Investment Analysis
Review Questions
Course Introduction
Investment Analysis introduces students to the fundamental concepts and techniques used to evaluate various investment opportunities, including stocks, bonds, mutual funds, and alternative assets. The course covers key topics such as risk and return analysis, portfolio theory, asset pricing models, fundamental and technical analysis, and the impact of market efficiency on investment decisions. Students learn to apply analytical tools to assess investment performance, construct diversified portfolios, and make informed recommendations based on quantitative and qualitative data. Emphasis is placed on real-world application through case studies and practical exercises, preparing students for careers in finance, asset management, and related fields.
Recommended Textbook
Financial Management Theory and Practice 15th Edition by Eugene F. Brigham
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Page 2
Chapter 1: An Overview of Financial Management and the Financial Environment
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Q1) One key value of limited liability is that it lowers owners' risks and thereby enhances a firm's value.
A)True
B)False
Answer: True
Q2) ? Which of the following is a primary market transaction?
A) ?You sell 200 shares of Johnson & Johnson stock on the NYSE through your broker.
B) ?Johnson & Johnson issues 2,000,000 shares of new stock and sells them to the public through an investment banker.
C) ?You buy 200 shares of Johnson & Johnson stock from your younger brother.You just give him cash and he gives you the stock-the trade is not made through a broker.
D) ?One financial institution buys 200,000 shares of Johnson & Johnson stock from another institution.An investment banker arranges the transaction.
E) ?You invest $10,000 in a mutual fund,which then uses the money to buy $10,000 of Johnson & Johnson shares on the NYSE.
Answer: B
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Chapter 2: Financial Statements, Cash Flow, and Taxes
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Q1) NNR Inc.'s balance sheet showed total current assets of $1,875,000 plus $4,225,000 of net fixed assets.All of these assets were required in operations.The firm's current liabilities consisted of $475,000 of accounts payable,$375,000 of 6% short-term notes payable to the bank,and $150,000 of accrued wages and taxes.Its remaining capital consisted of long-term debt and common equity.What was NNR's total investor-provided operating capital?
A) $4,694,128
B) $4,941,188
C) $5,201,250
D) $5,475,000
E) $5,748,750
Answer: D
Q2) Net operating profit after taxes (NOPAT)is the amount of net income a company would generate from its operations if it had no interest income or interest expense.
A)True
B)False
Answer: True
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Chapter 3: Analysis of Financial Statements
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Q1) The basic earning power ratio (BEP)reflects the earning power of a firm's assets after giving consideration to financial leverage and tax effects.
A)True
B)False
Answer: False
Q2) Hutchinson Corporation has zero debt it is financed only with common equity.Its total assets are $410,000.The new CFO wants to employ enough debt to bring the debt/assets ratio to 40%,using the proceeds from the borrowing to buy back common stock at its book value.How much must the firm borrow to achieve the target debt ratio?
A) $155,800
B) $164,000
C) $172,200
D) $180,810
E) $189,851
Answer: B
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Chapter 4: Time Value of Money
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Sample Questions
Q1) You have just purchased a U.S.Treasury bond for $747.25.No payments will be made until the bond matures 5 years from now,at which time it will be redeemed for $1,000.What interest rate will you earn on this bond?
A) 4.37%
B) 4.86%
C) 5.40%
D) 6.00%
E) 6.60%
Q2) Your uncle just won the weekly lottery,receiving $375,000,which he invested at a 7.5% annual rate.He now has decided to retire,and he wants to withdraw $35,000 at the end of each year,starting at the end of this year.What is the maximum number of whole payments that can be withdrawn before the account is exhausted,i.e. ,before the account balance would become negative? (Hint: Round down to the nearest whole number. )
A) 22
B) 23
C) 24
D) 25
E) 26
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Page 6
Chapter 5: Bonds, Bond Valuation, and Interest Rates
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Q1) Field Industries' outstanding bonds have a 25-year maturity and $1,000 par value.Their nominal yield to maturity is 9.25%,they pay interest semiannually,and they sell at a price of $850.What is the bond's nominal (annual)coupon interest rate?
