Introduction to Finance
Chapter Exam Questions
Course Introduction
Introduction to Finance provides students with a foundational understanding of financial concepts, principles, and practices essential for making informed business decisions. Topics covered include the role of financial markets, time value of money, risk and return, financial statement analysis, valuation of assets, and basics of capital budgeting. Through real-world examples and problem-solving exercises, students will gain insight into personal and corporate finance, preparing them for more advanced financial coursework and practical financial decision-making in their professional lives.
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Introduction to Corporate Finance 4th Edition by Sean Cleary
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Page 2
Chapter 1: An Introduction to Finance
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Q1) Human capital is
A) based on only the current skills, but not the education, of a country's citizens.
B) based on only the education, but not the current skills, of a country's citizens.
C) based on the skills and capital of citizens and should be included in a country's wealth.
D) difficult to measure and should therefore not be included in a country's wealth.
Answer: C
Q2) If Canadian households,in aggregate,own real assets with a market value of $3.194 trillion,and also own net financial assets with a market value of $2.344 trillion,the total net assets of Canadian households have a market value of
A) $3.194 trillion
B) $5.538 trillion
C) $-0.850 trillion
D) $0.850 trillion
Answer: B
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3
Chapter 2: Business Corporatefinance
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Q1) Which of the following illustrates a situation that would encourage a manager to work in the interests of a company's shareholders?
A) The manager's salary depends largely on increasing quarterly accounting profits.
B) The manager's salary depends largely on his/her ability to keep costs low.
C) The manager's total compensation depends on maximizing the share price.
D) The manager has access to many perks, which improves his/her personal work environment.
Answer: C
Q2) Which one of the following is NOT a criterion that managers prefer to be judged upon?
A) return on assets
B) return on equity
C) share price
D) market share
Answer: C
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Chapter 3: Financial Statements
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Q1) Why is an increase in net working capital a decrease in free cash flow?
Answer: Net working capital = Current assets - Current liabilities.For example: (Accounts receivable + Inventory)- Accounts Payable.
If NWC increases,we can have (among other possibilities):1.Accounts receivable increase: decreases free cash flows as customers are paying their bills later; we are receiving the cash later,hence less FCF
2.Inventory increase: have to invest more cash to buy inventory,hence less FCF "3.Accounts payable decrease: have to use cash to repay bills,hence less FCF As NWC increases,we are tying up more cash in AR and Inventory,and using cash to repay AP,so consequently we have lower free cash flow.
Q2) Frank lives and works in Alberta and earned $50,000 in income.Percival lives and works in Nova Scotia and also earned $50,000 income.If the only difference between the two people is where they live,then
A) Frank and Percival will have the same total income tax bill.
B) Frank and Percival will have the same Federal income tax bill.
C) Frank and Percival will have the same Provincial income tax bill.
D) Where they live has no impact on their income tax bill.
Answer: B
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Chapter 4: Financial Statement Analysis and Forecasting
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Q1) In 2015,Voyage Company had earnings per share of $45 and paid a dividend of $15 per share.The dividend yield was 8%.The book value per share is $100.The price-earnings (P/E)ratio was:
A) 4.167
B) 3.0000
C) 0.3333
D) 0.1500
Q2) What is the base,or denominator,of a productivity ratio?
A) Revenue
B) An asset value
C) A liability value
D) A shareholders' equity value
Q3) Mr.B.Baggins has just computed the operating margin and the gross profit margin for Hoppit Company and has found that the operating margin is greater than the gross profit margin.Is this possible? Why or why not? Explain your reasoning.
Q4) Discuss some difficulties when comparing the ratios of similar corporations from different countries.
Q5) What are the three ratios used in the DuPont system of financial analysis of return on equity?
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Chapter 5: Time Value of Money
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Q1) You invested $2,000 at 5 percent compounded annually.Determine the value of the investment in five years.(Round your answer to two decimals.)
A) $500.00
B) $552.56
C) $2,500.00
D) $2,552.56
Q2) Your mother has just retired.The balance in her investment account is $600,000 and she wants to receive monthly payments of $5,000.If she receives the payments at the end of the month,and the current interest rate is 7 percent,compounded quarterly,how many months will her investment account last for?
