Investment Analysis
Midterm Exam
Course Introduction
Investment Analysis explores the fundamental concepts and techniques used to evaluate various investment opportunities in financial markets. The course covers topics such as risk and return, asset valuation, portfolio theory, securities analysis, and the dynamics of both equity and fixed-income investments. Students learn to apply quantitative methods and analytical tools to assess the performance of stocks, bonds, mutual funds, and alternative investments. By the end of the course, participants are equipped to make informed investment decisions and understand the strategies used by institutional and individual investors in a global context.
Recommended Textbook
Finance Applications and Theory 3rd Edition by Marcia Millon Cornett
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Page 2
Chapter 1: Introduction to Financial Management
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Sample Questions
Q1) This should be the primary objective of a firm as it may actually be the most beneficial for society in the long run.
A)Minimizing layoffs
B)Maximizing market share
C)Minimizing costs
D)Maximizing shareholder value
Answer: D
Q2) Which of the following can create ethical dilemmas between corporate managers and stockholders?
A)Agency relationship
B)Auditors
C)Boards of directors
D)Venture capitalist
Answer: A
Q3) Explain Adam Smith's argument regarding the invisible hand of the market.
Answer: Acting through competition and the free price system,(Smith argued)would ensure that only those activities most efficient and beneficial to society as a whole would survive in the long run.When companies try to implement a goal other than profit maximization,their efforts tend to backfire.
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Page 3
Chapter 2: Reviewing Financial Statements
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Sample Questions
Q1) What are free cash flows for a firm? What does it mean when a firm's free cash flow is negative?
Answer: Free cash flows are the cash flows available to pay the firm's stockholders and debt holders after the firm has made the necessary working capital investments,fixed asset investments,and developed the necessary new products to sustain the firm's ongoing operations.If free cash flow is negative,the firm's operations produce no cash flows available for investors.
Q2) Balance Sheet Ted's Taco Shop has total assets of $5 million.Forty percent of these assets are financed with debt of which $400,000 is current liabilities.The firm has no preferred stock but the balance in common stock and paid-in surplus is $1 million.Using this information what is the balance for long-term debt and retained earnings on Ted's Taco Shop's balance sheet?
A)$400,000, $1 million
B)$1.6 million, $2 million
C)$1.6 million, $3 million
D)$2 million, $3 million
Answer: B
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Page 4
Chapter 3: Analyzing Financial Statements
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Sample Questions
Q1) Which of the following is unlikely to have a high capital intensity ratio?
A)Railroad
B)Automobile manufacturer
C)Law firm
D)Shipbuilder
Answer: C
Q2) Which of the following statements is correct?
A)Performing cross-sectional ratio analysis refers to assessing how a firm performed over a certain section of time.
B)Performing cross-sectional analysis is easy since industries are usually clustered with firms that are identical.
C)Time-series analysis is useless in assessing improvement or deterioration of ratios since the data is historical.
D)To interpret financial ratios, users should analyze the performance of the firm over time and the performance of the firm against one or more companies in the same industry.
Answer: D
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Chapter 4: Time Value of Money
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Sample Questions
Q1) Which of the following investments would you prefer?
A)An investment earning 10 percent for 20 years
B)An investment earning 8.5 percent for 20 years
C)An investment earning 5 percent for 40 years
D)An investment earning 3 percent for 40 years
Q2) What would be more valuable,receiving $1,895 today or receiving $3,450 in six years if interest rates are 8 percent?
A)Receiving $1,895 today
B)Receiving $3,450 in six years
C)They are worth the same amount
D)Need more information to make a determination
Q3) Say you double your money in five years.Explain why the rate of return is NOT 20 percent per year.
Q4) Solving for Rates What annual rate of return is implied on a $700 loan taken next year when $800 must be repaid in year 3?
A)4.55 percent
B)4.76 percent
C)6.90 percent
D)7.14 percent
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Chapter 5: Time Value of Money
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Sample Questions
Q1) What is the present value of a $775 annuity payment over six years if interest rates are 11 percent?
A)$3,017.84
B)$3,119.67
C)$3,2002.92
D)$3,278.67
Q2) Present Value of an Annuity Due If the present value of an ordinary,4-year annuity is $1,000 and interest rates are 6 percent,what is the present value of the same annuity due?
A)$943.40
B)$1,000.00
C)$1,040.00
D)$1,060.00
Q3) You wish to buy a $30,000 car.The dealer offers you a 5-year loan with a 9 percent
APR.What are the monthly payments? What is the monthly payment if you paid interest only?
