Financial Management
Exam Answer Key
Course Introduction
Financial Management is a course that explores the foundational principles and techniques used in the effective management of an organizations financial resources. The course covers key topics such as financial analysis, planning, and control, capital budgeting, risk management, valuation of financial assets, and the cost of capital. Students learn how to interpret financial statements, make informed investment decisions, and develop strategies to optimize the financial performance of businesses. Emphasis is placed on practical applications, ethical considerations, and decision-making processes that drive value creation for stakeholders in both domestic and international contexts.
Recommended Textbook Fundamentals of Financial Management 14th Edition by Eugene
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Page 2
F. Brigham
Chapter 1: An Overview of Financial Management
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Q1) Which of the following statements is CORRECT?
A)In most corporations, the CFO ranks above the CEO.
B)By law in most states, the chairman of the board must also be the CEO.
C)The board of directors is the highest ranking body in a corporation, and the chairman of the board is the highest ranking individual. The CEO generally works under the board and its chairman, and the board generally has the authority to remove the CEO under certain conditions. The CEO, however, cannot remove the board, but he or she can endeavor to have the board voted out and a new board voted in should a conflict arise. It is possible for a person to simultaneously serve as CEO and chairman of the board, though many corporate control experts believe it is bad to vest both offices in the same person.
D)The CFO generally reports to the firm's chief accounting officer, who is normally the controller.
E)The CFO is responsible for raising capital and for making sure that capital expenditures are desirable, but he or she is not responsible for the validity of the financial statements, as the controller and the auditors have that responsibility.
Answer: C
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Page 3
Chapter 2: Financial Markets and Institutions
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Q1) The term IPO stands for "individual purchase order," as when an individual (as opposed to an institution)places an order to buy a stock.
A)True
B)False
Answer: False
Q2) Which of the following is a primary market transaction?
A)You sell 200 shares of IBM stock on the NYSE through your broker.
B)You buy 200 shares of IBM stock from your brother. The trade is not made through a broker; you just give him cash and he gives you the stock.
C)IBM issues 2,000,000 shares of new stock and sells them to the public through an investment banker.
D)One financial institution buys 200,000 shares of IBM stock from another institution. An investment banker arranges the transaction.
E)IBM sells 2,000,000 shares of treasury stock to its employees when they exercise options that were granted in prior years.
Answer: C
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Chapter 3: Financial Statements, cash Flow, and Taxes
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Q1) A 7-year municipal bond yields 4.8%.Your marginal tax rate (including state and federal taxes)is 27%.What interest rate on a 7-year corporate bond of equal risk would provide you with the same after-tax return?
A)5.64%
B)5.93%
C)6.25%
D)6.58%
E)6.90%
Answer: D
Q2) The amount shown on the December 31,2015,balance sheet as "retained earnings" is equal to the firm's net income for 2015 minus any dividends it paid.
A)True
B)False Answer: False
Q3) On the balance sheet,total assets must always equal the sum of total liabilities and equity.
A)True
B)False Answer: True
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Page 5
Chapter 4: Analysis of Financial Statements
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Q1) Companies HD and LD have the same tax rate,sales,total assets,and basic earning power.Both companies have positive net incomes.Both firms finance using only debt and common equity and total assets equal total invested capital.Company HD has a higher total debt to total invested capital ratio and,therefore,a higher interest expense.Which of the following statements is CORRECT?
A)Company HD has a lower equity multiplier.
B)Company HD has more net income.
C)Company HD pays more in taxes.
D)Company HD has a lower ROE.
E)Company HD has a lower times-interest-earned (TIE) ratio.
Q2) Determining whether a firm's financial position is improving or deteriorating requires analyzing more than the ratios for a given year.Trend analysis is one method of examining changes in a firm's performance over time.
A)True
B)False
Q3) If a firm's ROE is equal to 9% and its ROA is equal to 6%,its equity multiplier must be 1.5.
A)True
B)False
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Page 6
Chapter 5: Time Value of Money
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Q1) What's the present value of $1,525 discounted back 5 years if the appropriate interest rate is 6%,compounded monthly?
A)$ 969
B)$1,020
C)$1,074
D)$1,131
E)$1,187
Q2) Suppose you inherited $275,000 and invested it at 8.25% per year.How much could you withdraw at the beginning of each of the next 20 years?
