Foundations of Finance
Textbook Exam Questions
Course Introduction
Foundations of Finance introduces students to the core principles and analytical tools essential for understanding the financial decisions made by individuals and firms. Topics include the time value of money, valuation of stocks and bonds, risk and return trade-offs, capital budgeting, and the functioning of financial markets. Through case studies and practical exercises, students learn how financial concepts apply to real-world scenarios, equipping them with the knowledge necessary for advanced study or professional roles in finance.
Recommended Textbook CFIN5 5th edition by Scott Besley
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Chapter 1: An Overview of Managerial Finance
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Q1) Identify a true statement about a limited liability partnership (LLP).
A) A general partner of a limited liability partnership is responsible for the negligence and irresponsibility of limited partners.
B) A limited partner of a limited liability partnership is responsible for the general management of the partnership business.
C) A general partner of a limited liability partnership is liable to pay tax on all the partnership income.
D) A general partner of a limited liability partnership is personally liable for all business debts.
E) A limited partner responsible for the negligence and irresponsibility of general partners.
Answer: D
Q2) Incentive compensation plans are used to attract and retain top managerial talent as well as to align the interests of management with shareholders.
A)True
B)False
Answer: True
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Page 3
Chapter 2: Analysis of Financial Statements
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Q1) A limitation of ratio analysis is that:
A) it is useful only for large, multidivisional firms.
B) inflation, which distorts the firm's balance sheet, is considered when calculating ratios.
C) seasonal factors that distort the firm's balance sheet are taken into account when calculating ratios.
D) window-dressing techniques will change the ratios of a firm.
E) statistical procedures are considered to analyze the net effects of a set of ratios.
Answer: D
Q2) A company will calculate changes in its balance sheet accounts based on the:
A) ratio analysis.
B) pro forma balance sheet construction.
C) statement of cash flows construction.
D) profit and loss analysis.
E) pro forma income statement construction
Answer: A
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Chapter 3: The Financial Environment: Markets, Institutions, and Investment Banking
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Q1) The New York Stock Exchange (NYSE) is an example of an over-the-counter exchange.
A)True
B)False
Answer: False
Q2) Primary markets are markets _____.
A) where the instruments traded have original maturities equal to one year or less
B) where loans are traded
C) where options and futures are issued by corporations
D) where financial assets that have previously been issued by various organizations are traded among investors
E) in which various organizations raise funds by issuing new securities
Answer: E
Q3) Whole-life polices offer both insurance coverage and a savings feature, whereas term life policies do not.
A)True
B)False
Answer: True
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Chapter 4: Time Value of Money
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Sample Questions
Q1) The future value of an uneven cash flow stream is also referred to as its _____.
A) discounted value
B) amortized value
C) consolidated value
D) terminal value
E) periodic value
Q2) Andrea's opportunity cost rate is 12 percent compounded annually. How much must he deposit in an account today if he wants to receive $2,100 at the beginning of each of the next seven years? Use the equation method to determine the amount.
A) $10,772
B) $11,625
C) $10,998
D) $11,887
E) $12,564
Q3) Ordinary annuity is an annuity with payments that occur at the beginning of each period.
A)True
B)False
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Chapter 5: The Cost of Money Interest Rates
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Q1) Inflation leads to increase in purchasing power of investors.
A)True
B)False
Q2) _____ can be negative if the value of the investment decreases during the period it is held.
A) Risk
B) Dividends
C) Maturity
D) Interests
E) Capital gains
Q3) Securities that can be easily converted to cash in the market will have a low:
A) liquidity premium.
B) maturity risk premium.
C) inflation premium.
D) default risk premium.
E) real risk premium.
Q4) The yield curve is downward sloping, or inverted, if the inflation rates are expected to increase.
A)True
B)False
Page 7
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Chapter 6: Bonds Debtcharacteristics and Valuation
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Q1) Bonds issued by BB&C Communications that have a coupon rate of interest equal to 10 percent currently have a yield to maturity (YTM) equal to 8 percent. Based on this information, it is understood that BB&C's bonds must currently be selling at a premium in the financial markets.
