Principles of Finance
Exam Questions
Course Introduction
Principles of Finance introduces students to the fundamental concepts and tools essential for understanding the financial decision-making process within organizations. Topics include time value of money, risk and return analysis, valuation of financial assets, capital budgeting, cost of capital, and the basics of financial markets and institutions. The course emphasizes the application of theoretical knowledge to practical scenarios, enabling students to analyze financial statements, assess investment opportunities, and make informed financial decisions in both personal and professional contexts.
Recommended Textbook
Corporate Finance A Focused Approach 6th Edition by Michael C. Ehrhardt
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Page 2
Chapter 1: An Overview of Financial Management and the Financial Environment
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Sample Questions
Q1) With which of the following statements would most people in business agree?
A) The short-run profits of a corporation will almost always increase if the firm takes actions the government has determined are in the nation's best interests.
B) Government agencies and firms almost always agree with one another regarding the restrictions that should be placed on hiring and firing employees.
C) Although people's moral characters are probably developed before they get into a business school, it is still useful for business schools to cover ethics, including giving students an idea about the adverse consequences of unethical behavior to themselves, their firms, and the nation.
D) Developing a formal set of rules defining ethical and unethical behavior is not useful for a large corporation. Such rules generally can't be applied in many specific instances, so it is better to deal with ethical issues on a case-by-case basis.
E) Because of the courage it takes to blow the whistle, "whistle blowers" are generally promoted more rapidly than other employees.
Answer: C
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3
Chapter 3: Analysis of Financial Statements
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Sample Questions
Q1) Last year Mason Inc. had a total assets turnover of 1.33 and an equity multiplier of 1.75. Its sales were $195,000 and its net income was $10,549. The CFO believes that the company could have operated more efficiently, lowered its costs, and increased its net income by $5,250 without changing its sales, assets, or capital structure. Had it cut costs and increased its net income in this amount, by how much would the ROE have changed?
A) 5.66%
B) 5.95%
C) 6.27%
D) 6.58%
E) 6.91%
Answer: C
Q2) Refer to the data for Pettijohn Inc. What is the firm's EBITDA coverage?
A) 3.29
B) 3.46
C) 3.64
D) 3.82
E) 4.01
Answer: C
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4
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) The payment made each period on an amortized loan is constant, and it consists of some interest and some principal. The closer we are to the end of the loan's life, the smaller the percentage of the payment that will be a repayment of principal.
A)True
B)False
Q3) Which of the following bank accounts has the lowest effective annual return?
A) An account that pays 8% nominal interest with daily (365-day) compounding.
B) An account that pays 8% nominal interest with monthly compounding.
C) An account that pays 8% nominal interest with annual compounding.
D) An account that pays 7% nominal interest with daily (365-day) compounding.
E) An account that pays 7% nominal interest with monthly compounding.
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Page 5
Chapter 5: Bonds, Bond Valuation, and Interest Rates
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Sample Questions
Q1) The prices of high-coupon bonds tend to be less sensitive to a given change in interest rates than low-coupon bonds, other things held constant.
A)True
B)False
Q2) Other things equal, a firm will have to pay a higher coupon rate on its subordinated debentures than on its second mortgage bonds.
A)True
B)False
Q3) Meacham Enterprises' bonds currently sell for $1,280 and have a par value of $1,000. They pay a $135 annual coupon and have a 15-year maturity, but they can be called in 5 years at $1,050. What is their yield to call (YTC)?
A) 6.39%
B) 6.72%
C) 7.08%
D) 7.45%
E) 7.82%
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Chapter 6: Risk, Return, and the Capital Asset Pricing Model
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Q1) Bloome Co.'s stock has a 25% chance of producing a 30% return, a 50% chance of producing a 12% return, and a 25% chance of producing a 18% return. What is the firm's expected rate of return?
A) 7.72%
B) 8.12%
C) 8.55%
D) 9.00%
E) 9.50%
Q2) The slope of the SML is determined by the value of beta.
A)True
B)False
Q3) An individual stock's diversifiable risk, which is measured by its beta, can be lowered by adding more stocks to the portfolio in which the stock is held.
