Principles of Finance
Pre-Test Questions
Course Introduction
Principles of Finance introduces students to the fundamental concepts and tools used in financial decision-making within organizations. The course covers key topics such as the time value of money, risk and return analysis, valuation of securities, capital budgeting, cost of capital, and financial statement analysis. Students will develop an understanding of how financial markets operate and the role of finance in business strategy, while applying quantitative techniques to real-world financial problems. The course prepares students for more advanced studies in finance and equips them with essential skills for effective financial management in their professional careers.
Recommended Textbook
Corporate Finance The Core 4th Edition by Jonathan Berk
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Page 2
Chapter 1: The Corporation
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Q1) A sole proprietorship is owned by:
A)one person.
B)two of more persons.
C)shareholders.
D)bankers.
Answer: A
Q2) You overhear your manager saying that she plans to book an Ocean-view room on her upcoming trip to Miami for a meeting.You know that the interior rooms are much less expensive and that your manager is traveling at the Company's expense.This use of additional funds comes about as a result of:
A)an agency problem.
B)an adverse selection problem.
C)a moral hazard.
D)a publicity problem.
Answer: A
Q3) Explain the difference between a sub-chapter "S" corporation and a sub-chapter "C" corporation.
Answer: 11ea857d_97fc_bb24_a31f_35a87a17a5c9_TB6458_00
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3
Chapter 2: Introduction to Financial Statement Analysis
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Q1) Suppose Novak Company experienced a reduction in its ROE over the last year.This fall could be attributed to:
A)an increase in net profit margin.
B)a decrease in asset turnover.
C)an increase in leverage.
D)a decrease in Equity.
Answer: B
Q2) Luther's earnings before interest,taxes,depreciation,and amortization (EBITDA)for the year ending December 31,2009 is closest to:
A)19.7 million
B)37.6 million
C)41.2 million
D)44.8 million
Answer: D
Q3) What is the role of an auditor in financial statement analysis?
Answer: Key points: 1.To ensure that the annual financial statements are prepared accurately. 2.To ensure that the annual financial statements are prepared according to GAAP. 3.To verify that the information used in preparing the annual financial statements is reliable.
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Page 4
Chapter 3: Financial Decision Making and the Law of One
Price
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Sample Questions
Q1) If the discount rate is 15%,the alternative with the lowest NPV is:
A)#1 with an NPV of approximately $350,000
B)#2 with an NPV of approximately $341,300
C)#3 with an NPV of approximately $329,570
D)#2 with an NPV of approximately $400,000
E)None of the above
Answer: C
Q2) If the interest rate is 7%,the NPV of alternative #2 is closest to:
A)$350,000
B)$357,196
C)$370,561
D)$401,121
Answer: C
Q3) Assuming that the film maker issues the new security,the NPV for this project is closest to what amount? Should the film maker make the investment?
A)$1.7 million; Yes
B)$1.7 million; No
C)$2.7 million; Yes
D)$2.7 million; No
Answer: C
Page 5
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Chapter 4: The Time Value of Money
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Sample Questions
Q1) You work for a pharmaceutical company that has developed a new drug.The patent on the drug will last for 17 years.You expect that the drug will produce cash flows of $10 million in its first year and that this amount will grow at a rate of 4% per year for the next 17 years.Once the patent expires,other pharmaceutical companies will be able to produce generic equivalents of your drug and competition will drive any future profits to zero.If the interest rate is 12% per year,then the present value of producing this drug is closest to:
A)$71 million
B)$90 million
C)$170 million
D)$105 million
Q2) You have an $8000 balance on your credit card,which charges 12% interest annually (1% per month).If you can afford to pay $100 per month,how many months will it take to pay the credit card in full?
A)170 months
B)14 months
C)162 months
D)You will never get the card paid off at that rate.
Q3) The future value at retirement (age 65)of your savings is:
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Page 6
Chapter 5: Interest Rates
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Q1) If the current inflation rate is 4.2% and you are earning a real rate of return on an investment of 3.8%,then the nominal rate on this investment is closest to:
A)3.8%
B)4.2%
C)8.0%
D)8.2%
Q2) Which of the following statements is FALSE?
