the currency spot rate is C$/JY=0.008872 and the one-year forward rate is 0.008738?
Q3) A 180-day U.S.T-bill has a bond discount yield of 4.135 percent.What is the bank equivalent yield on a 180-day Canadian T-bill with the same quoted price?
A) 4.28%
B) 4.24%
C) 4.19%
D) 4.16%
Q4) Which one of the following is not true?
A) A bond issuer's rating is affected by its default risk.
B) An investor holding the bond until maturity expects to receive its par value.
C) Inflation does not affect the interest rates of bonds.
D) Rating agencies use financial statements to assess the default probability of firms.
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8
Chapter 7: Equity Valuation
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Sample Questions
Q1) How much would you pay for a share of stock today,if you expect it will pay a dividend of $2.50 each year and will sell for $58 one year from now? Assume your required rate of return on this stock is 13 percent.
A) $60.50
B) $55.50
C) $53.54
D) $49.59
Q2) Suppose a firm has just reported an EPS of $4.55 and expects to maintain a dividend payout ratio of 48 percent.The firm's price-earnings ratio is 11 and its return on equity is 17.36 percent.
A) What is current dividend?
B) What is growth rate?
C) What is current stock price?
D) What is its required rate of return?
Q3) The rate of return required by investors is estimated as:
A) dividend yield plus expected capital gains yield.
B) dividend yield minus expected capital gains yield.
C) dividend yield / expected capital gains yield.
D) none of the above.
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Page 9
Chapter 8: Risk, return, and Portfolio Theory
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Q1) Discuss the validity of the following statement: "diversification benefits decreased because correlation between stocks increased."
Q2) Baxter Inc.'s annual returns for the past four years were: 2.75%,-1.8%,7.2%,and 6.5%.What are the arithmetic and geometric average annual returns for Baxter over the four-year period?
A) Arithmetic mean = 6.80%; geometric mean = 3.35%
B) Arithmetic mean = 3.66%; geometric mean = 3.60%
C) Arithmetic mean = 14.65%; geometric mean = 10.05%
D) Arithmetic mean = 18.03%; geometric mean = 21.20%
Q3) Steve bought a share of Toronto Skates Inc.three years ago for $45.00.He was paid two annual dividends of $4.50 in the past two years.If the stock price today is $ 48.50,what is the annual holding period return of the stock?
A) 7.78%
B) 15.56%
C) 27.78%
D) 9.26%
Q4) Discuss the difference between expected returns using subjective probabilities and expected returns based on historical values.
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Page 10
Chapter 9: The Capital Asset Pricing Model Capm
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Sample Questions
Q1) Use the following three statements to answer this question:
A) I, II and III are correct.
B) I, II and III are incorrect.
C) I and III are correct, II is incorrect.
D) I is incorrect, II and III are correct.
I.The capital market line (CML)depicts the highest attainable expected return for any given risk level that includes only efficient portfolios.
II.The security market line (SML)depicts the required rate of return for any given risk level that includes only individual securities.
III.The Security Market Line (SML)measures the price of systematic risk.
Q2) Which of the following is a FALSE statement of the market price of risk?
A) It is the incremental risk divided by the incremental expected return.
B) It is the slope of the capital market line.
C) It is the equilibrium price of risk in the capital market.
D) It indicates the additional expected return that the market demands for an increase in a portfolio's risk.
Q3) What is beta?
Q4) What is the role of the risk-free asset in the efficient portfolio?
Q5) Is it possible to invest more than 100 percent of your available funds?
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Chapter 10: Market Efficiency
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Sample Questions
Q1) Semi-strong form efficiency suggests:
A) stock prices will adjust instantaneously to public information.
B) stock prices reflect all information.
C) all of the above.
Q2) Boris,the business reporter on XOP radio,says that market efficiency doesn't matter.Provide two reasons why it does matter to investors.
Q3) Use the following statements to answer the question:
A) I is incorrect, II is correct.
B) I is correct, II is incorrect.
C) I and II are incorrect.
D) I and II are correct.
I.Increasing disclosure of information about the firm enhances transparency in the market.
II.Disclosure enhances the understanding of a firm's actions,hence it increases the efficiency of the market.