A) 98 months
B) 120 months
C) 170 months
D) 206 months
Q3) Explain what the effective (or equivalent)annual interest rate is and why we use it.
Q4) Explain the difference between simple interest and compound interest.
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Chapter 6: Bond Valuation and Interest Rates
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Q1) Use the following three statements to answer this question:
A) I is correct, II, III are incorrect.
B) I is incorrect, II, III are correct.
C) I, II and III are correct.
D) I, II and III are incorrect.
I.The prices of bonds with higher durations are more sensitive to interest rate changes than are those with lower durations.
II.All else being equal,durations will be higher when (1)market yields are lower,(2)bonds have longer maturities,and (3)bonds have lower coupons.
III.Duration is a measure of risk of the bond
Q2) Suppose you observed that one-year T-bills are trading at a YTM of 4.35 percent.The yield spread between AAA- and BBB-rated corporate bonds is 150 basis points.The maturity yield differential between the one-year T-bills and the five-year government bonds is 65 basis points.What yield would you expect to observe on BBB-rated corporate bonds with a five-year maturity?
A) 5.00%
B) 5.20%
C) 5.85%
D) 6.50%
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Chapter 7: Equity Valuation
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Q1) Suppose a firm's price/earnings ratio is 16.It has just paid a dividend of $1.80 per share to maintain a 45 percent payout ratio.What is the firm's current market price if its return on equity is 12 percent?
A) $68.22
B) $67.46
C) $66.54
D) $65.78
Q2) Explain the difference between required rate of return and growth rate,and show the relationship between the two.
Q3) What are the two basic types of Dividend Discount Models?
Q4) The Beautiful Mind Company's preferred stock is selling for $30 per share.What is the expected dividend of year four if the required rate of return is 7.5 percent?
A) $2.00
B) $2.25
C) $3.00
D) $3.25
Q5) Explain how earnings are implicitly considered in the DDM model.
Q6) What is the sustainable growth rate?
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Chapter 8: Risk, return, and Portfolio Theory
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Q1) On January 1,you forecasted that there is a 45 percent chance that the stock price of Edward Bear Inc.will be $95 in one year while there is a 55 percent chance that the stock price will be $35.Six months later,you revised the estimated probability to 25 percent chance of the high state (stock price of $95).If the market agrees with your revised forecasts,what is the expected change in stock price from January 1 to July 1? Assume the discount rate is zero.
A) Price goes up by 19.35%
B) Price goes down by 19.35%
C) Price goes up by 24%
D) Price goes down by 24%
Q2) Stocks A and B have a correlation of +1.If stock A went from $10 to $12 over the past month,what is the price of stock B,if its price one month ago was $5?
A) $5
B) $4
C) $6
D) Cannot be determined
Q3) Does diversification always reduce the overall risk?
Q4) Distinguish between systematic and non-systematic risk.
Q5) What are the components of total return and total risk?
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Chapter 9: The Capital Asset Pricing Model Capm
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Q1) Stock A has a standard deviation of 20 percent and a correlation coefficient of 0.64 with market returns.The expected return of the market is 12 percent with a standard deviation of 15 percent.The risk-free rate is 5 percent.What is the beta of Stock A?
A) 0.48
B) 0.75
C) 0.85
D) 1.33
Q2) If two stocks had the same beta,but Stock A had high non-systematic risk and Stock B had low non-systematic risk,would rational investors expect a higher return from holding one of these securities?
Q3) Is it possible to invest more than 100 percent of your available funds?
Q4) Stock Y has a beta of 0.8 and a required rate of return of 10 percent.What is the market risk premium if the risk-free rate is 5 percent?
A) 5.00%
B) 4.75%
C) 6.25%
D) 7.50%
Q5) What is the difference between CAPM and APT?
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Chapter 10: Market Efficiency
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Q1) Melanie has observed that stocks that have earned high returns over the past year tend to earn low returns over the next year.She has also observed that stocks that earned low returns over the past year tended to earn high returns over the next year.This is an example of:
A) the January effect.
B) mean reversion in stock prices.
C) stock price momentum.
D) size effect.
Q2) Liam,the manager of The Snoring Gryphon,your local Irish pub,is very confused.He has observed that the stock of Gryphon earns higher returns in January than in March.He expected the stock to do better around St.Patrick's Day when the pub's sales are the highest.Explain these two observations to Liam.
