Principles of Finance Exam Bank
Course Introduction
Principles of Finance introduces the fundamental concepts and tools used in financial decision-making within organizations and markets. The course covers essential topics such as the time value of money, risk and return analysis, valuation of stocks and bonds, capital budgeting, cost of capital, and an overview of financial markets and institutions. Emphasizing both theory and practical application, students develop foundational skills necessary to analyze financial statements, assess investment opportunities, and understand the financial environment influencing businesses and personal finance decisions.
Recommended Textbook
Fundamentals of Corporate Finance 2nd Edition by Jonathan Berk
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Page 2
Chapter 1: Corporate Finance and the Financial Manager
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Sample Questions
Q1) Which of the following types of firms do not have limited liability?
A)sole proprietorships
B)limited partnerships
C)corporations
D)none of the above
Answer: A
Q2) A sole proprietorship is owned by
A)one person.
B)two or more persons.
C)shareholders.
D)bankers.
Answer: A
Q3) Which of the following people may not manage the operations of a firm in which they are part or full owners?
A)stockholders in S corporations
B)stockholders in C corporations
C)limited partners in a limited partnership
D)general partners in a limited partnership
Answer: C
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Page 3
Chapter 2: Introduction to Financial Statement Analysis
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Sample Questions
Q1) The firm's statement of cash flows uses the balance sheet and the income statement to determine the amount of cash a firm has generated and how it has used that cash during a given period.
A)True
B)False Answer: True
Q2) In general,a successful firm will have a market-to-book ratio that is substantially greater than 1.
A)True
B)False Answer: True
Q3) Refer to the balance sheet above.If on December 31,2005 Luther has 8 million shares outstanding trading at $15 per share,then what is Luther's enterprise value?
Answer: Enterprise value = Market value of equity + Debt - Cash
Market value of equity = 8 million × $15 = $120 million
Debt = Notes payable + Current maturities of long-term debt + Long-term debt
Debt = 9.6 + 36.9 + 168.9 = 215.4
Cash = 58.5
So,enterprise value = $120 + 215.4 - 58.5 = $276.90.
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Page 4
Chapter 3: Time Value of Money: An Introduction
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Sample Questions
Q1) The Law of One Price states that if equivalent goods or securities are traded simultaneously in different competitive markets,they will trade for the same price in each market.
A)True
B)False Answer: True
Q2) In general,if an action increases a firm's value by providing benefits with a value greater than any costs involved,then that action is good for the firm's investors.
A)True
B)False
Answer: True
Q3) Advanced Micro Devices (NYSE: AMD)is currently trading at $20.75 on the NYSE.Advanced Micro Devices is also listed on NASDAQ and assume it is currently trading on NASDAQ at $20.50.Does an arbitrage opportunity exist and,if so,how would you exploit it and how much would you make on a block trade of 1000 shares?
Answer: Yes,buy 1000 shares × 20.50 and sell 1000 shares × 20.75 = $250.00.
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Page 5
Chapter 4: Time Value of Money: Valuing Cash Flow
Streams
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Sample Questions
Q1) The internal rate of return (IRR)is the interest rate that sets the net present value (NPV)of the cash flows equal to zero
A)True
B)False
Q2) The present value (PV)(at age 30)of your retirement savings is closest to:
A)$87,000
B)$108,000
C)$46,600
D)$75,230
Q3) Matthew wants to take out a loan to buy a car.He calculates that he can make repayments of $4000 per year.If he can get a five-year loan with an interest rate of 7.5%,what is the maximum price he can pay for the car?
A)$16,184
B)$18,243
C)$20,324
D)$21,674
Q4) If a few intermediate cash flows in valuing a stream of cash flows are zero can we delete those points on the timeline and squeeze the timeline to show only nonzero cash flows?
Page 6
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Chapter 5: Interest Rates
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Sample Questions
Q1) Given that the inflation rate in 2006 was about 3.24%,while a short term municipal bond offered a rate of 2.9%,which of the following statement is correct?
A)The purchasing power of investors in these bonds grew over the course of the year.
B)The real interest rate for investors in these bonds was greater than the rate of inflation.
C)Investors in these bonds were able to buy less at the end of the year than they could have purchased at the start of the year.
D)The nominal interest rate offered by these bonds gave the true increase in purchasing power that resulted from investing in these bonds.
Q2) The opportunity cost of capital is the best available expected return offered in the market on an investment of comparable risk and term to the cash flow being discounted.
