Financial Decision Making
Test Questions
Course Introduction
Financial Decision Making is a course designed to equip students with the knowledge and analytical skills required to make informed financial choices in both personal and organizational contexts. The course covers key areas such as budgeting, capital structure, risk assessment, investment analysis, and financial planning. Through case studies and practical exercises, students learn how to apply financial theories and models to real-world scenarios, enabling them to evaluate various financing and investment options. Emphasis is placed on understanding the impact of financial decisions on overall business strategy and value creation, preparing students to solve complex financial problems with confidence and sound judgment.
Recommended Textbook Fundamentals of Corporate Finance 2nd Edition by Jonathan Berk
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Chapter 1: Corporate Finance and the Financial Manager
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Q1) Explain some of the measures taken to reduce the agency conflict problem. Answer: The agency conflict problem can be reduced by taking measures that align the managers interests with those of the shareholders.For example,incentive-based compensation such as employee stock options help align the interests of these two constituents.
Q2) Which of the following are major duties of a financial manager?
I.To make investment decisions
II.To make financing decisions
III.To manage cash flow from operating activities
A)I only
B)I and II only
C)I and III only
D)all of the above
Answer: D
Q3) If broker will buy a share of stock from you at $3.85 and sell it to you at $3.87,the ask price would be $3.85.
A)True
B)False
Answer: False
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Page 3
Chapter 2: Introduction to Financial Statement Analysis
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Q1) Which of the following amounts would NOT be included on the right side of a balance sheet?
A)the value of government bonds held by the company
B)the cash held by the company
C)the amount of deferred tax liability held by the company
D)the amount of money owed to the company by customers who have not yet paid for goods and services they have received
Answer: C
Q2) Price-earnings ratios tend to be high for fast-growing firms.
A)True
B)False
Answer: True
Q3) Refer to the balance sheet above.If in 2006 Luther has 10.2 million shares outstanding and these shares are trading at $16 per share,then what is Luther's enterprise value?
A)-$63.3 million
B)$353.1 million
C)$389.7 million
D)$516.9 million
Answer: C
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Page 4
Chapter 3: Time Value of Money: An Introduction
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Q1) A backhoe can dig 150 feet of trench per hour and costs $500 per hour to hire and operate.A ditch digger can dig six feet of trench per hour.Based on this information,what is the most a ditch digger can charge for per hour when digging ditches?
A)$20 per hour
B)$25 per hour
C)$3.33 per hour
D)$83.33 per hour
Answer: A
Q2) Explain why a dollar today is worth more than a dollar tomorrow.
Answer: A dollar today can be invested to earn interest,which will make it worth more than a dollar tomorrow.
Q3) What is the present value (PV)of $100,000 received five years from now,assuming the interest rate is 8% per year?
A)$60,000.00
B)$68,058.32
C)$73,502.99
D)$82,609.42
Answer: B
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Chapter 4: Time Value of Money: Valuing Cash Flow
Streams
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Q1) You are considering purchasing a new home.You will need to borrow $250,000 to purchase the home.A mortgage company offers you a 15-year fixed rate mortgage (180 months)at 9% APR (0.75% month).If you borrow the money from this mortgage company,your monthly mortgage payment will be closest to:
A)$2585
B)$660
C)$2535
D)$1390
Q2) Which of the following is true about perpetuities?
A)All else equal,the value of a perpetuity is higher when the periodic cash flow is higher.
B)All else equal,the value of a perpetuity is higher when the interest rate is lower.
C)If two perpetuities have the same present value and the same interest rate,they must have the same cash flows.
D)All of the above are true statements.
Q3) If a few intermediate cash flows in valuing a stream of cash flows are zero can we delete those points on the timeline and squeeze the timeline to show only nonzero cash flows?
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Page 6
Chapter 5: Interest Rates
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Q1) In which of the following situations would the reserve bank in a certain country be most likely to lower interest rates?
A)The economy is growing slowly or not at all.
B)Inflation is rising rapidly.
C)The level of investment is very low.
D)The rate of savings is extremely high.