Q4) Explain the implications of having an inefficient market.
Q5) State the semi-strong form of market efficiency and its implications.
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Chapter 11: Forwards,futures,and Swaps
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Q1) Magdalena assumes a US$ 2,000 short position in a 1-year US forward contract (F = C$1.0312 per US).If the spot rate in one year is (a)C$1.04 per US (b)C$1.03 per US,what will her profit (loss)be in each case?
A) - C$8.8, 1.2
B) - C$20, 2.4
C) C$17.6, - 2.4
D) - C$17.6, 2.4
Q2) A "fixed for floating" interest rate swap is also referred to as:
A) plain vanilla
B) fixed swap
C) currency swap
D) plain swap
Q3) What is a relatively small (in terms of the contract value)deposit made with the clearinghouse?
A) Maintenance margin
B) Margin call
C) Initial margin
D) Daily resettlement
Q4) Explain how derivatives led to the worst recession in the post second world war era.
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Chapter 12: Options
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Q1) The current stock price is $568.36,a one-year call option with strike price of $500 is $102,and the risk-free rate is 2%.What should be the price of a one-year put option with the same strike price?
Q2) _________is an estimate of the ________ of the underlying asset based on observed option prices.
A) Price volatility; estimated volatility
B) Implied volatility; price volatility
C) Price volatility; implied volatility
D) Estimated volatility; price volatility
Q3) The strike price on a call option is $8 and the price of the underlying stock is $10.What is the time value of money of the call option if the option premium is $3?
A) $4
B) $3
C) $2
D) $1
Q4) Higher _________,higher ________
A) price volatility; estimated volatility
B) implied volatility; option price
C) estimated volatility; price volatility
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Chapter 13: Capital Budgeting, risk Considerations, and Other Special Issues
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Sample Questions
Q1) Which of the following statements is FALSE?
A) Contingent projects are projects for which the acceptance of one requires the acceptance of another, either beforehand or simultaneously.
B) The chain replication approach is a way to compare projects with equal lives by finding a time horizon into which all the project lives under consideration divide equally, and then assuming each project repeats until it reaches this horizon.
C) The equivalent annual NPV approach is a way to compare projects by finding the NPV of the individual projects, and then determining the amount of an annual annuity that is economically equivalent to the NPV generated by each project over its respective time horizon.
D) Mutually exclusive projects require the firm to choose one project over another.
Q2) The IRR and NPV may yield the same conclusion about a project except:
A) when interest rates are too high
B) when the project is short term
C) when cash flows are irregular
D) when the management is using debt to finance the project
Q3) What are the sources of risk in foreign direct investments?
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Page 15
Chapter 14: Cash Flow Estimation and Capital Budgeting
Decisions
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Q1) Which of the following are ways that inflation impacts the capital budgeting process?
A) III only.
B) I and II only.
C) I and III only.
D) I, II, and III.
I.Inflation affects future expected cash flows.
II.Inflation is reflected in the firm's discount rate.
III.Inflation increases the general price level.
Q2) Maritimes Toy Corporation (MTC)is considering investing in a piece of new equipment worth $50,000.The equipment will increase operating revenue by $10,000 per year for ten years.The equipment is expected to have no salvage value at the end of ten years,and capital cost allowance is claimed at 20 percent on a declining balance.The corporate tax rate is 38 percent,and MTC's opportunity cost of capital is 9 percent.Assume the asset class remains open after the asset is sold.The project's NPV is closest to:
A) $2,351.96
B) $3,321.44
C) $26,739.06
D) $27,708.54
Page 16
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Chapter 15: Mergers and Acquisitions
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Q1) When conducting shareholder value at risk (SVAR)analysis for acquisitions,it is found that:
A) Acquirers using cash bear all of the risk of the acquisition, while the risk in acquisitions using share swaps is borne by both sets of shareholders.
B) Acquirers using stock swaps bear all of the risk of the acquisition, while the risk in acquisitions using cash is borne by both sets of shareholders.
C) The risk of an acquisition is always borne equally between the acquiring firm and target firm shareholders.
D) None of the above.