A)$22,598.63
B)$23,788.03
C)$25,040.03
D)$26,357.92
E)$27,675.82
Q3) Starting to invest early for retirement increases the benefits of compound interest. A)True B)False
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Chapter 6: Interest Rates
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Q1) In the foreseeable future,the real risk-free rate of interest,r*,is expected to remain at 3%,inflation is expected to steadily increase,and the maturity risk premium is expected to be 0.1(t 1)%,where t is the number of years until the bond matures.Given this information,which of the following statements is CORRECT?
A)The yield on 2-year Treasury securities must exceed the yield on 5-year Treasury securities.
B)The yield on 5-year Treasury securities must exceed the yield on 10-year corporate bonds.
C)The yield on 5-year corporate bonds must exceed the yield on 8-year Treasury bonds.
D)The yield curve must be "humped."
E)The yield curve must be upward sloping.
Q2) The Federal Reserve tends to take actions to increase interest rates when the economy is very strong and to decrease rates when the economy is weak.
A)True
B)False
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Chapter 7: Bonds and Their Valuation
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Q1) If the required rate of return on a bond (r<sub>d</sub>)is greater than its coupon interest rate and will remain above that rate,then the market value of the bond will always be below its par value until the bond matures,at which time its market value will equal its par value.(Accrued interest between interest payment dates should not be considered when answering this question.)
A)True
B)False
Q2) There is an inverse relationship between bonds' quality ratings and their required rates of return.Thus,the required return is lowest for AAA-rated bonds,and required returns increase as the ratings get lower.
A)True
B)False
Q3) If its yield to maturity declined by 1%,which of the following bonds would have the largest percentage increase in value?
A)A 1-year zero coupon bond.
B)A 1-year bond with an 8% coupon.
C)A 10-year bond with an 8% coupon.
D)A 10-year bond with a 12% coupon.
E)A 10-year zero coupon bond.
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Page 9
Chapter 8: Risk and Rates of Return
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Q1) Stock A has a beta of 0.7,whereas Stock B has a beta of 1.3.Portfolio P has 50% invested in both A and B.Which of the following would occur if the market risk premium increased by 1% but the risk-free rate remained constant?
A)The required return on Portfolio P would increase by 1%.
B)The required return on both stocks would increase by 1%.
C)The required return on Portfolio P would remain unchanged.
D)The required return on Stock A would increase by more than 1%, while the return on Stock B would increase by less than 1%.
E)The required return for Stock A would fall, but the required return for Stock B would increase.
Q2) Market risk refers to the tendency of a stock to move with the general stock market.A stock with above-average market risk will tend to be more volatile than an average stock,and its beta will be greater than 1.0.
A)True
B)False
Q3) The slope of the SML is determined by the value of beta.
A)True
B)False
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Chapter 9: Stocks and Their Valuation
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Q1) Based on the corporate valuation model,Gay Entertainment's total corporate value is $1,200 million.The company's balance sheet shows $120 million of notes payable,$300 million of long-term debt,$50 million of preferred stock,$180 million of retained earnings,and $800 million of total common equity.If the company has 30 million shares of stock outstanding,what is the best estimate of its price per share?
A)$21.90
B)$24.33
C)$26.77
D)$29.44
E)$32.39
Q2) Rebello's preferred stock pays a dividend of $1.00 per quarter,and it sells for $55.00 per share.What is its effective annual (not nominal)rate of return?
A)6.62%
B)6.82%
C)7.03%
D)7.25%
E)7.47%
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11
Chapter 10: The Cost of Capital
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Q1) A.Butcher Timber Company hired your consulting firm to help them estimate the cost of equity.The yield on the firm's bonds is 8.75%,and your firm's economists believe that the cost of equity can be estimated using a risk premium of 3.85% over a firm's own cost of debt.What is an estimate of the firm's cost of equity from retained earnings?
A)12.60%
B)13.10%
C)13.63%
D)14.17%
E)14.74%
Q2) A company's perpetual preferred stock currently sells for $92.50 per share,and it pays an $8.00 annual dividend.If the company were to sell a new preferred issue,it would incur a flotation cost of 5.00% of the issue price.What is the firm's cost of preferred stock?
A)7.81%
B)8.22%
C)8.65%
D)9.10%
E)9.56%
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Page 12
Chapter 11: The Basics of Capital Budgeting
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Q1) A conflict will exist between the NPV and IRR methods,when used to evaluate two equally risky but mutually exclusive projects,if the projects' cost of capital is less than the rate at which the projects' NPV profiles cross.
A)True
B)False
Q2) The NPV and IRR methods,when used to evaluate two independent and equally risky projects,will lead to different accept/reject decisions and thus capital budgets if the projects' IRRs are greater than their costs of capital.
