Introduction to Finance Test Bank
Course Introduction
Introduction to Finance provides students with a foundational understanding of the principles and practices that underpin financial decision-making in businesses and personal contexts. The course covers key topics such as the time value of money, financial markets and instruments, risk and return, valuation of securities, and the basics of financial management. Students will learn how to analyze financial statements, understand capital budgeting, and evaluate investment opportunities. Emphasizing both theoretical concepts and practical applications, the course prepares students to make informed financial decisions and serves as a stepping stone for more advanced finance studies.
Recommended Textbook
Fundamentals of Corporate Finance Global 3rd Edition by Jonathan Berk
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Page 2
Chapter 1: The Corporation
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Q1) The largest stock market in the world is:
A)the London Stock Exchange.
B)NASDAQ.
C)the American Stock Exchange.
D)the New York Stock Exchange.
Answer: D
Q2) If you buy shares of Coca-Cola on the primary market:
A)Coca-Cola receives the money because the company has issued new shares.
B)you buy the shares from another investor who decided to sell the shares.
C)you buy the shares from a Stock Exchange.
D)you buy the shares from the government.
Answer: A
Q3) Which of the following organization forms accounts for the most revenue?
A)Sole proprietorship
B)Partnership
C)"Corporation
D)Limited Partnership
Answer: C
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3
Chapter 2: Introduction to Financial Statement Analysis
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Q1) The DuPont Identity expresses the firm's ROE in terms of:
A)profitability, asset efficiency, and leverage.
B)valuation, leverage, and interest coverage.
C)profitability, margins, and valuation.
D)equity, assets, and liabilities.
Answer: A
Q2) Which of the following is NOT a reason why cash flow may not equal net income?
A)Amortization is added in when calculating net income.
B)Changes in inventory will change cash flows but not income.
C)Capital expenditures are not recorded on the income statement.
D)Depreciation is deducted when calculating net income.
Answer: A
Q3) Luther Corporation's share price is $39 and the company has 20 million shares outstanding. Its Market value Debt-Equity Ratio for 2012 is closest to:
A)2.29
B)0.37
C)1.89
D)0.31
Answer: B
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Page 4
Chapter 3: Financial Decision Making and the Law of One
Price
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Q1) Which of the following statements regarding the Law of One Price is INCORRECT?
A)At any point in time, the price of two equivalent goods trading in different competitive markets will be the same.
B)One useful consequence of the Law of One Price is that when evaluating costs and benefits to compute a net present value, we can use any competitive price to determine a cash value, without checking the price in all possible markets.
C)If equivalent goods or securities trade simultaneously in different competitive markets, then they will trade for the same price in both markets.
D)An important property of the Law of One Price is that it holds even in markets where arbitrage is not possible.
Answer: D
Q2) If the interest rate is 7%, the NPV of alternative #3 is closest to:
A)$350,000
B)$357,196
C)$370,561
D)$401,121
Answer: B
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Page 5
Chapter 4: The Time Value of Money
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Q1) Draw a timeline detailing Joe's cash flows from the sale of the family business.
Q2) You work for a pharmaceutical company that has developed a new drug. The patent on the drug will last for 17 years. You expect that the drug will produce cash flows of $10 million in its first year and that this amount will grow at a rate of 4% per year for the next 17 years. Once the patent expires, other pharmaceutical companies will be able to produce generic equivalents of your drug and competition will drive any future profits to zero. If the interest rate is 12% per year, then the present value of producing this drug is closest to:
A)$71 million
B)$90 million
C)$170 million
D)$105 million
Q3) You are considering investing in a security that will pay you $80 in interest at the end of each of the next 10 years. If this security is currently selling for $588.81, then the IRR for investing in this security is closest to:
A)6.0%
B)7.0%
C)6.5%
D)5.0%
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Page 6
Chapter 5: Interest Rates
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Q1) If your income tax rate is 30%, then the after-tax EAR for your home equity loan is closest to:
A)6.0%
B)5.9%
C)8.6%
D)5.8%
Q2) The effective annual rate for a credit card that charges a 19.9% APR compounded daily is closest to:
A)18.15%
B)19.9%
C)22.0%
D)24.2%
Q3) The NPV of an investment that costs $2700 and pays $1000 certain at the end of one, three, and five years is closest to:
A)21.47
B)$1665.62
C)-100.26
D)-71.38
Q4) What is the effective after-tax rate of each instrument, expressed as an EAR?
