Principles of Finance Exam Review
Course Introduction
Principles of Finance introduces students to the fundamental concepts and tools necessary for understanding financial management in businesses and organizations. The course covers key topics such as the time value of money, risk and return analysis, valuation of stocks and bonds, financial statement analysis, capital budgeting, and the functioning of financial markets and institutions. Emphasis is placed on how financial decisions are made within a company and the impact those decisions have on overall organizational value. Through real-world examples and practical applications, students develop a foundational understanding of the role of finance in both corporate and personal contexts.
Recommended Textbook
Fundamentals of Corporate Finance 10th Edition by Stephen Ross
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Page 2
Chapter 1: Introduction to Corporate Finance
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Sample Questions
Q1) Decisions made by financial managers should primarily focus on increasing which one of the following?
A)size of the firm
B)growth rate of the firm
C)gross profit per unit produced
D)market value per share of outstanding stock
E)total sales
Answer: D
Q2) Why are so many businesses structured as sole proprietorships when the corporate form of business offers more advantages?
Answer: A significant advantage of the sole proprietorship is that it is inexpensive and easy to form.If the sole proprietor has limited capital to start with,it may not be desirable to spend part of that capital forming a corporation.Also,limited liability for business debts may not be a significant advantage if the proprietor has most of his or her personal assets tied up in the business already.Finally,for a typical small firm,having an unlimited life for the business has no real advantage since the heart and soul of the business is the person who founded it,thereby effectively limiting the life of the business to that of its founder.
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Chapter 2: Financial Statements,Taxes,and Cash Flow
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Sample Questions
Q1) Jake owns The Corner Market which he is trying to sell so that he can retire and travel.The Corner Market owns the building in which it is located.This building was built at a cost of $647,000 and is currently appraised at $819,000.The counters and fixtures originally cost $148,000 and are currently valued at $65,000.The inventory is valued on the balance sheet at $319,000 and has a retail market value equal to 1.2 times its cost.Jake expects the store to collect 98 percent of the $21,700 in accounts receivable.The firm has $26,800 in cash and has total debt of $414,700.What is the market value of this firm?
A)$857,634
B)$900,166
C)$919,000
D)$1,314,866
E)$1,333,700
Answer: B
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Chapter 3: Working With Financial Statements
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Sample Questions
Q1) Assume a firm has a positive cash balance which is increasing annually.Why then is it important to analyze a statement of cash flows?
Answer: It is possible that the increase in the cash balance is a result of issuing more equity or assuming more debt and not the result of generating cash from operations.If a firm cannot generate positive cash flows internally,the firm will eventually encounter difficulties in raising external funds and could possibly face bankruptcy.
Q2) Ratios that measure how efficiently a firm manages its assets and operations to generate net income are referred to as _____ ratios.
A)asset management
B)long-term solvency
C)short-term solvency
D)profitability
E)turnover
Answer: D
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Chapter 4: Long-Term Financial Planning and Growth
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Sample Questions
Q1) Miller Bros.Hardware is operating at full capacity with a sales level of $689,700 and fixed assets of $468,000.The profit margin is 7 percent.What is the required addition to fixed assets if sales are to increase by 10 percent?
A)$3,276
B)$4,680
C)$28,400
D)$32,760
E)$46,800
Q2) Financial planning accomplishes which of the following for a firm?
I.determination of asset requirements
II.development of plans to contend with unexpected events
III.establishment of priorities
IV.analysis of funding options
A)I and III only
B)II and IV only
C)I, III, and IV only
D)I, II, and III only
E)I, II, III, and IV
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Chapter 5: Introduction to Valuation: The Time Value of Money
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Q1) What is the present value of $150,000 to be received 10 years from today if the discount rate is 11 percent?
A)$52,827.67
B)$61,147.07
C)$64,141.41
D)$69,806.18
E)$73,291.06
Q2) Shelley won a lottery and will receive $1,000 a year for the next ten years.The value of her winnings today discounted at her discount rate is called which one of the following?
A)single amount
B)future value
C)present value
D)simple amount
E)compounded value
Q3) You want to deposit sufficient money today into a savings account so that you will have $1,000 in the account three years from today.Explain why you could deposit less money today if you could earn 3.5 percent interest rather than 3 percent interest.
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Page 7
Chapter 6: Discounted Cash Flow Valuation
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Q1) Which one of the following terms is defined as a loan wherein the regular payments,including both interest and principal amounts,are insufficient to retire the entire loan amount,which then must be repaid in one lump sum?
A)amortized loan
B)continuing loan
C)balloon loan
D)remainder loan
E)interest-only loan
Q2) Which one of the following statements concerning interest rates is correct?