Q3) The random walk theory suggests that
A) all stocks have an expected return of zero.
B) stock price changes are random.
C) stock prices are random.
D) diversification is pointless.
Q4) Explain the implications of having an inefficient market.
Q5) State the semi-strong form of market efficiency and its implications.
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Chapter 11: Forwards,futures,and Swaps
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Q1) Ronald's company enters a 3-year,$10,000 plain vanilla interest rate swap and agrees to pay LIBOR and receive a fixed rate of 5%.Payments are to be exchanged every six months.Determine the semi-annual payments that Ronald must receive,assuming LIBOR has the following values for each six-month period beginning now: 5%,5.5%,6%,4.75%,4.25%,4%.
Q2) An investor enters into a long position in 10,000 futures contracts of oil with a $50,000 initial margin and has a maintenance margin that is 75 percent of this amount.The futures price associated with this contract is $100.Assuming the price of the underlying asset decreases to $98,what is the margin call?
A) $50,000
B) $37,500
C) $7,500
D) No margin required
Q3) An exchange of an interest rate return for the total return on an equity index,plus or minus a spread is called:
A) a total return swap.
B) an interest rate swap.
C) a credit default swap.
D) a return forward.
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Chapter 12: Options
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Q1) Given current asset price = $50
strike price = $50
risk-free rate = 1%
time to expiration of the option = 2 years
N(d<sub>1</sub>)= 0.5793
N(d<sub>2</sub>)= 0.4602
Based on the Black-Scholes option pricing model,calculate the price of the corresponding call option (round to 2 decimal places).
A) $0
B) $5.49
C) $5.96
D) $6.41
Q2) Create a table illustrating the range of payoffs of a protective put strategy for the following values of the underlying asset: 60,70,80,90,100.The strike price of all options in the strategy is $80 and the current value of the underlying asset is $80.
Q3) Higher _________,higher ________
A) price volatility; estimated volatility
B) implied volatility; option price
C) estimated volatility; price volatility
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Chapter 13: Capital Budgeting, risk Considerations, and Other Special Issues
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Q1) Project X has a cost of capital of 8 percent and the following cash flows: investment of $10,000 in year 0,cash inflows of $2,000,$ 3,000,and $10,000 in years 1,2,and 3,respectively.
A) What is the IRR? What is the assumption of IRR on reinvesting cash?
B) Suppose the cash inflows are deposited in an account without interest. What is the MIRR?
C) Suppose the cash inflows are deposited in an account with an 8% annual interest rate. What is the MIRR?
D) Suppose the cash inflows are deposited in an account with a 17.69% annual interest rate. What is the MIRR?
E) When will IRR equal MIRR?
Q2) In the presence of capital rationing:
A) the cost of capital is no longer the appropriate opportunity cost.
B) firms can fully rely on either IRR or NPV as a criterion.
C) PIs are often useful to conclude on the optimal solution.
D) the investment decision should be based on which combination of projects generates the highest total NPV, regardless of the cost of the investment.
Q3) What are project interdependencies?
Q4) When a business faces capital rationing,what discount rate is used and why?
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Chapter 14: Cash Flow Estimation and Capital Budgeting
Decisions
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Q1) Montreal Sun Printing is looking at an opportunity of setting up a new production facility,which requires the purchase of a new printing press that costs $1 million.The costs to install the machine are $60,000.The new facility is to be built on a piece of land that the company bought for $150,000 five years ago.The market value of the land is $250,000.The R&D costs associated with the investment opportunity were $50,000.In addition,the company will need to purchase $40,000 additional inventory for the project use.How much of these costs can be categorized as a sunk cost?
A) $250,000
B) $60,000
C) $50,000
D) None of the above
Q2) What is the difference between the initial cash flow and the purchase price of an asset?
A) Set up costs only
B) Capital costs
C) Other capital costs and net working capital
D) None of the above
Q3) Discuss the two ways inflation impacts capital budgeting.
Q4) Explain why the CCA tax savings are discounted at the firm's cost of capital.
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Chapter 15: Mergers and Acquisitions
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Q1) Which of the following is NOT one of the requirements for the determination of fair market value (FMV)?