A)True
B)False
Q3) Assume a project has normal cash flows.All else equal,which of the following statements is CORRECT?
A)A project's IRR increases as the WACC declines.
B)A project's NPV increases as the WACC declines.
C)A project's MIRR is unaffected by changes in the WACC.
D)A project's regular payback increases as the WACC declines.
E)A project's discounted payback increases as the WACC declines.
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Page 13
Chapter 12: Cash Flow Estimation and Risk Analysis
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Q1) The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the total amount of depreciation that can be taken,assuming the asset is used for its full tax life,is greater.
A)True
B)False
Q2) If debt is to be used to finance a project,then when cash flows for a project are estimated,interest payments should be included in the analysis.
A)True
B)False
Q3) Accelerated depreciation has an advantage for profitable firms in that it moves some cash flows forward,thus increasing their present value.On the other hand,using accelerated depreciation generally lowers the reported current year's profits because of the higher depreciation expenses.However,the reported profits problem can be solved by using different depreciation methods for tax and stockholder reporting purposes.
A)True
B)False
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Chapter 13: Real Options and Other Topics in Capital
Budgeting
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Q1) If a firm practices capital rationing,this means that it is accepting fewer projects than would be theoretically optimal; hence,it is not maximizing its theoretical value.
A)True
B)False
Q2) Real options are options to buy real assets,especially stocks,rather than interest-bearing assets,like bonds.
A)True
B)False
Q3) Which one of the following statements best describes the most likely impact that a profitable abandonment option would have on a project's expected cash flow and risk?
A)No impact on the PV of expected cash flows, but risk will increase.
B)The PV of expected cash flows increases and risk decreases.
C)The PV of expected cash flows increases and risk increases.
D)The PV of expected cash flows decreases and risk decreases.
E)The PV of expected cash flows decreases and risk increases.
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15
Chapter 14: Capital Structure and Leverage
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Q1) A group of venture investors is considering putting money into Lemma Books,which wants to produce a new reader for electronic books.The variable cost per unit is estimated at $250,the sales price would be set at twice the VC/unit,or $500,and fixed costs are estimated at $750,000.The investors will put up the funds if the project is likely to have an operating income of $500,000 or more.What sales volume would be required in order to meet the minimum profit goal? (Hint: Use the break-even formula,but include the required profit in the numerator.)
A)4,513
B)4,750
C)5,000
D)5,250
E)5,513
Q2) Other things held constant,the lower a firm's tax rate,the more logical it is for the firm to use debt.
A)True
B)False
Q3) If a firm borrows money,it is using financial leverage.
A)True
B)False
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Page 16
Chapter 15: Distributions to Shareholders: Dividends and Share Repurchases
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Q1) One implication of the bird-in-the-hand theory of dividends is that a given reduction in dividend yield must be offset by a more than proportionate increase in growth in order to keep a firm's required return constant,other things held constant.
A)True
B)False
Q2) Other things held constant,the higher a firm's target payout ratio,the higher its expected growth rate should be.
A)True
B)False
Q3) D.Paul Inc.forecasts a capital budget of $725,000.The CFO wants to maintain a target capital structure of 45% debt and 55% equity,and she also wants to pay a dividend of $500,000.If the company follows the residual dividend model,how much income must it earn,and what will its dividend payout ratio be?
A)$ 898,750; 55.63%
B)$ 943,688; 58.41%
C)$ 990,872; 61.34%
D)$1,040,415; 64.40%
E)$1,092,436; 67.62%
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Chapter 16: Working Capital Management
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Q1) Which of the following statements is most consistent with efficient inventory management? The firm has a
A)below-average inventory turnover ratio.
B)low incidence of production schedule disruptions.
C)below-average total assets turnover ratio.
D)relatively high current ratio.
E)relatively low DSO.
Q2) Net working capital is defined as current assets divided by current liabilities.
A)True
B)False
Q3) As a rule,managers should try to always use the free component of trade credit but should use the costly component only if the cost of this credit is lower than the cost of credit from other sources.
A)True
B)False
Q4) Synchronization of cash flows is an important cash management technique,as proper synchronization can reduce the required cash balance and increase a firm's profitability.
A)True
B)False
Page 18
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Chapter 17: Financial Planning and Forecasting
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Q1) A typical sales forecast,though concerned with future events,will usually be based on recent historical trends and events as well as on forecasts of economic prospects.