A)$622.75; $225.00
B)$659.41; $291.23
C)$701.23; $291.23
D)$712.03; $271.19
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Chapter 7: Valuing Bonds
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Sample Questions
Q1) Which of these statements is false?
A)Bonds are more important capital sources than stocks for companies and governments.
B)Some bonds offer high potential for rewards and, consequently, higher risk.
C)The bond market is larger than the stock market.
D)Bonds are always less risky than stocks.
Q2) Rank from highest credit risk to lowest credit risk the following bonds,with the same time to maturity,by their yield to maturity: Treasury bond with yield of 6.55 percent,IBM bond with yield of 10.95 percent,Trump Casino bond with a yield of 9.15 percent,and Banc Ono bond with a yield of 9.46 percent.
A)Treasury, Trump Casino, Banc Ono, IBM
B)Banc Ono, Trump Casino, IBM, Treasury
C)Trump Casino, Treasury, Banc Ono, IBM
D)IBM, Banc Ono, Trump Casino, Treasury
Q3) Which of the following is a true statement?
A)If interest rates fall, U.S.Treasury bonds will have decreasing values.
B)If interest rates fall, corporate bonds will have decreasing values.
C)If interest rates fall, no bonds will enjoy rising values.
D)If interest rates fall, all bonds will enjoy rising values.
Q4) Explain how mortgage-backed securities work.
Page 8
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Chapter 8: Valuing Stockspart
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Q1) Buying Stock with Commission At your discount brokerage firm,it costs $9.95 per stock trade.How much money do you need to buy 100 shares of Ralph Lauren (RL),which trades at $85.13?
A)$8,503.05
B)$8,503.00
C)$8,522.95
D)$9,508.00
Q2) A preferred stock from DLC pays $3.00 in annual dividends.If the required return on the preferred stock is 9.3 percent,what is the value of the stock?
A)$34.89
B)$32.26
C)$38.49
D)$31.13
Q3) P/E Ratio and Stock Price Ralph Lauren (RL)has earnings per share of $3.85 and a P/E ratio of 17.37.What is the stock price?
A)$0.22
B)$4.51
C)$22.16
D)$66.87
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Page 9
Chapter 9: Characterizing Risk and Return
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Sample Questions
Q1) Sally wants to invest in only two stocks.Which pair of stocks should Sally select?
A)Stocks A and B move downward at the same time.
B)Stocks C and D move in opposite directions at the same time.
C)Stocks E and F move upward at the same time.
D)Stocks G and H move randomly at the same time.
Q2) Which of these is the term for portfolios with the highest return possible for each risk level?
A)Efficient portfolios
B)Modern portfolios
C)Optimal portfolios
D)Total portfolios
Q3) Standard Deviation Compute the standard deviation of the five monthly returns for PG&E: 1.25 percent,-1.50 percent,4.25 percent,3.75 percent,and 1.98 percent.
A)1.876 percent
B)1.946 percent
C)2.046 percent
D)2.287 percent
Q4) Identify and explain a common measure for risk-return relationship.
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Page 10
Chapter 10: Estimating Risk and Return
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Q1) You have a portfolio with a beta of 3.1.What will be the new portfolio beta if you keep 85 percent of your money in the old portfolio and 15 percent in a stock with a beta of 4.5?
A)3.31
B)3.51
C)3.61
D)3.71
Q2) Which of the following statements is incorrect regarding how beta is calculated?
A)The company return is the independent variable.
B)The market portfolio return is the dependent variable.
C)Using the oldest data possible will yield the most accurate results.
D)All of these statements are incorrect.
Q3) Portfolio Beta You have a portfolio with a beta of 1.25.What will be the new portfolio beta if you keep 80 percent of your money in the old portfolio and 20 percent in a stock with a beta of 1.75?
A)1.00
B)1.35
C)1.50 D)3.00
Q4) Contrast computing beta for riskless securities versus stocks.
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Chapter 11: Calculating the Cost of Capital
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Q1) Define subjective and objective approaches to divisional cost of capital.
Q2) IVY has preferred stock selling for 98 percent of par that pays a 7 percent annual coupon.What would be IVY's component cost of preferred stock?
