Principles of Finance
Exam Answer Key
Course Introduction
Principles of Finance introduces students to the fundamental concepts and tools used in financial decision-making. The course covers essential topics such as time value of money, risk and return, valuation of stocks and bonds, capital budgeting, financial statement analysis, and the functioning of capital markets. Emphasis is placed on understanding how individuals and businesses allocate resources over time and manage financial risks. By the end of the course, students will have a foundational understanding of how financial principles apply to both personal and corporate financial decisions, preparing them for advanced study in finance or related fields.
Recommended Textbook Financial Management for Decision Makers 2nd Canadian Edition by Peter Atrill
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Chapter 1: Introduction to Financial Management
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Sample Questions
Q1) The company is performing the function of financial control when it
A) Raises funds from capital markets
B) Takes corrective action to achieve business goals
C) Assesses the riskiness of investment projects
D) Identifies possible sources of funds
E) Reinvests profits from operations
Answer: B
Q2) For a company wishing to pursue a strategy of increasing shareholder wealth as opposed to profit maximization, which of the following would be the most appropriate action?
A) Increase short-term return over sustained growth
B) Reduce spending on research and development
C) Distribute all after-tax net income as dividends
D) Offer only established products for sale
E) Close a retail location in a declining market
Answer: E
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Chapter 2: Accounting - the Language of Business
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Q1) Allison Controls Ltd. follows a policy of paying cash for everything it buys. At the end of 2011 Allison had a balance in its machine account of $90,000 and the associated accumulated depreciation account of $45,000. Similar amounts at the end of 2010 were $100,000 and $50,000 respectively. During 2011 Allison sold a machine for $10,000. It had cost $25,000 and had accumulated depreciation of $10,000 at the time of the sale. How would these amounts appear on the income and cash flow statements?
A) A loss of $5,000 on the income statement and a net cash outflow of $5,000 on the cash flow statement.
B) A loss of $10,000 on the income statement and a net cash outflow of $15,000 on the cash flow statement.
C) A loss of $15,000 on the income statement and a net cash outflow of $25,000 on the cash flow statement.
D) A loss of $20,000 on the income statement and a net cash outflow of $10,000 on the cash flow statement.
E) A loss of $30,000 on the income statement and a net cash outflow of $20,000 on the cash flow statement.
Answer: A
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Chapter 3: Financial Planning and Pro Forma Financial Statements
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Q1) The Block Defender video game sells for $50 and costs $10 to manufacture. Fixed costs were $5,000,000. Which of the following statements is correct?
A) The contribution margin ratio is 20% and the breakeven point is 5,000,000 units.
B) The contribution margin ratio is 20% and the breakeven point is 6,250,000 units.
C) The contribution margin ratio is 80% and the breakeven point is 5,000,000 units.
D) The contribution margin ratio is 80% and the breakeven point is 6,250,000 units.
E) The contribution margin ratio is 500% and the breakeven point is 1,000,000 units.
Answer: A
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Chapter 4: Analyzing and Interpreting Financial Statements
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Q1) Last year the price earning ratio was 10 for the market as a whole and was 20 for Hi Tek Plastics Ltd. Hi Tek's share price ended the year at $50.00. This year the economy is expected to boom and P/E multiple expansion is underway. At the end of the year, the P/E multiple is expected to be 20 for the market. If Hi Tek's is expected to be in the same risk class as last year and its net income is supposed to triple, at what price should Hi Tek's shares finish the year?
A) $25.00
B) $75.00
C) $100.00
D) $150.00
E) $300.00
Q2) The company's leverage ratio has moved from 15.2% to 32%. Its return on equity ratio has also moved up, from 20.5% to 45.3%. Its times interest earned ratio has dropped to 3.5. Which of the following is the best statement to describe the company?
A) Is not in a risky financial position
B) Is depending on debt to finance its expansion
C) Cannot pay the interest on its long-term debt
D) Is depending on equity to finance its expansion
E) Has a sizable cushion to pay the interest on its debt
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Chapter 5: The Time Value of Money
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Q1) A bond with the term of 20 years, face value of $5,000, a coupon rate of 8%, compounded quarterly and payments 4 times a year, was issued 15 years ago. Currently, interest rates are at 12%. What could the bond be sold for today?