A)True
B)False
Q2) When we use the AFN equation to forecast the additional funds needed (AFN),we are implicitly assuming that all financial ratios are constant.If financial ratios are not constant,regression techniques can be used to improve the financial forecast.
A)True
B)False
Q3) Last year Wei Guan Inc.had $350 million of sales,and it had $270 million of fixed assets that were used at 65% of capacity.In millions,by how much could Wei Guan's sales increase before it is required to increase its fixed assets?
A)$170.09
B)$179.04
C)$188.46
D)$197.88
E)$207.78
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Chapter 18: Derivatives and Risk Management
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Q1) Which of the following is NOT an example of a derivative security?
A)Futures.
B)Options.
C)Swaps.
D)Forward contracts.
E)Preferred stock.
Q2) Looking at The Wall Street Journal you observe that the settlement price on a hypothetical 10-year,semiannual payment,6% coupon Treasury note is 105-21.If the note has a $1,000 par value,what is the implied Treasury note rate?
A)5.27%
B)5.53%
C)5.80%
D)6.10%
E)6.40%
Q3) The value of a stock option depends on all of the following EXCEPT:
A)Exercise price.
B)Variability of the stock price.
C)Length of time until option expiration.
D)Risk-free rate of interest.
E)Bond price.
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Chapter 19: Multinational Financial Management
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Q1) Currently,a U.S.trader notes that in the 6-month forward market,the Japanese yen is selling at a premium (that is,you receive more dollars per yen in the forward market than you do in the spot market),while the British pound is selling at a discount.Which of the following statements is CORRECT?
A)If interest rate parity holds, 6-month interest rates should be the same in the U.S., Britain, and Japan.
B)If interest rate parity holds among the three countries, the United States should have the highest 6-month interest rates and Japan should have the lowest rates.
C)If interest rate parity holds among the three countries, Britain should have the highest 6-month interest rates and Japan should have the lowest rates.
D)If interest rate parity holds among the three countries, Japan should have the highest 6-month interest rates and Britain should have the lowest rates.
E)If interest rate parity holds among the three countries, the United States should have the highest 6-month interest rates and Britain should have the lowest rates.
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Chapter 20: Hybrid Financing: Preferred Stock, leasing, warrants,
and Convertibles
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Q1) Its investment bankers have told Donner Corporation that it can issue a 25-year,8.1% annual payment bond at par.They also stated that the company can sell an issue of annual payment preferred stock to corporate investors who are in the 40% tax bracket.The corporate investors require an after-tax return on the preferred that exceeds their after-tax return on the bonds by 1.0%,which would represent an after-tax risk premium.What coupon rate must be set on the preferred in order to issue it at par?
A)6.66%
B)6.99%
C)7.34%
D)7.71%
E)8.09%
Q2) Refer to Exhibit 20.1.What is the bond's initial conversion value when issued?
A)$698.15
B)$734.89
C)$773.57
D)$814.29
E)$857.14
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Page 22
Chapter 21: Mergers and Acquisitions
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Q1) At the beginning of the year Ham Inc.'s management is considering making an offer to buy Egg Corporation.Egg's projected operating income (EBIT)for the current year is $30 million,but Ham believes that if the two firms were merged,it could consolidate some operations,reduce Egg's expenses,and raise its EBIT to $40 million.Neither company uses any debt,and they both pay income taxes at a 40% rate.Ham has a better reputation among investors,who regard it as better managed and also less risky,so Ham's stock has a P/E ratio of 15 versus a P/E of 12 for Egg.Since Ham's management will be running the entire enterprise after a merger,investors will value the resulting corporation based on Ham's P/E.Based on expected market values,how much synergy should the merger create?
A)$129.96
B)$136.80
C)$144.00
D)$151.20
E)$158.76
Q2) A conglomerate merger occurs when two firms with either a horizontal or a vertical business relationship combine.
A)True
B)False
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Page 23
Chapter 22: Continuous Compounding and Discounting
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Q1) How much should you be willing to pay for an account today that will have a value of $1,000 in 10 years under continuous compounding if the nominal rate is 10%?
A)$349.49
B)$367.88
C)$386.27
D)$405.59
E)$425.87
Q2) In six years' time,you are scheduled to receive money from a trust established by your grandparents.When the trust matures there will be $100,000 in the account.If the account earns 9% compounded continuously,how much is in the account today?
A)$55,361.08
B)$58,274.83
C)$61,188.57
D)$64,247.99
E)$67,460.39
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24
Chapter 23: Zero Coupon Bonds
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Q1) S.Claus & Co.is planning a zero coupon bond issue that has a par value of $1,000 and matures in 2 years.The bonds will be sold today at a price of $826.45.If the firm's marginal tax rate is 40%,what is the annual after-tax cost of debt to the company on this issue?