A)True
B)False
Q4) The realized return on a stock portfolio is the weighted average of the expected returns on the stocks in the portfolio.
A)True
B)False
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Chapter 7: Stocks, Stock Valuation, and Stock Market
Equilibrium
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Sample Questions
Q1) A stock just paid a dividend of D<sub>0</sub> = $1.50. The required rate of return is r<sub>s</sub> = 10.1%, and the constant growth rate is g = 4.0%. What is the current stock price?
A) $23.11
B) $23.70
C) $24.31
D) $24.93
E) $25.57
Q2) Reynolds Construction's value of operations is $750 million based on the free cash flow valuation model. Its balance sheet shows $50 million of short-term investments that are unrelated to operations, $100 million of accounts payable, $100 million of notes payable, $200 million of long-term debt, $40 million of common stock (par plus paid-in-capital), and $160 million of retained earnings. What is the best estimate for the firm's value of equity, in millions?
A) $429
B) $451
C) $475
D) $500
E) $525
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Chapter 8: Financial Options and Applications in Corporate Finance
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Q1) The exercise value is also called the strike price, but this term is generally used when discussing convertibles rather than financial options.
A)True
B)False
Q2) If the current price of a stock is below the strike price, then an option to buy the stock is worthless and will have a zero value.
A)True
B)False
Q3) Because of the time value of money, the longer before an option expires, the less valuable the option will be, other things held constant.
A)True
B)False
Q4) As the price of a stock rises above the strike price, the value investors are willing to pay for a call option increases because both (1) the immediate capital gain that can be realized by exercising the option and (2) the likely exercise value of the option when it expires have both increased.
A)True
B)False
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Chapter 9: The Cost of Capital
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Sample Questions
Q1) The cost of common equity obtained by retaining earnings is the rate of return the marginal stockholder requires on the firm's common stock.
A)True
B)False
Q2) Assume that you are an intern with the Brayton Company, and you have collected the following data: The yield on the company's outstanding bonds is 7.75%; its tax rate is 40%; the next expected dividend is $0.65 a share; the dividend is expected to grow at a constant rate of 6.00% a year; the price of the stock is $15.00 per share; the flotation cost for selling new shares is F = 10%; and the target capital structure is 45% debt and 55% common equity. What is the firm's WACC, assuming it must issue new stock to finance its capital budget?
A) 6.89%
B) 7.26%
C) 7.64%
D) 8.04%
E) 8.44%
Q3) "Capital" is sometimes defined as funds supplied to a firm by investors.
A)True
B)False
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Page 10
Chapter 10: The Basics of Capital Budgeting: Evaluating Cash Flows
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Sample Questions
Q1) The NPV method's assumption that cash inflows are reinvested at the cost of capital is generally more reasonable than the IRR's assumption that cash flows are reinvested at the IRR. This is an important reason why the NPV method is generally preferred over the IRR method.
A)True
B)False
Q2) When evaluating mutually exclusive projects, the modified IRR (MIRR) always leads to the same capital budgeting decisions as the NPV method, regardless of the relative lives or sizes of the projects being evaluated.
A)True
B)False
Q3) 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
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11
Chapter 11: Cash Flow Estimation and Risk Analysis
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Sample Questions
Q1) Which of the following statements is CORRECT?
A) Under current laws and regulations, corporations must use straight-line depreciation for all assets whose lives are 3 years or longer.
B) If firms use accelerated depreciation, they will write off assets slower than they would under straight-line depreciation, and as a result projects' forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes.
C) If they use accelerated depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects' forecasted NPVs are normally lower than they would be if straight-line depreciation were required for tax purposes.
D) If they use accelerated depreciation, firms can write off assets faster than they could under straight-line depreciation, and as a result projects' forecasted NPVs are normally higher than they would be if straight-line depreciation were required for tax purposes.
E) Since depreciation is not a cash expense, and since cash flows and not accounting income are the relevant input, depreciation plays no role in capital budgeting.
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Page 12
Chapter 12: Financial Planning and Forecasting Financial Statements
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Q1) Which of the following statements is CORRECT?
A) 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.
