Principles of Finance
Exam Materials
Course Introduction
Principles of Finance introduces students to the fundamental concepts and tools essential for understanding the financial decision-making process in organizations and markets. The course covers topics such as the time value of money, risk and return, valuation of stocks and bonds, capital budgeting, financial statement analysis, and the role of financial markets and institutions. Through both theoretical frameworks and practical case studies, students gain the analytical skills necessary to evaluate investment opportunities, assess financial health, and make informed financial decisions in a corporate context.
Recommended Textbook
Fundamentals of Financial Management 14th Edition by Eugene F. Brigham
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Page 2
Chapter 1: An Overview of Financial Management
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Sample Questions
Q1) Which of the following statements is CORRECT?
A)Due to limited liability, unlimited lives, and ease of ownership transfer, the vast majority of U.S. businesses (in terms of number of businesses) are organized as corporations.
B)Most businesses (by number and total dollar sales) are organized as proprietorships or partnerships because it is easier to set up and operate one of these forms rather than as a corporation. However, if the business gets very large, it becomes advantageous to convert to a corporation, primarily because corporations have important tax advantages over proprietorships and partnerships.
C)Due to legal considerations related to ownership transfers and limited liability, which affect the ability to attract capital, most business (measured by dollar sales) is conducted by corporations in spite of large corporations' less favorable tax treatment.
D)Large corporations are taxed more favorably than proprietorships.
E)Corporate stockholders are exposed to unlimited liability.
Answer: C
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Chapter 2: Financial Markets and Institutions
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Q1) If you decide to buy 100 shares of Google,you would probably do so by calling your broker and asking him or her to execute the trade for you.This would be defined as a secondary market transaction,not a primary market transaction.
A)True
B)False
Answer: True
Q2) Trades on the NYSE are generally completed by having a brokerage firm acting as a "dealer" buy securities and adding them to its inventory or selling from its inventory.The NASDAQ,on the other hand,operates as an auction market,where buyers offer to buy,and sellers to sell,and the price is negotiated on the floor of the exchange.
A)True
B)False
Answer: False
Q3) The NYSE is defined as a "primary" market because it is one of the largest and most important stock markets in the world.
A)True
B)False
Answer: False
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4
Chapter 3: Financial Statements, cash Flow, and Taxes
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Q1) If we were describing the income statement and the balance sheet,it would be correct to say that the income statement is more like a video while the balance sheet is more like a snapshot.
A)True
B)False Answer: True
Q2) Houston Pumps recently reported $185,250 of sales,$140,500 of operating costs other than depreciation,and $9,250 of depreciation.The company had $35,250 of outstanding bonds that carry a 6.75% interest rate,and its federal-plus-state income tax rate was 35%.In order to sustain its operations and thus generate future sales and cash flows,the firm was required to spend $15,250 to buy new fixed assets and to invest $6,850 in net operating working capital.What was the firm's free cash flow?
A)$10,225
B)$10,736
C)$11,273
D)$11,837
E)$12,429
Answer: A
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Page 5
Chapter 4: Analysis of Financial Statements
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Q1) Which of the following statements is CORRECT?
A)The use of debt financing will tend to lower the basic earning power ratio, other things held constant.
B)A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure.
C)If two firms have identical sales, interest rates paid, operating costs, and assets, but differ in the way they are financed, the firm with less debt will generally have the higher expected ROE.
D)The numerator used in the TIE ratio is earnings before taxes (EBT). EBT is used because interest is paid with post-tax dollars, so the firm's ability to pay current interest is affected by taxes.
E)All else equal, increasing the total debt to total capital ratio will increase the ROA.
Q2) The return on invested capital measures the total return that a company has provided for its investors.
A)True
B)False
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Chapter 5: Time Value of Money
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Q1) Suppose a U.S.treasury bond will pay $2,500 five years from now.If the going interest rate on 5-year treasury bonds is 4.25%,how much is the bond worth today?
A)$1,928.78
B)$2,030.30
C)$2,131.81
D)$2,238.40
E)$2,350.32
Q2) Suppose a State of New York bond will pay $1,000 ten years from now.If the going interest rate on these 10-year bonds is 5.5%,how much is the bond worth today?
A)$585.43
B)$614.70
C)$645.44
D)$677.71
E)$711.59
Q3) All other things held constant,the present value of a given annual annuity increases as the number of periods per year increases.
A)True
B)False
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Chapter 6: Interest Rates
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Q1) If the Treasury yield curve were downward sloping,the yield to maturity on a 10-year Treasury coupon bond would be higher than that on a 1-year T-bill.
