Financial Management
Practice Questions
Course Introduction
Financial Management focuses on the principles and practices involved in the effective acquisition, allocation, and control of financial resources within an organization. This course covers key concepts such as financial analysis, budgeting, capital structure, investment decision-making, working capital management, and the assessment of risk and return. Students will gain practical skills in interpreting financial statements, valuing assets and firms, and developing strategies to maximize shareholder value. Emphasis is placed on the role of financial managers in both corporate and non-corporate settings, preparing students to make informed decisions in dynamic business environments.
Recommended Textbook Essentials of Corporate Finance 7th Edition by
Stephen A. Ross Westerfield
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Chapter 1: Introduction to Financial Management
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Q1) Limited liability companies are primarily designed to:
A) allow a portion of its owners to enjoy limited liability while granting the other portion of its owners control over the entity.
B) provide the benefits of the corporate structure to foreign-based entities.
C) spin-off a wholly-owned subsidiary.
D) allow companies to reorganize themselves through the bankruptcy process.
E) provide limited liability while avoiding double taxation.
Answer: E
Q2) Which one of the following is a general characteristic of a securities broker?
A) Trades from his or her own inventory
B) Trades only foreign securities
C) Trades listed securities in an auction market
D) Trades electronically from any geographic location
E) Is the principal trader of debt securities
Answer: C
Q3) Todd wants to start his own business and is debating between organizing the business as a sole proprietorship or a corporation. Explain the pros and cons of both forms of business organization.
Answer: 11ea6eac_0fca_a420_8f54_ef199a56b08c_TB2378_00
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Chapter 2: Financial Statements, Taxes, and Cash Flow
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Sample Questions
Q1) Explain why the marginal tax rate, rather than the average tax rate, is used when computing the cash flows from a proposed new project.
Answer: The marginal tax rate is used because that is the tax rate that will apply to the incremental taxable income generated by the new project.
Q2) Operating cash flow is defined as:
A) a firm's net profit over a specified period of time.
B) the cash that a firm generates from its normal business activities.
C) a firm's operating margin.
D) the change in the net working capital over a stated period of time.
E) the cash that is generated and added to retained earnings.
Answer: B
Q3) Highly liquid assets:
A) increase the probability a firm will face financial distress.
B) appear on the right side of a balance sheet.
C) generally produce a high rate of return.
D) can be sold quickly at close to full value.
E) include all intangible assets.
Answer: D
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Chapter 3: Working With Financial Statements
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Sample Questions
Q1) Which one of the following transactions will increase the liquidity of a firm?
A) Cash purchase of new production equipment
B) Payment of an account payable
C) Cash purchase of inventory
D) Credit sale of inventory at cost
E) Cash payment of employee wages
Answer: D
Q2) Which one of the following statements is true concerning the price-earnings (PE) ratio?
A) A high PE ratio may indicate that a firm is expected to grow significantly.
B) A PE ratio of 16 indicates that investors are willing to pay $1 for every $16 of current earnings.
C) PE ratios are unaffected by the accounting methods employed by a firm.
D) The PE ratio is classified as a profitability ratio.
E) The PE ratio is a constant value for each firm.
Answer: A
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Chapter 4: Introduction to Valuation: The Time Value of Money
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Sample Questions
Q1) Draw a graph that illustrates the relationship between interest rates and the present value of $1,000 to be received in one year.
Q2) You have $2,158 today in your savings account. How long must you wait for your savings to be worth $4,000 if you are earning 2.1 percent interest, compounded annually?
A) 26.68 years
B) 29.69 years
C) 32.13 years
D) 33.33 years
E) 34.14 years
Q3) Sue needs to invest $3,626 today in order for her savings account to be worth $5,000 six years from now. Which one of the following terms refers to the $3,626?
A) Present value
B) Compound value
C) Future value
D) Complex value
E) Factor value
Q4) Explain the time value of money principle and also identify the underlying assumption of that principle.
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Chapter 5: Discounted Cash Flow Valuation
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Q1) The Good Life Store has a 6-year, interest-only loan at 9 percent interest. The firm originally borrowed $125,000. How much will the firm pay in total interest over the life of the loan?
A) $42,189.84
B) $53,666.67
C) $67,500.00
D) $69,000.00
E) $74,500.00
Q2) A credit card has a stated interest rate of 13.9 percent. What is the APR if interest is compounded monthly?
A) 13.09 percent
B) 13.46 percent
C) 13.90 percent
D) 14.56 percent
E) 14.82 percent
Q3) Explain the similarities and differences among an ordinary annuity, an annuity due, and a perpetuity.
Q4) What does it mean when a loan is amortized? Explain how amortization methods can vary from one loan to another.
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Chapter 6: Interest Rates and Bond Valuation
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Q1) Global Trade, Inc. has $1,000 face value bonds outstanding with a market price of $1,013. The bonds pay interest annually, mature in 11 years, and have a yield to maturity of 5.34 percent. What is the current yield?