A) 6.27%
B) 6.60%
C) 6.95%
D) 7.32%
E) 7.70%
Q2) A Treasury bond has an 8% annual coupon and a 7.5% yield to maturity.Which of the following statements is CORRECT?
A) The bond has a current yield greater than 8%.
B) The bond sells at a discount.
C) The bond's required rate of return is less than 7.5%.
D) If the yield to maturity remains constant,the price of the bond will decline over time.
E) The bond sells at a price below par.
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Chapter 6: Risk and Return
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Q1) Assume that in recent years both expected inflation and the market risk premium (r<sub>M</sub> r<sub>RF</sub>)have declined.Assume also that all stocks have positive betas.Which of the following would be most likely to have occurred as a result of these changes?
A) The required returns on all stocks have fallen,but the fall has been greater for stocks with higher betas.
B) The average required return on the market,r<sub>M</sub>,has remained constant,but the required returns have fallen for stocks that have betas greater than 1.0.
C) Required returns have increased for stocks with betas greater than 1.0 but have declined for stocks with betas less than 1.0.
D) The required returns on all stocks have fallen by the same amount.
E) The required returns on all stocks have fallen,but the decline has been greater for stocks with lower betas.
Q2) The tighter the probability distribution of its expected future returns,the greater the risk of a given investment as measured by its standard deviation.
A)True B)False
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Page 8
Chapter 7: Corporate Valuation and Stock Valuation
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Q1) Preferred stock is a hybrid a sort of cross between a common stock and a bond in the sense that it pays dividends that normally increase annually like a stock but its payments are contractually guaranteed like interest on a bond.
A)True
B)False
Q2) Stocks A and B have the same price and are in equilibrium,but Stock A has the higher required rate of return.Which of the following statements is CORRECT?
A) Stock B must have a higher dividend yield than Stock A.
B) Stock A must have a higher dividend yield than Stock B.
C) If Stock A has a higher dividend yield than Stock B,its expected capital gains yield must be lower than Stock B's.
D) Stock A must have both a higher dividend yield and a higher capital gains yield than Stock B.
E) If Stock A has a lower dividend yield than Stock B,its expected capital gains yield must be higher than Stock B's.
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Chapter 8: Financial Options and Applications in Corporate Finance
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Q1) Braddock Construction Co.'s stock is trading at $20 a share.Call options that expire in three months with a strike price of $20 sell for $1.50.Which of the following will occur if the stock price increases 10%,to $22 a share?
A) The price of the call option will increase by more than $2.
B) The price of the call option will increase by less than $2,and the percentage increase in price will be less than 10%.
C) The price of the call option will increase by less than $2,but the percentage increase in price will be more than 10%.
D) The price of the call option will increase by more than $2,but the percentage increase in price will be less than 10%.
E) The price of the call option will increase by $2.
Q2) Since investors tend to dislike risk and like certainty,the more volatile a stock,the less valuable will be an option to purchase the stock,other things held constant.
A)True
B)False
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Page 10
Chapter 9: The Cost of Capital
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Q1) As the assistant to the CFO of Johnstone Inc. ,you must estimate its cost of common equity.You have been provided with the following data: D<sub>0</sub> = $0.80;P<sub>0</sub> = $22.50;and g<sub>L</sub> = 8.00% (constant).Based on the dividend growth model,what is the cost of common from reinvested earnings?
A) 10.69%
B) 11.25%
C) 11.84%
D) 12.43%
E) 13.05%
Q2) The cost of external equity capital raised by issuing new common stock (r<sub>e</sub>)is defined as follows,in words: "The cost of external equity equals the cost of equity capital from retaining earnings (r<sub>s</sub>),divided by one minus the percentage flotation cost required to sell the new stock, (1 F)."
