Introduction to Finance
Chapter Exam Questions
Course Introduction
Introduction to Finance provides students with a foundational understanding of the key principles and concepts within the field of finance. The course covers topics such as the time value of money, risk and return, financial markets and instruments, valuation of stocks and bonds, and the basics of financial statement analysis. Students will be introduced to the roles of individuals, corporations, and financial institutions in the economy, and will develop the analytical skills necessary to make informed financial decisions in personal and professional contexts.
Recommended Textbook
Finance Applications and Theory 2nd Edition by Marcia Millon Cornett
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Page 2
Chapter 1: Introduction to Financial Management
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Sample Questions
Q1) All of the following are functions of the board of directors except ________.
A) Hire the CEO
B) Evaluate the CEO
C) Design compensation contracts for the CEO
D) Provide reports to the auditors
Answer: D
Q2) As individual legal entities, corporations assume liability for their own debts, so the shareholders hold
A) only limited liability.
B) unlimited liability.
C) shared liability.
D) joint liability.
Answer: A
Q3) Which of the following is the firm's highest-level financial manager?
A) Chief Executive Officer
B) Chief Financial Officer
C) Board of Directors
D) Corporate Governance
Answer: B
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Page 3
Chapter 2: Reviewing Financial Statements
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Q1) GW Inc. had $800 million in retained earnings at the beginning of the year. During the year, the firm paid $.75 per share dividend and generated $1.92 earnings per share. The firm has 100 million shares outstanding. At the end of year, what was the level of retained earnings for GW?
A) $725 million
B) $917 million
C) $882 million
D) $807 million
Answer: B
Q2) On which of the four major financial statements would you find net plant and equipment?
A) Balance Sheet
B) Income Statement
C) Statement of Cash Flows
D) Statement of Retained Earnings
Answer: A
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Chapter 3: Analyzing Financial Statements
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Sample Questions
Q1) A firm that is efficient in inventory management will have ____________.
A) a high inventory turnover ratio and a low days sales in inventory ratio
B) a low inventory turnover ratio and a low days sales in inventory ratio
C) a high inventory turnover ratio and a high days sales in inventory ratio
D) a low inventory turnover ratio and a high days sales in inventory ratio
Answer: A
Q2) This measures the number of days that the firm holds accounts payable before it has to extend cash to buy raw materials.
A) Accounts receivable turnover
B) Average collection period
C) Average payment period
D) Accounts payable turnover
Answer: C
Q3) Which of these is NOT considered a coverage ratio?
A) Cash coverage ratio
B) Current ratio
C) Fixed-charge coverage ratio
D) Times Interest Earned
Answer: B
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Page 5
Chapter 4: Time Value of Money 1: Analyzing Single Cash Flows
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Sample Questions
Q1) General TVM Ten years ago, Jane invested $1,000 and locked in a 7 percent annual interest rate for 30 years (end 20 years from now). James can made a twenty year investment today and lock in a 6 percent interest rate. How much money should he invest now in order to have the same amount of money in 20 years as Jane?
A) $673.75
B) $1,206.59
C) $1,967.15
D) $2,373.54
Q2) Solving for Rates What annual rate of return is earned on a $4,000 investment made in year 2 when it grows to $8,000 by the end of year eight?
A) 9.00%
B) 12.00%
C) 12.25%
D) 50.00%
Q3) Which of the following will not increase a present value?
A) Increase the interest rate.
B) Decrease the number of periods.
C) Increase the future value.
D) None of these answers is correct.
Page 6
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Chapter 5: Time Value of Money 2: Analyzing Annuity Cash
Flows
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Sample Questions
Q1) A local furniture store is advertising a deal in which you buy a $3,500 living room set with 3 years before you need to make payments (no interest is incurred). How much money would have to deposit now in a savings account earning 3.5% APR, compounded monthly, to pay the $3,500 bill in three years?
A) $2,981.17
B) $3,151.62
C) $3,200.61
D) $3,886.89
Q2) The interest on your home mortgage is tax deductible. Why are the early years of the mortgage more helpful in reducing taxes than the later years?
Q3) Future Value Compute the future value in year 10 of a $1,000 deposit in year 1 and another $1,500 deposit at the end of year 4 using an 8% interest rate.
A) $3,120.73
B) $4,379.31
C) $4,500.00
D) $5,397.31
Q4) What is the difference between an annuity due and an ordinary annuity?
Q5) Describe how compounding affects the future value computation of an annuity.