A)True
B)False
Q2) Assume that the rate on a 1-year bond is now 6%,but all investors expect 1-year rates to be 7% one year from now and then to rise to 8% two years from now.Assume also that the pure expectations theory holds,hence the maturity risk premium equals zero.Which of the following statements is CORRECT?
A)The yield curve should be downward sloping, with the rate on a 1-year bond at 6%.
B)The interest rate today on a 2-year bond should be approximately 6%.
C)The interest rate today on a 2-year bond should be approximately 7%.
D)The interest rate today on a 3-year bond should be approximately 7%.
E)The interest rate today on a 3-year bond should be approximately 8%.
Q3) An upward-sloping yield curve is often call a "normal" yield curve,while a downward-sloping yield curve is called "abnormal."
A)True
B)False
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Chapter 7: Bonds and Their Valuation
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Q1) Which of the following statements is CORRECT?
A)Senior debt is debt that has been more recently issued, and in bankruptcy it is paid off after junior debt because the junior debt was issued first.
B)A company's subordinated debt has less default risk than its senior debt.
C)Convertible bonds generally have lower coupon rates than non-convertible bonds of similar default risk because they offer the possibility of capital gains.
D)Junk bonds typically provide a lower yield to maturity than investment-grade bonds.
E)A debenture is a secured bond that is backed by some or all of the firm's fixed assets.
Q2) Moerdyk Corporation's bonds have a 15-year maturity,a 7.25% semiannual coupon,and a par value of $1,000.The going interest rate (r<sub>d</sub>)is 6.20%,based on semiannual compounding.What is the bond's price?
A)$1,047.19
B)$1,074.05
C)$1,101.58
D)$1,129.12
E)$1,157.35
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9
Chapter 8: Risk and Rates of Return
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Q1) Mikkelson Corporation's stock had a required return of 11.75% last year,when the risk-free rate was 5.50% and the market risk premium was 4.75%.Then an increase in investor risk aversion caused the market risk premium to rise by 2%.The risk-free rate and the firm's beta remain unchanged.What is the company's new required rate of return? (Hint: First calculate the beta,then find the required return.)
A)14.38%
B)14.74%
C)15.11%
D)15.49%
E)15.87%
Q2) Which is the best measure of risk for a single asset held in isolation,and which is the best measure for an asset held in a diversified portfolio?
A)Variance; correlation coefficient.
B)Standard deviation; correlation coefficient.
C)Beta; variance.
D)Coefficient of variation; beta.
E)Beta; beta.
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Chapter 9: Stocks and Their Valuation
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Q1) Based on the corporate valuation model,the total corporate value of Chen Lin Inc.is $900 million.Its balance sheet shows $110 million in notes payable,$90 million in long-term debt,$20 million in preferred stock,$140 million in retained earnings,and $280 million in total common equity.If the company has 25 million shares of stock outstanding,what is the best estimate of its stock price per share?
A)$22.03
B)$24.48
C)$27.20
D)$29.92
E)$32.91
Q2) The Ramirez Company's last dividend was $1.75.Its dividend growth rate is expected to be constant at 25% for 2 years,after which dividends are expected to grow at a rate of 6% forever.Its required return (r<sub>s</sub>)is 12%.What is the best estimate of the current stock price?
A)$41.58
B)$42.64
C)$43.71
D)$44.80
E)$45.92
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Chapter 10: The Cost of Capital
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Q1) The firm's cost of external equity raised by issuing new stock is the same as the required rate of return on the firm's outstanding common stock.
A)True
B)False
Q2) Which of the following statements is CORRECT?
A)Since debt capital can cause a company to go bankrupt but equity capital cannot, debt is riskier than equity, and thus the after-tax cost of debt is always greater than the cost of equity.
B)The tax-adjusted cost of debt is always greater than the interest rate on debt, provided the company does in fact pay taxes.
C)If a company assigns the same cost of capital to all of its projects regardless of each project's risk, then the company is likely to reject some safe projects that it actually should accept and to accept some risky projects that it should reject.
D)Because no flotation costs are required to obtain capital as retained earnings, the cost of retained earnings is generally lower than the after-tax cost of debt.
E)Higher flotation costs tend to reduce the cost of equity capital.
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Page 12
Chapter 11: The Basics of Capital Budgeting
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Q1) The primary reason that the NPV method is conceptually superior to the IRR method for evaluating mutually exclusive investments is that multiple IRRs may exist,and when that happens,we don't know which IRR is relevant.
