Financial Management
Study Guide Questions
Course Introduction
Financial Management is a fundamental course that introduces students to the principles and practices involved in managing an organizations financial resources. The course covers key concepts such as financial analysis, planning and control, capital budgeting, working capital management, and the cost of capital. Students learn how to evaluate investment opportunities, make informed financing decisions, and understand the risk-return tradeoff. Emphasis is placed on the application of theoretical concepts to real-world scenarios, equipping students with the decision-making tools essential for maximizing firm value and achieving long-term financial stability.
Recommended Textbook Fundamentals of Corporate Finance 4th Edition Jonathan Berk
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Page 2
Chapter 1: Corporate Finance and the Financial Manager
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Sample Questions
Q1) Raising new capital by issuing bonds is an example of a commercial banking activity.
A)True
B)False
Answer: False
Q2) In which of the following relationships is an agency conflict problem LEAST likely to arise?
A) the relationship between a hire-car company and the persons who hire that company's cars regarding the treatment of those cars
B) the relationship between high-level military officers and the soldiers who serve under them regarding the willingness of the soldiery to take risks
C) the relationship between a restaurateur and the suppliers of produce to that restaurant regarding the freshness of the produce supplied
D) the relationship between a driver and the passengers in a car regarding the safe driving of that car
Answer: D
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3
Chapter 2: Introduction to Financial Statement Analysis
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Q1) A firm's statement of cash flows uses the balance sheet and the income statement to determine the amount of cash a firm has generated and how it has used that cash during a given period.
A)True
B)False
Answer: True
Q2) What is a firm's net income?
A) the difference between the sales and other income generated by a firm, and all costs, taxes, and expenses incurred by the firm in a given period
B) the last or "bottom" line of the income statement
C) a measure of the firm's profitability over a given period
D) all of the above
Answer: D
Q3) What will be the effect on the income statement if a firm buys a new processing plant through a new loan?
Answer: The effect on the income statement will be in the form of a depreciation expense for the first year on the new processing plant.
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4
Chapter 3: Time Value of Money: an Introduction
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Q1) Advanced Micro Devices (NYSE: AMD) is currently trading at $20.75 on the NYSE. Advanced Micro Devices is also listed on NASDAQ. Assume it is currently trading on NASDAQ at $20.50. Does an arbitrage opportunity exist and, if so, how would you exploit it and how much would you make on a block trade of 1000 shares?
Answer: Yes, buy 1,000 shares × 20.50 ($20,500) and sell 1,000 shares × 20.75 ($20,750) = $250.00.
Q2) Which of the following statements is INCORRECT based on the time value of money?
A) In general, money today is worth more than money in one year.
B) We define the risk-free interest rate (r<sub>f</sub>) for a given period as the interest rate at which money can be borrowed or lent without risk over that period.
C) We refer to (1 - r<sub>f</sub>) as the interest rate factor for risk-free cash flows.
D) For most financial decisions, costs and benefits occur at different points in time. Answer: C
Q3) 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.
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Page 5
Chapter 4: Time Value of Money: Valuing Cash Flow
Streams
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Q1) If the current rate of interest is 7%, then the future value (FV) of an investment that pays $1200 per year and lasts 18 years is closest to ________.
A) $24,479
B) $40,799
C) $48,959
D) $57,119
Q2) How do the growth perpetuity results differ with negative and positive growths of similar magnitude assuming everything else remains unchanged?
Q3) A perpetuity will pay $900 per year, starting five years after the perpetuity is purchased. What is the present value (PV) of this perpetuity on the date that it is purchased, given that the interest rate is 11%?
A) $2695
B) $4312
C) $5390
D) $3234
Q4) 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?
Page 6
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Chapter 5: Interest Rates
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Q1) A truck costing $111,000 is paid off in monthly installments over four years with 8.10% APR. After three years the owner wishes to sell the truck. What is the closest amount from the following list that he needs to pay on his loan before he can sell the truck?
A) $24,956
B) $37,434
C) $31,195
D) $43,673
Q2) Can the nominal interest rate ever be negative? Can the real interest rate ever be negative? Explain.
Q3) The yield curve is typically ________.