A)Savers would prefer annual compounding over monthly compounding.
B)The effective annual rate decreases as the number of compounding periods per year increases.
C)The effective annual rate equals the annual percentage rate when interest is compounded annually.
D)Borrowers would prefer monthly compounding over annual compounding.
E)For any positive rate of interest, the effective annual rate will always exceed the annual percentage rate.
Q3) Why might a borrower select an interest-only loan instead of an amortized loan,which would be cheaper?
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Page 8
Chapter 7: Interest Rates and Bond Valuation
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Sample Questions
Q1) A U.S.Treasury bond that is quoted at 100: 11 is selling:
A)for 11 percent more than par value.
B)at an 11 percent discount.
C)for 100.11 percent of face value.
D)at par and pays an 11 percent coupon.
E)for 100 and 11/32nds percent of face value.
Q2) Redesigned Computers has 6.5 percent coupon bonds outstanding with a current market price of $832.The yield to maturity is 16.28 percent and the face value is $1,000.Interest is paid semiannually.How many years is it until these bonds mature?
A)2.10 years
B)4.19 years
C)7.41 years
D)9.16 years
E)18.32 years
Q3) Define liquidity risk,default risk,and taxability risk and explain how these risks relate to bonds and bond yields.
Q4) Describe the relationships that exist between the coupon rate,the yield to maturity,and the current yield for both a discount bond and a premium bond.
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Page 9
Chapter 8: Stock Valuation
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Sample Questions
Q1) You want to purchase some shares of Green World stock but need a 15 percent rate of return to compensate for the perceived risk of such ownership.What is the maximum you are willing to spend per share to buy this stock if the company pays a constant $0.90 annual dividend per share?
A)$5.40
B)$6.00
C)$6.90
D)$7.20
E)$7.80
Q2) National Trucking has paid an annual dividend of $1.00 per share on its common stock for the past fifteen years and is expected to continue paying a dollar a share long into the future.Given this,one share of the firm's stock is:
A)basically worthless as it offers no growth potential.
B)equal in value to the present value of $1 paid one year from today.
C)priced the same as a $1 perpetuity.
D)valued at an assumed growth rate of one percent.
E)worth $1 a share in the current market.
Q3) Explain the primary change that occurred in the structure of the NYSE in 2006 and how that change affected the exchange members.
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Page 10
Chapter 9: Net Present Value and Other Investment Criteria
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Q1) Kristi wants to start training her most junior assistant,Amy,in the art of project analysis.Amy has just started college and has no experience or background in business finance.To get her started,Kristi is going to assign the responsibility for all projects that have initial costs less than $1,000 to Amy to analyze.Which method is Kristi most apt to ask Amy to use in making her initial decisions?
A)discounted payback
B)profitability index
C)internal rate of return
D)payback
E)average accounting return
Q2) An investment project provides cash flows of $1,190 per year for 10 years.If the initial cost is $8,000,what is the payback period?
A)3.36 years
B)5.28 years
C)6.72 years
D)8.13 years
E)never
Q3) Explain the differences and similarities between net present value (NPV)and the profitability index.
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Page 11
Chapter 10: Making Capital Investment Decisions
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Sample Questions
Q1) What is the primary purpose of computing the equivalent annual costs when comparing two machines? What is the assumption that is being made about each machine?
Q2) Keyser Mining is considering a project that will require the purchase of $980,000 in new equipment.The equipment will be depreciated straight-line to a zero book value over the 7-year life of the project.The equipment can be scraped at the end of the project for 5 percent of its original cost.Annual sales from this project are estimated at $420,000.Net working capital equal to 25 percent of sales will be required to support the project.All of the net working capital will be recouped.The required return is 16 percent and the tax rate is 35 percent.What is the recovery amount attributable to net working capital at the end of the project?
A)$21,000
B)$54,600
C)$105,000
D)$178,000
E)$196,000
Q3) How can two firms arrive at two different bid prices when bidding for the same job and given the same bid specifications?
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Page 12
Chapter 11: Project Analysis and Evaluation
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Sample Questions
Q1) At the accounting break-even point,Swiss Mountain Gear sells 14,600 ski masks at a price of $12 each.At this level of production,the depreciation is $58,000 and the variable cost per unit is $4.What is the amount of the fixed costs at this production level?
A)$58,800
B)$59,400
C)$61,300
D)$87,600
E)$145,600
Q2) Which one of the following statements concerning variable costs is correct?
A)Variable costs minus fixed costs equal marginal costs.
B)Variable costs are equal to fixed costs when production is equal to zero.
C)An increase in variable costs increases the operating cash flow.