A)True
B)False
Q3) What is the general relationship between the absolute values of APR and EAR for an investment?
Q4) Everything else remaining same,under what situation will APR and EAR be equal?
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Page 7
Chapter 6: Bonds
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Sample Questions
Q1) Based upon the information provided in the table above,you can conclude A)that the yield curve is flat.
B)nothing about the shape of the yield curve.
C)that the yield curve is downward sloping.
D)that the yield curve is upward sloping.
Q2) Assuming that this bond trades for $903,then the YTM for this bond is closest to:
A)8.0%
B)6.8%
C)9.9%
D)9.2%
Q3) The above table shows the yields to maturity on a number of one-year,zero-coupon securities.What is the price per $100 of the face value of a one-year,zero-coupon corporate bond with a BBB rating?
A)$92.21
B)$93.54
C)$94.16
D)$94.87
Q4) How can the financial calculator be used to calculate the price of a coupon bond from its yield to maturity?
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Chapter 7: Stock Valuation
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Sample Questions
Q1) How can the dividend-discount model handle changing growth rates?
Q2) Aaron Inc.has 316 million shares outstanding.It expects earnings at the end of the year to be $602 million.The firm's equity cost of capital is 11.5%.Aaron pays out 50% of its earnings in total: 30% paid out as dividends and 20% used to repurchase shares.If Aaron's earnings are expected to grow at a constant 6% per year,what is Aaron's share price?
A)$8.66
B)$17.32
C)$25.98
D)$34.64
Q3) Stocks that do not pay a dividend must have a value of $0. A)True B)False
Q4) The ownership in a corporation is divided into shares of stock,which carry rights to share in the profits of the firm through future dividend payments. A)True
B)False
Q5) What is the relationship between the growth rate and the cost of equity implied in the dividend-discount model?
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Chapter 8: Investment Decision Rules
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Sample Questions
Q1) If WiseGuy Inc.uses payback period rule to choose projects,which of the projects (Project A or Project B) will rank highest?
A)Project A
B)Project B
C)Project A and Project B have the same ranking.
D)Cannot calculate a payback period without a discount rate.
Q2) Assume that your capital is constrained,so that you only have $500,000 available to invest in projects.If you invest in the optimal combination of projects given your capital constraint,then the total net present value (NPV)for all the projects you invest in will be closest to:
A)$111,000
B)$69,000
C)$80,000
D)$58.000
Q3) The payback period for project A is closest to:
A)2.0 years
B)2.4 years
C)2.5 years
D)2.2 years
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Chapter 9: Fundamentals of Capital Budgeting
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Sample Questions
Q1) An analysis that breaks the net present value (NPV)calculation into its component assumptions and shows how the net present value (NPV)varies as one of the underlying assumptions changes is called
A)scenario analysis.
B)internal rate of return (IRR)analysis.
C)accounting break-even analysis.
D)sensitivity analysis.
Q2) A company planning to market a new model of motor scooter analyzes the effect of changes in the selling price of the motor scooter,the number of units that will be sold,the cost of making the motor scooter,the effect on Net Working Capital,and the cost of capital for the project.They predict that the break-even point for sales price for the motor scooter is $2480.What does this mean?
A)If the motor scooter is sold for $2480,then the project will make a profit.
B)If the motor scooter is sold for $2480,then the net present value (NPV)for the product will be zero.
C)The predicted selling price of the motor scooter is $2480.
D)The maximum that the motor scooter can sell for and still make the project have a positive net present value (NPV)is $2480.
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Chapter 10: Stock Valuation: A Second Look
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Q1) Which of the following is the appropriate way to calculate the price of a share of a given company using the free cash flow valuation model?
A)P<sub>0</sub> = Div<sub>1</sub>/(r<sub>E</sub> - g)
B)P<sub>0</sub> = PV(Future Free Cash Flow of Firm)/(Shares Outstanding<sub>0</sub>)
C)P<sub>0</sub> = [Div<sub>1</sub>/(r<sub>E</sub> - g)]/(Shares Outstanding<sub>0</sub>)
D)P<sub>0</sub> = (V<sub>0</sub> + Cash<sub>0</sub> - Debt<sub>0</sub>)/(Shares Outstanding<sub>0</sub>)
Q2) Which of the following statements is FALSE?
A)The most common valuation multiple is the price-earnings ratio.
B)You should be willing to pay proportionally more for a stock with lower current earnings.