A) downward sloping
B) upward sloping
C) flat
D) inverted
Q4) A(n) 12% APR with monthly compounding is closest to ________.
A) an EAR of 10.14%
B) an EAR of 15.22%
C) an EAR of 12.68%
D) an EAR of 25.36%
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Chapter 6: Bonds
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Q1) Which of the following bonds will be most sensitive to a change in interest rates?
A) a ten-year bond with a $2,000 face value whose yield to maturity is 5.8% and coupon rate is 5.8% APR paid semiannually
B) a 15-year bond with a $5,000 face value whose yield to maturity is 7.4% and coupon rate is 6.2% APR paid annually
C) a 20-year bond with a $3,000 face value whose yield to maturity is 6.0% and coupon rate is 5.4% APR paid semiannually
D) a 30-year bond with a $1,000 face value whose yield to maturity is 5.5% and coupon rate is 6.4% APR paid annually
Q2) A bond has five years to maturity, a $1000 face value, and a 5.5% coupon rate with annual coupons. What is its yield to maturity if it is currently trading at $846.11?
A) 11.41%
B) 13.31%
C) 7.61%
D) 9.51%
Q3) Under what situation can a zero-coupon bond be selling at a premium?
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Chapter 7: Stock Valuation
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Q1) Spacefood Products will pay a dividend of $2.40 per share this year. It is expected that this dividend will grow by 5% per year each year in the future. What will be the current value of a single share of Spacefood's stock if the firm's equity cost of capital is 12%?
A) $24.00
B) $22.29
C) $30.86
D) $34.29
Q2) Kirkevue Industries pays out all its earnings as dividends, currently expects earnings to be constant and has a share price of $27. In order to expand, Kirkevue announces it will cut its dividend payments from $2.15 to $1.75 per share and reinvest the retained funds. What is the growth rate that should be achieved on the reinvested funds to keep the equity cost of capital unchanged?
A) 1.48%
B) 0.14%
C) 0.17%
D) 0.15%
Q3) Assuming everything else remains unchanged, how does a firm's decision to increase its dividend-payout ratio affect its growth rate?
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Chapter 8: Investment Decision Rules
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Q1) A firm has an opportunity to invest $95,000 today that will yield $109,250 in one year. If interest rates are 4%, what is the net present value (NPV) of this investment?
A) $10,048
B) $11,053
C) $16,077
D) $14,250
Q2) 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
Q3) Preference for cash today versus cash in the future in part determines net present value (NPV).
A)True
B)False
Q4) How do you apply the Net Present Value rule when multiple projects are available and you have the added constraint of accepting only one project?
Q5) Is there a unique way for calculating the MIRR to resolve the multiple IRR situation?
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Chapter 9: Fundamentals of Capital Budgeting
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Q1) The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30,000 and the machine will be depreciated straight line over its three-year life to a residual value of $0. The cane manufacturing machine will result in sales of 2400 canes in year 1. Sales are estimated to grow by 9% each year through year 3. The price per cane that Sisyphean will charge its customers is $15 each and is to remain constant. The canes have a cost per unit to manufacture of $8 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 3% of its annual sales in cash, 5% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 6% of its annual sales in accounts payable. The firm is in the 35% tax bracket and has a cost of capital of 8%.
The change in net working capital from year 1 to year 2 is closest to ________.
A) a decrease of $356
B) an increase of $356
C) an increase of $389
D) a decrease of $389
Q2) What do you understand by break-even analysis?
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Page 11
Chapter 10: Stock Valuation: a Second Look
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Q1) On a particular day, a mining company reveals that, due to new extraction technology, the extractable yield from several of its nickel/lead mines has risen by 15%.
Which of the following is the LEAST likely consequence of such an announcement?
A) The price of the stock would rise.
B) Investors would determine that the estimates of the firm's value on the date prior to the announcement were too high.
C) Investors would increase their forecast of future cash flows in that firm.
D) Investors would revise their estimates of the net present value (NPV) of the firm.
Q2) In the method of comparables, the known values of a firm's cash flows are used to estimate the unknown cash flows of a similar firm.
A)True
B)False
Q3) Which is the best valuation technique when using comparables?