Q5) Should you purchase the delivery truck or lease it? Why?
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Chapter 6: Valuing Bonds
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Q1) Which of the following statements is FALSE?
A)The bond's expected return, which is equal to the firm's debt cost of capital, is less than the yield to maturity if there is a risk of default.
B)The two best-known bond-rating companies are Standard & Poor's and Dow Jones.
C)Bonds in the bottom five categories are often call speculative bonds, junk bonds, or high-yield bonds.
D)Bond ratings encourage widespread investor participation and relatively liquid markets.
Q2) Sovereign debt is:
A)debt issued by national governments.
B)debt denominated in sovereigns.
C)always riskless.
D)debt issued by Greece.
Q3) The credit spread of the BBB corporate bond is closest to:
A)1.0%
B)5.6%
C)1.6%
D)0.8%
Q4) Plot the zero-coupon yield curve (for the first five years).
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Chapter 7: Investment Decision Rules
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Q1) Assuming that Dewey's cost of capital is 12% EAR, then the number of potential IRRs that exist for this problem is equal to:
C)2 D)12
Q2) Which of the following statements is FALSE?
A)The payback rule is useful in cases where the cost of making an incorrect decision might not be large enough to justify the time required for calculating the NPV.
B)The payback rule is reliable because it considers the time value of money and depends on the cost of capital.
C)For most investment opportunities expenses occur initially and cash is received later.
D)Fifty percent of firms surveyed reported using the payback rule for making decisions.
Q3) What is one of the incremental IRRs for project B over project A? Would you feel comfortable basing your decision on the incremental IRR?
Q4) If the discount rate for project B is 15%, then what is the NPV for project B?
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Chapter 8: Fundamentals of Capital Budgeting
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Q1) Which of the following statements is FALSE?
A)When evaluating a capital budgeting decision, the correct tax rate to use is the firm's average corporate tax rate.
B)To determine the capital budget, firms analyze alternative projects and decide which ones to accept through a process called capital budgeting.
C)A new product typically has lower sales initially, as customers gradually become aware of the product.
D)Sunk costs have been or will be paid regardless of the decision whether or not to proceed with the project.
Q2) The incremental cash flow that Galt Motors will incur in year 10 if they elect to manufacture armatures in house is closest to:
A)40,000
B)335,000
C)375,000
D)415,000
Q3) Construct a simple income statement showing the incremental EBIT and the incremental unlevered net income for all three years of the Sisyphean Companies project.
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Chapter 9: Valuing Stocks
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Q1) Vacinox is a biotechnology firm that is about to announce the results of its clinical trials of a potential new vaccine. If the trials are successful, Vacinox stock will be worth $80 per share. However, if the trials are not successful, then Vacinox stock will only be worth $12 per share. If on the morning that the announcement is schedule, Vacinox stock is trading for $60.96, then the probability that investors place on the trials being successful are closest to:
A)48%
B)50%
C)60%
D)72%
Q2) Which of the following statements is FALSE?
A)Estimating dividends, especially for the distant future, is difficult.
B)A firm can only pay out its earnings to investors or reinvest their earnings.
C)Successful young firms often have high initial earnings growth rates.
D)According to the constant dividend growth model, the value of the firm depends on the current dividend level, divided by the equity cost of capital plus the growth rate.
Q3) What are the implications of the efficient market hypothesis for corporate managers?
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Chapter 10: Capital Markets and the Pricing of Risk
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Q1) Suppose that Luther's beta is 0.9. If the market risk premium is 8% and the risk-free interest rate is 4%, then then expected return for Luther stock is?
A)7.6%
B)11.6%
C)11.2%
D)12.9%
Q2) Which of the following investments offered the highest overall return over the past eighty years?
A)Treasury Bills
B)S&P 500
C)Small stocks
D)Corporate bonds
Q3) The standard deviation for the return on an individual firm is closest to:
A)23.0%
B)5.25%
C)15.0%
D)10.0%
Q4) Do expected returns for individual stocks increase proportionately with volatility?