A)6.86 percent
B)7.00 percent
C)7.14 percent
D)14.00 percent
Q3) Suppose your firm has decided to use a divisional WACC approach to analyze projects.The firm currently has four divisions,A through D,with average betas for each division of 0.5,1.0,1.3 and 1.6,respectively.If all current and future projects will be financed with half debt and half equity,and if the current cost of equity (based on an average firm beta of 1.0 and a current risk-free rate of 7 percent)is 14 percent and the after-tax yield on the company's bonds is 8 percent,what are the WACCs for divisions A through D?
A)9.00 percent; 10.25 percent; 12.95 percent; 13.15 percent
B)9.75 percent; 12.00 percent; 12.65 percent; 13.75 percent
C)9.25 percent; 11.00 percent; 12.05 percent; 13.10 percent
D)8.95 percent; 10.15 percent; 12.50 percent; 13.45 percent
Q4) List and explain all the components of the WACC equation.
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Chapter 12: Estimating Cash Flows on Capital Budgeting Projects
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Sample Questions
Q1) You have been asked by the president of your company to evaluate the proposed acquisition of a new special-purpose truck for $70,000.The truck falls into the MACRS three-year class,and it will be sold after three years for $5,000.Use of the truck will require an increase in NWC (spare parts inventory)of $10,000.The truck will have no effect on revenues,but it is expected to save the firm $32,000 per year in before-tax operating costs,mainly labor.The firm's marginal tax rate is 40 percent.What will the operating cash flow for this project be during year 2?
A)$531
B)$885
C)$31,646
D)$50,315
Q2) How do replacement projects' cash flows differ from new projects' cash flows?
Q3) Suppose you sell a fixed asset for $99,000 when its book value is $129,000.If your company's marginal tax rate is 39 percent,what will be the effect on cash flows of this sale (i.e.,what will be the after-tax cash flow of this sale)?
A)$80,700
B)$110,700
C)$77,300
D)$84,800
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Chapter 13: Weighing Net Present Value and Other Capital
Budgeting Criteria
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Q1) The benchmark for the profitability index (PI)is the:
A)cost of capital.
B)managers' maximum number of years.
C)zero or anything larger than zero.
D)zero or anything less than zero.
Q2) Which of the following is a capital budgeting technique that converts a project's cash flows using a more consistent reinvestment rate prior to applying the Internal Rate of Return,IRR,decision rule?
A)Discounted payback
B)Net present value
C)Modified internal rate of return
D)Profitability index
Q3) Use NPV profiles to reconcile sources of conflict between NPV and IRR methods.
Q4) All of the following are strengths of NPV EXCEPT:
A)it works equally well for independent and mutually exclusive projects.
B)managers have a preference for using a statistic that is in percent instead of dollars.
C)it uses a conservative reinvestment rate assumption.
D)these are all strengths of the NPV statistic.
Q5) Explain what a PI of 35.23 percent would signify.
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Chapter 14: Working Capital and Policies
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Sample Questions
Q1) Which of these is a short-term loan secured by a company's assets?
A)Commercial loan
B)Line of credit
C)Asset-based loan
D)Inventory loan
Q2) PBJ Enterprises estimates that it takes,on average,three days for their customers' payments to reach them,three days for the payments to be processed and deposited by their bookkeeping department,and three more days for the checks to clear once they're deposited.What is their collection float?
A)5 days
B)6 days
C)9 days
D)18 days
Q3) Which of the following actions will cause a firm's net working capital to decrease?
A)The firm relaxes its credit policy.
B)The firm increases its usage of accruals.
C)The firm pays off a short-term bank loan with cash.
D)None of these will cause a firm's net working capital to decrease.
Q4) List and explain the "five C's" of credit analysis.
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Chapter 15: Financial Planning and Forecasting
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Q1) Silly Putty Inc.has had sales of $12 million,$17 million,and $16 million for each of the last three years.What would be the MAPE if the actual sales were $15 million using the average approach?
A)0.24 percent
B)1.01 percent
C)0 percent
D)-0.43 percent
Q2) Which of the following will increase the additional funds needed from external sources?
A)The firm's profit margin increases
B)The firm's dividend payout ratio decreases
C)The firm's debt ratio decreases
D)The firm becomes more capital intensive
Q3) Which of the following will increase a firm's need for additional funds?
A)An increase in the firm's average collection period
B)An increase in the retention ratio
C)A decrease in sales growth
D)An increase in accrued wages
Q4) Contrast the difference between first order effects and higher order effects when forecasting financial statements.