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Chapter 6: Understanding Financial Markets and Institutions
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Sample Questions
Q1) Classify the following transactions as taking place in the primary or secondary markets:
a. A company issues new common stock.
b. A company issues common stock in an IPO.
c. A shareholder sells preferred stock out of its marketable securities portfolio.
d. A mutual fund buys previously issued bonds.
e. An insurance company sells another company's common stock.
f. A company buys another company's stock from a mutual fund.
Q2) Unbiased Expectations Theory One-year Treasury bills currently earn 5.50 percent. You expect that one year from now, one-year Treasury bill rates will increase to 5.75 percent. If the unbiased expectations theory is correct, what should the current rate be on two-year Treasury securities?
A) 5.50%
B) 5.625%
C) 5.75%
D) 11.25%
Q3) How do Financial Intermediaries (FIs) act as asset transformers?
Q4) Why is it useful to calculate forward rates?
Q5) What is a derivative security and what determines its value?
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Chapter 7: Valuing Bonds
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Sample Questions
Q1) Which of the following is not a correct statement?
A) Treasury inflation-protected securities have fixed coupon rates.
B) The federal government adjusts the par value of Treasury inflation-protected securities at the rate of inflation.
C) At maturity, investor in Treasury inflation-protected securities receives an inflation-adjusted principal amount.
D) All of these statements are correct.
Q2) Which of the following bonds makes no interest payments?
A) a bond whose coupon rate is equal to the market interest rates
B) a bond whose coupon rates are greater than market interest rates
C) a bond whose coupon rates are less than the market interest rates
D) zero coupon bond
Q3) Which of the following is a reason municipal bonds offer lower rates of interest income for their investors?
A) They are able to avoid interest rate risk.
B) They are able to avoid reinvestment rate risk.
C) They are able to offer reduced credit risk as they are backed by the federal government.
D) They are tax exempt-at least at the federal level.
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Page 9
Chapter 8: Valuing Stocks
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Sample Questions
Q1) A firm has been losing sales due to technological obsolescence. It projects growth for the future to be -3%. Its recent divided was $2.50. What is the value of this stock when the required return is 7%?
A) $28.17
B) $24.25
C) $17.42
D) $15.53
Q2) A firm is expected to pay a dividend of $2.00 next year and $3.75 the following year. Financial analysts believe the stock will be at their price target of $125.00 in two years. Compute the value of this stock with a required rate of return of 15%.
A) $78.34
B) $81.05
C) $87.13
D) $99.09
Q3) Value stocks are _________________________.
A) stocks that are expected to exhibit high growth
B) stocks that have low P/E ratios and are selling at a bargain price
C) stocks that have high valuation ratios, such as P/E
D) None of these.
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Page 10
Chapter 9: Characterizing Risk and Return
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Sample Questions
Q1) This is a measure of risk to reward earned by an investment over a specific period of time.
A) coefficient of variation
B) market deviation
C) standard deviation
D) total variation
Q2) If you own 400 shares of Xerox at $15.00, 500 shares of Qwest at $10.00, and 350 shares of Liz Claiborne at $45.00, what are the portfolio weights of each stock?
A) Weight of Xerox: 22.43%; Weight of Qwest: 11.09%; Weight of Liz Claiborne: 58.88%
B) Weight of Xerox: 34.67%; Weight of Qwest: 16.69%; Weight of Liz Claiborne: 48.64%
C) Weight of Xerox: 22.43%; Weight of Qwest: 18.69%; Weight of Liz Claiborne: 58.88%
D) Weight of Xerox: 36.98%; Weight of Qwest: 61.07%; Weight of Liz Claiborne: 1.95%
Q3) What does diversification do to the risk and return characteristics of a portfolio?
Q4) Diversifying Consider the characteristics of the following three stocks:
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11
Chapter 10: Estimating Risk and Return
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Q1) Required Return Using the information in the table, compute the required return for each company using both CAPM and the constant growth model. Compare and discuss the results. Assume that the market portfolio will earn 11 percent and the risk-free rate is 2.5 percent.
Q2) The set of probabilities for all possible occurrences.
A) probability
B) probability distribution
C) stock market bubble
D) market probabilities
Q3) Stock Market Bubble If the Japanese stock market bubble peaked at 37,500, and two and a half years later it had fallen to 25,900, what was the percentage decline?
A) -10.31%
B) -27.63%
C) -30.93%
D) -69.07%
Q4) List and describe the three basic levels of market efficiency,
Q5) Describe how adding a risk-free security to modern portfolio theory allows investors to do better than the efficient frontier.