D)Variable costs are inversely related to fixed costs.
E)Variable costs per unit are inversely related to the contribution margin per unit.
Q3) What is forecasting risk and why is it important to the analysis of capital expenditure projects?
What methods can be used to reduce this risk?
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Chapter 12: Some Lessons From Capital Market History
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Sample Questions
Q1) Your friend is the owner of a stock which had returns of 25 percent,-36 percent,1 percent,and 16 percent for the past four years.Your friend thinks the stock may be able to achieve a return of 50 percent or more in a single year.Based on these returns,what is the probability that your friend is correct?
A)less than 0.5 percent
B)greater than 0.5 percent but less than 1.0 percent
C)greater than 1.0 percent but less than 2.5 percent
D)greater than 2.5 percent but less than 16 percent
E)greater than 16.0 percent
Q2) You bought one of Great White Shark Repellant Co.'s 10 percent coupon bonds one year ago for $815.These bonds pay annual payments,have a face value of $1,000,and mature 14 years from now.Suppose you decide to sell your bonds today when the required return on the bonds is 14 percent.The inflation rate over the past year was 3.7 percent.What was your total real return on this investment?
A)2.97 percent
B)1.75 percent
C)1.18 percent
D)3.44 percent
E)2.58 percent
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Page 14
Chapter 13: Return,Risk,and the Security Market Line
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Sample Questions
Q1) You own a portfolio with the following expected returns given the various states of the economy.What is the overall portfolio expected return? \[\begin{array} { l c c }
\text { State of Economy } & \underline { \text { Probability of State of Economy } } & \text { Rate of Return if State Occurs } \\
\text { Boom } & 27 \% & 17 \% \\
\text { Normal } & 70 \% & 8 \% \\
\text { Recession } & 3 \% & - 11 \%
\end{array}\]
A)6.49 percent
B)8.64 percent
C)8.87 percent
D)9.86 percent
E)10.23 percent
Q2) Explain how the slope of the security market line is determined and why every stock that is correctly priced,according to CAPM,will lie on this line.
Q3) Explain the difference between systematic and unsystematic risk.Also explain why one of these types of risks is rewarded with a risk premium while the other type is not.
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Page 15
Chapter 14: Cost of Capital
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Sample Questions
Q1) Tidewater Fishing has a current beta of 1.21.The market risk premium is 8.9 percent and the risk-free rate of return is 3.2 percent.By how much will the cost of equity increase if the company expands its operations such that the company beta rises to 1.50?
A)1.88 percent
B)2.58 percent
C)2.60 percent
D)3.10 percent
E)3.26 percent
Q2) The dividend growth model:
A)is only as reliable as the estimated rate of growth.
B)can only be used if historical dividend information is available.
C)considers the risk that future dividends may vary from their estimated values.
D)applies only when a firm is currently paying dividends.
E)uses beta to measure the systematic risk of a firm.
Q3) What role does the weighted average cost of capital play when determining a project's cost of capital?
Q4) What are some advantages of the subjective approach to determining the cost of capital and why do you think that approach is utilized?
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Page 16
Chapter 15: Raising Capital
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Sample Questions
Q1) The Metallica Heavy Metal Mining (MHMM)Corporation wants to diversify its operations.Some recent financial information for the company is shown here: \[\begin{array} { l r }
\text { Number of shares outstanding } & 24,000 \\
\text { Book value } & \$ 320,000 \\
\text { Market value } & \$ 457,600 \\
\text { Net income } & \$ 18,000 \end{array}\] MHMM is considering an investment that has the same P/E ratio as the firm.The cost of the investment is $800,000,and it will be financed with a new equity issue.What would the ROE on the investment have to be if we wanted the price after the offering to be $115 per share? Assume the PE ratio remains constant.
A)18.28 percent
B)21.41 percent
C)27.63 percent
D)37.27 percent
E)40.03 percent
Q2) It can be argued that the decision to accept venture capital is one of the most critical decisions an entrepreneur must make.Explain why.
Q3) Explain both a rights offering and the basic characteristics of a right.
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Page 17
Chapter 16: Financial Leverage and Capital Structure Policy
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Sample Questions
Q1) A business firm ceases to exist as a going concern as a result of which one of the following?
A)divestiture
B)share repurchase
C)liquidation
D)reorganization
E)capital restructuring
Q2) Galaxy Products is comparing two different capital structures,an all-equity plan (Plan I)and a levered plan (Plan II).Under Plan I,Galaxy would have 178,500 shares of stock outstanding.Under Plan II,there would be 71,400 shares of stock outstanding and $1.79 million in debt outstanding.The interest rate on the debt is 10 percent and there are no taxes.What is the breakeven EBIT?