Q2) Assuming that you have made all of the first 24 payments on time,then the outstanding principal balance on your SUV loan is closest to:
A)$31,250
B)$20,300
C)$19,200
D)$32,000
Q3) Five years ago you took out a 30-year mortgage with an APR of 6.5% for $200,000.If you were to refinance the mortgage today for 20 years at an APR of 4.25%,,how much would your monthly payment change by?
A)The monthly payment will increase by $104.79.
B)The monthly payment will decrease by $104.79
C)The monthly payment will increase by $343.12.
D)The monthly payment will decrease by $343.12.
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Page 7
Chapter 6: Bonds
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Q1) 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
Q2) The coupon value of a bond is the face value of that bond. A)True B)False
Q3) Which of the following bonds will be most sensitive to a change in interest rates if all bonds have the same initial yield to maturity?
A)a ten-year bond with a $1000 face value whose coupon rate is 5.8% APR paid semiannually
B)a ten-year bond with a $1000 face value whose coupon rate is 7.4% APR paid semiannually
C)a 20-year bond with a $1000 face value whose coupon rate is 5.8% APR paid semiannually
D)a 20-year bond with a $1000 face value whose coupon rate is 7.4% APR paid semiannually
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Page 8
Chapter 7: Stock Valuation
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Q1) Assuming everything else remains unchanged,how does a firm's decision to increase its dividend-payout ratio affect its growth rate?
Q2) Aaron Inc.has 316 million shares outstanding.It expects earnings at the end of the year to be $602 million.The firm's equity cost of capital is 11.5%.Aaron pays out 50% of its earnings in total: 30% paid out as dividends and 20% used to repurchase shares.If Aaron's earnings are expected to grow at a constant 6% per year,what is Aaron's share price?
A)$8.66
B)$17.32
C)$25.98
D)$34.64
Q3) The Valuation Principle states that the value of a stock is equal to the present value (PV)of both the dividends and future sale price of that stock which the investor will receive.
A)True
B)False
Q4) Can the dividend-discount model handle negative growth rates?
Q5) What is a major assumption about growth rate in the dividend-discount model?
Q6) How can the dividend-discount model handle changing growth rates?
Page 9
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Chapter 8: Investment Decision Rules
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Q1) An auto-parts company is deciding whether to sponsor a racing team for a cost of $1 million.The sponsorship would last for three years and is expected to increase cash flows by $580,000 per year.If the discount rate is 7.5%,what will be the change in the value of the company if it chooses to go ahead with the sponsorship?
A)$508,305
B)$740,000
C)$808,786
D)$863,000
Q2) The net present value (NPV)for project alpha is closest to:
A)$20.96
B)$16.92
C)$24.01
D)$14.41
Q3) The internal rate of return (IRR)rule will agree with the Net Present Value rule even when positive cash flows precede negative cash flows.
A)True
B)False
Q4) What is the Net Present Value rule?
Q5) Under what situation can the net present value (NPV)profile be upward sloping?
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Chapter 9: Fundamentals of Capital Budgeting
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Q1) CathFoods will release a new range of candies which contain anti-oxidants.New equipment to manufacture the candy will cost $2 million,which will be depreciated by straight-line depreciation over five years.In addition,there will be $5 million spent on promoting the new candy line.It is expected that the range of candies will bring in revenues of $4 million per year for five years with production and support costs of $1.5 million per year.If CathFood's marginal tax rate is 35%,what are the incremental earnings in the second year of this project?
A)$1.365 million
B)$1.500 million
C)$1.753 million
D)$2.100 million
Q2) A company spends $20 million researching whether it is possible to create a durable plastic from the process waste from feedstock preparation.How should the $20 million best be considered?
A)as a sunk cost
B)as an opportunity cost
C)as a fixed overhead expense
D)as a capital cost
Q3) What are project externalities?
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Page 11
Chapter 10: Stock Valuation: A Second Look
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Q1) The table above shows the stock prices and multiples for a number of firms in the newspaper publishing industry.Another newspaper publishing firm (not shown)had sales of $620 million,EBITDA of $84 million,excess cash of $66 million,$14 million of debt,and 120 million shares outstanding.If the average enterprise value to sales for comparable businesses is used,which of the following is the best estimate of the firm's share price?
A)$6.89
B)$6.98
C)$7.41
D)$7.65
Q2) If a manager wishes to raise his stock's price,he should do which of the following?