A)True
B)False
Q2) An investor is contemplating the purchase of a 20-year bond that pays $50 interest every six months. The investor plans to hold the bond only for 10 years, at which time she will sell it in the marketplace. She requires a 12 percent annual return but believes the market will require only an 8 percent return when she sells the bond 10 years from now. Assuming she is a rational investor, how much should she be willing to pay for the bond today? (Round the answer to two decimal places.)
A) $1,126.85
B) $1,081.43
C) $737.50
D) $927.68
E) $856.91
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Page 8
Chapter 7: Stocks Equity Characteristics and Valuation
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Q1) What is the risk of investing money in American depository receipts (ADRs)?
A) Risks associated with the corporations in which the investments are made
B) ADRs are not foreign stocks
C) Inability to take funds such as dividends out of the country
D) Risk of translation of value into domestic terms
E) Risk of translation of information into domestic terms
Q2) A stock's par value is equal to the market value of the stock on the last day of the fiscal year for a firm.
A)True
B)False
Q3) If the price of a firm's stock is overvalued, then the company may repurchase shares of their common stock.
A)True
B)False
Q4) What is the formula to calculate P/E ratio?
A) Market price per share ÷ Book value per share
B) Earnings available to common stockholders (EAC) ÷ Number of shares
C) Common dividends ÷ Number of shares
D) Market price per share ÷ Earnings per share
E) Average cost of funds × Invested capital
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Chapter 8: Risk and Rates of Return
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Q1) The variance of the returns of Stock X is 62.5%, and the expected return from the stock is 18%. Calculate the coefficient of variation of the stock. (Round your answer to two decimal places.)
A) 3.47
B) 0.44
C) 0.29
D) 2.27
E) 1.82
Q2) The beta coefficient of Zed Corporation is equal to 0.7 and the required rate of return on the stock equals 12 percent. If the expected return on the market is 12.5 percent, what is the risk-free rate of return? (Round off the answer to two decimal places.)
A) 11.56%
B) 10.83%
C) 9.52%
D) 12.25%
E) 8.89%
Q3) Liquidity risk is an unsystematic risk and can be diversified by the investors.
A)True
B)False
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Chapter 9: Capital Budgeting Techniques
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Q1) Which of the following statements is true of capital budgeting analysis?
A) A project's discounted payback is normally shorter than its regular payback because discounted payback takes account of the required rate of return.
B) In the NPV method, the discount rate is specified and the equation is solved for NPV, while in the IRR method the NPV is set equal to zero and the discount rate is found.
C) If the required rate of return is less than the crossover rate for two mutually exclusive projects' NPV profiles, a NPV/IRR conflict will not occur.
D) If you are choosing between two projects that have the same life, and if their NPV profiles cross, then the smaller project will probably be the one with the steeper NPV profile.
E) If the required rate of return is relatively high, this will favor larger, longer-term projects over smaller, shorter- term alternatives because it is good to earn high rates on larger amounts over longer periods.
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Chapter 10: Project Cash Flows and Risk
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Q1) Tech Engineering Company is considering the purchase of a new machine to replace an existing one. The current market value of the old machine is $14,000 and its book value is $5,000. The new machine's cost is $30,000. If the tax rate is 40%, the initial investment outlay for the new machine is _____.
A) $24,600
B) $30,000
C) $14,000
D) $16,000
E) $36,000
Q2) Which of the following methods involves calculating an average beta for firms in a similar business and then applying that beta to determine the beta of its own project?
A) Sensitivity Analysis
B) Pure play method
C) Accounting beta method
D) Capital asset pricing model (CAPM) method
E) Net present value (NPV) analysis
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Chapter 11: The Cost of Capital
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Q1) The cost of equity raised by retaining earnings can be less than, equal to, or greater than the cost of equity raised by selling new issues of common stock, depending on tax rates, flotation costs, the attitude of investors, and other factors.
A)True
B)False
Q2) The before-tax cost of debt of a firm using funds from bond issue is equal to the _____ of the bond.