A)The plot of the relationship between the investment risk and the interest rate is call the yield curve.
B)Each of the last six recessions in the United States was preceded by a period with an inverted yield curve.
C)The nominal interest rate does not represent the increase in purchasing power that will result from investing.
D)A risk-free cash flow received in two years should be discounted at the two-year interest rate.
Q3) What is the NPV of an investment that costs $2500 and pays $1000 certain at the end of one,three,and five years?
Q4) Should you purchase the delivery truck or lease it? Why?
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Page 7
Chapter 6: Valuing Bonds
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Q1) Consider a zero coupon bond with 20 years to maturity.The amount that the price of the bond will change if its yield to maturity decreases from 7% to 5% is closest to:
A)$120
B)-$53
C)$53
D)$673
Q2) The discount rate that sets the present value of the promised bond payments equal to the current market price of the bond is called:
A)the current yield.
B)the yield to maturity.
C)the zero coupon yield.
D)the discount yield.
Q3) Assuming that this bond trades for $1112,then the YTM for this bond is closest to:
A)8.0%
B)3.4%
C)6.8%
D)9.2%
Q4) Compute the yield to maturity for each of the five zero-coupon bonds.
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Chapter 7: Investment Decision Rules
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Q1) Which of the following statements is FALSE?
A)In general,the IRR rule works for a stand-alone project if all of the project's positive cash flows precede its negative cash flows.
B)There is no easy fix for the IRR rule when there are multiple IRRs.
C)The payback rule is primarily used because of its simplicity.
D)No investment rule that ignores the set of alternative investment alternatives can be optimal.
Q2) The number of potential IRRs that exist for Rearden's mining operation is equal to:
A)0
B)1
C)2
D)12
Q3) The NPV profile graphs:
A)the project's NPV over a range of discount rates.
B)the project's IRR over a range of discount rates.
C)the project's cash flows over a range of NPVs.
D)the project's IRR over a range of NPVs.
Q4) If the discount rate for project B is 15%,then what is the NPV for project B?
Q5) If the discount rate for project A is 16%,then what is the NPV for project A?
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Chapter 8: Fundamentals of Capital Budgeting
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Q1) Which of the following statements is FALSE?
A)The simplest method used to calculate depreciation is the straight-line method.
B)A sunk cost is any unrecoverable cost for which the firm is already liable.
C)Unlevered Net Income = EBIT × <sub>c</sub>.
D)The decision to continue or abandon should be based only on the incremental costs and benefits of the project going forward.
Q2) Construct a simple income statement showing the incremental EBIT and the incremental unlevered net income for all three years of the Sisyphean Companies project.
Q3) You are considering investing $600,000 in a new automated inventory system that will provide after-tax cost savings of $50,000 next year.These cost savings are expected to grow at the same rate as sales.If sales are expected to grow at 5% per year and your cost of capital is 10%,then what is the NPV of the automated inventory system?
A)$400,000
B)$500,000
C)-$100,000
D)$1,000,000
Q4) What is sensitivity analysis?
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Page 10
Chapter 9: Valuing Stocks
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Q1) Which of the following statements is FALSE?
A)The total payout model allows us to ignore the firm's choice between dividends and share repurchases.
B)By repurchasing shares,the firm increases its share count,which decreases its earning and dividends on a per-share basis.
C)The total payout model discounts the total payouts that the firm makes to shareholders,which is the total amount spent on both dividends and share repurchases.
D)In the dividend discount model,we implicitly assume that any cash paid out to the shareholders takes the form of a dividend.
Q2) Which of the following statements is FALSE?
A)We must discount the cash flows from stock based on the equity cost of capital for the stock.
B)The divided yield is the percentage return the investor expects to earn from the dividend paid by the stock.
C)The firm might pay out cash to its shareholders in the form of a dividend.