Q4) Individual investors trade conservatively, given the difficulty of finding over-valued and under-valued stocks.
A)True
B)False
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Chapter 11: Risk and Return in Capital Markets
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Q1) Stocks with high returns are expected to have ________.
A) high variability
B) low variability
C) no relation to variability
D) inverse relationship with variability
Q2) Fluctuations of a stock's return that are due to market-wide news representing common risk is the ________.
A) idiosyncratic risk
B) systematic risk
C) unique risk
D) unsystematic risk
Q3) Rational investors ________ fluctuations in the value of their investments.
A) are averse to B) prefer
C) are indifferent to
D) are in favor of
Q4) What is the diversification achieved by an investor if he invests in Exxon Mobil, Dell, and Bank of America?
Q5) Is volatility a reasonable measure of risk when evaluating the investment in a single stock?
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Chapter 12: Systematic Risk and the Equity Risk Premium
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Q1) The market or equity risk premium can be estimated by computing the historical average excess return on the market portfolio.
A)True
B)False
Q2) Historically, the average excess return of the S&P 500 over the return of U.S. Treasury bonds has been ________ and is proxy for the market risk premium.
A) between 10% and 12%
B) between 14% and 16%
C) between 5% and 7%
D) between 11% and 13%
Q3) When we combine stocks in a portfolio, the amount of risk that is eliminated depends on the degree to which the stocks face common risks and move together.
A)True
B)False
Q4) What role does the correlation of two assets play in computation of the expected return of the two asset portfolio?
Q5) Is it possible for a stock to have high total risk but low systematic risk?
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14
Chapter 13: The Cost of Capital
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Q1) Why do we use market values rather than book values in calculation of WACC?
Q2) Outstanding debt of Home Depot trades with a yield to maturity of 5%. The tax rate of Home Depot is 40%. What is the effective cost of debt of Home Depot?
A) 4.50%
B) 4.65%
C) 3.60%
D) 3.00%
Q3) The fact that the after-tax cost of debt is lower than the pretax cost of debt implicitly assumes that interest expense can be ________.
A) expensed
B) margined
C) refinanced
D) capitalized
Q4) Is it incorrect to use the coupon rate of debt toward cost of debt?
Q5) Leverage is the amount of ________ on a firm's balance sheet.
A) equity
B) debt
C) preferred stock
D) retained earnings
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Chapter 14: Raising Equity Capital
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Q1) Managers will try to protect their existing shareholders by selling new shares at a price that correctly values or overvalues their firm, leading investors to reason that the announcement of an SEO indicates that a company is over-valued.
A)True
B)False
Q2) Big Box retailing has a market capitalization of $500 million and 4 million shares outstanding. In order to finance its growth, the management of Big Box plans to raise further capital through a rights issue. All shareholders will be issued ten rights to purchase ten shares at a price of $1.00 per share. How much money will this raise, if all shareholders exercise their rights?
A) $20.0 million
B) $40.0 million
C) $60.0 million
D) $80.0 million
Q3) Which of the following is an advantage of a cash offer over a rights offer?
A) The underwriter can credibly attest to the issue's quality.
B) The overall costs are lower.
C) There is no loss imposed on the current holders of stock.
D) There are lower underwriting fees.
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Page 16
Chapter 15: Debt Financing
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Q1) Convertible bonds have a provision that gives the bondholder an option to convert each bond owned into a fixed number of shares of common stock.
A)True
B)False
Q2) Private debt cannot be in the form of bonds.
A)True
B)False
Q3) Which of the following statements about bonds that are both convertible and callable is NOT true?
A) If these bonds are called by the issuer, the holder can choose to convert them rather than let them be called.
B) Prior to maturity, the value of such bonds will be greater than the shares of stock that bond can be converted into.
C) The decision to be made by the bondholders when the bonds are called is the same as they would have to make at maturity.
D) By calling the bonds, the issuer can force bondholders to decide to convert at a time of the issuer's choice.
Q4) What is yield to maturity?
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Chapter 16: Capital Structure
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Q1) Even if two firms operate in the same industry, they may prefer different choices of debt-equity ratios.
A)True
B)False
Q2) What effect does debt have on a firm's weighted average cost of capital?