A)True
B)False
Q2) Normal Projects S and L have the same NPV when the discount rate is zero.However,Project S's cash flows come in faster than those of L.Therefore,we know that at any discount rate greater than zero,L will have the higher NPV.
A)True
B)False
Q3) For a project with one initial cash outflow followed by a series of positive cash inflows,the modified IRR (MIRR)method involves compounding the cash inflows out to the end of the project's life,summing those compounded cash flows to form a terminal value (TV),and then finding the discount rate that causes the PV of the TV to equal the project's cost.
A)True
B)False
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Page 13
Chapter 12: Cash Flow Estimation and Risk Analysis
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Q1) If an investment project would make use of land which the firm currently owns,the project should be charged with the opportunity cost of the land.
A)True
B)False
Q2) Extending the lives of projects with different lives out to a common life for comparison purposes,while theoretically appealing,is valid only if there is a reasonably high probability that the projects will actually be repeated beyond their initial lives.
A)True
B)False
Q3) Any cash flows that can be classified as incremental to a particular project: i.e.,results directly from the decision to undertake the project: should be reflected in the capital budgeting analysis.
A)True
B)False
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14
Chapter 13: Real Options and Other Topics in Capital
Budgeting
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Q1) Traditionally,an NPV analysis assumes that projects will be accepted or rejected,which implies that they will be undertaken now or never.However,in practice,companies sometimes have a third choice--delay the decision until later,when more information will be available.Because the analysis extends out at least one additional year from the original analysis,it is unlikely that the firm would ever delay a project--particularly given the loss of the "first mover advantage."
A)True
B)False
Q2) Refer to Exhibit 13.1.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) For planning purposes,managers must forecast the total capital budget because the amount of capital raised affects the WACC.
A)True
B)False
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Chapter 14: Capital Structure and Leverage
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Q1) Companies HD and LD have identical tax rates,total assets,total investor-supplied capital,and returns on investors' capital (ROIC),and their ROICs exceed their after-tax costs of debt,r<sub>d</sub>(1 T).However,Company HD has a higher debt ratio and thus more interest expense than Company LD.Which of the following statements is CORRECT?
A)Company HD has a higher net income than Company LD.
B)Company HD has a lower ROA than Company LD.
C)Company HD has a lower ROE than Company LD.
D)The two companies have the same ROA.
E)The two companies have the same ROE.
Q2) According to the signaling theory of capital structure,firms first use common equity for their capital,then use debt if and only if they can raise no more equity on "reasonable" terms.This occurs because the use of debt financing signals to investors that the firm's managers think that the future does not look good.
A)True
B)False
Q3) If a firm borrows money,it is using financial leverage.
A)True
B)False
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Page 16
Chapter 15: Distributions to Shareholders: Dividends and Share Repurchases
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Q1) If investors prefer firms that retain most of their earnings,then a firm that wants to maximize its stock price should set a low payout ratio.
A)True
B)False
Q2) Miller and Modigliani's dividend irrelevance theory says that the percentage of its earnings a firm pays out in dividends has no effect on its cost of capital,but it does affect its stock price.
A)True
B)False
Q3) Mid-State BankCorp recently declared a 7-for-2 stock split.Prior to the split,the stock sold for $80 per share.If the firm's total market value is unchanged by the split,what will the stock price be following the split?
A)$20.63
B)$21.71
C)$22.86
D)$24.00
E)$25.20
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Page 17
Chapter 16: Working Capital Management
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Q1) A firm buys on terms of 2/8,net 45 days,it does not take discounts,and it actually pays after 58 days.What is the effective annual percentage cost of its non-free trade credit? (Use a 365-day year.)
A)14.34%
B)15.10%
C)15.89%
D)16.69%
E)17.52%
Q2) If one of your firm's customers is "stretching" its accounts payable,this may be a nuisance but it does not represent a real financial cost to your firm as long as the customer periodically pays off its entire balance.
A)True
B)False
Q3) The prime rate charged by big money center banks at any one time is likely to vary greatly (for example,as much as 2 to 4 percentage points)across banks due to banks' ability to differentiate themselves and because different banks operate in different parts of the country.
A)True
B)False
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Page 18
Chapter 17: Financial Planning and Forecasting
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Q1) Which of the following statements is CORRECT?
A)Since accounts payable and accrued liabilities must eventually be paid off, as these accounts increase, AFN as calculated by the AFN equation must also increase.