A) $4,279
B) $4,471
C) $4,853
D) $5,047
E) $4,256
Q2) As a bond approaches within weeks of its maturity date, its market price
A) Approaches zero
B) Rises or drops below the face value of the bond based on current interest rates
C) Is equal to the face value of the bond plus the total interest earned
D) Approaches the face value of the bond
E) Is equal to the future value of the stream of interest payments
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Chapter 6: Making Capital Investment Decisions
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Q1) One of the important results of the large number of companies now using post-completion audits is that
A) It is easier to discover fraudulent behaviour
B) Cost overruns on projects have been virtually eliminated
C) There is early detection of projects going wrong
D) A higher overall cash flow is being achieved
E) More realistic investment proposals are being submitted
Q2) Omaro Ltd. would like to clear their warehouse and yard of damaged equipment and metal scrap. If the company purchases an industrial recycling bin for $1800, a contractor will pick up the materials and pay by the kilogram for the scrap. Omaro adjusts all cash flows for time value and uses a 10% discount rate. What dollar value of scrap do they have to generate each year to be able to break even on their investment in three years?
A) $544
B) $ 600
C) $ 724
D) $ 844
E) $1,352
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Chapter 7: Making Capital Investment Decisions: Further Issues
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Q1) Li'l Lucy's Fried Chicken would like to invest $2 million to buy land and build a a restaurant in an area that has been rezoned from agricultural to residential. The company expects a 9% return. The company believes there is a 15% probability that the neighbouring land will be fully developed into family homes resulting in income before depreciation of $800,000 a year. It also believes in a 60% chance that the neighbouring land will be gradually developed resulting in Year 1 income of $150,000, Year 2 income of $200,000, Years 3, 4 and 5 income of $500,000 and Years 6 and 7 income of $800,000. There exists a 25% chance that there will be no development resulting in an income of $150,000 a year from an alternative use of the land. Based on ENPV, should Li'l Lucy's Fried Chicken build the restaurant?
A) Yes, ENPV equals $164,207
B) Yes, ENPV equals $250,654
C) Yes, ENPV equals $452,170
D) No, ENPV equals ($5)
E) No, ENPV equals ($483,899)
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Chapter 8: Financing a Business 1: Sources of Funds
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Q1) A company has 16 million common shares outstanding and on Dec. 31st, declared a year-end net income after tax of $48 million. It pays a fixed dividend of $1.20 on its 4.8 million preferred shares outstanding. The company's has expanded rapidly and traded steadily at a price/earnings ratio of 32. Four years ago, it issued $42 million worth of debt at 4% compounded annually with a convertible feature that could be exercised December 31st of year 4 of the loan at a price of $84.00. If the company issues new shares to the bondholders, what is the dilution in current earnings per share if maximum conversion occurs?
A) No dilution as the current market price of the share is too low for conversion to take place.
B) Earning per share will drop by 8.0 cents per share after full conversion.
C) No dilution as the current market price of the share is too high for conversion to take place.
D) No dilution will occur as the liquidation of the loan through conversion will boost net income after tax.
E) Earnings per share will drop by 9.1 cents per share after full conversion.
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Chapter 9: Financing a Business 2: Raising Long-Term Funds
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Q1) The share price of Royal Software Inc. bottomed out at $15.00 and over the next two months gradually rose through $16.00 to where it currently stands at $17.50. Which of the following stock patterns is a technical analyst investor following if he buys the stock at $17.50?
A) Channel.
B) Head and shoulders.
C) Line trend.
D) Triangle.
E) Cup with handle.
Q2) Pioneer Logging owns a tug boat to manage floating booms of felled trees off the Queen Charlotte Islands. The boat was purchased in February of 2006 for $128,000. If the rate for the asset class is 15%, what is the amount of CCA (capital cost allowance) that the company can claim on their 2008 income tax return?