D)The dividend yield is the expected annual dividend of a stock,divided by its expected future sale price.
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Page 11
Chapter 10: Capital Markets and the Pricing of Risk
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Q1) The geometric average annual return on Stock A from 2000 to 2009 is closest to:
A)12.4%
B)16.7%
C)13.2%
D)17.8%
Q2) The expected overall payoff to Bank A is:
A)$5,000,000
B)$6,000,000
C)$94,000,000
D)$95,000,000
Q3) What is the excess return for Treasury Bills?
A)0%
B)-8.4%
C)-2.7%
D)-1.4%
Q4) The expected overall payoff to Bank B is:
A)$5,000,000
B)$6,000,000
C)$94,000,000
D)$95,000,000
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Chapter 11: Optimal Portfolio Choice and the Capital Asset Pricing Model
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Q1) The expected return of a portfolio that is equally invested in Duke Energy and Microsoft is closest to:
A)28%
B)29%
C)24%
D)23%
Q2) Suppose over the next year Ball has a return of 12.5%,Lowes has a return of 20%,and Abbott Labs has a return of -10%.The return on your portfolio over the year is:
A)0%
B)7.5%
C)3.5%
D)5.0%
Q3) Explain how having different interest rates for borrowing and lending affects the CAPM and the SML.
Q4) The covariance between Stock X's and Stock Y's returns is closest to: A)0.10
Chapter 12: Estimating the Cost of Capital
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Q1) Which of the following statements is FALSE?
A)All investors should demand the same efficient portfolio of securities in the same proportions.
B)The Capital Asset Pricing Model (CAPM)allows corporate executives to identify the efficient portfolio (of risky assets)by using knowledge of the expected return of each security.
C)If investors hold the efficient portfolio,then the cost of capital for any investment project is equal to its required return calculated using its beta with the efficient portfolio. D)The CAPM identifies the market portfolio as the efficient portfolio.
Q2) The Market's average historical excess return is closest to:
A)-2.50%
B)-3.33%
C)-4.33%
D)-5.17%
Q3) Luther's weighted average cost of capital is closest to:
A)9.8%
B)10.8%
C)11.5%
D)13.0%
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Chapter 13: Investor Behavior and Capital Market Efficiency
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Q1) Which of the following statements is FALSE?
A)Nonzero alphas may merely indicate that the wrong market proxy is beings used; they do not necessarily indicate forgone positive NPV investment opportunities.
B)The true market portfolio contains much more than just stocks,it includes bonds,real estate,art,precious metals,and any other investment vehicles available.
C)If the true market portfolio is efficient,but the proxy portfolio is not highly correlated with the true market portfolio,then the true market portfolio will not be efficient and stocks will have nonzero alphas.
D)Much of the investment wealth cannot be included in the proxy for the market portfolio since it does not trade in competitive markets.
Q2) The market value for Bernard is closest to:
A)$12.0 million
B)$10 million
C)$15.0 million
D)$12.5 million
Q3) What does the existence of a positive alpha investment strategy imply?
Q4) Explain why the market portfolio proxy may not be efficient.
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15
Chapter 14: Capital Structure in a Perfect Market
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Q1) Suppose that to raise the funds for the initial investment the firm borrows $40,000 at the risk free rate and issues new equity to cover the remainder.In this situation,the cash flow that equity holders will receive in one year in a strong economy is closest to:
A)$117,000
B)$75,000
C)$50,000
D)$0
Q2) Which of the following statements is FALSE?
A)When a firm issues new shares that account for a significant percentage of its outstanding shares,the transaction is called a leveraged recapitalization.
B)MM Proposition I applies to capital structure decisions made at any time during the life of the firm.
C)By choosing positive-NPV projects that are worth more than their initial investment,the firm can enhance its value.
D)Holding fixed the cash flows generated by the firm's assets,however,the choice of capital structure does not change the value of the firm.
Q3) What is the conservation of value principle?