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Chapter 11: Optimal Portfolio Choice and the Capital Asset
Pricing
Model
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Q1) Which of the following statements is FALSE?
A)The expected return of a portfolio is equal to the weighted average expected return, but the volatility of a portfolio is less than the weighted average volatility.
B)Each security contributes to the volatility of the portfolio according to its volatility, scaled by its covariance with the portfolio, which adjusts for the fraction of the total risk that is common to the portfolio.
C)Nearly half of the volatility of individual stocks can be eliminated in a large portfolio as a result of diversification.
D)The overall variability of the portfolio depends on the total co-movement of the stocks within it.
Q2) Suppose that you want to maximize your expected return without increasing your risk. How can you achieve this goal? Without increasing your risk, what is the maximum expected return you can expect?
Q3) Explain how having different interest rates for borrowing and lending affects the CAPM and the SML.
Q4) The variance on a portfolio that is made up of a $6000 investments in Microsoft and a $4000 investment in Wal-Mart stock is closest to:
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Chapter 12: Estimating the Cost of Capital
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Q1) Your estimate of the asset beta for Taggart Transcontinental is closest to:
A)0.42
B)0.59
C)0.66
D)0.71
Q2) Suppose that you are holding a market portfolio and you have invested $9,000 in Rearden Metal. The amount that you have invested in Taggart Transcontinental is closest to:
A)$4,500
B)$6,000
C)$7,715
D)$9,000
Q3) The overall cost of capital for Wyatt Oil is closest to:
A)8.1%
B)8.5%
C)8.8%
D)9.3%
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Chapter 13: Investor Behavior and Capital Market Efficiency
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Sample Questions
Q1) When investors imitate each other's actions, this is known as ________ behavior.
A)pack
B)flock
C)herd
D)shepherd
Q2) A group of portfolios from which we can form an efficient portfolio are called:
A)factor portfolios.
B)semi-efficient portfolios.
C)partially efficient portfolios.
D)characteristic portfolios.
Q3) Which of the following statements is FALSE?
A)It is not actually necessary to identify the efficient portfolio itself. All that is required is to identify a collection of portfolios from which the efficient portfolio can be constructed.
B)Although we might not be able to identify the efficient portfolio itself, we know some characteristics of the efficient portfolio.
C)An efficient portfolio can be constructed from other diversified portfolios.
D)An efficient portfolio need not be well diversified.
Q4) Explain why the market portfolio proxy may not be efficient.
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15
Chapter 14: Capital Structure in a Perfect Market
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Q1) With perfect capital markets, what is the market price per share of Luther's stock after the share repurchase?
A)$25
B)$24
C)$15
D)$20
Q2) Suppose that to raise the funds for the initial investment the firm borrows $40,000 at the risk free rate and issues new equity to cover the remainder. In this situation, the cost of capital for the firm's levered equity is closest to:
A)23%
B)25%
C)15%
D)18%
Q3) At the conclusion of this transaction, the number of shares that d'Anconia Copper will have outstanding is closest to:
A)5 million
B)15 million
C)20 million
D)40 million
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Page 16
Chapter 15: Debt and Taxes
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Q1) Your firm currently has $250 million in debt outstanding with an 8% interest rate. The terms of the loan require the firm to repay $50 million of the balance each year. Suppose that the marginal corporate tax rate is 35% and that the interest tax shields have the same risk as the loan. What is the present value of the interest tax shields from this debt?
Q2) Assume that investors in Google pay a 15% tax rate on income from equity and a 35% tax rate on interest income. If Google were to issue sufficient debt to reduce its taxes by $1 billion per year permanently, then the effective tax advantage of this debt would be closest to:
A)10%
B)15%
C)25%
D)30%
Q3) Rosewood's net income is closest to:
A)$450 million
B)$180 million
C)$290 million
D)$95 million
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17
Chapter 16: Financial Distress, Managerial Incentives, and Information
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Q1) Suppose that MI has zero-coupon debt with a $125 million face value due next year. The initial value of MI's equity is closest to:
A)$30 million
B)$15 million
C)$29 million
D)$24 million
Q2) The idea that claims in one's self-interest are credible only if they are supported by actions that would be too costly to take if the claims were untrue is known as the:
A)pecking order hypothesis.