A)$287,878.78
B)$298,333.33
C)$351,111.11
D)$333,333.33
E)$341,414.14
Q3) Explain how a firm loses value during the bankruptcy process from both a creditors and a shareholders perspective.
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Page 18
Chapter 17: Dividends and Payout Policy
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Q1) Which of the following tends to increase the ability of a shareholder to create his or her own homemade dividend policy?
I.low taxes on capital gains
II.dividend reinvestment plans
III.large holdings of shares
IV.low cost equity purchases
A)II only
B)II and III only
C)I, II, and III only
D)II, III, and IV only
E)I, II, III, and IV
Q2) Green Roof Motels has more cash on hand than its operations require.Thus,the firm has decided to pay out some of its earnings in the form of cash to its shareholders.What are these payments to shareholders called?
A)dividends
B)stock payments
C)repurchases
D)payments-in-kind
E)stock splits
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Chapter 18: Short-Term Finance and Planning
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Q1) Jill is the CFO of Summertime Adventures which is a seasonal firm specializing in products related to water sports.The firm purchases inventory one month before it is sold and pays for its purchases 60 days after the invoice date.Sales are highest during July and August.Currently,Jill is preparing the cash disbursements section of the firm's cash budget.Which one of the following statements is supported by this information?
A)Inventory purchases will be highest during the months of July and August.
B)Inventory purchases will be highest during the months of May and June.
C)Payments to suppliers will be highest during the months of June and July.
D)Payments to suppliers will be highest during the months of July and August.
E)Payments to suppliers will be highest during the months of August and September.
Q2) Compensating balances are frequently a part of revolving lending arrangements with banks,yet they add to the cost of financing for the borrower.Why,then,would borrowers agree to such terms? What other types of alternative financing are available?
Q3) List and describe the three basic types of secured inventory loans.Compare the advantages and disadvantages of these loans.
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20
Chapter 19: Cash and Liquidity Management
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Q1) Which of the following will reduce collection time?
I.billing customers electronically rather than by mail
II.accepting debit cards but not checks as payment for a sale
III.offering cash discounts for early payment
IV.reducing the processing delay by one day
A)I and II only
B)I and III only
C)I, II, and III only
D)II, III, and IV only
E)I, II, III, and IV
Q2) Which of the following costs related to holding cash are minimized when the level of cash a firm holds is optimized?
A)opportunity costs
B)trading costs
C)total costs
D)both trading and opportunity costs
E)trading costs, opportunity costs, and total costs
Q3) Explain how the unethical use of uncollected funds has been impacted by the growth of on-line retailing and banking.
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Chapter 20: Credit and Inventory Management
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Q1) The Cellar Door currently sells 9,620 units a month for total monthly sales of $316,000.The company is considering replacing its current cash only credit policy with a net 30 policy.The variable cost per unit is $15 and the monthly interest rate is 1.5 percent.What is the switch break-even level of sales?
A)9,711 units
B)9,779 units
C)9,814 units
D)9,957 units
E)9,889 units
Q2) Your current sales consist of 45 units per month at a price of $390 a unit.You are weighing the pros and cons of switching to a net 30 credit policy from your current cash only policy.If you decide to switch your credit policy you also plan to increase the sales price to $410 a unit.The monthly interest rate is 1.4 percent.What is the break-even default rate of the proposed switch?
A)3.55 percent
B)3.68 percent
C)4.29 percent
D)4.71 percent
E)4.88 percent
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Page 22
Chapter 21: International Corporate Finance
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Q1) The type of exchange rate risk known as translation exposure is best described as:
A)the risk that a positive net present value (NPV) project could turn into a negative NPV project because of changes in the exchange rate between two countries.
B)the problem encountered by an accountant of an international firm who is trying to record balance sheet account values.
C)the fluctuation in prices faced by importers of foreign goods.
D)the variance in relative pay rates based on the currency used to pay an employee.
E)the variance between the revenue of an exporter who uses forward rates and an equivalent exporter who does not use forward rates.
Q2) Assume that ¥95.42 equal $1.Also assume that SKr7.7274 equal $1.How many Japanese yen can you acquire in exchange for 3,000 Swedish krone?
A)¥235
B)¥261
C)¥37,045
D)¥39,024
E)¥39,520
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Chapter 22: Behavioral Finance: Implications for Financial Management
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Q1) Historical returns support which one of the following statements?
A)Financial markets are highly inefficient as suggested by behavioral finance.
B)Professional money managers tend to outperform the Vanguard 500 index fund about 55 percent of the time on average.
