Principles of Finance Practice Exam
Course Introduction
Principles of Finance introduces students to the foundational concepts and tools of financial decision-making in both personal and business contexts. The course covers fundamental topics such as the time value of money, asset valuation, risk and return, capital budgeting, financial statement analysis, and the functioning of financial markets. Emphasis is placed on understanding how financial managers use data and analytical methods to make investment and financing decisions that maximize organizational value. By the end of the course, students gain practical insights into financial management, enabling them to analyze financial problems and evaluate alternative solutions effectively.
Recommended Textbook
Financial Management Principles and Applications 12th Edition by Sheridan Titman
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Page 2
Chapter 1: Getting Started-Principles of Finance
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Sample Questions
Q1) The area of finance that deals with long-term investment decisions is known as
A)capital structure.
B)working capital management.
C)financial strategy.
D)capital budgeting.
Answer: D
Q2) Consider the following equally likely project outcomes: Profit
X Y
Pessimistic prediction
$ 0 $500
Expected outcome $ 500 $500
Optimistic prediction $1000 $500
A)Investors will prefer project X because it potentially offers a higher profit.
B)Investors will reject both projects because the profit is too low.
C)Investors will prefer project Y because the expected return is the same as for project X but the outcome is certain.
D)Since Projects X and Y have the same expected outcomes of $500,investors will view them as identical in value.
Answer: C
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Chapter 2: Firms and the Financial Market
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Sample Questions
Q1) All of the following are true about insurance companies EXCEPT
A)They invest their reserves.
B)They may guarantee to reimburse lenders should lenders' loans go into default.
C)They participate in equipment leasing.
D)They may only invest their reserves in interest paying bank accounts under Federal law.
Answer: D
Q2) The purpose of financial markets is to bring borrowers and savers together. A)True
B)False Answer: True
Q3) The principal savers in the financial markets are A)businesses. B)banks.
C)individuals.
D)governments. Answer: C
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Chapter 3: Understanding Financial Statements,taxes,and Cash Flows
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Sample Questions
Q1) The income statement represents a snapshot of account balances at one point in time.
A)True
B)False
Answer: False
Q2) Tax tables are based on ________ tax rates.
A)marginal
B)average
C)implied
D)investment
Answer: A
Q3) Which of the basic financial statements is best used to answer questions about changes in owner's equity that are not explained by the income statement?
A)Balance sheet
B)Statement of shareholder's equity
C)Income statement
D)Cash flow statement
Answer: B
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Chapter 4: Financial Analysis-Sizing up Firm Performance
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Sample Questions
Q1) In 2014,the improvement in ABC's return on equity occurred because
A)ABC used more debt than in 1994.
B)ABC lowered its expenses in 1995 and was,therefore,more profitable.
C)ABC utilized its total assets more efficiently in 1995.
D)None of the above explain the improvement in ABC's return on equity.
Q2) The DuPont method decomposes return on equity into
A)return on assets and the debt ratio.
B)return on assets and the equity multiplier.
C)operating income and inventory turnover.
D)net profit margin and fixed asset turnover.
Q3) Which of the following statements is true?
A)Current assets consist of cash,accounts receivable,inventory,and net plant,property,and equipment.
B)The quick ratio is a more restrictive measure of a firm's liquidity than the current ratio.
C)For the average firm,inventory is considered to be more "liquid" than accounts receivable.
D)A successful firm's current liabilities should always be greater than its current assets.
Q4) Discuss the limitations of ratio analysis.
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Page 6
Chapter 5: Time Value of Money-The Basics
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Sample Questions
Q1) The present value of a future sum of money increases as the number of years before the payment is received increases.
A)True
B)False
Q2) Briefly discuss how non-annual compounding (more than one compounding period per year)is preferable to annual compounding if you are an investor.
Q3) The annual percentage rate (APR)is calculated as which of the following?
A)Interest rate per period x compounding periods per year
B)(1+quoted annual rate/compounding periods per year)<sup>compounding periods per year</sup>-1
C)Interest rate per period / compounding periods per year
D)1+quoted annual rate/compounding periods per year)<sup>1/compounding periods per year</sup>-1
Q4) The present value of a single sum
A)increases as the discount rate decreases.