A)5.70%
B)6.00%
C)6.30%
D)6.61%
E)6.95%
Q2) Refer to Exhibit 7A.1.What is the nominal dollar value of the interest tax savings to the firm in the third year of the issue?
A)$38.27
B)$40.29
C)$42.30
D)$44.42
E)$46.64
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25
Chapter 24: Bankruptcy and Reorganization
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Q1) Which of the following statements is most CORRECT?
A)The primary test of feasibility in a reorganization is whether every claimant agrees with the reorganization plan.
B)The basic doctrine of fairness states that all debt holders must be treated equally.
C)Since the primary issue in bankruptcy is to determine the sharing of losses between owners and creditors, the "public interest" is not a relevant concern.
D)While the firm is in bankruptcy, the existing management is always allowed to remain in control of the firm, though the court monitors its actions closely.
E)To a large extent, the decision to dissolve a firm through liquidation or to keep it alive through reorganization depends upon the value of the firm if it is rehabilitated versus its value if its assets are sold off individually.
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Chapter 25: Calculating Beta Coefficients
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Q1) Refer to Exhibit 8A.1.Calculate both stocks' betas.What is the difference between the betas? That is,what is the value of beta<sub>R</sub> beta<sub>S</sub>? (Hint: The graphical method of calculating the rise over run,or (Y<sub>2</sub> Y<sub>1</sub>)divided by (X<sub>2</sub> X<sub>1</sub>)may aid you.)
A)1.3538
B)1.4250
C)1.5000
D)1.5750
E)1.6538
Q2) Refer to Exhibit 8A.1.Set up the SML equation and use it to calculate both stocks' required rates of return,and compare those required returns with the expected returns given above.You should invest in the stock whose expected return exceeds its required return by the widest margin.What is the widest positive margin,or greatest excess return (expected return required return)?
A)1.97%
B)2.19%
C)2.43%
D)2.70%
E)3.00%
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27
Chapter
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Q1) Sunshine Inc.has two equally-sized divisions.Division A has a beta of 0.8 and Division B has a beta of 1.2.The company is 100% equity financed.The risk-free rate is 6% and the market risk premium is 5%.Sunshine assigns different hurdle rates to each division based on each division's market risk.Which of the following statements is CORRECT?
A)Sunshine's composite WACC is 10%.
B)Division B has a lower WACC than Division A.
C)If the same WACC is used for each division, the firm would select too many Division A projects and reject too many Division B projects.
D)If the same WACC is used for each division, the firm would select too many Division B projects and reject too many Division A projects.
E)Sunshine's composite WACC is 12%.
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Chapter 27: Techniques for Measuring Beta Risk
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Q1) Interstate Transport has a target capital structure of 50% debt and 50% common equity.The firm is considering a new independent project that has a return of 13% and is not related to transportation.However,a pure-play proxy firm has been identified that has a beta of 1.38.Both firms have a marginal tax rate of 40%,and Interstate's before-tax cost of debt is 12%.The risk-free rate is 10% and the market risk premium is 5%.The firm should:
A)Reject the project; its return is less than the firm's required rate of return on the project of 16.9%.
B)Accept the project; its return is greater than the firm's required rate of return on the project of 12.05%.
C)Reject the project; its return is only 13%.
D)Accept the project; its return exceeds the risk-free rate and the before-tax cost of debt.
E)Be indifferent between accepting or rejecting; the firm's required rate of return on the project equals its expected return.
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Chapter 28: Degree of Leverage
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Sample Questions
Q1) Monroe Corporation currently sells 150,000 units a year at a price of $4.00 a unit.Its variable costs are approximately 30% of sales,and its fixed costs amount to 50% of revenues at its current output level.Although fixed costs are based on revenues at the current output level,the cost level is fixed.What is Marcus's degree of operating leverage in sales dollars?
A)3.1588
B)3.3250
C)3.5000
D)3.6750
E)3.8588
Q2) Coats Corp.generates $10,000,000 in sales.Its variable costs equal 85% of sales and its fixed costs are $500,000.Therefore,the company's operating income (EBIT)equals $1,000,000.The company estimates that if its sales were to increase 10%,its net income and EPS would increase 17.5%.What is the company's interest expense?
A)$122,482
B)$128,929
C)$135,714
D)$142,857
E)$150,000
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