B)credibility principle.
C)lemons principle.
D)signaling theory of debt.
Q3) Kinston's current share price is closest to:
A)$20.40
B)$9.40
C)$11.00
D)$10.00
Q4) List five general categories of indirect costs associated with bankruptcy.
Page 18
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Chapter 17: Payout Policy
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Q1) Assume that Rockwood is not able to repurchase shares prior to the market becoming aware of the new information regarding Rockwood's true value. If Rockwood repurchases the shares following the release of the new information, then the number of shares outstanding following the repurchase is closest to:
A)92 million
B)90 million
C)75 million
D)10 million
Q2) Assume that you own 2500 shares of Omicron stock and that Omicron uses the entire $50 million to pay a special dividend. Suppose you are unhappy with Omicron's decision and would prefer that Omicron used the excess cash to repurchase shares. The number of shares that you would have to buy in order to undo the special cash dividend that Omicron paid is closest to:
A)125
B)275
C)250
D)310
Q3) Calculate the effective tax disadvantage for retaining cash in 1999, 2001, and 2005.
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Chapter 18: Capital Budgeting and Valuation With Leverage
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Q1) Consider the following equation: r<sub>wacc</sub> = r<sub>U</sub><sub>c</sub>dr<sub>D</sub>
The term<sub> </sub>r<sub>U</sub> in this equation is:
A)the firm's unlevered cost of debt.
B)the firm's cost of debt.
C)the project's unlevered cost of capital.
D)the project's debt to value ratio.
Q2) The unlevered value of Aardvark's new project is closest to:
A)$205
B)$100
C)$164
D)$202
Q3) Given that Rose issues new debt of $50 million initially to fund the acquisition, the total value of this acquisition using the APV method is equal to?
Q4) Nielson's share price is closest to:
A)$20.80
B)$24.40
C)$27.50
D)$31.20
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Chapter 19: Valuation and Financial Modeling: a Case Study
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Q1) The free cash flow to equity in 2010 is closest to:
A)6,255
B)10,684
C)11,559
D)18,394
Q2) Based upon the average EV/Sales ratio of the comparable firms, if Ideko holds $6.5 million of cash in excess of its working capital needs, then Ideko's target market value of equity is closest to:
A)$165 million
B)$157 million
C)$193 million
D)$191 million
Q3) Assuming that Ideko has a EBITDA multiple of 9.4, then the continuation unlevered P/E ratio of Ideko in 2010 is closest to:
A)17.2
B)16.4
C)14.5
D)19.4
Q4) What is the purpose of the sensitivity analysis?
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Chapter 20: Financial Options
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Q1) Consider the following equation: C = P + S - PV(K)- PV(Div)
In this equation the term C refers to:
A)the value of the call option.
B)the stock's current price.
C)the payoff of a zero coupon bond.
D)the strike price of the option.
Q2) The payoff to the holder of a put option is given by:
A)P = max(K - S, 0)
B)P= max(S - K, 0)
C)P = min(S - K, 0)
D)P = max(K, 0)
Q3) Which of the following best describes Galt's debt using a call option?
A)Long $700 million in the firm's assets and Short a call option with a $700 strike price
B)Short $700 million in the firm's assets and Long a call option with a $700 strike price
C)Long $700 million in the firm's assets and Short a call option with a $200 strike price
D)Short $700 million in the firm's assets and Long a call option with a $200 strike price
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22
Chapter 21: Option Valuation
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Q1) Assuming the Beta on KD stock is 1.1, the calculated beta for a one-year call option on KD stock with a strike price of $20 is closest to:
A)-1.8
B)2.4
C)-7.7
D)4.6
Q2) Which of the following statements is FALSE?
A)N(d)is the cumulative normal distribution-that is, the probability that a normally distributed variable is greater than d.
B)Of the five required inputs in the Black-Scholes formula, four are directly observable.
C)The Black-Scholes formula is derived assuming that the call is a European option.