B)decreases as the discount rate decreases.
C)increases as the number of discount periods increases.
D)increases as the discount rate increases.
E)none of the above.
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Chapter 6: The Time Value of Money-Annuities and Other Topics
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Sample Questions
Q1) You have just won a magazine sweepstakes and have a choice of three alternatives.You can get $100,000 now,or $10,000 per year in perpetuity,or $50,000 now and $150,000 at the end of 10 years.If the appropriate discount rate is 12%,which option should you choose?
A)$100,000 now
B)$10,000 perpetuity
C)$50,000 now and $150,000 in 10 years
Q2) You have a credit card with a balance of $18,000.The annual interest rate on the card is 18% compounded monthly,and the minimum payment is $400 per month.If you pay only the minimum payment each month and do not make any new charges on the card,how many years will it take for you to pay off the $18,000 balance?
Q3) Consider an investment that has cash flows of $500 the first year and $400 for the next four years.If your opportunity cost is 10%,you should be willing to pay $1,607.22 for this investment.
A)True
B)False
Q4) The present value of a $100 perpetuity discounted at 5% is $1200.
A)True
B)False
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Chapter 7: An Introduction to Risk and Return-History of
Financial Market Returns
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Sample Questions
Q1) An investor who wishes to hold a stock for five years will be most interested in geometric average rather than in the arithmetic average return.
A)True
B)False
Q2) Risky investments have the potential for higher returns,but also larger losses.
A)True
B)False
Q3) Even though an investor expects a positive rate of return,it is possible that the actual return will be negative.
A)True
B)False
Q4) You purchased the stock of Sargent Motors at a price of $75.75 one year ago today.If you sell the stock today for $89.00,what is your rate of return?
A)35.00%
B)12.50%
C)17.50%
D)25.00%
Q5) Under the efficient market hypothesis,would securities be properly priced.
Page 9
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Chapter 8: Risk and Return-Capital Market Theory
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Sample Questions
Q1) A stock's beta is a measure of its A)systematic risk.
B)unsystematic risk.
C)company-specific risk.
D)diversifiable risk.
Q2) Asset A has a required return of 18% and a beta of 1.4.The expected market return is 14%.What is the risk-free rate? Plot the security market line.
Q3) The market risk premium is measured by A)beta.
B)market return less risk-free rate.
C)T-bill rate.
D)standard deviation.
Q4) If there is a 20% chance we will get a 16% return,a 30% chance of getting a 14% return,a 40% chance of getting a 12% return,and a 10% chance of getting an 8% return,what is the expected rate of return?
A)12%
B)13%
C)14%
D)15%
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Chapter 9: Debt Valuation and Interest Rates
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Sample Questions
Q1) Bonds cannot be worth less than their book value.
A)True
B)False
Q2) Advantages of privately placing debt include all of the following except A)speed.
B)reduced placement costs.
C)restrictive covenants.
D)flexibility.
Q3) A basis point is equal to one hundredth of a percentage point.
A)True
B)False
Q4) Bonds with ratings lower than Standard & Poor's BBB or Moody's Baa are classified as A)in default.
B)investment grade.
C)not investment grade.
D)medium quality.
Q5) Maturity risk and liquidity risk are equivalent terms. A)True
B)False
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Chapter 10: Stock Valuation
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Sample Questions
Q1) Marshall Manufacturing has common stock which paid a dividend of $1.00 a share last year.You expect the stock to grow at 5% per year.If the appropriate rate of return on this stock is 12%,how much are you willing to pay for the stock today?
A)$13.00
B)$15.00
C)$17.00
D)$19.00
Q2) Tannerly Worldwide's common stock is currently selling for $48 a share.If the expected dividend at the end of the year is $2.40 and last year's dividend was $2.00,what is the rate of return implicit in the current stock price?
Q3) What allows common stockholders the right to cast a number of votes equal to the number of directors being elected?
A)The majority voting provision
B)The casting feature
C)The cumulative voting provision
D)The proxy method
Q4) Discuss two reasons why preferred stock would be viewed as less risky than common stock to investors.