Q3) A firm will give a one-time cash flow of $24,000 after one year. If the project risk requires a return of 10%, what is the levered value of the firm with perfect capital markets?
A) $17,454.55
B) $26,181.82
C) $21,818.18
D) more information needed
Q4) Suppose Blank Company has only one project, as forecast above, and an unlevered cost of equity of 8%. If the company uses no leverage, what is expected return to equity holders?
A) 8.0%
B) 11.6%
C) 9.33%
D) 30.0%
Q5) What is the capital structure of a firm?
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Chapter 17: Payout Policy
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Q1) A firm has $400 million of assets that includes $40 million of cash and 12 million shares outstanding. The firm uses $40 million of its cash to pay dividends. If an investor has 1000 shares, how many shares must she sell to create a homemade dividend of $4,900?
A) 52.22 shares
B) 41.78 shares
C) 62.67 shares
D) 73.11shares
Q2) The way a firm chooses between alternate uses of free cash flow is referred to as
A) retention ratio
B) payout policy
C) call policy
D) debt policy
Q3) In perfect capital markets, buying and selling securities is a zero-NPV transaction, so retaining cash versus paying it out does not affect firm value.
A)True
B)False
Q4) What are the ways in which a firm can retain its free cash flow?
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Chapter 18: Financial Modeling and Pro Forma Analysis
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Q1) The sustainable growth rate assumes that the firm will raise no new debt financing.
A)True
B)False
Q2) Compute the after-tax interest expense for a firm with Interest on Excess Cash = $5,000, Interest on Debt = $8,000, and a tax rate of 30%.
A) $2,100
B) $2,200
C) $2,500
D) $2,700
Q3) A services firm does all its business in cash only. The firm projects a cash balance of $2,000 in its account after all taxes and costs are paid. The owners plan to invest $5,000 and pay a dividend of $1000. How much net new financing is needed?
A) $4,000
B) $5,000
C) $6,000
D) $7,000
Q4) Why is EBITDA multiple used for valuation rather than sales or earnings?
Q5) What is the implied assumption in percent of sales method?
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Chapter 19: Working Capital Management
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Q1) ALT had $25 million in sales last year. Its cost of goods sold was $15 million and its average inventory balance was $3 million. The average days of inventory in the industry is 65 days. What would ALT's average inventory need to be so that it would meet the industry average?
A) $4.45 million
B) $3.65 million
C) $3.33 million
D) $2.67 million
Q2) Which of the following best describes short-term debt issued by banks with a minimum denomination of $100,000?
A) certificates of deposit
B) repurchase agreements
C) banker's acceptances
D) commercial paper
Q3) What is a firm's operating cycle?
Q4) What are the costs of holding inventory?
Q5) Working capital alters a firm's value by affecting its free cash flow.
A)True
B)False
Q6) What are the advantages of holding inventory?
Page 21
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Chapter 20: Short-Term Financial Planning
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Q1) In which quarter are Fancy's seasonal working capital needs the greatest?
A) 1
B) 2
C) 3
D) 4
Q2) What are loan origination fees and what effect does it have on the loan?
Q3) A written, legally binding agreement that obligates the bank to lend a firm any amount up to a stated maximum, regardless of the financial condition of the firm (unless the firm is bankrupt) as long as the firm satisfies any restrictions in the agreement is called ________.
A) a bridge loan
B) a single, end-of-period-payment loan
C) a short-term mortgage loan
D) a committed line of credit
Q4) Firms need short-term financing to deal with seasonal working capital requirements, negative cash flow shocks, or positive cash flow shocks.
A)True
B)False
Q5) What are compensating balance and what effect does it have on the loan?
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Chapter 21: Option Applications and Corporate Finance
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Q1) The ________ is the total number of contracts of a particular option that have been written and not yet closed.
A) mark interest
B) open interest
C) turnover
D) local turnover
Q2) Using options to reduce risk is called ________.
A) speculation
B) a naked position
C) hedging
D) a covered position
Q3) The value of an otherwise identical American call option is ________ if the exercise date is ________.
A) higher, longer
B) lower, longer
C) higher, closer
D) none of the above
Q4) What are American options?
Q5) What is a call option?
Q6) When is an option out-the-money?