B) If a firm retains all of its earnings, then it cannot require any additional funds to support sales growth.
C) 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.
D) If a firm has a positive free cash flow, then it must have either a zero or a negative AFN.
E) 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.
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13
Chapter 13: Corporate Valuation, Value-Based
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Sample Questions
Q1) Two important issues in corporate governance are (1) the rules that cover the board's ability to fire the CEO and (2) the rules that cover the CEO's ability to remove members of the board.
A)True
B)False
Q2) Which of the following is NOT normally regarded as being a barrier to hostile takeovers?
A) Targeted share repurchases.
B) Shareholder rights provisions.
C) Restricted voting rights.
D) Poison pills.
E) Abnormally high executive compensation.
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.
14
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Chapter 14: Distributions to Shareholders: Dividends and Repurchases
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Q1) If a firm adheres strictly to the residual dividend policy, then if its optimal capital budget requires the use of all earnings for a given year (along with new debt according to the optimal debt/total assets ratio), then the firm should pay
A) no dividends to common stockholders.
B) dividends only out of funds raised by the sale of new common stock.
C) dividends only out of funds raised by borrowing money (i.e., issue debt).
D) dividends only out of funds raised by selling off fixed assets.
E) no dividends except out of past retained earnings.
Q2) Which of the following should not influence a firm's dividend policy decision?
A) A strong preference by most shareholders for current cash income versus capital gains.
B) Constraints imposed by the firm's bond indenture.
C) The fact that much of the firm's equipment has been leased rather than bought and owned.
D) The fact that Congress is considering changes in the tax law regarding the taxation of dividends versus capital gains.
E) The firm's ability to accelerate or delay investment projects.
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Page 15
Chapter 15: Capital Structure Decisions
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Q1) Which of the following statements is CORRECT?
A) Since debt financing is cheaper than equity financing, raising a company's debt ratio will always reduce its WACC.
B) Increasing a company's debt ratio will typically reduce the marginal cost of both debt and equity financing. However, this action still may raise the company's WACC.
C) Increasing a company's debt ratio will typically increase the marginal cost of both debt and equity financing. However, this action still may lower the company's WACC.
D) Since a firm's beta coefficient it not affected by its use of financial leverage, leverage does not affect the cost of equity.
E) Since debt financing raises the firm's financial risk, increasing a company's debt ratio will always increase its WACC.
Q2) If Miller and Modigliani had incorporated the costs of bankruptcy into their model, it is unlikely that they would have concluded that 100% debt financing is optimal. A)True B)False
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Chapter 16: Working Capital Management
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Q1) The risk to the firm of borrowing using short-term credit is usually greater than if it used long-term debt. Added risk stems from (1) the greater variability of interest costs on short-term than long-term debt and (2) the fact that even if its long-term prospects are good, the firm's lenders may not be willing to renew short-term loans if the firm is temporarily unable to repay those loans.
A)True
B)False
Q2) Which of the following is NOT directly reflected in the cash budget of a firm that is in the zero tax bracket?
A) Depreciation.
B) Cumulative cash.
C) Repurchases of common stock.
D) Payment for plant construction.
E) Payments lags.
Q3) The calculated cost of trade credit for a firm that buys on terms of 2/10 net 30 is lower (other things held constant) if the firm plans to pay in 40 days than in 30 days.
A)True
B)False
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Chapter 17: Multinational Financial Management
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Q1) Calculating a currency cross rate involves determining the exchange rate for two currencies by using a third currency as a base.
A)True
B)False
Q2) Suppose Stackpool Inc. had inventory in Britain valued at 240,000 pounds one year ago. The exchange rate for dollars to pounds was 1£ = 2 U.S. dollars. This year the exchange rate is 1£ = 1.82 U.S. dollars. The inventory in Britain is still valued at 240,000 pounds. What is the gain or loss in inventory value in U.S. dollars as a result of the change in exchange rates?
A) $240,000
B) $43,200
C) $0
D) $43,200
E) $47,473
Q3) Legal and economic differences among countries, although important, do NOT pose significant problems for most multinational corporations when they coordinate and control worldwide operations of subsidiaries.
A)True
B)False
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Page 18