A) $12,832
B) $13,872
C) $14,076
D) $15,096
E) $16,320
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Chapter 10: The Cost of Capital and the Capital Structure
Decision
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Q1) UPad Wireless needs to raise $10 million to build another factory to meet the strong demand for its latest product. UPad will either issue 12% bonds at par or common shares that they have determined that investors require a 15% return. The fair value of UPad's currently outstanding bonds is $5 million, it shares is $5 million, and its preferred shares is $5 million. UPad's retained earnings is $5 million. The preferred shares also have a 12% dividend. UPad's tax rate is 30%. What is the minimum hurdle rate UPad should set for this investment project?
A) 8.4% if UPad issues bonds to finance the factory.
B) 11.7% if UPad issues preferred shares to finance the factory.
C) 12.0% if UPad issues bonds or preferred shares to finance the factory.
D) 12.6% if UPad issues bonds or preferred shares or common shares to finance the factory.
E) 15.0% if UPad issues common shares to finance the factory.
Q2) Which of the following is an internal source of long-term capital?
A) Retained Earnings.
B) Common Shares
C) Preferred Shares
D) Bonds
E) Loans
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Chapter 11: Developing a Dividend Policy
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Q1) What does dividend smoothing refers to?
A) Adopting a consistent, rising dividend over time.
B) Declaring an EPS that does not change much in value from year to year.
C) Offsetting declines in income with higher dividend payouts.
D) Providing a DRIP (dividend reinvestment programs) to absorb unwanted cash payouts.
E) Ensuring that the dividend yield ratio is the same from year to year.
Q2) A company has 21 million common shares outstanding at a price of $63.00 each and an EPS of $12.00 per share. If the company wishes to provide a stock dividend of 30%, how many shares will shareholders receive for every ten shares currently held?
A) 4.8 shares.
B) 5 shares.
C) 5.7 shares.
D) 3.33 shares.
E) 3 shares.
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Chapter 12: Managing Working Capital
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Q1) Your company has been informed that a major supplier is doubling the order processing fee it charges customers from $10 to $20 per order. Meanwhile general interest rates have risen from 1% to 4% due to rapid economic growth in the economy. What else would have to occur for this data not to affect inventory planning by a company?
A) Units sold would have to double.
B) Prices would have to decrease.
C) Total costs would have to decrease.
D) The holding cost line would have to shift down.
E) The minimum cost point would increase.
Q2) Bowden Building Supply's opening inventory for the year was $810,000 and ending inventory was $625,000 on sales of $6,650,000 and cost of goods sold of $3,600,000.
What was Bowden Building Supply's Average Inventory Turnover Period?
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Chapter 13: Measuring and Managing for Shareholder Value
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Q1) Social Games Ltd. has a business value of $50 million, capital invested of $32 million, and annually generates returns that exceed investors required returns by $4 million. What is the percentage required return demanded by investors?
A) 8.0%
B) 12.5%
C)
Q2) Harry Hermes Delivery Service's has been restructured to stem losses. The company's EVA for the year just ending was ($300,000). In its medium range plan Harry Hermes has projected EVA for the following three years to be ($150,000), $25,000, and $500,000, respectively. If the company's weighted average cost of capital is 10%, what is the gain or loss in shareholder value over the period?
A) ($36,408)
B) ($40,055)
C) $23,622
D) $75,000
E) $185,168
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Chapter 14: Mergers, Acquisitions, and the Valuation of Shares
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Q1) What is the concept underlying the term "market for corporate control"?
A) Threat of takeover leads managers to adopt short term profit objectives rather than long-term development of shareholder wealth.
B) Management talent is a scare resource that can be extended through strategic acquisitions.
C) Competition by management teams for control of corporations deflects managers from their primary tasks of maximizing shareholder wealth.
D) Shareholders may resist beneficial mergers because of fears of diluting their control of a corporation.
E) Weak management teams will be eliminated through merger and acquisition and this activity helps to ensure maximum corporate profitability.
Q2) Granastein Grocers purchased Ridgway Food Warehousing and Logistics Inc. What is this type of merger?
A) Vertical
B) Conglomerate
C) Unilateral
D) Stratified
E) Horizontal
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