Investment Analysis and Portfolio Management Study Guide Questions
Course Introduction
Investment Analysis and Portfolio Management provides students with a comprehensive understanding of the fundamental concepts and techniques used in analyzing various investment opportunities and constructing optimal portfolios. The course covers topics such as financial market structures, risk and return analysis, asset pricing models, security valuation, portfolio theory, and portfolio performance evaluation. Emphasis is placed on practical applications of theory using quantitative tools to assess investment alternatives, develop diversification strategies, and manage portfolio risk. By blending theoretical frameworks with real-world case studies, the course prepares students to make informed investment decisions and manage portfolios effectively in dynamic financial environments.
Recommended Textbook
Corporate Finance A Focused Approach 6th Edition by Michael C. Ehrhardt
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Page 2
Chapter 1: An Overview of Financial Management and the Financial Environment
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Q1) Which of the following factors would be most likely to lead to an increase in interest rates in the economy?
A) Households reduce their consumption and increase their savings.
B) The Federal Reserve decides to try to stimulate the economy.
C) There is a decrease in expected inflation.
D) The economy falls into a recession.
E) Most businesses decide to modernize and expand their manufacturing capacity, and to install new equipment to reduce labor costs.
Answer: E
Q2) The major advantage of a regular partnership or a corporation as a form of business organization is the fact that both offer their owners limited liability, whereas proprietorships do not.
A)True
B)False
Answer: False
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Chapter 3: Analysis of Financial Statements
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Q1) Vang Corp.'s stock price at the end of last year was $33.50 and its earnings per share for the year were $2.30. What was its P/E ratio?
A) 13.84
B) 14.57
C) 15.29
D) 16.06
E) 16.86
Answer: B
Q2) A firm's new president wants to strengthen the company's financial position. Which of the following actions would make it financially stronger?
A) Increase inventories while holding sales and cost of goods sold constant.
B) Increase accounts receivable while holding sales constant.
C) Increase EBIT while holding sales constant.
D) Increase accounts payable while holding sales constant.
E) Increase notes payable while holding sales constant.
Answer: C
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Chapter 4: Time Value of Money
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Q1) What is the PV of an ordinary annuity with 5 payments of $4,700 if the appropriate interest rate is 4.5%?
A) $16,806
B) $17,690
C) $18,621
D) $19,601
E) $20,633
Q2) Suppose Randy Jones plans to invest $1,000. He can earn an effective annual rate of 5% on Security A, while Security B has an effective annual rate of 12%. After 11 years, the compounded value of Security B should be somewhat less than twice the compounded value of Security A. (Ignore risk, and assume that compounding occurs annually.)
A)True
B)False
Q3) If the discount (or interest) rate is positive, the future value of an expected series of payments will always exceed the present value of the same series.
A)True
B)False
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Chapter 5: Bonds, Bond Valuation, and Interest Rates
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Q1) Stephenson Co.'s 15-year bond with a face value of $1,000 currently sells for $850. Which of the following statements is CORRECT?
A) The bond's current yield exceeds its yield to maturity.
B) The bond's yield to maturity is greater than its coupon rate.
C) The bond's current yield is equal to its coupon rate.
D) If the yield to maturity stays constant until the bond matures, the bond's price will remain at $850.
E) The bond's coupon rate exceeds its current yield.
Q2) Because short-term interest rates are much more volatile than long-term rates, you would, in the real world, generally be subject to much more interest rate price risk if you purchased a 30-day bond than if you bought a 30-year bond.
A)True
B)False
Q3) If a firm raises capital by selling new bonds, it is called the "issuing firm," and the coupon rate is generally set equal to the required rate on bonds of equal risk.
A)True
B)False
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Page 6
Chapter 6: Risk, Return, and the Capital Asset Pricing Model
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Q1) Dixon Food's stock has a beta of 1.4, while Clark Café's stock has a beta of 0.7. Assume that the risk-free rate, r<sub>RF</sub>, is 5.5% and the market risk premium, (r<sub>M</sub> r<sub>RF</sub>), equals 4%. Which of the following statements is CORRECT?
A) If the market risk premium increases but the risk-free rate remains unchanged, Dixon's required return will increase because it has a beta greater than 1.0 but Clark's required return will decline because it has a beta less than 1.0.
B) Since Dixon's beta is twice that of Clark's, its required rate of return will also be twice that of Clark's.
C) If the risk-free rate increases while the market risk premium remains constant, then the required return on an average stock will increase.