C)A firm's price-earnings ratio is equal to the share price divided by its earnings per share.
D)The intuition behind the use of the price-earnings ratio is that when you buy a stock,you are in a sense buying the rights to the firm's future earnings,and differences in the scale of firms' earnings are likely to persist.
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12
Chapter 11: Risk and Return in Capital Markets
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Sample Questions
Q1) The average annual return over the period 1926-2009 for the S&P 500 is 11.7%,and the standard deviation of returns is 20.5%.Based on these numbers,what is a 95% confidence interval for 2010 returns?
A)1.5%,,22.0%
B)-8.8%,32.2%
C)-29.3%,52.7%
D)-29.3%,73.2%
Q2) Which type of investment has historically had the highest volatility?
Q3) Suppose you invested $98 in the Ishares High Yield Fund (HYG)a month ago.It paid a dividend of $0.47 today and then you sold it for $99.What was your dividend yield and capital gains yield on the investment?
A)0.45%,1.09%
B)0.47%,1.02%
C)0.47%,1.08%
D)1.02%,1.12%
Q4) Investors should earn a risk premium for bearing unsystematic risk.
A)True
B)False
Q5) What are the two components of realized return from a stock investment?
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Chapter 12: Systematic Risk and the Equity Risk Premium
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Sample Questions
Q1) The security market line is a graph of the expected return of a stock as a function of systematic risk (beta).
A)True
B)False
Q2) A stock market comprises 2000 shares of stock A and 2000 shares of stock B.The share prices for stocks A and B are $20 and $10,respectively.What proportion of the market portfolio is comprised of each stock?
A)Stock A is 66.7% and Stock B is 33.3%
B)Stock A is 33.3% and Stock B is 66.7%
C)Stock A is $40,000 and Stock B is $20,000
D)Stock A is 200% and Stock B is 100%
Q3) A stock market comprises 5000 shares of stock A and 2000 shares of stock B.Assume the share prices for stocks A and B are $20 and $35,respectively.What proportion of the market portfolio is comprised of stock A?
A)58.8%
B)41.2%
C)$100,000
D)$70,000
Q4) Is it possible for a stock to have high total risk but low systematic risk?
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Chapter 13: The Cost of Capital
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Sample Questions
Q1) Why do we use market values rather than book values in calculation of WACC?
Q2) Ford Motors expects a new hybrid-engine project to produce incremental cash flows of $60 million each year,and expects these to grow at 4% each year.The upfront project costs are $420 million and Ford's weighted average cost of capital is 9%.If the issuance costs for external finances are $15 million,what is the net present value (NPV)of the project?
A)$710 million
B)$765 million
C)$790 million
D)$805 million
Q3) The book value of equity of a firm is $100 million and the market value of equity is $200 million.The face value of debt of the firm is $50 million and the market value of debt is $60 million.What is the market value of assets of the firm?
A)$150 million
B)$160 million
C)$260 million
D)$250 million
Q4) What is the difference between the effective cost of debt and the cost of debt?
Q5) Is it incorrect to use the coupon rate of debt toward cost of debt?
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Chapter 14: Raising Equity Capital
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Sample
Questions
Q1) Moon Company plans to issue 10 million shares in a seasoned equity offering.The owner,Ken Moon,plans to sell 4 million shares as part of the offering.Which of the following is true regarding the seasoned equity issue?
A)It is a primary offering.
B)It is a secondary offering.
C)Some shares are primary shares and some shares are secondary shares.
D)None of the above is true regarding this seasoned equity offering.
Q2) Suppose you sold the 1 million shares to the angel investor for $500,000.What was your percentage ownership in the company immediately following the angel investor's investment?
A)50%
B)33.3%
C)66.7%
D)100%
Q3) A equity issue that raises new funds for a publicly traded company is called:
A)an initial public offering.
B)a seasoned equity offering.
C)an underpriced offering.
D)a secondary offering.
Q4) How many types of seasoned equity offerings are there?
Page 16
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Chapter 15: Debt Financing
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Q1) A company issues a 10-year,callable bond at par with 8% annual coupon payments.The bond can be called at par in one year after issue or any time after that on a coupon payment date.The call price is $105 per $100 of face value.What is the yield to call if this bond is called in one year?
A)8%
B)13%
C)11%
D)5%
Q2) Which of the following statements is FALSE?
A)When bond yields have increased,by exercising the call on the callable bond and then immediately refinancing,the issuer can lower its borrowing costs.