I.Focus on maximizing the present value (PV)of the free cash flow.
II Focus on accounting earnings.
III.Focus on financial policy.
A)I only
B)II only
C)I and II
D)II and II
Q3) Which is the best valuation technique when using comparables?
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Chapter 11: Risk and Return in Capital Markets
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Q1) Apple computer's stock price jumped when it announced that its revenue had increased because of the successful launch of iPad and the increased sales of Macbook computers.This is an example of A)market risk.
B)unsystematic risk.
C)systematic risk.
D)both A and C
Q2) What are the two components of realized return from a stock investment?
Q3) If returns on stock A are more volatile than the returns on stock B,the geometric average return of stock A is ________ the geometric average return of stock B when their arithmetic average return is the same.
A)the same as B)higher than C)lower than
D)cannot say for sure
Q4) Rational investors may be willing to choose an investment that has additional risk but does not offer additional reward.
A)True
B)False
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Chapter 12: Systematic Risk and the Equity Risk Premium
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Q1) Suppose over the next year Ball has a return of 12.5%,Lowes has a return of 20%,and Abbott Labs has a return of -10%.The value of your portfolio over the year is:
A)$21,000
B)$20,000
C)$20,700
D)$21,500
Q2) The Capital Asset Pricing Model (CAPM)says that the excess return on a stock is equal to its beta times the market risk premium.
A)True
B)False
Q3) Your retirement portfolio comprises 100 shares of the Standard & Poor's 500 fund (SPY)and 100 shares of iShares Barclays Aggregate Bond Fund (AGG).The price of SPY is $120 and that of AGG is $98.If you expect the return on SPY to be 10% in the next year and the return on AGG to be 5%,what is the expected return for your retirement portfolio?
A)7.75%
B)8.82%
C)6.65%
D)7.01%
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Page 14
Chapter 13: The Cost of Capital
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Q1) Financial managers do not need to use all sources of financing in order to determine the cost of capital.
A)True
B)False
Q2) The book value of equity of a firm is $100 million and the market value of equity is $200 million.The face value of debt of the firm is $50 million and the market value of debt is $60 million.What is the market value of assets of the firm?
A)$150 million
B)$160 million
C)$260 million
D)$250 million
Q3) Internal financing is more costly than external financing because of issuance costs. A)True B)False
Q4) Why do we use market values rather than book values in calculation of WACC?
Q5) Which of the three costs - debt,preferred stock and common equity - is most difficult to estimate?
Q6) Why do we use leverage if it increases the risk of a firm?
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Chapter 14: Raising Equity Capital
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Q1) Highlander Homes stock trades at $32 per share and there are 50 million shares outstanding.The management would like to raise $200 million in an SEO.If the underwriter charges 5% of gross proceeds,how many shares must it sell?
A)5.875 million
B)6.05 million
C)6.25 million
D)6.58 million
Q2) Assuming that this is the venture capitalist's first investment in your firm,what percentage of the firm will the venture capitalist own?
A)50%
B)40%
C)25%
D)33%
Q3) How does IPO pricing puzzle financial economists?
Q4) Which of the following is a notable puzzle in IPOs?
A)The number of IPOs is highly underestimated.
B)The number of IPOs is highly cyclical.
C)The number of IPOs is highly seasonal.
D)The number of IPOs is almost the same every year.
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Chapter 15: Debt Financing
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Q1) Which of the following statements is FALSE?
A)Global bonds combine the features of domestic,foreign,and Eurobonds,and are offered for sale in several different markets simultaneously.
B)In a leveraged buyout (LBO),a group of private investors purchases all the equity of a public corporation.
C)A term loan is a bank loan that lasts for a specific term.
D)Eurobonds are international bonds that are denominated in the local European currency of the country in which they are issued.
Q2) A company issues a 20-year,callable bond at par with an 6% annual coupon payments.The bond can be called at par in three years or any time after that on a coupon payment date.The call price is $110 per $100 of face value.What is the yield to call?
A)4%
B)12%
C)6%
D)9%
Q3) What is yield to maturity?
Q4) What is an original issue discount bond?
Q5) What are callable bonds?
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Chapter 16: Capital Structure
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Q1) What are indirect costs of financial distress?
