Financial Management
Practice Questions
Course Introduction
Financial Management is a foundational course that introduces students to the principles and practices of managing an organizations financial resources. The course covers essential topics such as financial analysis, budgeting, capital structure, investment decision-making, working capital management, and risk assessment. Students learn how to interpret financial statements, analyze financial performance, and apply quantitative tools to make informed decisions regarding asset acquisition, financing strategies, and dividend policies. By blending theoretical concepts with real-world applications, the course equips learners with the skills necessary to optimize financial performance and contribute to the strategic goals of a business or organization.
Recommended Textbook
Financial Reporting Financial Statement Analysis and Valuation 6th Edition by Clyde
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Page 2
P. Stickney
Chapter 1: Overview of Financial Reporting, Financial
Statement Analysis, and Valuation
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Q1) Under the Sarbanes-Oxley Act ____________________ assumes responsibility for establishing and maintaining adequate internal control structure and procedures.
Answer: management
Q2) Obtaining a competitive advantage by being the first company to introduce new concepts or ideas is referred to as ________________________________________.
Answer: first mover advantage
Q3) The first step in financial statement analysis is to identify the __________________________________________________ of the industry in which a firm participates.
Answer: economic characteristics
Q4) Nonmonetary assets include assets that are ____________________, such as inventories, and assets that are ____________________ such as brand names. Answer: tangible, intangible
Q5) Firms intending to issue new bonds or capital stock file a ____________________ with the SEC that describes the offering.
Answer: prospectus
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Chapter 2: Asset and Liability Valuation and Income
Measurement
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Q1) H. Solo Company purchased a new piece of equipment with a list price of $175,000 and subject to a 5 percent discount if paid within 45 days. H. Solo paid within the discount period. The company also paid $1,500 to obtain title to the equipment and $600 as the license fee for the first year of operation. It paid $2,500 to level the area in which the equipment would be located and $12,500 to relocate other equipment that would have interfered with the proper operation of the new equipment. H. Solo paid $400 for property and liability insurance for the first year of operation. What is the acquisition cost of this equipment that H. Solo should record in its accounting records? Indicate the treatment of any amount not included in acquisition cost.
Answer: H. Solo should record the equipment at the following cost: 11ea92c5_78a0_10bb_9469_3f4caaab36ad_TB5976_00 The $600 license for the first year of operations is a period expense, $400 should be treated as insurance expense for the period.
Q2) Discuss the two principal reasons income before taxes for financial reporting differs from taxable income.
Answer: 11ea92c5_789e_14e4_9469_e73c6edd1d92_TB5976_00
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Chapter 3: Income Flows Versus Cash Flows: Key
Relationships in the Dynamics of a Business
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Q1) Which of the following companies would you expect to report significant amounts of cash provided by financing activities?
A) A yet to be profitable biotechnology company.
B) A mature company operating in the oil refinery industry.
C) A profitable established company in the retail industry.
D) A large multinational pharmaceutical company.
Answer: A
Q2) J. Jill is a women's clothing retailer. The company started as a mail order company and has expanded into mall department stores. The company now receives approximately half of its revenues from mail order and half from retail outlets. Over the time period 2002 to 2004 sales increased approximately 25%. Discuss the relationship between net income, working capital from operations and cash flow from operations and between cash flows from operating, investing and financing activities over the three year period.
Answer: 11ea92c5_7894_03b6_9469_573cfad2c29a_TB5976_00 Some points that may be addressed:
11ea92c5_7894_2ac7_9469_6be6d7879f43_TB5976_00
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Chapter 4: Profitability Analysis
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Q1) Firms with high operating leverage have a higher proportion of _________________________ in their cost structure.
Answer:
Q2) Which of the following factors does not explain differences or changes in ROA?
A) Operating leverage
B) Cyclicality of sales
C) Product life cycle
D) Financial leverage
Q3) Return on common equity can be disaggregated into three components, which of the three is not one of the components?
A) Assets Turnover ratio
B) Profit Margin ratio
C) Debt to Equity ratio
D) Capital Structure Leverage ratio
Q4) Discuss how the following three elements of risk help us understand return on assets differs across firms and changes over time:
1. Operating leverage
2. Cyclicality of sales
3. Product life cycle
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Chapter 5: Risk Analysis
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Q1) The source of risk related to technology, regulation and availability of raw materials is ____________________.