D)The Black-Scholes Option Pricing Model can be derived from the Binomial Option Pricing Model by making the length of each period, and the movement of the stock price per period, shrink to zero and letting the number of periods grow infinitely large.
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Chapter 22: Real Options
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Q1) Which of the following statements is FALSE?
A)In particular, because real options allow a decision maker to choose the most attractive alternative after new information has been learned, the presence of real options adds value to an investment opportunity.
B)To make an investment decision correctly, the value of embedded real options must be included in the decision-making process.
C)A key distinction between a real option and a financial option is that real options, and the underlying assets on which they are based, are often traded in competitive markets.
D)We can compute the value of the real option by comparing the expected profit without the real option to the value with the option.
Q2) Assuming that this project will provide Rearden with perpetual annual cash flows of $65,000, Rearden should:
A)invest today since the NPV is positive.
B)invest today since the NPV is negative.
C)invest today since the NPV using the hurdle rate is positive.
D)delay investing since the NPV using the hurdle rate is negative.
E)delay investing since the NPV using the hurdle rate is positive.
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Chapter 23: Raising Equity Capital
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Q1) Which of the following statements is FALSE?
A)The preferred stock issued by young companies typically does not pay regular cash dividends.
B)The preferred stock issued by young companies usually gives the owner an option to convert it into common stock on some future date, so it is often called callable preferred stock.
C)If the company runs into financial difficulties, the preferred stockholders have a senior claim on the assets of the firm relative to any common stockholders.
D)Preferred stock issued by mature companies such as banks usually has a preferential dividend and seniority in any liquidation and sometimes special voting rights.
Q2) The share of any positive return generated by venture capital firms that is taken by the firm's partners is known as:
A)carried interest.
B)partner return.
C)carried capital.
D)angel interest.
Q3) What will the offer price of these shares be if Luther is selling 800,000 shares?
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Chapter 24: Debt Financing
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Q1) Which of the following statements is FALSE?
A)Global bonds combine the features of domestic, foreign, and Eurobonds, and are offered for sale in several different markets simultaneously.
B)In a leveraged buyout (LBO), a group of private investors purchases all the equity of a public corporation.
C)A term loan is a bank loan that lasts for a specific term.
D)Eurobonds are international bonds that are denominated in the local European currency of the country in which they are issued.
Q2) You own a bond with a face value of $1,000 and a conversion ratio of 45. The conversion price is closest to:
A)$18
B)$22
C)$45
D)$1,000
Q3) What is the Yield to Maturity (YTM)on this bond?
Q4) What is the Yield to Maturity (YTM)on this bond?
Q5) What is the Yield to Call (YTC)on this bond?
Q6) What is the Yield to Call (YTC)on this bond?
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Chapter 25: Leasing
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Q1) Is St. Martin's better off leasing the CT scanner or financing the purchase of the CT scanner with a lease-equivalent loan and by how much is St Martin's better off?
Q2) 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
Q3) A lease where the lessee has the option to purchase the asset at the end of the lease for a set price that is set upfront in the lease contract is called a:
A)fixed price lease.
B)$1.00 out lease.
C)fair market value lease.
D)fair market value cap lease.
Q4) What will Luther's balance sheet look like if they acquire the new fleet of delivery trucks using a capital lease?
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Chapter 26: Working Capital Management
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Q1) Which of the following statements is FALSE?
A)The main components of net working capital are cash, inventory, receivables, and payables.
B)The firm's cash cycle is the average length of time between when a firm originally purchases its inventory and when it receives the cash back from selling its product.
C)Working capital includes the cash that is needed to run the firm on a day-to-day basis. It does not include excess cash, which is cash that is not required to run the business and can be invested at a market rate.
D)If the firm pays cash for its inventory, the firm's operating cycle is identical to the firm's cash cycle.
Q2) Which of the following is NOT a direct cost associated with inventory?
A)Acquisition costs
B)Order costs
C)Carrying costs
D)Stock out costs
Q3) Describe "just-in-time" inventory management.
Q4) Calculate the number of days in Luther's Operating Cycle.
Q5) What is a compensating balance?
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Chapter 27: Short-Term Financial Planning
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Q1) When a company analyzes its short-term financing needs, it typically examines cash flows at
A)monthly intervals.