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Page 12
Chapter 11: Investment Decision Criteria
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Sample Questions
Q1) Frazier Fudge has a project with an initial outlay of $40,000,followed by three years of annual incremental cash flows of $35,000.At the end of the third year,equipment will be sold producing additional cash flow of $10,000.Assuming a cost of capital of 10%,calculate the MIRR of the project.
A)46.5%
B)51.3%
C)62.9%
D)74.7%
Q2) Project H requires an initial investment of $100,000 and the produces annual cash flows of $45,000 per year for each of the next 3 years.Project T also requires an initial investment of $100,000 and produces cash flows of $30,000 in year 1,$40,000 in year 2,and $70,000 in year 3.If the discount rate is 10% and the projects are not mutually exclusive
A)Project H should be chosen.
B)Project T should be chosen.
C)H and T are equally attractive.
D)Both projects should be accepted.
Q3) Discuss the merits and shortcomings of using the payback period for capital budgeting decisions.
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Chapter 12: Analyzing Project Cash Flows
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Sample Questions
Q1) If an investment project would make use of land which the firm currently owns,the project should be charged with
A)a sunk cost.
B)an opportunity cost.
C)amortization.
D)interest.
Q2) If SuperMart decides to offer a line of groceries at its discount retail outlet,inventories are expected to increase by $1,200,000,accounts receivable by $300,000 and accounts payable by $500,000.What is the cash outflow for working capital requirements?
A)$2,000,000
B)$1,700,000
C)$1,500,000
D)$1,000,000
Q3) The initial outlay involves the immediate cash outflow necessary to purchase the asset and put it in operating order.
A)True
B)False
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Chapter 13: Risk Analysis and Project Evaluation
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Sample Questions
Q1) There is a 30% probability that an office building will be sold after 5 years for $30 million,a 50% probability that it will be sold for $20 million and a 20% probability that it will be sold for $10 million.What is the expected value of the office building in 5 years?
A)$20 million
B)$21 million
C)$30 million
D)$10 million
Q2) One advantage of simulation is that it can differentiate between unsystematic and systematic risk.
A)True
B)False
Q3) Which of the following abilities are crucial for risk analysis?
A)A knowledge of marketing
B)A knowledge of cost accounting
C)A knowledge of economics
D)All of the above
Q4) Why is it important to consider real options in the capital budgeting process? Give two specific examples.
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Chapter 14: The Cost of Capital
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Sample Questions
Q1) The CAPM approach is used to determine the cost of A)debt.
B)preferred stock.
C)common equity.
D)long term funds.
Q2) Lott Bros Developers evaluates a great many small to medium size projects each year.Some are riskier than others.Lott Bros should probably
A)allow individual project managers to estimate their own discount rates.
B)try to identify the specific funding sources for each project.
C)use the company's overall WACC for all projects.
D)spend a great deal of time and money to estimate discount rates for each project.
Q3) The firm financed completely with equity capital has a cost of capital equal to the required return on common stock.
A)True
B)False
Q4) All capital projects incur flotation costs,no matter how they are financed.
A)True
B)False
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Chapter 15: Capital Structure Policy
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Sample Questions
Q1) Investors require a higher return on common stock investments if a firm uses less leverage.
A)True
B)False
Q2) An optimal capital structure is achieved
A)when a firm's expected profits are maximized.
B)when a firm's expected EPS are maximized.
C)when a firm's expected stock price is maximized.
D)when a firm's break-even point is achieved.
Q3) Total shares outstanding will be
A)20,000 under alternative I and zero under alternative II.
B)40,000 under alternative I and 60,000 under alternative II.
C)60,000 under alternative I and 40,000 under alternative II.
D)60,000 under both alternative I and alternative II.
Q4) The debt ratio is usually computed using book values for both debt and equity. A)True B)False
Q5) High coverage ratios,compared with a standard,imply unused debt capacity. A)True
B)False
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Chapter 16: Dividend Policy
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Q1) Noblesville Auto Supply Company's stock is trading ex-dividend at $5 per share.The company just paid a 10% stock dividend.The P/E ratio for the stock is 10.What was the price of the stock prior to trading ex-dividend?