A)True
B)False
Q3) "Capital" is sometimes defined as funds supplied to a firm by investors.
A)True
B)False
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11
Chapter 10: The Basics of Capital Budgeting: Evaluating Cash Flows
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Q1) The IRR of normal Project X is greater than the IRR of normal Project Y,and both IRRs are greater than zero.Also,the NPV of X is greater than the NPV of Y at the cost of capital.If the two projects are mutually exclusive,Project X should definitely be selected,and the investment made,provided we have confidence in the data.Put another way,it is impossible to draw NPV profiles that would suggest not accepting Project X.
A)True
B)False
Q2) In theory,capital budgeting decisions should depend solely on forecasted cash flows and the opportunity cost of capital.The decision criterion should not be affected by managers' tastes,choice of accounting method,or the profitability of other independent projects.
A)True
B)False
Q3) Because "present value" refers to the value of cash flows that occur at different points in time,a series of present values of cash flows should not be summed to determine the value of a capital budgeting project.
A)True
B)False
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Chapter 11: Cash Flow Estimation and Risk Analysis
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Q1) Which of the following procedures best accounts for the relative risk of a proposed project?
A) Adjusting the discount rate downward if the project is judged to have above-average risk.
B) Reducing the NPV by 10% for risky projects.
C) Picking a risk factor equal to the average discount rate.
D) Ignoring risk because project risk cannot be measured accurately.
E) Adjusting the discount rate upward if the project is judged to have above-average risk.
Q2) A firm that bases its capital budgeting decisions on either NPV or IRR will be more likely to accept a given project if it uses accelerated depreciation than if it uses straight-line depreciation,other things being equal.
A)True
B)False
Q3) Opportunity costs include those cash inflows that could be generated from assets the firm already owns if those assets are not used for the project being evaluated.
A)True
B)False
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Chapter 12: Financial Planning and Applications to Corporate Valuation
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Q1) Firms pay a low interest rate on spontaneous liabilities so these funds are its cheapest source of capital.Consequently,the firm should make arrangements with its suppliers to use as much of this credit as possible.
A)True
B)False
Q2) A firm's AFN must come from external sources.Typical sources include short-term bank loans,long-term bonds,preferred stock,and common stock.
A)True
B)False
Q3) 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
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Chapter 13: 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 good reason to establish an ESOP?
A) To enable the firm to borrow at a below-market interest rate.
B) To make it easier to grant stock options to employees.
C) To help prevent a hostile takeover.
D) To help retain valued employees.
E) To increase worker productivity.
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) Consider two very different firms,M and N.Firm M is a mature firm in a mature industry.Its annual net income and net cash flows are both consistently high and stable.However,M's growth prospects are quite limited,so its capital budget is small relative to its net income.Firm N is a relatively new firm in a new and growing industry.Its markets and products have not stabilized,so its annual operating income fluctuates considerably.However,N has substantial growth opportunities,and its capital budget is expected to be large relative to its net income for the foreseeable future.Which of the following statements is correct?
A) Firm M probably has a higher dividend payout ratio than Firm N.
B) If the corporate tax rate increases,the debt ratio of both firms is likely to decline.
C) The two firms are equally likely to pay high dividends.
D) Firm N is likely to have a clientele of shareholders who want to receive consistent,stable dividend income.
E) Firm M probably has a lower debt ratio than Firm N.
Q2) Stock dividends and stock splits should,at least conceptually,have the same effect on shareholders' wealth.
A)True B)False
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Chapter 15: Capital Structure Decisions
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Q1) A new company to produce state-of-the-art car stereo systems is being considered by Jagger Enterprises.The sales price would be set at 1.5 times the variable cost per unit;the VC/unit is estimated to be $2.50;and fixed costs are estimated at $120,000.What sales volume would be required in order to break even,i.e. ,to have an EBIT of zero for the stereo business?