A) yield to maturity (YTM)
B) maturity value
C) coupon rate
D) discount rate
E) internal rate of return
Q3) The after-tax cost of debt is used to calculate the weighted average cost of capital since we are concerned with the after-tax cash flows of the firm.
A)True
B)False
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Chapter 12: Capital Structure
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Q1) Which of the following is true of the advantages of raising corporate debt through bank loans?
A) Capital gains on debt are not taxed.
B) Costs associated with monitoring debt are low.
C) Equity capital costs are low.
D) Corporations are equally inclined to use debt and equity.
E) The threat of potential bankruptcy is high in equity financing compared to bank loans.
Q2) A degree of operating leverage of 1.5 times indicates that _____.
A) for every 1 percent change in EPS there will be a 1.5 percent change in sales
B) for every 1 percent change in interest there will be a 1.5 percent change in EBIT
C) for every 1 percent change in sales there will be a 1.5 percent change in EBIT
D) for every 1 percent change in EBIT there will be a 1.5 percent change in EPS
E) for every 1 percent change in sales there will be a 1.5 percent change in EPS
Q3) The lower the times-interest-earned ratio, the lower the probability that a firm will default on its debt.
A)True
B)False
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Page 14
Chapter 13: Distribution of Retained Earnings: Dividends and Stock Repurchases
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Q1) The level of risk associated with future expected dividends affects dividend policies of companies around the world.
A)True
B)False
Q2) Which of the following statements is true about the free cash flow hypothesis?
A) Firms should distribute earnings based on investors' preferences toward current income and future income.
B) Firms should distribute earnings that can be reinvested at a very profitable rate.
C) Firms should pay dividends when free cash flows in excess of capital budgeting needs exist.
D) Firms that retain free cash flows have higher values than firms that distribute free cash flows.
E) Firms should never distribute their free cash flows.
Q3) The information content hypothesis proposes that a firm's dividend policy can provide information about management's behavior with respect to wealth maximization.
A)True
B)False
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Chapter 14: Managing Short-Term Financing Liabilities
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Q1) The inventory conversion period of a firm is equivalent to the average age of its inventory.
A)True
B)False
Q2) The inventory turnover of Long Corporation is 16, and its closing inventory is $20,000.
Assuming there are 360 days in a year, the company's inventory conversion period is:
A) 22.50 days.
B) 24.25 days.
C) 32.50 days.
D) 42.75 days.
E) 50.75 days.
Q3) The maturity matching approach calls for matching the maturities of:
A) long-term liabilities and equity.
B) long-term liabilities and short-term liabilities.
C) long-term assets and short-term assets.
D) assets and equity.
E) assets and liabilities.
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Chapter 15: Managing Short-Term Assets
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Q1) Jumpdisk Company writes checks averaging $15,000 a day, and it takes 5 days for these checks to clear. The firm also receives checks in the amount of $17,000 per day, but the firm loses three days while its receipts are being deposited and cleared. The firm's net float in dollars is:
A) $126,000.
B) $75,000.
C) $32,000.
D) $24,000.
E) $16,000.
Q2) Trust Chemicals is considering changing its credit policy. It conducted a net present value (NPV) analysis for both its existing credit policy and proposed credit policy. The net change in NPV on a daily basis is $20 and the expected return is 10%. Assuming there are 360 days in a year, the increase in the firm's value is _____.
A) $50,000
B) $72,000
C) $43,000
D) $20,000
E) $67,000
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Chapter 16: Financial Planning and Control
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Q1) Which of the following statements is true of financial forecasts in the financial planning process?
A) The forecast of money the firm needs is estimated by adding the increases in assets and spontaneous liabilities and subtracting the operating income.
B) The projected balance sheet method of forecasting financial needs requires only a forecast of the firm's balance sheet.
C) The projected balance sheet method forces recognition of the fact that new financing creates additional financial obligations.
D) The projected balance sheet method of forecasting financial needs does not consider dividends paid out to shareholders as these are after tax payments from retained earnings.
E) Financing feedback describes the effect on the firm's stock price of the announcement that the firm will sell new equity or debt to raise the needed capital on its stock price.
Q2) Any deviation from projections must be dealt with to improve future forecasts.
A)True
B)False
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