Q2) Discuss the differences between Chapter 7 and Chapter 11 bankruptcy filings?
Q3) _________________________ concerns a firm's ability to make interest and principal payments on borrowings as they become due.
Q4) Bankruptcy prediction research has identified three broad factors influencing long-term solvency risk, which of the following is not one of the factors?
A) Investment factors
B) Financing factors
C) Operating factors
D) Credit factors
Q5) When a financial analyst examines the credit risk of a company it is common that he or she uses a set of factors that all begin with the letter "C". Each factor provides a consideration that enters into the lending decision. List and discuss how each of the factors affects a company's credit risk.
Q6) Common shareholders benefit with increasing proportions of debt in the capital structure as long as the firm maintains an excess of ____________________ over the after-tax cost of debt
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Chapter 6: Quality of Accounting Information and Adjustments to Reported Financial Statement Data
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Q1) When evaluating the quality of accounting information the user should consider the ____________________ of the measurements made.
Q2) Which of the following is not a characteristic of an extraordinary item?
A) Unusual in nature
B) Infrequent in occurrence
C) Material in amount
D) Subject to a firm commitment
Q3) Many times an analyst will have to make judgments as to whether to include unrealized gains and losses when assessing earnings persistence and predicting future profitability. Discuss the case for and the case against including unrealized gains and losses as part of sustainable earnings when examining earnings persistence and future profitability.
Q4) When evaluating the quality of accounting information, an analyst should consider all of the following except:
A) reliability of the measurements made
B) adequacy of disclosures
C) comparability of estimates
D) economic faithfulness of the measurements made
Page 8
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Chapter 7: Revenue Recognition and Related Expenses
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Q1) An inventory pricing procedure in which the oldest costs incurred rarely have an effect on the ending inventory valuation is
A) FIFO
B) LIFO
C) Base stock
D) Weighted-average
Q2) The installment method of revenue recognition can be used when cash collectibility is uncertain. The installment method
A) requires that no income is recognized until all installments are received.
B) requires that gross profit is recognized as each installment payment is received.
C) requires that entire cost of the sale be recovered prior to any income being recognized.
D) allows revenue recognition at the time of the sale.
Q3) Under current accounting rules an asset is ____________________ when its carrying amount is deemed "not recoverable".
Q4) ___________________________________ is primarily a question of timing.
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Chapter 8: Liability Recognition and Related Expenses
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Q1) One of the conditions that must be met to recognize an estimated loss from a contingency is that the amount of loss can be estimated with
Q2) Liabilities requiring the future delivery of goods or services appear on the balance sheet at the ______________________________ of those goods and services.
Q3) Which of the following is not normally recognized as a liability on the balance sheet?
A) Warranties Payable.
B) Bonds payable.
C) Subscription Fees Received in Advance.
D) Employment Commitments.
Q4) Derivative instruments acquired to hedge exposure to changes in the fair value of an asset or liability are ______________________________ hedges.
Q5) Assume that you are currently negotiating a lease transaction in the role of the lessee. Discuss whether you would rather structure the lease as an operating lease or a capital lease and why. In addition, provide the conditions that would require that the lease be accounted for as a capital lease.
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Chapter 9: Intercorporate Entities
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Q1) Ashley Company purchased 2,000 of the 10,000 outstanding shares of Judd, Inc.'s common stock for $60,000 on January 1, 2005. During 2005, Judd declared a dividend of $5 per share and reported net income of $75,000. At the end of 2005 the market value of a share of Judd, Inc. stock has increased to $32 per share. If Ashley Company accounts for the investment as a minority, passive and classifies the investment as an available-for-sale investment, Ashley will recognize what amount of 2005 income from the investment?
A) $4,000
B) $10,000
C) $25,000
D) $15,000
Q2) When a company has a minority passive investment it will recognize changes in the market value of the investment as ____________________ gains and losses.
Q3) An investing firm consolidates the variable interest entity if it absorbs the majority of the entity's expected ____________________ if they occur, receives a majority of the entity's expected ______________________________ if they occur, or both.
Q4) The _________________________ is the date a firm gives a stock option to employees.
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Chapter 10: Forecasting Financial Statements
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Q1) As an analyst it is important when projecting sales to make estimates about future changes in sales volume. Compare how you might make estimates about future sales value for a company in a mature industry and one in a rapidly growing industry.