D) If the market risk premium decreases but the risk-free rate remains unchanged, Dixon's required return will decrease because it has a beta greater than 1.0 and Clark's will also decrease, but by more than Dixon's because it has a beta less than 1.0.
E) If the risk-free rate increases but the market risk premium remains unchanged, the required return will increase for both stocks but the increase will be larger for Dixon since it has a higher beta.
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Chapter 7: Stocks, Stock Valuation, and Stock Market
Equilibrium
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Q1) From an investor's perspective, a firm's preferred stock is generally considered to be less risky than its common stock but more risky than its bonds. However, from a corporate issuer's standpoint, these risk relationships are reversed: Bonds are the most risky for the firm, preferred is next, and common is least risky.
A)True
B)False
Q2) Decker Tires' free cash flow was just FCF<sub>0</sub> = $1.32. Analysts expect the company's free cash flow to grow by 30% this year, by 10% in Year 2, and at a constant rate of 5% in Year 3 and thereafter. The WACC for this company 9.00%. Decker has $4 million in short-term investments and $14 million in debt and 1 million shares outstanding. What is the best estimate of the stock's current intrinsic price?
A) $31.59
B) $32.65
C) $33.75
D) $34.87
E) $35.99
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Page 8
Chapter 8: Financial Options and Applications in Corporate Finance
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Q1) As the price of a stock rises above the strike price, the value investors are willing to pay for a call option increases because both (1) the immediate capital gain that can be realized by exercising the option and (2) the likely exercise value of the option when it expires have both increased.
A)True
B)False
Q2) Because of the time value of money, the longer before an option expires, the less valuable the option will be, other things held constant.
A)True
B)False
Q3) If we define the "premium" on an option to be the difference between the price at which an option sells and the exercise value (or the difference between the stock's current market price and the strike price), then we would expect the premium to increase as the stock price increases, other things held constant.
A)True
B)False
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9
Chapter 9: The Cost of Capital
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Q1) With its current financial policies, Flagstaff Inc. will have to issue new common stock to fund its capital budget. Since new stock has a higher cost than reinvested earnings, Flagstaff would like to avoid issuing new stock. Which of the following actions would REDUCE its need to issue new common stock?
A) Increase the percentage of debt in the target capital structure.
B) Increase the proposed capital budget.
C) Reduce the amount of short-term bank debt in order to increase the current ratio.
D) Reduce the percentage of debt in the target capital structure.
E) Increase the dividend payout ratio for the upcoming year.
Q2) Refer to the data for the Collins Group. What is the best estimate of the after-tax cost of debt?
A) 4.64%
B) 4.88%
C) 5.14%
D) 5.40%
E) 5.67%
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Chapter 10: The Basics of Capital Budgeting: Evaluating Cash Flows
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Q1) Which of the following statements is CORRECT?
A) The discounted payback method recognizes all cash flows over a project's life, and it also adjusts these cash flows to account for the time value of money.
B) The regular payback method was, years ago, widely used, but virtually no companies even calculate the payback today.
C) The regular payback is useful as an indicator of a project's liquidity because it gives managers an idea of how long it will take to recover the funds invested in a project.
D) The regular payback does not consider cash flows beyond the payback year, but the discounted payback overcomes this defect.
E) The regular payback method recognizes all cash flows over a project's life.
Q2) The phenomenon called "multiple internal rates of return" arises when two or more mutually exclusive projects that have different lives are compared to one another.
A)True B)False
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11
Chapter 11: Cash Flow Estimation and Risk Analysis
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Q1) Estimating project cash flows is generally the most important, but also the most difficult, step in the capital budgeting process. Methodology, such as the use of NPV versus IRR, is important, but less so than obtaining a reasonably accurate estimate of projects' cash flows.
A)True
B)False
Q2) The change in net working capital associated with new projects is always positive, because new projects mean that more working capital will be required. This situation is especially true for replacement projects.
A)True
B)False
Q3) Changes in net working capital should not be reflected in a capital budgeting cash flow analysis because capital budgeting relates to fixed assets, not working capital. A)True
B)False
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12
Chapter 12: Financial Planning and Forecasting Financial Statements
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Q1) Refer to the Judd Enterprises financial statements. If Judd does not plan on issuing new stock or additional long-term debt, then what is the additional net financing needed for the projected year?
A) $30
B) $33
C) $37
D) $339
E) $396
Q2) Based on the projections, Decker will have
A) a financing surplus of $36
B) a financing deficit of $36
C) a financing surplus of $255
D) a financing deficit of $255
E) zero financing surplus or deficit
Q3) As long as a firm does not pay out 100% of its earnings, the firm's annual profit that is retained in the business (i.e., the addition to retained earnings) is another source of funds for a firm's expansion.