Q2) In contrast to the question above,in the U.S.what percentage of shares purchased by an investor is considered the early warning threshold signalling that the company is a possible target?
A) 5%
B) 10%
C) 25 %
D) 50 + 1%
Q3) What is a tender offer?
Q4) Define and distinguish between acquisitions and amalgamations.
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Page 17
Chapter 16: Leasing
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Q1) Canada Lease Co.is considering switching from using operating leases to financial leases.The expected impact on its stock price is:
A) the price should fall as the earnings per share will decline.
B) the price should not change as the ROA does not change.
C) the price should not change as the total cash flows will not change.
D) the price should rise as the cash flow from operations will rise.
Q2) What is the impact of shifting the purchase of equipment to operating leases?
Q3) The lease term is four years,while the economic life of the asset is six years.The annual lease payment is $10,000 at the beginning of each year,and the appropriate discount rate is 7 percent.There is no salvage value at the end of the lease.The lessee uses the straight-line depreciation method.
A) Estimate the value of the asset.
B) Estimate the change in NI, CFO, and CFF at the end of the first year if a firm decides to enter into a lease agreement.
Q4) Which of the following are reasons for leasing from the lessee's point of view?
A) Expensive borrowing cost
B) The lessor pays the insurance costs
C) The lessor maintains the leased asset
D) All of the above
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Chapter 17: Investment Banking and Securities Law
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Q1) Which of the following is a fraudulent activity?
A) I and II are fraudulent.
B) I and II are not fraudulent.
C) I is fraudulent and II is not fraudulent.
D) I is not fraudulent and II is fraudulent.
I.Selling stocks on an institution where there is zero external activity.
II.Selling penny stocks as blue chip stocks
Q2) Which of the following statements is not true about underpricing?
A) It "leaves money on the table."
B) It is done to get more IPO proceeds for the issuing firm.
C) It is calculated as the difference between the initial offering price and the price on the first day of trading.
D) It involves pricing an IPO at less than its market value.
Q3) Use the following statements to answer this question:
A) I and II are correct.
B) I and II are incorrect.
C) I is correct and II is incorrect.
D) I is incorrect and II is correct.
I.Spinning encourages underpricing in the market.
II.Spinning is unethical.
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Chapter 18: Debt Instruments
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Q1) In general,a line of credit has a ______ maturity while a term loan has a ______ maturity.
A) fixed; floating
B) floating; fixed
C) fixed; fixed
D) floating; floating
Q2) Laurentide Ski Resort has to make a choice between two different debt issues.Issue 1 has an interest rate of 5% and the interest is tax deductible.Issue 2 has an interest rate of 4% but the interest is not tax deductible.If the firm has a tax rate of 40%,which issue is preferred and why?
A) Issue 2 because the interest rate of 4% is less than the 5% of issue 1.
B) Issue 1 because the after-tax cost is 3% while the after-tax cost of issue 2 is 4%
C) Issue 1 because the after-tax cost is 2% while the after-tax cost of issue 2 is 4%
D) Issue 2 because the after-tax cost is 1.6% while the after-tax cost of Issue 1 is 2%
Q3) Laurentide Resort Company would like to issue $100 million of commercial paper.Define liquidity support and describe why it would be important to investors.
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Page 20
Chapter 19: Equity and Hybrid Instruments
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Q1) In the event of liquidation,preferred shareholders rank ahead of:
A) subordinated debt holders.
B) secured debt.
C) common shareholders.
D) debenture holders.
Q2) Rank the risk of the following securities from lowest to highest.
A) I, II, III, IV
B) IV, III, II, I
C) I, II, IV, III
D) IV, I, II, III
I.Long-term unsecured debt
II.Convertible preferred shares
III.Common equity
IV.Bank loans
Q3) Why is there a difference between the way the market classifies debt and the way the CRA classifies it.
Q4) Discuss how preferred shares have features of both debt and equity instruments.
Q5) What are the costs and benefits of preferred share financing?
Q6) Explain the importance of warrants in financing for firms.
Q7) Explain how equity can be viewed as a call option on the firm.