Q2) The Modigliani and Miller dividend irrelevancy theorem states that A)dividends are preferable to stock repurchases. B)the timing of cash distributions is important. C)the timing of cash distributions is unimportant. D)stock repurchases are preferable to dividends.
Q3) Pettry,Inc.expects EPS this year to be $5.25.If EPS grows at an average annual rate of 10%,and if Pettry pays 60% of its earnings as dividends,what will the expected dividend per share be in 10 years?
Q4) A stock dividend increases a firm's retained earnings.
A)True B)False
Q5) The clientele effect suggests that firms can change their dividend policy frequently with no potential adverse effect on the firm.
A)True B)False
Q6) What is meant by "dividend clienteles"? Give specific examples.
Page 18
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Chapter 17: Financial Forecasting and Planning
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Sample Questions
Q1) A budget is a forecast of future events.
A)True
B)False
Q2) Miller Metalworks had sales in November of $60,000,in December of $40,000,and in January of $80,000.Miller collects 40% of sales in the month of the sale and 60% one month after the sale.Calculate Miller's cash receipts for January.
A)$44,000
B)$56,000
C)$64,000
D)$72,000
Q3) Holding other things constant,a firm's "discretionary financing needed" (the additional funds required in order to finance the firm)would be reduced if the firm experienced an increase in which of the following?
A)The dividend pay-out ratio
B)The profit margin
C)The accounts receivable average collection period
D)The expected growth rate in sales
Q4) What is meant by spontaneous financing?
Q5) What is meant by discretionary financing?
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Chapter 18: Working Capital Management
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Sample Questions
Q1) Which item would constitute poor collateral for an inventory loan?
A)Lumber
B)Vegetables
C)Copper
D)Chemicals
Q2) Which of the following would be considered an issue that is related to the management of working capital?
A)How much inventory should the firm maintain?
B)How should a firm finance its current assets?
C)To whom should the firm grant trade credit?
D)All of the above
Q3) The Omega Corp.plans to borrow $10,000 for a 2 months.At maturity,Omega will repay the $10,000 principal plus $100 interest.What is the annual percentage rate (APR)rate of interest on this loan?
A)6%
B)1%
C)4%
D)6.4%
Q4) Discuss the advantages of using commercial paper.
Q5) Describe the differences between secured and unsecured short-term credit.
Page 20
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Chapter 19: International Business Finance
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Q1) RAH Inc. ,a U.S.corporation is evaluating a proposal to construct and lease an office building in Kiev.RAH's weighted average cost of capital is 11%.The risk free rate in the U.S.is 3.75%.RAH believes that conditions in Kiev warrant a required rate of return that is 12% above the risk-free rate.Cash flows from the hotel project should be discounted at A)23%.
B)14.75%.
C)15.75%.
D)12%.
Q2) What is the law of one price? How does it apply to foreign exchange rates?
Q3) Arbitrage is the process of buying and selling in one market in order to make a riskless profit.
A)True
B)False
Q4) A direct quote in Bombay tells one how many British pounds can buy one Indian rupee.
A)True
B)False
Q5) What is the difference between and "ask" quote and a "bid" quote.
Q6) What is the role of arbitrage in the foreign exchange markets?
Page 21
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Chapter 20: Corporate Risk Management
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Sample Questions
Q1) A(n)________ is a financial instrument that can be used to eliminate the effect of both favorable and unfavorable price movements.
A)convertible securities
B)call option
C)put option
D)futures contracts
Q2) The purpose of a hedging strategy is to
A)avoid speculation on future prices.
B)speculate that future prices will be lower than the spot price.
C)speculate that future prices will be higher than the spot price.
D)avoid exposure to commodity rate risk.
Q3) A firm agrees to accept payments on a $1,000,000 loan with a fixed interest rate of 8% in exchange for making the payments on a loan with floating rate payments based on LIBOR.Payments are interest only with principal due in 10 years.The firm will benefit
A)if LIBOR falls.
B)if LIBOR rises.
C)if Libor remains unchanged.
D)if LIBOR fluctuates randomly.
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