A) Open and restricted markets
B) Informed and prudent parties
C) Arm's length transaction
D) Neither party is under compulsion to transact
Q2) In contrast to the question above,in the U.S.what percentage of shares purchased by an investor is considered the early warning threshold signalling that the company is a possible target?
A) 5%
B) 10%
C) 25 %
D) 50 + 1%
Q3) Define synergy and explain what effect it can have on a merged company.
Q4) Define and distinguish between acquisitions and amalgamations.
Q5) Which of the following best defines an acquisition?
A) Two firms combining to form a completely new firm.
B) One firm purchases goods from another firm.
C) One firm completely absorbing another firm.
D) All of the above.
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Chapter 16: Leasing
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Q1) RonCo Company is considering a recycling project.The project will result in a significant decrease in their garbage disposal costs.The acquisition cost of the recycling machine is $100,000.The present value of the depreciation tax shield (CCA)is $35,000 and the machine is expected to have a zero salvage value.The firm can lease the machine instead of buying it - the present value of the before-tax lease payments is $60,000 and the present value of the tax savings from the lease payments is $20,000.Should the firm lease the recycling machine and why or why not?
A) Yes, the NPV of leasing is $60,000.
B) Yes, the NPV of leasing is $25,000.
C) No, the NPV of leasing is $40,000.
D) No, the NPV of leasing is $175,000.
Q2) An operating lease compared to a financial lease will result in:
A) higher net income in the early years and no difference in net income in the later years.
B) higher net income in the early years and lower net income in the later years.
C) lower net income in the early years and higher net income in the later years.
D) no difference as the classification of the lease has no effect on net income.
Q3) What is the impact of shifting the purchase of equipment to operating leases?
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Chapter 17: Investment Banking and Securities Law
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Q1) To which of the following does Gresham's Law apply?
A) The used car market
B) Counterfeit money in circulation
C) Capital markets
D) Gresham's Law is applicable to all of the above.
Q2) What is venture capital?
A) Money raised from private investors in the exempt market.
B) Money raised from public investors in the capital market.
C) Money raised from private investors in the over-the-counter market.
D) All of the above are examples of venture capital.
Q3) Discuss some challenges with initial public offerings (IPOs).
Q4) Which of the following statements is not true about underpricing?
A) It "leaves money on the table."
B) It is done to get more IPO proceeds for the issuing firm.
C) It is calculated as the difference between the initial offering price and the price on the first day of trading.
D) It involves pricing an IPO at less than its market value.
Q5) Identify two types of firms that may have their newly issued securities distributed on a best efforts basis,and discuss why this basis would be used.
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Chapter 18: Debt Instruments
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Q1) The Globe Theatre Company is negotiating a line of credit with a large bank.The bank is willing to provide credit up to the minimum of 65% of the value of receivables or 70% of the inventory value.If the firm currently has receivables valued at $50 million and inventory valued at $60 million,what is the maximum credit limit available to this firm?
Q2) Indicate important sources of finance available to corporations in the money market.
Q3) Which of the following is an example of a covenant?
A) Requirement to maintain a minimum level of current ratio
B) Requirement to maintain a maximum level of net worth
C) No requirement to limit dividend payments
D) All of the above
Q4) Which of the following is the least important for assessing the company's profile for a letter of credit?
A) Current ratio
B) Debt to equity ratio
C) Price to earnings ratio
D) Receivables turnover
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Chapter 19: Equity and Hybrid Instruments
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Q1) In which of the following ways do warrants differ from call options?
A) I, II, and III
B) I, III, and V
C) II, IV, and V
D) I and II
I.Warrants impact the firm while call options do not.
II.Call options generally have shorter maturities than warrants.
III.Any profit received from call options is taxable while that from warrants is not taxable.
IV.Volatility increases the value of call options but makes warrants less valuable.
V.The longer maturities of warrants make them less valuable.
Q2) Which of the following statements is correct?
A) Family trusts ensure income flows to the people descended from the company founder.
B) Family trusts ensure all the votes are held by the trustees.
C) Family trusts nominate the managers of the corporation.
D) all of the above.
E) a and b
Q3) Discuss how preferred shares have features of both debt and equity instruments.