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Page 12
Chapter 11: Calculating the Cost of Capital
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Sample Questions
Q1) This is an estimated WACC computed using some sort of proxy for the average equity risk of the projects in a particular division.
A) Average WACC
B) Divisional WACC
C) Proxy WACC
D) Pure-play WACC
Q2) Fern has preferred stock selling for 95 percent of par that pays an 8 percent annual coupon. What would be Fern's component cost of preferred stock?
A) 7.60%
B) 8.00%
C) 8.42%
D) 9.00%
Q3) When calculating WACC, should project-specific or firmwide debt and preferred stock components be used, and why?
Q4) What is the theoretical minimum for the weighted average cost of capital?
A) The after-tax cost of debt
B) The cost of preferred stock
C) CAPM
D) The cost of equity
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Chapter 12: Estimating Cash Flows on Capital Budgeting Projects
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Sample Questions
Q1) A new project would require an immediate increase in raw materials in the amount $17,000. The firm expects that accounts payable will automatically increase $7,000. How much must the firm expect its investment in net working capital to increase if they accept this project?
A) $17,000
B) $7,000
C) $10,000
D) $24,000
Q2) An asset's cost plus the amounts you paid for items such as sales tax, freight charges, and installation and testing fees is referred to as the
A) Opportunity cost
B) Sunk cost
C) Asset costing reference
D) Depreciable basis
Q3) Accelerated depreciation allows firms to
A) receive less of the dollars of depreciation earlier in the asset's life.
B) receive more of the dollars of depreciation earlier in the asset's life.
C) not pay any taxes during an asset's life.
Page 14
D) receive more of the dollars of depreciation later in the asset's life.
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Chapter 13: Weighing Net Present Value and Other Capital Budgeting Criteria
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Q1) Use the MIRR decision rule to evaluate this project; should it be accepted or rejected?
A) -10.60%, reject
B) 10.60%, accept
C) -15.33%, reject
D) 15.33%, accept
Q2) Use the payback decision rule to evaluate these projects; which one(s) should be accepted or rejected?
A) accept both A and B
B) accept neither A nor B
C) accept A, reject B
D) reject A, accept B
Q3) Which of the following statements is correct?
A) Discounted payback solves all the shortcomings of payback.
B) The reinvestment rate of NPV and MIRR is the same.
C) The MIRR and IRR have the same reinvestment rate.
D) All of these are correct statements.
Q4) Suppose two projects with normal cash flows, X and Y, have exactly the same required initial investment, but X has a longer payback. Can we say anything about X's IRR versus that of Y?
Page 15
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Chapter 14: Working Capital Management and Policies
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Sample Questions
Q1) Suppose your firm is seeking a 7-year, amortizing $400,000 loan with annual payments and your bank is offering you the choice between a $410,000 loan with a $10,000 compensating balance and a $400,000 loan without a compensating balance. If the interest rate on the $400,000 loan is 9.5 percent, how low would the interest rate on the loan with the compensating balance have to be in order for you to choose it?
A) The interest rate would have to be lower than 8.76%.
B) The rate would have to be lower than 8.29%.
C) The rate would have to be lower than 8.14%.
D) The rate would have to be lower than 7.99%.
Q2) Which of the following approach for determining the target cash balance assumes that the distribution of daily net cash flows is normally distributed, and allows for both cash inflows and outflows?
A) The Baumol Model
B) The Miller-Orr Model
C) The Merton Model
D) The Interbank Financial Model
Q3) If demand for a firm's products suddenly slows down so that inventory increases while sales decrease, how will the firm's needs for net working capital react?
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Chapter 15: Financial Planning and Forecasting
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Q1) Which of the following statements is correct?
A) The sales forecast is the driver for corporate financial planning.
B) The addition to retained earnings is the driver for corporate financial planning.
C) The debt ratio is the driver for corporate financial planning.
D) None of the above
Q2) The simplest approach to estimating a future period's sales is to assume that they will be equal to those of the latest observed period. In statistics, this is often simply referred to as which of the following?
A) base case approach
B) deseaonalized approach
C) naïve approach
D) pro forma approach
Q3) Which of the following is likely to increase the firm's additional funds needed?
A) The firm cuts its dividend by 50%.
B) The firm reduces its usage of trade credit.
C) The firm has unused fixed assets.
D) All of these
Q4) How is the capital intensity ratio calculated? How is it used in the AFN formula?