Page 16
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Chapter 16: Assessing Long-Term Debt, equity, and Capital Structure
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Q1) A firm faces a 30 percent tax rate and has $500m in assets,currently financed entirely with equity.Equity is worth $100 per share,and book value of equity is equal to market value of equity.Also,let's assume that the firm's expected EBIT is $60m.The firm is considering switching to a 25 percent debt capital structure,and has determined that they would have to pay a 10 percent yield on perpetual debt.How much will ROE change if they switch to the proposed capital structure?
A)There will be no change in the firm's ROE.
B)The ROE will increase by 0.47 percent.
C)The ROE will increase by 1.15 percent.
D)The ROE will increase by 0.82 percent.
Q2) If the U.S.government completely eliminated taxation at the corporate level:
A)we would expect to no change in the capital structure since it is independent of the tax rate.
B)we would expect to see lower debt levels since debt would no longer enjoy a tax advantage.
C)we would expect to see higher debt levels since debt would become cheaper relative to equity.
D)we would expect to see higher percentages of preferred stock since it enjoys a tax advantage over debt.
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Chapter 17: Sharing Firm Wealth: Dividends, share
Repurchases and Other Payouts
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Q1) JAY Corp.is expected to pay a dividend of $5.00 per year indefinitely.If the appropriate rate of return on this stock is 13 percent per year,and the stock consistently goes ex-dividend 30 days before dividend payment date,what will be the expected maximum price in light of the dividend payment logistics?
A)$3.16
B)$38.08
C)$38.46
D)$43.03
Q2) Analyze a firm's decision to distribute constant ordinary dividends or extraordinary dividends.
Q3) Suppose a firm pays total dividends of $50,000 out of net income of $500,000.What would the firm's payout ratio be?
A)0.10
B)1.00
C)10.00
D)50.00
Q4) When might raising a firm's dividend payout ratio be viewed as a negative signal?
Q5) Explain the residual dividend model.
Page 18
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Chapter 18: Issuing Capital and the Investment Banking Process
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Q1) A commitment fee is:
A)the back-end fee.
B)the facility fee.
C)the up-front fee.
D)none of these.
Q2) 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 is known as:
A)shelf registration.
B)shelf prospectus.
C)SEC registration.
D)originating registration.
Q3) All of the following are advantages of an IPO EXCEPT:
A)the market provides a market value for the firm's common stock.
B)the original owners can reallocate their personal wealth away from the firm into more diversified portfolios.
C)the market provides a transparent measure of firm performance which can attract more investors.
D)IPOs are traditionally priced at a premium to cover the costs of the underwriters.
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Chapter 19: International Corporate Finance
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Q1) Exchange Rate Quote Convert the following indirect quote to a dollar direct quote:
$1 = 2,150.4 Venezuelan bolivar
A)$0.00046503
B)$4.65
C)$1.465
D)$2.1504
Q2) Exchange Rate Risk In the late 1990s,many East Asian currencies suddenly and dramatically devalued.What is the percentage change in value of a $75 million investment in Indonesia when the exchange rate changes from $1 = 1,000 rupiah to $1 = 7,000 rupiah?
A)14.29 percent
B)85.71 percent
C)12.5 percent
D)87.5 percent
Q3) The concept of interest parity describes:
A)why spot and forward rates differ.
B)how inflation causes exchange rates to change.
C)why identical products should have the same price.
D)none of these.
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Chapter 20: Mergers and Acquisitions and Financial
Distress
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Q1) If Verizon buys the Green Bay Packers,this would be an example of a:
A)horizontal merger.
B)vertical merger.
C)market extension merger.
D)conglomerate merger.
Q2) Calculation of Average Costs with Economies of Scope Jewelry Designs is considering a merger with Beads Supply Stores.Jewelry's total operating costs of producing services are $300,000 for sales volume of $2 million.Beads' total operating costs of producing services are $125,000 for a sales volume (J<sub>P</sub>)of $2.25 million.For a sales volume of $4.25 million,calculate the reduction in production costs the merged firms need to experience such that the total average cost (TAC)for the merged firms is equal to 8 percent.
A)Decrease of $340,000
B)Decrease of $85,000
C)Decrease of $40,000
D)Decrease of $25,000
Q3) What is a credit-scoring model?
Q4) List the order for the distribution of the funds from asset liquidation in a bankruptcy.
Q5) The Altman's Z-score model has several weaknesses.What are they?
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