A) 86,640
B) 91,200
C) 96,000
D) 100,800
E) 105,840
Q2) The Miller model begins with the MM model without corporate taxes and then adds personal taxes.
A)True
B)False
Q3) Firm A has a higher degree of business risk than Firm B.Firm A can offset this by using less financial leverage.Therefore,the variability of both firms' expected EBITs could actually be identical.
A)True
B)False
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Chapter 16: Supply Chains and Working Capital Management
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Q1) Funds from short-term loans can generally be obtained faster than from long-term loans for two reasons: (1)when lenders consider long-term loans they must make a more thorough evaluation of the borrower's financial health,and (2)long-term loan agreements are more complex.
A)True
B)False
Q2) The four primary elements in a firm's credit policy are (1)credit standards, (2)cash discounts offered, (3)credit period,and (4)collection policy.
A)True
B)False
Q3) The twin goals of inventory management are (1)to ensure that the inventories needed to sustain operations are available,but (2)to hold the costs of ordering and carrying inventories to the lowest possible level.
A)True
B)False
Q4) Changes in a firm's collection policy can affect sales,working capital,and profits.
A)True
B)False
Page 18
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Chapter 17: Multinational Financial Management
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Q1) Suppose a foreign investor who holds tax-exempt Eurobonds paying 9% is considering investing in an equivalent-risk domestic bond in a country with a 28% withholding tax on interest paid to foreigners.If 9% after-tax is the investor's required return,what before-tax rate would the domestic bond need to pay to provide the required after-tax return?
A) 9.00%
B) 10.20%
C) 11.28%
D) 12.50%
E) 13.57%
Q2) A product sells for $750 in the United States.The exchange rate is $1 to 1.65 Swiss francs.If purchasing power parity (PPP)holds,what is the price of the product in Switzerland?
A) 123.75 Swiss francs
B) 454.55 Swiss francs
C) 750.00 Swiss francs
D) 1,237.50 Swiss francs
E) 1,650.00 Swiss francs
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Q1) In its negotiations with its investment bankers,Patton Electronics has reached an agreement whereby the investment bankers receive a smaller fee now (6% of gross proceeds versus their normal 10%)but also receive a 1-year option to purchase an additional 200,000 shares at $5.00 per share.Patton will go public by selling $5,000,000 of new common stock.The investment bankers expect to exercise the option and purchase the 200,000 shares in exactly one year,when the stock price is forecasted to be $6.50 per share.However,there is a chance that the stock price will actually be $12.00 per share one year from now.If the $12 price occurs,what would the present value of the entire underwriting compensation be? Assume that the investment banker's required return on such arrangements is 15%,and ignore taxes.
A) $1,235,925
B) $1,300,973
C) $1,369,446
D) $1,441,522
E) $1,517,391
Q2) If its managers make a tender offer and buy all shares that were not held by the management team,this is called a private placement.
A)True
B)False
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Chapter 19: Lease Financing
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Q1) Under a sale and leaseback arrangement,the seller of the leased property is the lessee and the buyer is the lessor.
A)True
B)False
Q2) Leasing is typically a financing decision and not a capital budgeting decision.Thus,the availability of lease financing cannot affect the size of the capital budget.
A)True
B)False
Q3) In the lease versus buy decision,leasing is often preferable
A) because,generally,no down payment is required,and there are no indirect interest costs.
B) because lease obligations do not affect the firm's risk as seen by investors.
C) because the lessee owns the property at the end of the least term.
D) because the lessee may have greater flexibility in abandoning the project in which the leased property is used than if the lessee bought and owned the asset.
E) because it has no effect on the firm's ability to borrow to make other investments.
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Page 21
Chapter 20: Hybrid Financing: Preferred Stock, Warrants, and Convertibles
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Q1) Unlike bonds,the cost of preferred stock to the issuing firm is the same on a before-tax and after-tax basis.This is because dividends on preferred stock are not tax deductible,whereas interest on bonds is deductible.