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Chapter 22: Mergers and Acquisitions
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Q1) Consider two firms, Thither and Yon. Both companies will either make $30 million or lose $10 million every year with equal probability. The companies' profits are perfectly negatively correlated. What are the expected after-tax profits of Thither in any year, assuming a corporate tax rate of 35% and no tax loss carry back or carry forward?
A) $19.5 million
B) $6.5 million
C) $4.75 million
D) -$6.5 million
Q2) You work for a levered buyout firm and are evaluating a potential buyout of Boogle Inc. Boogle's stock price is $18, and it has 3 million shares outstanding. You believe that if you buy the company and replace its dismal management team, its value will increase by 50%. You are planning on doing a levered buyout of Boogle and will offer $25 per share for control of the company. Assuming you get 50% control, what will your gain from the transaction be?
Q3) On average, when a bid is announced, the stock price of the target drops.
A)True
B)False
Q4) What is a white knight?
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Page 24
Chapter 23: International Corporate Finance
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Q1) A U.S. firm acquires a British firm that will generate cash flows of 10,000 pounds next year and these cash flows will grow at 6% a year. If the British WACC is 9% and the spot exchange rate is $1.9/pound, what is the present value (PV) of the cash flows from this acquisition to domestic shareholders?
A) $633,333
B) $654,876
C) $691,543
D) $716,289
Q2) 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
Q3) All investors in the developed and developing world have access to the financial securities in all markets.
A)True
B)False
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Chapter 24: Leasing
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Q1) Should St. Martin lease the scanner or borrow the funds and buy the scanner?
A) Buy the scanner; the NPV of the decision = $74,890.28.
B) Buy the scanner; the NPV of the decision = $1,749,890.28
C) Lease the scanner; the NPV of the decision = $1,812,027.19
D) Lease the scanner; the NPV of the decision = $692,559.51
Q2) If St. Martin purchases the CT scanner, what is the amount of the lease-equivalent loan?
Q3) If Luther acquires the new fleet of delivery trucks using a capital lease, Luther's debt-to-equity ratio will be closest to ________.
A) 0.66
B) 1.5
C) 0.80
D) 2.0
Q4) What will Luther's balance sheet look like if they acquire the new fleet of delivery trucks using an operating lease?
Q5) Calculate the monthly lease payments for a four-year $1.00-out lease of the Bulldozer.
Q6) In the chapter, the lease versus buy decision was called an unfair comparison. Why? What is the correct comparison?
Page 26
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Chapter 25: Insurance and Risk Management
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Q1) The value of insurance comes from its ability to reduce the cost of ________ for the firm.
A) adverse selection
B) vertical integration
C) overhead
D) market imperfections
Q2) Which of the following statements is FALSE?
A) The swap contract-like forward and futures contracts-is typically structured as a "zero-cost" security.
B) An interest rate swap is a contract entered into with a bank, much like a forward contract, in which the firm and the bank agree to exchange the coupons from two different types of loans.
C) In a standard interest rate swap, one party agrees to pay coupons based on a fixed interest rate in exchange for receiving coupons based on the prevailing market interest rate during each coupon period.
D) If short-term interest rates were to fall while long-term rates remained stable, then short-term securities would fall in value relative to long-term securities, despite their shorter duration.
Q3) What is the actuarially fair cost of full insurance?
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Chapter 26: Corporate Governance
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Q1) Which of the following statements is FALSE?
A) When the CEO is also chairman of the board, the nominating letter offering a seat to a new director comes from her. This process merely serves to reinforce the sense that the outside directors owe their positions to the CEO and work for the CEO rather than for the shareholders.
B) Over time, most of the independent directors will have been nominated by the CEO. Even though they have no business ties to the firm, they are still likely to be friends or at least acquaintances of the CEO.
C) Researchers have found the surprisingly robust result that larger boards are associated with greater firm value and performance.
D) The CEO can be expected to stack the board with directors who are less likely to challenge her.
Q2) What is corporate governance?
Q3) The costs and benefits of a corporate governance structure ________.
A) are the same in all countries
B) are the same for all companies within a country
C) depend on cultural norms
D) are not important in maximizing shareholder wealth
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