Q2) An analyst using the inventory turnover ratio to calculate future levels of inventory may face the problem that
A) the method reduces the potential understatement inherent in average balances.
B) the method can introduce artificial volatility in ending balances.
C) the method results in understating inventory each year.
D) the method results in overstating inventory each year.
Q3) To develop forecasts of individual assets the analyst must first link historical growth rates for individual assets to historical growth rates in ____________________ and other activity-based drivers.
Q4) Firms which have differentiated ___________________________________ for its products may have a greater potential to increase prices.
Q5) A company that has a cost structure in which its costs grow at a lesser rate than its sale enjoys ___________________________________.
Q6) Realistic expectations are ____________________ and ____________________.
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Chapter 11: Risk-Adjusted Expected Rates of Return and the Dividends Valuation Approach
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Q1) In theory, the value of a share of common equity is the present value of ____________________________________________________________.
Q2) A company with a market beta of 1 has systemic risk ____________________ to the average amount of systemic risk of all equity securities in the market.
Q3) One criticism in using the CAPM to calculate the cost of equity capital is that ______________________________ and the __________________________________________________ are quite sensitive to the time period and methodology used in their computation.
Q4) Because the market equity beta reflects the level of operating leverage, financial leverage, variability of sales and other characteristics of a firm there are situations where an analyst might have to adjust the beta because of changes in the capital structure. A situation that might require an analyst to estimate a new levered beta is a ___________________________________.
Q5) Suppose a firm has a market beta of 1.34 and the risk free interest rate is 5.3%. In addition, the excess return over the risk-free rate is 5.9%. Calculate the firm's cost of equity capital using the CAPM model.
Q6) Provide the rationale for using expected dividends in a valuation model.
Page 13
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Chapter 12: Valuation: Cash-Flow-Based Approaches
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Q1) The present value of future free cash flows valuation method focuses on free cash flows, a base that economists argue has more economic meaning than
Q2) Continuing free cash flows represent
A) the cash flows remaining after deducting cash flows attributable to debt holders
B) the free cash flows after the point at which the firm has settled into a long-run steady-state growth rate.
C) all sustainable free cash flows
D) all after-tax free cash flows
Q3) The risk-adjusted discount rate used to compute the present value of all the projected free cash flows for common equity shareholders equals the
Q4) For most firms, ______________________________ include cash and short-term investment securities, accounts receivable, inventory, property, plant and equipment, intangible assets and investments in affiliated companies.
Q5) Changes in general price levels cause the ______________________________ of the monetary unit to change over time.
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Chapter 13: Valuation: Earnings-Based Approaches
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Q1) Assume that a firm had shareholders' equity on the balance sheet at a book value of $1,600 at the end of 2005. During 2006 the firm earns net income of $1,300, pays dividends to shareholders of $600, and uses $300 to repurchase common shares. The book value of shareholders equity at the end of 2006 is:
A) $2,000
B) $400
C) $3,800
D) $2,600
Q2) The required earnings of the firm equals the product of the required rate of return on common equity capital times the __________________________________________________ at the beginning of the period.
Q3) Investors have invested $25,000 in common equity in a company. Given the risk inherent in the company the investors expect to earn a 15 percent return. In addition, the investors expect that the company will reinvest all income in projects that will earn 16%. The company is forecasted to earn $6,000 the first year, $5,000 the second year, $5,500 the third year and $6,244 each year after the third year. For this company determine the company's residual income valuation (round all numbers to the nearest dollar).
Q4) What is the rationale for using expected earnings as a basis for valuations?
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Chapter 14: Valuation: Market-Based Approaches
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Q1) A firm's value-to-book and market-to-book ratios may differ from one for a number of reasons. Discuss how a successful internally funded research and development program would create a situation where the value-to-book and market-to-book ratios differ from one.
Q2) The differences in industry market-to-book ratios may be the result of differences in growth, ROCE relative to R<sub>E</sub>, as well as differences in
Q3) Which of the following normally does not introduce measurement error into the calculation of P/E ratios?
A) differences in firm specific growth rates
B) restructuring losses
C) transitory gains
D) deferred taxes
Q4) The market price of a share of common equity reflects
A) the aggregated expectations of all of the market participants following that particular stock.
B) the present value of future residual income.
C) book value plus the present value of future residual income.
D) the correct value for the particular stock.
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