A) 5.39 percent
B) 5.43 percent
C) 5.50 percent
D) 5.61 percent
E) 5.77 percent
Q2) Which one of the following terms refers to a bond's rate of return that is required by the market place?
A) Coupon rate
B) Yield to maturity
C) Dirty yield
D) Call yield
E) Discount rate
Q3) List the various determinants of bond yields and indicate the type of situation that would cause each determinant to increase the yield on a bond.
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Chapter 7: Equity Markets and Stock Valuation
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Q1) Computing the present value of a growing perpetuity is most similar to computing the current value of which one of the following?
A) Non-dividend-paying stock
B) Stock with a constant dividend
C) Stock with irregular dividends
D) Stock with a constant growth dividend
E) Stock with growing dividends for a limited period of time
Q2) Which one of the following types of securities has no priority in a bankruptcy proceeding?
A) Convertible bond
B) Senior debt
C) Common stock
D) Preferred stock
E) Straight bond
Q3) How are preferred stock dividends treated for tax purposes by the issuer, an individual shareholder, and a corporate shareholder?
Q4) Explain the difference between computing the value of a zero growth dividend-paying stock and computing the value of a constant growth dividend-paying stock.
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Chapter 8: Net Present Value and Other Investment Criteria
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Q1) Which one of the following methods of analysis is most appropriate to use when two investments are mutually exclusive?
A) Internal rate of return
B) Profitability index
C) Net present value
D) Modified internal rate of return
E) Average accounting return
Q2) Which one of the following indicates that a project should be rejected?
A) Average accounting return that exceeds the requirement
B) Payback period that is shorter than the requirement period
C) Positive net present value
D) Profitability index less than 1.0
E) Internal rate of return that exceeds the required return
Q3) The average net income of a project divided by the project's average book value is referred to as the project's:
A) required return.
B) market rate of return.
C) internal rate of return.
D) average accounting return.
E) discounted rate of return.
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Chapter 9: Making Capital Investment Decisions
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Q1) Which of the following should be included when compiling pro forma statements for a proposed investment? I. forecasted sales
II) start-up costs
III) aftertax salvage value of any assets sold
IV) anticipated changes in net working capital
A) I only
B) II and IV only
C) I, II, and III only
D) II, III, and IV only
E) I, II, III, and IV
Q2) Better Berries has a new project that requires $869,000 of equipment. What is the depreciation in year 6 of this project if the equipment is classified as 7-year property for MACRS purposes? The MACRS allowance percentages are as follows, commencing with year one: 14.29, 24.49, 17.49, 12.49, 8.93, 8.92, 8.93, and 4.46 percent.
A) $17,294
B) $17,301
C) $32,988
D) $77,515
E) $77,602
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Chapter 10: Some Lessons From Capital Market History
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Q1) You earned 26.3 percent on your investments for a time period when the risk-free rate was 3.8 percent and the inflation rate was 3.1 percent. What was your real rate of return for the period?
A) 19.92 percent
B) 20.06 percent
C) 22.50 percent
D) 21.67 percent
E) 21.08 percent
Q2) There are regulations that prohibit "insider trading", which is the use of non-public information about a security to earn abnormal profits from trading that security. Which form of market efficiency would make these laws unnecessary? Explain why.
Q3) Which one of the following is the hypothesis that securities markets are efficient?
A) Geometric market hypothesis
B) Standard deviation hypothesis
C) Efficient markets hypothesis
D) Capital market hypothesis
E) Financial markets hypothesis
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Chapter 11: Risk and Return
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Q1) LKP, Inc., stock has an expected return of 14.47 percent. The risk-free rate is 3.8 percent and the market risk premium is 8.6 percent. What is the stock's beta?
A) 1.19
B) 1.21
C) 1.24
D) 1.28
E) 1.32
Q2) You own a portfolio equally invested in a risk-free asset and two stocks. If one of the stocks has a beta of 1.04 and the total portfolio is equally as risky as the market, what must the beta be for the other stock in your portfolio?
A) 1.37
B) 1.54
C) 1.96
D) 2.30
E) 2.97
Q3) Explain the differences between total risk, unsystematic risk, and systematic risk. Identify which risk is measured by standard deviation and which is measured by beta.
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Chapter 12: Cost of Capital
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Q1) Sunshine Cruises issues only common stock and coupon bonds. The firm has a debt-equity ratio of 0.55. The cost of equity is 16.3 percent and the pre-tax cost of debt is 9.9 percent. What is the capital structure weight of the firm's equity if the firm's tax rate is 34 percent?
A) 46.75 percent
B) 49.97 percent
C) 52.93 percent
D) 61.08 percent
E) 64.52 percent
Q2) Major Manufacturing issued 30-year, 8.5 percent semiannual bonds 6 years ago. The bonds currently sell at 101 percent of face value. What is the firm's aftertax cost of debt if the tax rate is 35 percent?
A) 5.46 percent
B) 5.62 percent
C) 5.76 percent
D) 6.59 percent
E) 6.83 percent
Q3) Explain the concept of the subjective approach to assigning a required return to a project.