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Page 16
Chapter 15: Debt and Taxes
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Q1) In 2000,assuming an average dividend payout ratio of 50%,the effective tax rate for equity holders was closest to:
A)69%
B)65%
C)55%
D)30%
Q2) Which of the following statements is FALSE?
A)Given a forecast of future interest payments,we can determine the interest tax shield and compute its present value by discounting it at a rate that corresponds to its risk.
B)The total value of the unlevered firm exceeds the value of the firm with leverage due to the present value of the tax savings from debt.
C)To compute the increase in the firm's total value associated with the interest tax shield,we need to forecast a firm's debt and its interest payments.
D)There is an important tax advantage to the use of debt financing.
Q3) If Flagstaff currently maintains a .8 debt to equity ratio,then calculate the value of Flagstaff's interest tax shield.
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Chapter 16: Financial Distress,managerial Incentives,and Information
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Q1) What is the overall expected payoff to Wildcat from the speculative oil lease deal?
A)$360 million
B)$275 million
C)$85 million
D)$160 million
Q2) The cost of ________ is highest for firms that can easily increase the risk of their investments.
A)asset substitution
B)debt overhang
C)debt covenants
D)debt maturity
Q3) Suppose that the managers at Rearden Metal will increase risk to maximize the expected payoff to equity holders.If Rearden has $230 million in debt due in one year,then the expected value of Rearden's assets are closest to:
A)$280 million
B)$295 million
C)$300 million
D)$900 million
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Chapter 17: Payout Policy
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Q1) Which of the following statements is FALSE?
A)If firms smooth dividends,the firm's dividend choice will contain information regarding management's expectations of future earnings.
B)Because of the increasing popularity of repurchases,firms cut dividends much more frequently than they increase them.
C)Announcing a share repurchase today does not necessarily represent a long-term commitment to repurchase shares.
D)While cutting the dividend is costly for managers in terms of their reputation and the reaction of investors,it is by no means as costly as failing to make debt payments.
Q2) Assuming Luther issues a 25% stock dividend,then Luther's new share price is closest to:
A)$24.00
B)$30.00
C)$16.00
D)$32.00
Q3) Calculate the effective tax disadvantage for retaining cash in 1999,2001,and 2005.
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19
Chapter 18: Capital Budgeting and Valuation With Leverage
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Q1) Consider the following equation for the Project WACC with a fixed debt schedule:
R<sub>wacc</sub> = r<sub>U</sub> - d <sub>c</sub>[rD + f(r<sub>U</sub>r<sub>D</sub>)]
The term d in this equations represents:
A)a measure of the permanence of the debt level.
B)the annual adjustment percentage to the amount of debt.
C)the debt-to-value ratio.
D)the dollar amount of debt outstanding.
Q2) If KT expects to maintain a debt to equity ratio for this project of 1 then KT's project based WACC,r<sub>wacc</sub>,for this project is closest to:
A)11.1%
B)10.8%
C)9.6%
D)10.5%
Q3) The unlevered value of Rose's acquisition is closest to:
A)$63 million
B)$50 million
C)$167 million
D)$100 million
Q4) Calculate the debt capacity of Omicron's new project for years 0,1,and 2.
Page 20
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Chapter 19: Valuation and Financial Modeling: a Case Study
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Q1) If Ideko's loans will have an interest rate of 6.8%,then the interest expense paid in 2008 is closest to:
A)$6800
B)$7310
C)$7820
D)$7990
Q2) What range for the market value of equity for Ideko is implied by the range of EV/Sales multiples for the comparable firms if Ideko holds $6.5 million of cash in excess of its working capital needs?
Q3) Assuming that Ideko has a EBITDA multiple of 8.5,then the continuation levered P/E ratio of Ideko in 2010 is closest to:
A)19.0
B)17.2
C)16.4
D)14.5
Q4) What is the purpose of the sensitivity analysis?
Q5) What range for the market value of equity for Ideko is implied by the range of EV/EBITDA multiples for the comparable firms if Ideko holds $6.5 million of cash in excess of its working capital needs?
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