B)To understand how call provisions affect the price of a bond,we first need to consider when an issuer will exercise its right to call the bond.
C)If the call provision offers a cheaper way to retire the bonds the issuer will forgo the option of purchasing the bonds in the open market and call the bonds instead.
D)An issuer can always retire one of its bonds early by repurchasing the bond in the open market.
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Page 17
Chapter 16: Capital Structure
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Q1) A firm will give a one-time cash flow of $22,000 after one year.If the project risk requires a return of 11%,what is the levered value of the firm with perfect capital markets?
A)$18,182
B)$20,000
C)$19,820
D)more information needed
Q2) What role do industries play in the capital structure choice for a firm?
Q3) What are indirect costs of financial distress?
Q4) With perfect capital markets,because different choices of capital structure offer a benefit to investors,they affect the value of the firm.
A)True
B)False
Q5) A firm requires an investment of $20,000 and will return $26,500 after one year.If the firm borrows $5,000 at 7% what is the return on levered equity?
A)43%
B)39%
C)41%
D)45%
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Chapter 17: Payout Policy
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Q1) The date on which the board of directors of a company authorizes the dividend is called the ________ date.
A)declaration
B)record
C)ex-dividend
D)distribution
Q2) Palo Alto Enterprises has $200,000 in cash.They wish to invest the money in Treasury bills at 5% and use the returns to pay dividends to shareholders after a year.Alternately they can pay a dividend and allow shareholders to make the investment.If corporate tax rates are 30%,which option will shareholders prefer in perfect capital markets?
A)immediate cash dividend
B)dividend after one year
C)prefer half from each source
D)indifferent between options
Q3) Future investment plans are important determinants of payout policy because of A)signal to investors.
B)costs of raising new capital.
C)stock price depreciation.
D)debt holder restrictions.
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Chapter 18: Financial Modeling and Pro Forma Analysis
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Q1) Long term financial planning allows a financial manager to understand the business by ________ between sales,costs,capital investments and financing.
A)increasing the spread between
B)identifying linkages
C)decreasing the spread between D)identify wastage
Q2) Compute the after-tax interest expense for a firm with Interest on Excess Cash = $5000,Interest on Debt = $8000,and a tax rate of 30%.
A)$2100
B)$2200
C)$2500
D)$2700
Q3) Internal growth rate assumes that the firm can finance investments via sale of debt. A)True
B)False
Q4) What is the implied assumption in percent of sales method?
Q5) Is total net working capital or incremental net working capital more relevant for calculation of free cash flow?
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Chapter 19: Working Capital Management
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Q1) What is a precautionary balance?
A)the cash a firm holds to counter the uncertainty surrounding its future cash needs
B)the cash a firm places into short-term investments
C)the cash a firm holds in order to pay its bills
D)the cash a firm holds to gain tax advantages
Q2) Effective inventory management builds up assets through increases in inventory and thus increases a firm's value.
A)True
B)False
Q3) Which of the following money market investments is a draft written by the borrower and guaranteed by the bank on which the draft is drawn? It is typically used in international trade transactions.The borrower is an importer who writes the draft in payment for goods.
A)Treasury bills
B)repurchase agreement
C)certificates of deposit
D)banker's acceptance
E)commercial paper
Q4) What is a firm's cash cycle?
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Chapter 20: Short-Term Financial Planning
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Sample Questions
Q1) What is permanent working capital?
Q2) Which of the following statements is FALSE?
A)The matching principle indicates that the firm should finance permanent working capital with short-term sources of funds.
B)Following the matching principle should,in the long run,help minimize a firm's transaction costs.
C)In a perfect capital market,the choice of financing is irrelevant;thus how the firm chooses to finance its short-term cash needs cannot affect value.
D)A portion of a firm's investment in its accounts receivable and inventory is temporary and results from seasonal fluctuations in the firm's business or unanticipated shocks.
Q3) Gemini Real Estate is offered a $2 million line of credit for four months at an APR of 9%.This loan has a loan origination fee of 1.5%.What is the actual four-month interest rate paid,expressed as an EAR?
A)4.57%
B)9.68%
C)12.44%
D)14.34%
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Page 22
Chapter 21: Option Applications and Corporate Finance
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Q1) The Black-Scholes formula gives the price of an American call option.
A)True
B)False
Q2) When is an option in-the-money?
Q3) A ________ in the volatility of assets of the firm benefits ________ at a cost to debt holders.