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Chapter 16: Assessing Long-Term Debt, Equity, and Capital Structure
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Q1) Which of the following is incorrect with respect to leverage buyouts (LBOs)?
A) They originated in the 1960s and were originally known as bootstrap transactions which reflected the general consensus that the firm was, more or less, paying for its own acquisition.
B) The typical LBO uses a ratio of 70% debt to 30% equity but levels of debt can reach much higher.
C) LBOs are an extreme example of releveraging because debt is used to buy out the majority of the equityholders to gain control of the firm.
D) None of these statements is incorrect.
Q2) Suppose that a company's equity is currently selling for $30 per share and that there are 5 million shares outstanding. If the firm also has 20 thousand bonds outstanding, which are selling at 98 percent of par ($1,000), what are the firm's current capital structure weights for equity and debt respectively?
A) 50%, 50%
B) 88.44%, 11.56%
C) 99.60%, 0.40%
D) 88.23%, 11.77%
Q3) Explain why utility firms tend to have fairly high debt ratios.
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Chapter 17: Sharing Firm Wealth: Dividends, Share
Repurchases, and Other Payouts
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Q1) Suppose a firm pays total dividends of $750,000 out of net income of $2 million. What would the firm's retention ratio be?
A) 37.50%
B) 47.50%
C) 25.50%
D) 62.50%
Q2) Which of the following is the primary goal of a firm?
A) maximize sales
B) maximize net income
C) maximize earnings per share
D) maximize shareholder wealth
Q3) What type of clientele would you expect to prefer dividends over capital gains? Why?
Q4) Which of the following is described as a firm buying back shares of its own stock?
A) ex-dividend
B) ex-stock purchase
C) repurchase or buyback
D) repossession
Q5) Explain the residual dividend model.
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Chapter 18: Issuing Capital and the Investment Banking Process
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Q1) Calculating Costs of Issuing Stock Video Games, Inc., with the help of its investment bank recently issued 10 million shares of new stock. The offer price on the stock was $47.50 per share and Video's received a total of $446,500,000 through this stock offering. Calculate the net proceeds and the underwriter's spread on the stock offering. What percentage of the gross price is the investment bank charging Video's for underwriting the stock issue?
A) 3%
B) 30%
C) 6%
D) 9%
Q2) This is defined as a method of registering securities that allows firms that plan to offer multiple issues of the security over a two-year period to submit one registration statement.
A) shelf registration
B) shelf prospectus
C) SEC registration
D) originating registration
Q3) How does a competitive sale of securities differ from a negotiated sale?
Q4) How does a best effort underwriting differ from a firm commitment underwriting?
Page 20
Q5) As a new or small firm considers going public, what must the owners consider?
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Chapter 19: International Corporate Finance
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Q1) Currency Exchange Compute the number of dollars that can be bought with 2 million of foreign currency units: $1 = 48.210 Philippine Peso
A) $41,485.16905
B) $1,959,439.60
C) $414,851.6905
D) $4,148,516.905
Q2) Discount Rates A financial manager has determined that the appropriate discount rate for a foreign project is 15 percent. However, that discount rate applies in the United States using dollars. What discount rate should be used in the foreign country using the foreign currency? The inflation rate in the United States and in the foreign country is expected to be 8 percent and 4 percent, respectively.
A) 11%
B) 19%
C) 21%
D) 12%
Q3) If a popular video gaming system costs $400 in the United States, what do you think it should cost in Japan? What are some reasons that your price might not be right?
Q4) What are the advantages of borrowing money in the country you plan to invest in?
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Page 21
Chapter 20: Mergers and Acquisitions and Financial
Distress
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Q1) Calculating the Probability of Bankruptcy A linear probability model you have developed finds there are two factors influencing the past bankruptcy behavior of firms: the debt-to-equity ratio and the sales-to-total assets ratio. Based on past bankruptcy experience, the linear probability model is estimated as: PD<sub>i</sub> = .60 (debt/equity) + .02 (sales/total assets)
A firm you are thinking of lending to has a sales-to-assets ratio of 1.75 and its expected probability of default, or bankruptcy, is estimated to be 8.1 percent. Calculate the firm's debt ratio.
A) 7.667%
B) 7.12%
C) 92.88%
D) 8.1%
Q2) Which of the following is a formal bankruptcy proceeding which outlines the process to be followed for liquidating a failed firm?
A) Chapter 7
B) Chapter 11
C) Chapter 13
D) Chapter 179
Q3) What is a credit-scoring model?
Page 22
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