A)True
B)False
Q2) Firms generally do not call their convertibles unless the conversion value is greater than the call price.
A)True B)False
Q3) Preferred stock can provide a financing alternative for some firms when market conditions are such that they cannot issue either pure debt or common stock at any reasonable cost.
A)True B)False
Q4) Many preferred stocks extend voting rights to preferred shareholders if the preferred dividend has been omitted for some specified period,for example,4 quarters. A)True B)False
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Chapter 21: Dynamic Capital Structures and Corporate Valuation
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Q1) MM showed that in a world without taxes,a firm's value is not affected by its capital structure.
A)True
B)False
Q2) The market value of Firm L's debt is $200,000 and its yield is 9%.The firm's equity has a market value of $300,000,its earnings are growing at a 5% rate,and its tax rate is 40%.A similar firm with no debt has a cost of equity of 12%.Using the compressed adjusted present value model,what would Firm L's total value be if it had no debt?
A) $358,421
B) $377,286
C) $397,143
D) $417,000
E) $437,850
Q3) In the compressed adjusted present value model,the appropriate discount rate for the tax shield is the after-tax cost of debt.
A)True
B)False
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Page 23
Chapter 22: Mergers and Corporate Control
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Q1) If the capital structure is stable,and free cash flows are expected to be growing at a constant rate at the horizon date,then the horizon value is calculated by discounting the free cash flows plus the expected future tax shields at the weighted average cost of capital.
A)True
B)False
Q2) A parent holding company sells shares in its subsidiary such that the parent now owns only 65% of the subsidiary and,thus,the tax returns of the parent and its subsidiary can't be consolidated.The parent receives annual dividends from the subsidiary of $2,500,000.If the parent's marginal tax rate is 34% and if the exclusion on intercompany dividends is 70%,what is the effective tax rate on the intercompany dividends,and how much net dividends are received?
A) 10.2%;$2,245,000
B) 10.2%;$2,135,000
C) 23.8%;$1,905,000
D) 10.2%;$1,750,000
E) 34.0%;$1,650,000
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Chapter 23: Enterprise Risk Management
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Q1) A swap is a method used to reduce financial risk.Which of the following statements about swaps,if any,is NOT CORRECT?
A) The earliest swaps were currency swaps,in which companies traded debt denominated in different currencies,say dollars and pounds.
B) Swaps are very often arranged by a financial intermediary,who may or may not take the position of one of the counterparties.
C) A problem with swaps is that no standardized contracts exist,which has prevented the development of a secondary market.
D) A company can swap fixed interest payments for floating interest payments.
E) A swap involves the exchange of cash payment obligations.
Q2) One objective of risk management can be to reduce the volatility of a firm's cash flows.
A)True B)False
Q3) Interest rate swaps allow a firm to exchange fixed for floating-rate payments,but a swap cannot reduce actual net interest expenses.
A)True
B)False
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25
Chapter 24: Bankruptcy, Reorganization, and Liquidation
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Q1) Bankruptcy plays no role in settling labor disputes and product liability suits.Such issues are outside the bounds of bankruptcy law and are covered by other statutes.
A)True
B)False
Q2) Even if a firm's cash flow projections indicate that it will soon be unable to meet its interest payments,a bankruptcy case cannot begin until the firm actually defaults on a scheduled payment.
A)True
B)False
Q3) In the event of bankruptcy under the federal bankruptcy laws,debtholders have a prior claim to a firm's income and assets before both common and preferred stockholders.Moreover,in a bankruptcy all debtholders are treated equally as a single class of claimants.
A)True
B)False
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Chapter 25: Portfolio Theory and Asset Pricing Models
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Q1) Which of the following statements is CORRECT?
A) The characteristic line is the regression line that results from plotting the returns on a particular stock versus the returns on a stock from a different industry.
B) The slope of the characteristic line is the stock's standard deviation.
C) The distance of the plot points from the characteristic line is a measure of the stock's market risk.