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Chapter 20: Cost of Capital
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Q1) The long-term debt of Laurentide Union Bank is currently selling for 103 percent of its face value.The issue matures in 20 years and pays an annual coupon of 8 percent of face.The corporate tax rate is 40 percent.What is the after-tax cost of debt for Laurentide Union?
A) 3.08%
B) 4.62%
C) 4.80%
D) 7.70%
Q2) The Saguenay Tourism Company is an all-equity company and is able to fund a $1 million investment using cash.The company has a beta of 1.4,the risk-free rate is 2 percent,and the return on the market is 8 percent.Flotation costs for new equity are 5 percent.The tax rate is zero.The appropriate cost of capital is:
A) 0.00%
B) 5.00%
C) 10.40%
D) Greater than 10.40%
Q3) What is the cost of internally generated funds?
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Chapter 21: Capital Structure Decisions
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Q1) Briefly explain the trade-off theory of capital structure.
Q2) The effect of financial leverage on ROE depends on:
A) the firm's financing strategy.
B) the amount of dividends paid out.
C) the market value of the debt.
D) none of the above.
Q3) Increasing the operating or business risk of a firm will increase the variability of:
A) return on equity (ROE).
B) return on investment (ROI).
C) increasing the operating or business risk of the firm has no effect on the variability of ROE and ROI.
D) a and b
Q4) The M&M proof of capital structure irrelevance relies on:
A) arbitrage arguments
B) personal and corporate leverage are perfect substitutes
C) both of the above
D) neither of the above
Q5) Explain the importance of debt in minimizing the agency cost problem between the managers and the shareholders.
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Chapter 22: Dividend Policy
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Q1) A dividend reinvestment plan (DRIP)differs from a stock dividend in which way?
A) DRIPs allow investors to use dividends to buy new shares, while a stock dividend is a dividend paid in additional shares.
B) Stock dividends allow shareholders to purchase additional shares with their dividends at a special discount, whereas a DRIP allows shareholders to purchase shares at the market price.
C) DRIPs allow shareholders to buy additional shares at a discount, whereas with a stock dividend shareholders receive no discount.
D) Stock dividends are voluntary whereas DRIPs are mandatory.
Q2) Which of the following is not a side effect of a stock dividend?
A) In terms of accounting, it is treated like a regular cash dividend.
B) Investors may ascribe an informational content to a stock dividend.
C) Investors pay the same amount of tax on stock dividends.
D) The stock price will increase.
Q3) Which of these factors is not a motivation for share repurchases:
A) offset the exercise of executive stock options
B) repurchase dissident shares
C) take the firm private
D) to reduce the firm's levels of debt
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Chapter 23: Working Capital Management: General Issues
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Q1) Why is it better to use sales rather than cost of goods sold when calculating the average days sales in inventory value?
A) The values for COGS are not always comparable across firms
B) COGS is not the driving variable behind the accumulation of inventory
C) Inventory is accumulated regardless of its COGS
D) There are three types of COGS, raw materials, work in progress, and finished goods, and since all are slightly different, using one or the other would make the calculations inaccurate.
Q2) Explain what the break-even sales growth rate means and what impact it has on the development of a firm's operations and credit granting (financial)policy.
Q3) Montreal Bagel Bakery collects 35% of its monthly sales immediately and the rest a month later.Its production costs are 65% of sales.It holds 1 month of sales in inventory,and it pays half its bills immediately and half after 30 days.Calculate the operating cycle and the cash conversion cycle for Montreal Bagel Bakery.
A) 49.5 and 34.5
B) 49.5 and 15
C) 0 and 30
D) 35 and 65
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Chapter 24: Working Capital Management: Current Assets and
Current Liabilities
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Q1) Your supplier offers you 6/20 net 60 terms.What is the effective annual interest rate for not paying on time,approximately?
A) 45.7%
B) 58.2%
C) 75.9% QUOTE
D) 209.3%
Q2) The following pairs are all benefits of holding inventory except:
A) receive discounts on large-volume purchases
B) keep sufficient levels of raw materials to minimize disruptions in the production process
C) minimize lost sales because of shortage
D) reduce interest payments
Q3) One way to alleviate the problem of the low returns associated with cash,but still maintain high liquidity is to
A) keep no cash on hand.
B) invest in more bonds.
C) borrow funds at a lower interest rate.
D) invest in marketable securities.
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