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Chapter 13: Leverage and Capital Structure
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Q1) Tropical Fruit Extracts expects its earnings before interest and taxes to be $218,000 a year forever. Currently, the firm has no debt. The cost of equity is 16.3 percent and the tax rate is 35 percent. The company is in the process of issuing $2 million of bonds at par that carry a 6.5 percent annual coupon. What is the unlevered value of the firm?
A) $371,429
B) $431,971
C) $747,485
D) $869,325
E) $988,315
Q2) An all-equity firm has a return on assets of 15.3 percent. The firm is considering converting to a debt-equity ratio of 0.30. The pre-tax cost of debt is 8.1 percent. Ignoring taxes, what will the cost of equity be if the firm switches to the levered capital structure?
A) 15.57 percent
B) 16.28 percent
C) 16.67 percent
D) 17.46 percent
E) 18.19 percent
Q3) Explain how taxes affect the value of a firm based on M&M Proposition I.
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Chapter 14: Dividends and Dividend Policy
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Q1) Which one of the following dates is the date on which the board of directors votes to pay a dividend?
A) Record date
B) Declaration date
C) Ex-dividend date
D) Payment date
E) Settlement date
Q2) Elkins Feed Lot is an all-equity firm with positive net income. Which one of the following will result if the firm pays a cash dividend?
A) Number of shares outstanding will increase
B) Earnings per share will decrease
C) Total assets will remain constant
D) Price-earnings ratio will decrease
E) Total equity will increase
Q3) The ex-dividend date is defined as _____ day(s) before the date of record.
A) three business
B) three
C) two business
D) two
E) one
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Chapter 15: Raising Capital
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Q1) You own 100 of the 15,000 outstanding shares of Delta Movers stock. The firm just announced that it will be issuing an additional 5,000 shares to the general public in a cash offer at $22 per share. What type of event are you participating in if you opt to purchase 100 of these additional shares?
A) Dutch auction
B) Seasoned equity offering
C) Private placement
D) IPO
E) Rights offer
Q2) Which one of the following is an intended result of a lockup agreement?
A) Temporarily supporting the market price of IPO shares
B) Maximizing the return to a firm's original owners from an initial spike in the market price of IPO shares
C) Increasing the volume of trading for shares of a recent IPO
D) Limiting the price volatility of recent IPO shares caused by day trading
E) Guaranteeing a minimum number of sold shares for an IPO
Q3) Explain how a Dutch auction operates and why a firm might choose to sell its securities in this manner.
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Chapter 16: Short-Term Financial Planning
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Q1) Which one of the following actions is indicative of a restrictive short-term financial policy?
A) Granting increasing amounts of credit to customers
B) Expanding the number of inventory items carried
C) Increasing the firm's investment in the current accounts
D) Minimizing the cash balances held by the firm
E) Investing relatively large amounts in marketable securities
Q2) Which one of the following will increase the operating cycle?
A) Decreasing the accounts payable period
B) Increasing the accounts payable turnover rate
C) Increasing the cash cycle
D) Decreasing the accounts receivable turnover rate
E) Decreasing the inventory period
Q3) Which one of the following activities is a source of cash?
A) Decreasing long-term debt
B) Increasing inventory
C) Repurchasing shares of stock
D) Increasing fixed assets
E) Decreasing accounts receivable
Q4) How can a firm benefit from preparing a short-term financial plan?
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Chapter 17: Working Capital Management
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Q1) Which one of the following is a primary benefit of implementing zero-balance accounts into a cash management system?
A) Increased disbursements float
B) Total elimination of all safety stocks
C) Additional cash availability
D) Decreased collection float
E) Elimination of all float
Q2) Charlies' writes 135 checks a day for an average amount of $480 each. These checks generally clear the bank in 3 days. In addition, the firm generally receives an average of $159,000 a day in checks that are deposited immediately. Deposited funds are available in 1.5 days. What is the firm's net float?
A) Net disbursement float of $94,200
B) Net disbursement float of $44,100
C) Net disbursement float of $34,750
D) Net collection float of $44,100
E) Net collection float of $94,200
Q3) Explain the basic structure and workings of a disbursement system that utilizes zero-balance accounts.
Q4) What are some of the pros and cons of a JIT inventory management system?
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Chapter 18: International Aspects of Financial Management
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Q1) Suppose a U.S. firm builds a factory in China, staffs it with Chinese workers, uses materials supplied by Chinese companies, and finances the entire operation with a loan from a Chinese bank located in the same town as the factory. This firm is most likely trying to greatly reduce, or eliminate, which one of the following?
A) Interest rate disparities
B) Short-run exposure to exchange rate risk
C) Long-run exposure to exchange rate risk
D) Political risk associated with the foreign operations
E) Translation exposure to exchange rate risk
Q2) Rembrandt, Samurai, Yankee, and Bulldog are all names associated with which one of the following?
A) Eurobonds
B) Currencies
C) Cross rate
D) Foreign bonds
E) Foreign interest rates
Q3) Explain what is meant when a news broadcaster states "the value of the dollar fell today relative to all currencies". How will this change in value affect U.S. imports and exports?
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