A)decrease,equity holders
B)increase,equity holders
C)decrease,directors
D)increase,directors
Q4) A put option gives the owner the right to ________ an asset at a fixed price at some future date.
A)sell
B)buy
C)hold
D)none of the above
Q5) What effect does volatility of the underlying asset have on the price of the option?
Q6) What is the short position of an options contract?
Q7) When is an option at-the-money?
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Chapter 22: Mergers and Acquisitions
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Q1) Assume that Martin pays no premium to acquire Luther.Calculate Martin's price-earnings (P/E)ratio both pre and post merger.
Q2) The justification for the benefits of diversification from mergers include all of the following except
A)tax loss benefits.
B)lower cost of debt or increased debt capacity.
C)direct risk reduction.
D)liquidity enhancement.
Q3) Which of the following statements is false?
A)There are two primary mechanisms by which ownership and control of a public corporation can change: Either another corporation or group of individuals can acquire the target firm,or the target firm can merge with another firm.
B)Merger activity is greater during economic contractions than during expansions.
C)Mergers and acquisitions are part of what is often referred to as "the market for corporate control."
D)The takeover market is also characterized by merger waves-peaks of heavy activity followed by quiet troughs of few transactions.
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Chapter 23: International Corporate Finance
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Q1) A ________ capital market is one where all investors do not have access to all the financial securities in the various markets.
A)integrated
B)divested
C)managed
D)segmented
Q2) Firms use forward foreign exchange contracts rather than a cash-and-carry strategy because
A)of lower transaction costs.
B)of inability to borrow in different currencies.
C)of higher interest costs if credit quality is poor.
D)all of the above
Q3) What is a currency forward contract?
Q4) Exchange rate risk exists if the firm's free cash flows are correlated with the spot exchange rate.
A)True
B)False
Q5) What is a currency timeline?
Q6) How are exchange rates quoted in the Wall Street Journal?
Q7) What is cash-and-carry?
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Chapter 24: Leasing
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Q1) The lease is treated as a capital lease (financial lease)for the lessee and must be listed on the firm's balance sheet if it satisfies any of the following conditions except:
A)The lease contains an option to purchase the asset at its fair market value.
B)The present value of the minimum lease payments at the start of the lease is 90% or more of the asset's fair market value.
C)The title to the property transfers to the lessee at the end of the lease term.
D)The lease term is 75% or more of the estimated economic life of the asset.
Q2) Calculate the monthly lease payments for a four year fixed price lease that allows the lessee to buy the Bulldozer at the end of the lease for $8,000.
Q3) A lease where the lessee can purchase the asset at the minimum of its fair market value and a fixed price is called a
A)$1.00 out lease.
B)fixed price lease.
C)fair market value lease.
D)fair market value cap lease.
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26
Chapter 25: Insurance and Risk Management
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Q1) To insure their assets against hazards such as fire,storm damage,vandalism,earthquakes,and other natural and environmental risks firms commonly purchase
A)key personnel insurance.
B)business liability insurance.
C)business interruption insurance.
D)property insurance.
Q2) Which of the following statements is false?
A)Horizontal integration entails the merger of a firm and its supplier or a firm and its customer.
B)Like insurance,hedging involves contracts or transactions that provide the firm with cash flows that offset its losses from price changes.
C)For many firms,changes in the market prices of the raw materials they use and the goods they produce may be the most important source of risk to their profitability.
D)Because an increase in the price of the commodity raises the firm's costs and the supplier's revenues,these firms can offset their risks by merging.
Q3) What is the actuarially fair cost of full insurance?
Q4) What are some of the disadvantages of long-term supply contracts?
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Chapter 26: Corporate Governance
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Q1) Which of the following statements is false?
A)An active takeover market is part of the system through which the threat of dismissal is maintained.
B)When internal governance systems such as ownership,compensation,board oversight,and shareholder activism fail,the one remaining way to remove poorly performing managers is by mounting a hostile takeover.
C)Likely because hostile takeovers and internal governance systems are substitute mechanisms,researchers have found that boards are less likely to fire managers for poor performance during active takeover markets than they are during lulls in takeover activity.
D)The effectiveness of the corporate governance structure of a firm depends on how well protected its managers are from removal in a hostile takeover.
Q2) Directors who are employees,former employees,or family members of employees are called
A)Managing Directors.
B)Independent Directors.
C)Inside Directors.
D)Gray Directors.
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