B)Suppose a firm is operating its fixed assets at below 100% of capacity, but it has no excess current assets. Based on the AFN equation, its AFN will be larger than if it had been operating with excess capacity in both fixed and current assets.
C)If a firm retains all of its earnings, then it cannot require any additional funds to support sales growth.
D)Additional funds needed (AFN) are typically raised using a combination of notes payable, long-term debt, and common stock. Such funds are non-spontaneous in the sense that they require explicit financing decisions to obtain them.
E)If a firm has a positive free cash flow, then it must have either a zero or a negative AFN.
Q2) The first,and most critical,step in constructing a set of forecasted financial statements is the sales forecast.
A)True
B)False
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Page 19
Chapter 18: Derivatives and Risk Management
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Q1) Which of the following statements is CORRECT?
A)An option's value is determined by its exercise value, which is the market price of the stock less its strike price. Thus, an option can't sell for more than its exercise value.
B)As a stock's price increases, the premium portion of an option on that stock increases because the difference between the stock price and the fixed strike price increases.
C)If the company is consistently profitable, its call options will always be in the money.
D)The market value of an option depends in part on the option's length of time until expiration and on the variability of the underlying stock's price.
E)The potential loss on an option decreases as the option sells at higher and higher prices because the profit margin becomes larger.
Q2) In theory,reducing the volatility of its cash flows will always increase a company's value.
A)True
B)False
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Chapter 19: Multinational Financial Management
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Q1) If the inflation rate in the United States is greater than the inflation rate in Britain,other things held constant,the British pound will
A)appreciate against the U.S. dollar.
B)depreciate against the U.S. dollar.
C)remain unchanged against the U.S. dollar.
D)appreciate against other major currencies.
E)appreciate against the dollar and other major currencies.
Q2) Suppose in the spot market 1 U.S.dollar equals 1.75 Canadian dollars.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? In other words,how many Canadian dollars are required to purchase one U.S.dollar in the 180-day forward market?
A)1.2727
B)1.4141
C)1.5712
D)1.7458
E)1.9203
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Chapter 20: Hybrid Financing: Preferred Stock, leasing, warrants,
and Convertibles
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Q1) Which of the following statements is most CORRECT?
A)Preferred stock generally has a higher component cost of capital to the firm than does common stock.
B)By law in most states, all preferred stock must be cumulative, meaning that the compounded total of all unpaid preferred dividends must be paid before any dividends can be paid on the firm's common stock.
C)From the issuer's point of view, preferred stock is less risky than bonds.
D)Whereas common stock has an indefinite life, preferred stocks always have a specific maturity date, generally 25 years or less.
E)Unlike bonds, preferred stock cannot have a convertible feature.
Q2) Most convertible securities are bonds or preferred stocks that,under specified terms and conditions,can be exchanged for common stock at the option of the holder.
A)True
B)False
Q3) A warrant holder is not entitled to vote,but he or she does receive any cash dividends paid on the underlying stock.
A)True
B)False
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Chapter 21: Mergers and Acquisitions
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Q1) At the beginning of the year Giant Inc.'s management is considering making an offer to buy Micro Corporation.Micro's projected operating income (EBIT)for the current year is $30 million,but Giant believes that if the two firms were merged,it could consolidate some operations,reduce Micro's expenses,and raise its EBIT to $35 million.Neither company uses any debt,and they both pay income taxes at a 35% rate.Giant has a better reputation among investors,who regard it as very well managed and not very risky,so its stock has a P/E ratio of 12 versus a P/E of 9 for Micro.Since Giant's management would be running the entire enterprise after a merger,investors would value the resulting corporation based on Giant's P/E.If Micro has 10 million shares outstanding,by how much should the merger increase its share price,assuming all of the synergy will go to its stockholders?
A)$7.94
B)$8.36
C)$8.80
D)$9.26
E)$9.75
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Page 23
Chapter 22: Continuous Compounding and Discounting
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Q1) Assume one bank offers you a nominal annual interest rate of 6% compounded daily while another bank offers you continuous compounding at a 5.9% nominal annual rate.You decide to deposit $1,000 with each bank.Exactly two years later you withdraw your funds from both banks.What is the difference in your withdrawal amounts between the two banks?
A)$2.24
B)$2.35
C)$2.47
D)$2.59
E)$2.72
Q2) You have $5,436.60 in an account that pays 10% interest,compounded continuously.If you deposited some funds 10 years ago,how much was your original deposit?