A)True
B)False
Page 13
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Chapter 13: Corporate Valuation, Value-Based
Management and Corporate Governance
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Q1) ESOPs were originally designed to help improve worker productivity, but today they are also used to help prevent hostile takeovers.
A)True
B)False
Q2) The CEO of D'Amico Motors has been granted some stock options that have provisions similar to most other executive stock options. If D'Amico's stock underperforms the market, these options will necessarily be worthless.
A)True
B)False
Q3) Which of the following is NOT normally regarded as being a barrier to hostile takeovers?
A) Targeted share repurchases.
B) Shareholder rights provisions.
C) Restricted voting rights.
D) Poison pills.
E) Abnormally high executive compensation.
Q4) A poison pill is also known as a corporate restructuring.
A)True
B)False
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Chapter 14: Distributions to Shareholders: Dividends and Repurchases
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Q1) Warren Supply Inc. is evaluating its capital budget. The company finances with debt and common equity, but because of market conditions, wants to avoid issuing any new common stock during the coming year. It is forecasting an EPS of $3.00 for the coming year on its 500,000 outstanding shares of stock. Its capital budget is forecasted at $800,000, and it is committed to maintaining a $2.00 dividend per share. Given these constraints, what percentage of the capital budget must be financed with debt?
A) 30.54%
B) 32.15%
C) 33.84%
D) 35.63%
E) 37.50%
Q2) Even if a stock split has no information content, and even if the dividend per share adjusted for the split is not increased, there can still be a real benefit (i.e., a higher value for shareholders) from such a split, but any such benefit is probably small.
A)True
B)False
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Chapter 15: Capital Structure Decisions
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Q1) Morales Publishing's tax rate is 40%, its beta is 1.10, and it uses no debt. However, the CFO is considering moving to a capital structure with 30% debt and 70% equity. If the risk-free rate is 5.0% and the market risk premium is 6.0%, by how much would the capital structure shift change the firm's cost of equity?
A) 1.53%
B) 1.70%
C) 1.87%
D) 2.05%
E) 2.26%
Q2) Other things held constant, which of the following events is most likely to encourage a firm to increase the amount of debt in its capital structure?
A) The costs that would be incurred in the event of bankruptcy increase.
B) Management believes that the firm's stock has become overvalued.
C) Its degree of operating leverage increases.
D) The corporate tax rate increases.
E) Its sales become less stable over time.
Q3) Whenever a firm borrows money, it is using financial leverage.
A)True
B)False
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Page 16
Chapter 16: Working Capital Management
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Q1) The calculated cost of trade credit can be reduced by paying late.
A)True
B)False
Q2) Refer to the data for Hardwig, Inc.Assume now that the company believes that if it adopts a restricted policy, its sales will fall by 15% and EBIT will fall by 10%, but its total assets turnover, debt ratio, interest rate, and tax rate will all remain the same. In this situation, what's the difference between the projected ROEs under the restricted and relaxed policies?
A) 2.24%
B) 2.46%
C) 2.70%
D) 2.98%
E) 3.27%
Q3) If a firm sells on terms of 2/10 net 30 days, and its DSO is 28 days, then the fact that the 28-day DSO is less than the 30-day credit period tells us that the credit department is functioning efficiently and there are no past-due accounts.
A)True
B)False
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Chapter 17: Multinational Financial Management
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Q1) The threat of expropriation creates an incentive for the multinational firm to minimize inventory holdings in certain countries and to bring in goods only as needed.
A)True
B)False
Q2) Suppose 1 U.S. dollar equals 1.60 Canadian dollars in the spot market. 6-month Canadian securities have an annualized return of 6% (and thus a 6-month periodic return of 3%). 6-month U.S. securities have an annualized return of 6.5% and a periodic return of 3.25%. If interest rate parity holds, what is the U.S. dollar-Canadian dollar exchange rate in the 180-day forward market?
A) 1 U.S. dollar = 0.6235 Canadian dollars
B) 1 U.S. dollar = 0.6265 Canadian dollars
C) 1 U.S. dollar = 1.0000 Canadian dollars
D) 1 U.S. dollar = 1.5961 Canadian dollars
E) 1 U.S. dollar = 1.6039 Canadian dollars
Q3) If the United States is running a deficit trade balance with China, then in a free market we would expect the value of the Chinese yuan to depreciate against the U.S. dollar.
A)True
B)False
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