Q2) The optimal capital structure depends on ________ such as taxes,distress costs and agency costs.
A)capital market factors
B)market imperfections
C)firm specific risks
D)systematic risks
Q3) The presence of a large amount of debt can encourage shareholders to take excessive risk because
A)equity holders are risk seeking by nature.
B)the costs of failure are borne largely by debt holders.
C)debt holders are risk seeking.
D)firm value increases with risk taking.
Q4) MM Proposition I states that in a perfect capital market the total value of a firm is equal to the market value of the ________ generated by its assets.
A)earnings after taxes
B)earnings after interest
C)cash flows after taxes
D)free cash flows
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Chapter 17: Payout Policy
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Q1) A firm has $75 million of assets that includes $12 million of cash and 25 million shares outstanding.If the firm uses $12 million of cash to repurchase shares,what is the new price per share?
A)$1
B)$2
C)$3
D)$4
Q2) Assume that Omicron uses the entire $50 million in excess cash to pay a special dividend.The amount of the regular yearly dividends in the future is closest to:
A)$4.50
B)$5.00
C)$4.00
D)$9.00
Q3) Long-term investors can defer capital gains tax until they sell,and therefore,there is a tax advantage for share repurchases over dividends.
A)True
B)False
Q4) What is the effect on the stock price when a firm repurchases its shares?
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19
Chapter 18: Financial Modeling and Pro Forma Analysis
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Q1) Based upon the average EV/EBITDA ratio of the comparable firms,if Ideko holds $6.5 million of cash in excess of its working capital needs,then Ideko's target market value of equity is closest to:
A)$155 million
B)$157 million
C)$165 million
D)$191 million
E)$193 million
Q2) Assuming that Ideko has a EBITDA multiple of 9.4,then the continuation unlevered price-earnings ratio of Ideko in 2015 is closest to:
A)17.2
B)16.4
C)14.5
D)28.6
Q3) Forecasting a balance sheet with percent of sales method requires two passes a first pass to determine financing needs and a second pass that shows the sources and amounts of financing.
A)True
B)False
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Page 20
Chapter 19: Working Capital Management
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Q1) What is collection float?
Q2) A firm has an average accounts payable balance of $180,000.Its average daily cost of goods sold is $12,000.What is the average number of days that the firm takes to pay its debt?
A)2 days
B)8 days
C)15 days
D)21 days
Q3) Your firm purchases goods from its supplier on terms of 1/10 net 30.The effective annual cost to your firm if it chooses not to take advantage of the trade discount offered and stretches the accounts payable to 45 days is closest to:
A)13.0%
B)11.1%
C)15.9%
D)20.1%
Q4) Working capital alters a firm's value by affecting its free cash flow.
A)True
B)False
Q5) What are the costs of holding inventory?
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Chapter 20: Short-Term Financial Planning
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Q1) Which of the following best describes the agreement where a firm sells receivables to a lender and the lender agrees to pay the firm the amount due from its customers at the end of the firm's payment period,with the provision that the lender will receive payment from the borrower if the customers default on their payments?
A)trust receipt
B)pledging of accounts receivable
C)factoring of accounts receivable with recourse
D)factoring of accounts receivable without recourse
Q2) Which of the following statements is FALSE?
A)Firms with seasonal cash flows may find themselves with a surplus of cash during some months that is sufficient to compensate for a shortfall during other months.However,because of timing differences,such firms often have short-term financing needs.
B)A company forecasts its cash flows to determine whether it will have surplus cash or a cash deficit for each period.
C)Positive cash flow shocks cannot create short-term financing needs.
D)When sales are concentrated during a few months,sources and uses of cash are also likely to be seasonal.
Q3) What is temporary working capital?
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Page 22
Chapter 21: Option Applications and Corporate Finance
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Q1) According to put-call parity,which of the following would cause the value of a call option to decrease?
A)A decrease in the present value of future dividends.
B)A decrease in the present value of the strike price.
C)An increase in the stock price.
D)A decrease in the price of the put price.
Q2) Which of the following statements is FALSE?
A)When a holder of an option enforces the agreement and buys or sells a share of stock at the agreed-upon price,he is exercising the option.
B)There are two kinds of options.European options allow their holders to exercise the option on any date up to and including a final date called the expiration date.