A)$1,900
B)$2,000
C)$2,100
D)$2,205
E)$2,315
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24
Chapter 23: Zero Coupon Bonds
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Q1) A 4-year,zero coupon Treasury bond sells at a price of $762.8952.A 3-year,zero coupon Treasury bond sells at a price of $827.8491.Assuming the expectations theory is correct,what does the market believe the price of 1-year,zero coupon bonds will be in 3 years?
A)$921.54
B)$939.97
C)$958.77
D)$977.94
E)$997.50
Q2) U.S.Delay Corporation,a subsidiary of the Postal Service,must decide whether to issue zero coupon bonds or quarterly payment bonds to fund construction of new facilities.The $1,000 par value quarterly payment bonds would sell at $795.54,have a 10% coupon rate,and mature in 10 years.At what price would the zero coupon bonds with a maturity of 10 years have to sell to earn the same effective annual rate as the quarterly payment bonds?
A)$220.77
B)$232.39
C)$244.62
D)$257.50
E)$270.37
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Page 25
Chapter 24: Bankruptcy and Reorganization
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Q1) Chapter 7 of the Bankruptcy Act is designed to do all of the following EXCEPT:
A)Provides safeguards against the withdrawal of assets by the owners of the bankrupt firm.
B)Allows insolvent debtors to discharge all of their obligations and to start over unhampered by a burden of prior debt.
C)Provides for an equitable distribution of the assets among the creditors.
D)Details the procedures to be followed when a firm is liquidated.
E)Establishes the rules of reorganization for firms with projected cash flows that eventually will be sufficient to meet debt payments.
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Chapter 25: Calculating Beta Coefficients
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Q1) Which of the following statements is CORRECT?
A)The CAPM is an ex ante model, which means that all of the variables should be historical values that can reasonably be projected into the future.
B)The beta coefficient used in the SML equation should reflect the expected volatility of a given stock's return versus the return on the market during some future period.
C)The general equation: Y = a + bX + e, is the standard form of a simple linear regression where b = beta, and X equals the independent return on an individual security being compared to Y, the return on the market, which is the dependent variable.
D)The rise-over-run method is not a legitimate method of estimating beta because it measures changes in an individual security's return regressed against time.
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Chapter
Cost of Capital
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Q1) Using the Security Market Line concept in capital budgeting,which of the following statements is CORRECT?
A)If the expected rate of return on a given capital project lies above the SML, the project should be accepted even if its beta is greater than the beta of the firm's average project.
B)If a project's return lies below the SML, it should be rejected if it has a beta greater than the firm's existing beta but accepted if its beta is below the firm's beta.
C)If two mutually exclusive projects' expected returns are both above the SML, the project with the lower risk should be accepted.
D)If a project's expected rate of return is greater than the expected rate of return on an average project, it should be accepted.
E)None of the statements is correct.
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Chapter 27: Techniques for Measuring Beta Risk
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Q1) Which of the following methods involves calculating an average beta for comparable firms and using that beta to determine a project's beta?
A)Risk premium method
B)Pure play method
C)Accounting beta method
D)CAPM method
E)Discounted cash flow model
Q2) Northern Conglomerate has two divisions,Division A and Division B.Northern looks at competing pure-play firms to estimate the betas of each of the two divisions.After this analysis,Northern concludes that Division A has a beta of 0.8 and Division B has a beta of 1.5.The two divisions are the same size.The risk-free rate is 5% and the market risk premium is 6%.Assume that Northern is 100% equity financed.What is the overall composite WACC for Northern Conglomerate?
A)10.74%
B)11.31%
C)11.90%
D)12.50%
E)13.12%
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Chapter 28: Degree of Leverage
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23 Verified Questions
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Sample Questions
Q1) PQR Manufacturing Corporation has $1,500,000 in debt outstanding.The company's before-tax cost of debt is 10%.Sales for the year totaled $3,500,000 and variable costs were 60% of sales.Net income was equal to $600,000 and the company's tax rate was 40%.If PQR's degree of total leverage is equal to 1.40,what is its degree of operating leverage?
A)1.0987
B)1.1565
C)1.2174
D)1.2783
E)1.3422
Q2) Monroe Corporation currently sells 150,000 units a year at a price of $4.00 a unit.Its variable costs are approximately 30% of sales,and its fixed costs amount to 50% of revenues at its current output level.Although fixed costs are based on revenues at the current output level,the cost level is fixed.What is Marcus's degree of operating leverage in sales dollars?
A)3.1588
B)3.3250
C)3.5000
D)3.6750
E)3.8588
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