B)yearly intervals.
C)quarterly intervals.
D)weekly intervals.
Q2) The Luther Industries wants to borrow $1 million for two months. Using its inventory as collateral, it can obtain a 10% (APR)loan (compounded monthly). The lender requires that a warehouse arrangement be used. The warehouse fee is $10,000, payable at the end of the two months. Calculate the effective annual rate of this loan for Row Cannery.
Q3) Occasionally, a company will encounter circumstances in which cash flows are temporarily negative for an unexpected reason. We refer to such a situation as:
A)a liquidity shock.
B)a negative cash flow shock.
C)a negative liquidity shock.
D)a cash crunch.
Q4) Calculate the temporary working capital needs for each of the four quarters for Hasbeen Toys.
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Chapter 28: Mergers and Acquisitions
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Q1) Which of the following statements regarding efficiency gains is FALSE?
A)Takeovers relying on the improvement of target management are difficult to complete, and post-takeover resistance to change can be great. Thus not all inefficiently run organizations are necessarily more efficient following a takeover.
B)Although identifying poorly performing corporations is relatively easy, fixing them is another matter entirely.
C)A justification that acquirers cite for paying a premium for a target is efficiency gains, which are often achieved through an elimination of duplication.
D)A chief executive of an inefficiently run corporation can be ousted by current shareholders voting to replace the board of directors, and in fact a large number of ineffective managers are replaced in this way.
Q2) Assume that Martin pays no premium to acquire Luther. Calculate Martin's price-earnings (P/E)ratio both pre and post merger.
Q3) What is a white knight?
Q4) If Martin pays no premium to acquire Luther, what will the earnings per share be after the merger?
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Page 30
Chapter 29: Corporate Governance
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Q1) Which of the following statements is FALSE?
A)The Cadbury Commission stiffened the criminal penalties for providing false information to shareholders.
B)The Exchange Acts of 1933 and 1934, among other things, established the Securities and Exchange Commission (SEC)and prohibited trading on private information gained as an insider of a firm.
C)Many of the problems at Enron, WorldCom, and elsewhere were kept hidden from boards and shareholders until it was too late. In the wake of these scandals, many people felt that the accounting statements of these companies, while often remaining true to the letter of GAAP, did not present an accurate picture of the financial health of a company.
D)While one study found that those firms that separated the position of CEO and chairman performed better, another found no relation between the independence of key board committees and firm performance in the post-Cadbury era.
Q2) What are some of the negative effects of increasing the sensitivity of managerial pay to firm performance?
Q3) What is the role of takeovers in corporate governance?
Q4) What is corporate governance?
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Page 31
Chapter 30: Risk Management
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Q1) The duration of SFTSL's equity is closest to:
A)6 years
B)8 years
C)10 years
D)14 years
Q2) Which of the following statements regarding futures contracts is FALSE?
A)Both the buyer and the seller can get out of the contract at any time by selling it to a third party at the current market price.
B)Futures prices are not prices that are paid today. Rather, they are prices agreed to today, to be paid in the future.
C)Futures contracts are traded anonymously on an exchange at a publicly observed market price and are generally very illiquid.
D)Traders are required to post collateral, called margin, when buying or selling commodities using futures contracts.
Q3) What is the actuarially fair cost of full insurance?
Q4) Assuming that your firm will purchase insurance, what is the minimum-size deductible that would leave your firm with an incentive to implement the new safety policies?
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Chapter 31: International Corporate Finance
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Q1) The present value of Rearden Metal's cash outflow computed by first converting to dollars and then discounting the cash flow at the appropriate Argentine Peso rate is closest to:
A)$469,500
B)$475,000
C)$481,000
D)$484,500
Q2) The amount of the taxes paid in dollars for the Irish operations is closest to:
A)$20.5 million
B)$5.1 million
C)$29.5 million
D)$50.0 million
Q3) What is the dollar present value of the project?
Q4) The present value of Rearden Metal's cash outflow computed by first discounting the cash flow at the appropriate Argentine Peso rate and then converting to dollars is closest to:
A)$469,500
B)$475,000
C)$481,000
D)$484,500
Page 33
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