C)Because an option is a contract between two parties,for every owner of a financial option,there is also an option writer,the person who takes the other side of the contract.
D)The price at which the holder buys or sells the share of stock when the option is exercised is called the strike price or exercise price.
Q3) When is an option in-the-money?
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Page 23
Chapter 22: Mergers and Acquisitions
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Q1) Assume that Martin pays no premium to acquire Luther.Calculate Martin's price-earnings (P/E)ratio both pre and post merger.
Q2) A situation where every director serves a three-year term and the terms are staggered so that only one-third of the directors are up for election each year is called a A)white knight.
B)classified board.
C)poison pill.
D)golden parachute.
Q3) The justification for the benefits of diversification from mergers include all of the following except
A)tax loss benefits.
B)lower cost of debt or increased debt capacity.
C)direct risk reduction.
D)liquidity enhancement.
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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24
Chapter 23: International Corporate Finance
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Q1) Multinational firms often use currency forward contracts and options to hedge foreign exchange rate risk.
A)True
B)False
Q2) Using the covered interest parity condition,the calculated one-year forward rate
F<sub>1 </sub>is closest to:
A)$1.8568/£
B)$1.8764/£
C)$1.9161/£
D)$1.8961/£
Q3) The implied foreign interest rate computed using spot and forward exchange rates may be lower than the actual foreign interest rate if the foreign country has a high
A)default risk.
B)inflation risk.
C)depreciation risk.
D)none of the above
Q4) What is foreign exchange market?
Q5) What is a currency forward contract?
Q6) What are internationally segmented capital markets?
25
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Chapter 24: Leasing
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Q1) Which of the following is a valid argument for leasing?
A)tax differences
B)reduced resale costs
C)efficiency gains from specialization
D)All of the above are valid arguments for leasing.
Q2) Which of the following statements is false?
A)Most financial analysts and sophisticated investors consider operating leases (which must be listed in the footnotes of the financial statements)to be additional sources of leverage.
B)By carefully avoiding the four criteria that define a operating lease for accounting purposes,a firm can avoid listing the long-term lease as a liability.
C)Because a lease is equivalent to a loan,the firm can increase its actual leverage without increasing the debt-to-equity ratio on its balance sheet.
D)For most large corporations,the amount of leverage the firm can obtain through a lease is unlikely to exceed the amount of leverage the firm can obtain through a loan.
Q3) Calculate the monthly lease payments for a four year $1.00 out lease of the Bulldozer.
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26
Chapter 25: Insurance and Risk Management
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Q1) The duration of a five-year bond with 8% annual coupons trading at par is closest to:
A)2.5 Years
B)4.3 Years
C)5.0 Years
D)6.2 Years
Q2) Farmville Industries is a major agricultural firm and is concerned about the possibility of drought impacting corn production.In the event of a drought,Farmville Industries anticipates a loss of $75 million.Suppose the likelihood of a drought is 10% per year,and the beta associated with such a loss is 0.4.If the risk-free interest rate is 5% and the expected return on the market is 10%,then what is the actuarially fair insurance premium?
Q3) To insure their assets against hazards such as fire,storm damage,vandalism,earthquakes,and other natural and environmental risks firms commonly purchase
A)key personnel insurance.
B)business liability insurance.
C)business interruption insurance.
D)property insurance.
Q4) What are some of the disadvantages of long-term supply contracts?
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Chapter 26: Corporate Governance
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Q1) Tammy is a member of the Board of Directors of Moon Corporation.Her husband is the manager of a large division.What type of director is Tammy?
A)Inside director.
B)Outside director.
C)Gray director.
D)Resident director.
Q2) Which of the following statements is false?
A)The relationship between managerial ownership and firm value is unlikely to be the same for every firm,or even for different executives of the same firm.
B)Even with the risk benefits of separating ownership and control,there are still examples of corporations in which the top managers have substantial ownership interests.
C)Academic studies do not support the notion that greater managerial ownership is associated with fewer value-reducing actions by managers.
D)While increasing managerial ownership may reduce perquisite consumption,it also makes managers harder to fire-thus reducing the incentive effect of the threat of dismissal.
Q3) What is the difference between Inside,gray,and outside directors?
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