C)The longer the time span, the more apt a professional money manager is to outperform an index fund, such as the S&P 500.
D)Historical data supports the statement that arbitrage is unlimited and results in a totally efficient market.
E)The financial markets appear to be efficient because, on average, they outperform professional money managers.
Q2) Bill feels that he possesses a good dose of "street smarts".Thus,he makes his business decisions based on how a project feels to him rather than taking the time to financially analyze a project.This type of behavior is referred to as:
A)overconfidence.
B)endowment effect.
C)money illusion.
D)affect heuristic.
E)sentiment-based risk.
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Chapter 23: Enterprise Risk Management
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Q1) A bakery generally enters into a forward contract in wheat as a:
A)hedger.
B)speculator.
C)spot trader.
D)broker.
E)spectator.
Q2) A firm with a variable-rate loan wants to protect itself from increases in interest rates.Which of the following would interest this firm?
I.interest rate floor
II.interest rate cap
III.put option on an interest rate
IV.call option on an interest rate
A)I only
B)I and III only
C)I and IV only
D)II and III only
E)II and IV only
Q3) What is cross-hedging?
Why do you suppose firms use this method of risk management? What are some of the drawbacks?
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Chapter 24: Options and Corporate Finance
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Q1) Explain the rationale behind the idea that equity is a call option on a firm's assets.When would a shareholder allow this call to expire?
Q2) The common stock of Westover Foods is currently priced at $28.80 a share.One year from now,the stock price is expected to be either $25 or $30 a share.The risk-free rate of return is 4.2 percent.What is the current value of one call option on this stock if the exercise price is $27.50?
A)$0
B)$2.40
C)$3.00
D)$3.80
E)$4.00
Q3) You own a convertible bond with a face value of $1,000 and a market value of $1,034.The bond can be converted into 16 shares of stock.What is the conversion price?
A)$62.50
B)$64.63
C)$71.43
D)$73.86
E)$74.33
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26
Chapter 25: Option Valuation
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Q1) What is the value of d<sub>2</sub> given the following information on a stock?
\[\begin{array} { l l }
\text { Stock price } & \$ 19.20 \\
\text { Exercise price } & \$ 15.00 \\
\text { Time to expiration } & 9 \text { months } \\
\text { Risk-free rate } & 3.75 \text { percent } \\
\text { Standard deviation } & 58 \text { percent } \\
\mathrm { d } _ { 1 } & 0.63355
\end{array}\]
A)0.1218
B)0.1225
C)0.1313
D)0.1335
E)0.1340
Q2) Identify the five variables that affect the value of an American put option and indicate how an increase in each of the variables will affect the value of the put.Also indicate the common name,if any,given to each variable.
Q3) Explain why the equity ownership of a firm is equivalent to owning a call option on the firm's assets.
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Page 27
Chapter 26: Mergers and Acquisitions
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Q1) If General Electric,a highly diversified company,were to acquire Ocean Freight Limited,the acquisition would be classified as a _____ acquisition.
A)horizontal
B)longitudinal
C)conglomerate
D)vertical
E)integrated
Q2) Biltwell Hotels is acquiring all of the assets of Green Roof Inns.As a result,Green Roof Inns:
A)will become a fully owned subsidiary of Biltwell Hotels.
B)will remain as a shell corporation unless the shareholders opt to dissolve it.
C)will be fully merged into Biltwell Hotels and will no longer exist as a separate entity.
D)and Biltwell Hotels will both cease to exist and a new firm will be formed.
E)will automatically be dissolved.
Q3) Empirical evidence indicates that the returns to shareholders of the target firm vary significantly from the returns to the shareholders of the acquiring firm.Identify the shareholders that tend to realize the smaller return and provide some possible explanation for these low returns.
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Chapter 27: Leasing
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Sample Questions
Q1) Jane's Floor Care is contemplating the acquisition of some new equipment for refinishing wood floors.The purchase price is $74,000.The firm uses MACRS depreciation which allows for 33.33 percent,44.44 percent,14.82 percent,and 7.41 percent depreciation over years 1 to 4,respectively.The equipment can be leased for $24,600 a year.The firm can borrow money at 9.5 percent and has a 34 percent tax rate.What is the amount of the depreciation tax shield in year 4?
A)$1,758.09
B)$1,864.36
C)$1,940.80
D)$2,011.67
E)$2,221.08
Q2) Which one of the following is most likely the primary reason why a lessee opts to lease an asset on a short-term basis rather than buy that asset?
A)keep the asset off the balance sheet
B)tax avoidance
C)lower total cost
D)increased collateral
E)nonrecourse protection
Q3) Why might a firm opt to sell and leaseback an asset which it currently owns?
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