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Chapter 20: Cost of Capital
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Q1) Toronto Skaters Company is an all-equity company and is able to fund a $1 million investment using cash.The company has a beta of 1.4,the risk-free rate is 3 percent,and the return on the market is 8 percent.Flotation costs for new equity are 3 percent.The tax rate is zero.The appropriate cost of capital is:
A) 0% as the firm is using cash.
B) 0% as the firm is using funds that have already been raised from the capital markets.
C) The required return on the outstanding equity.
D) The cost of equity taking into account the flotation costs.
Q2) Use the following statements to answer this question:
A) I and II are correct.
B) I and II are incorrect.
C) I is correct and II is incorrect.
D) I is incorrect and II is correct.
I.Without taxes,the benefit of having debt on the WACC largely vanishes.
II.Preferred shares cost the same as common equity financing.
Q3) Explain the reasoning behind the Fed's stock valuation model and how it estimates the overvaluation or undervaluation of the stock market.
Q4) What is the cost of internally generated funds?
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Page 22
Chapter 21: Capital Structure Decisions
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Q1) According to the Deutsche Bank survey,rank the following reasons for capital structure:
A) I, II, IV, III
B) II, I, III, IV
C) I, IV, III, II
D) IV, III, II, I
I.Credit rating
II.Ability to manage earnings per share
III.Transaction costs on debt issues
IV.Tax shield
Q2) Toronto Skaters Company (TSC)has a before-tax cost of debt of 8 percent,a debt/equity ratio of 3,and pays tax at the rate of 40 percent.The unlevered cost of equity for a firm with TSC's risk characteristics is 15 percent.Debt is $30,000.If TSC expects a perpetual EBIT of $20,000,then the value of the firm is:
A) $38,261
B) $80,000
C) $133,333
D) $190,476
Q3) Briefly explain the trade-off theory of capital structure.
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Page 23
Chapter 22: Dividend Policy
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Q1) Toronto Trust Corp.is expecting an earnings increase this year.The CEO thinks that the earnings increase may be temporary.Instead of raising dividends,she decides to repurchase stock.Why does she choose stock repurchases over dividend increases?
Q2) Use the following statements to answer this question:
A) I and II are correct.
B) I and II are incorrect.
C) I is correct and II is incorrect.
D) I is incorrect and II is correct.
I.The Lintner equation shows that the relationship between past and current dividends exists
II."Stickiness" of dividends contradicts the M&M irrelevance theory
Q3) According to the residual theory of dividends:
A) Paying dividends would affect the value of the firm
B) Dividends would be as volatile as earnings
C) Dividends should be very smooth
D) Mature companies would pay higher dividends
Q4) Describe the similarities and differences between stock dividends and dividend reinvestment plans.
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Page 24
Chapter 23: Working Capital Management: General Issues
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Q1) For a given operating cycle,a firm estimates the amount of financing it requires by
A) Calculating the expected profit from sales over the operating cycle
B) Calculating the total expected sales over the operating cycle
C) Calculating the longest period it can possibly obtain to fulfill its payables
D) Calculating the longest period it can possibly grant for customers' payables
Q2) A good value for the quick ratio is
A) 1
B) 1.5
C) 2
D) Varies from industry to industry
Q3) The operating cycle allows firms to estimate
A) the average time between when a firm pays cash for its inventory purchases and when it receives cash for its sales
B) the average time a firm must keep any borrowed funds
C) the average time required for a firm to acquire inventory, sell it, and collect the proceeds
D) the amount of cash a firm needs to be profitable
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Chapter 24: Working Capital Management: Current Assets and
Current Liabilities
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Q1) You are offered the following terms: 5/25 net 50.What is the effective annual interest rate for not paying on time,approximately?
A) 111.5%
B) 103.9%
C) 76.8%
D) 45.4%
Q2) In the case of delayed or non-payment,describe in detail the general steps that firms must take in an attempt to force payment or recover as much value as possible from the defaulting customer or customers.
Q3) List and explain the four C's of credit: capacity,character,collateral,and conditions.
Q4) Inventory consists of:
A) raw materials.
B) work in process.
C) finished goods.
D) all of the above.
Q5) Explain the difference between a firm's decision to grant customers trade credit and that of a bank's decision whether to extend loans to their customers.In your explanation provide a numerical example.
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