D) The distance of the plot points from the characteristic line is a measure of the stock's diversifiable risk.
E) "Characteristic line" is another name for the Security Market Line.
Q2) If you plotted the returns of Selleck & Company against those of the market and found that the slope of your line was negative,the CAPM would indicate that the required rate of return on Selleck's stock should be less than the risk-free rate for a well-diversified investor,assuming that the observed relationship is expected to continue in the future.
A)True
B)False
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Chapter 26: Real Options
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Q1) Refer to the data for Drilling Experts.Calculate the project's coefficient of variation.(Hint: Use the expected NPV. )
A) 5.87
B) 6.52
C) 7.25
D) 7.97
E) 8.77
Q2) Refer to the data for Drilling Experts,Incorporated.Since the project is considered to be quite risky,a 20% cost of capital is used.What is the project's expected NPV,in thousands of dollars?
A) $336.15
B) $373.50
C) $415.00
D) $461.11
E) $507.22
Q3) Real options affect the size,but not the risk,of a project's expected cash flows. A)True B)False
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Chapter 27: Providing and Obtaining Credit
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Questions
Q1) Danby Design Inc.has approached the bank with its plan to borrow $12,000.The bank offers the choice of a 12 percent discount interest loan or a 10.19 percent add-on,one-year installment loan,payable in 4 equal quarterly payments.What is the approximate (nominal)rate of interest on the 10.19 percent add-on loan?
A) 5.10%
B) 10.19%
C) 12.00%
D) 20.38%
E) 30.57%
Q2) If sales are seasonal,the days sales outstanding will fluctuate from month to month,even if the amount of time customers take to pay remains unchanged.
A)True
B)False
Q3) Cash discounts are mostly used to get new customers in the door since existing customers almost always use the delayed payment terms.
A)True
B)False
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Chapter 28: Advanced Issues in Cash Management and Inventory Control
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29 Verified Questions
29 Flashcards
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Sample Questions
Q1) Refer to Exhibit 28.1.According to the Baumol model,what should be Duckett's average cash balance?
A) $35,356
B) $3,536
C) $22,157
D) $70,711
E) $42,918
Q2) Refer to Exhibit 28.2.What is the economic ordering quantity for chips?
A) 12,088
B) 3,175
C) 6,243
D) 13,675
E) 8,124
Q3) A just-in-time system is designed to stretch accounts payable as long as possible. A)True
B)False
Q4) If a company increases its safety stock,then its EOQ will go up. A)True
B)False
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Chapter 29: Pension Plan Management
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Sample Questions
Q1) Which of the following statements about defined contribution plans is incorrect?
A) In general,employees can choose the investment vehicle under a defined contribution plan.Thus,highly risk-averse employees can choose low-risk investments,while more risk-tolerant employees can choose high-risk investments.
B) In a defined contribution plan,the employer must make larger-than-average contributions to the pension plan when investment returns have been below expectations.
C) Defined benefit plans are used more often by large corporations than by small companies.
D) The PBGC insures a portion of pension benefits.
E) A defined contribution plan places the risk of poor pension portfolio performance on the employee.
Q2) Under a defined contribution plan,employees agree to contribute some percentage of their salaries,up to 20 percent,to the firm's pension fund.
A)True
B)False
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Sample Questions
Q1) Which of the following statements about municipal bond financing is most correct?
A) Whereas the vast majority of Treasury and corporate bonds are held by institutions,no municipal bonds are held by individual investors.
B) The primary attraction of municipal bonds to individual investors is their high before-tax yields.
C) Municipal bonds usually pay higher coupon rates than corporate bonds with similar ratings.
D) Municipal bonds are risk-free.
E) In contrast to corporate bonds,municipal bond issues are not required to be registered with the Securities and Exchange Commission.
Q2) The net present social value model formally recognizes that not-for-profit firms must consider the social value along with the financial value of proposed new projects.
A)True
B)False
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