Principles of Finance Question
Bank
Course Introduction
Principles of Finance provides an introduction to the foundational concepts and tools used in the field of finance. The course covers key topics such as the time value of money, risk and return analysis, financial statement interpretation, asset valuation, capital budgeting, and financing decisions. Students will explore how individuals and organizations allocate resources over time, assess investment opportunities, and manage financial risks. By applying quantitative and analytical approaches, learners will gain a solid understanding of how financial decisions impact the value and performance of businesses in both local and global 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) Cheers Inc. operates as a partnership. Now the partners have decided to convert the business into a regular corporation. Which of the following statements is CORRECT?
A) Assuming Cheers is profitable, less of its income will be subject to federal income taxes.
B) Cheers will now be subject to fewer regulations.
C) Cheers' shareholders (the ex-partners) will now be exposed to less liability.
D) Cheers' investors will be exposed to less liability, but they will find it more difficult to transfer their ownership.
E) Cheers will find it more difficult to raise additional capital.
Answer: C
Q2) Two disadvantages of a proprietorship are (1) the relative difficulty of raising new capital and (2) the owner's unlimited personal liability for the business' debts.
A)True
B)False
Answer: True
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Chapter 3: Analysis of Financial Statements
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Sample Questions
Q1) Northwest Lumber had a profit margin of 5.25%, a total assets turnover of 1.5, and an equity multiplier of 1.8. What was the firm's ROE?
A) 12.79%
B) 13.47%
C) 14.18%
D) 14.88%
E) 15.63%
Answer: C
Q2) Nikko Corp.'s total common equity at the end of last year was $305,000 and its net income after taxes was $60,000. What was its ROE?
A) 16.87%
B) 17.75%
C) 18.69%
D) 19.67%
E) 20.66%
Answer: D
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Chapter 4: Time Value of Money
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Sample Questions
Q1) What is the PV of an ordinary annuity with 5 payments of $4,700 if the appropriate interest rate is 4.5%?
A) $16,806
B) $17,690
C) $18,621
D) $19,601
E) $20,633
Q2) Your investment advisor has recommended your invest in bonds that pay 6.0%, compounded annually. If you invest $10,000 today, how many years will it take for your investment to grow to $30,000?
A) 12.37
B) 13.74
C) 15.27
D) 16.97
E) 18.85
Q3) A "growing annuity" is any cash flow stream that grows over time.
A)True
B)False
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Chapter 5: Bonds, Bond Valuation, and Interest Rates
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Sample Questions
Q1) If 10-year T-bonds have a yield of 6.2%, 10-year corporate bonds yield 8.5%, the maturity risk premium on all 10-year bonds is 1.3%, and corporate bonds have a 0.4% liquidity premium versus a zero liquidity premium for T-bonds, what is the default risk premium on the corporate bond?
A) 1.90%
B) 2.09%
C) 2.30%
D) 2.53%
E) 2.78%
Q2) If the required rate of return on a bond (r<sub>d</sub>) is greater than its coupon interest rate and will remain above that rate, then the market value of the bond will always be below its par value until the bond matures, at which time its market value will equal its par value. (Accrued interest between interest payment dates should not be considered when answering this question.)
A)True
B)False
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Chapter 6: Risk, Return, and the Capital Asset Pricing Model
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Sample Questions
Q1) Portfolio AB was created by investing in a combination of Stocks A and B. Stock A has a beta of 1.2 and a standard deviation of 25%. Stock B has a beta of 1.4 and a standard deviation of 20%. Portfolio AB has a beta of 1.25 and a standard deviation of 18%. Which of the following statements is CORRECT?
A) Stock A has more market risk than Stock B but less stand-alone risk.
B) Portfolio AB has more money invested in Stock A than in Stock B.
C) Portfolio AB has the same amount of money invested in each of the two stocks.
D) Portfolio AB has more money invested in Stock B than in Stock A.
E) Stock A has more market risk than Portfolio AB.
Q2) When adding a randomly chosen new stock to an existing portfolio, the higher (or more positive) the degree of correlation between the new stock and stocks already in the portfolio, the less the additional stock will reduce the portfolio's risk.
A)True
B)False
Q3) The tighter the probability distribution of its expected future returns, the greater the risk of a given investment as measured by its standard deviation.
A)True
B)False
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Chapter 7: Stocks, Stock Valuation, and Stock Market
Equilibrium
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Sample Questions
Q1) You, in analyzing a stock, find that its expected return exceeds its required return. This suggests that you think
A) the stock should be sold.
B) the stock is a good buy.
C) management is probably not trying to maximize the price per share.
D) dividends are not likely to be declared.
E) the stock is experiencing supernormal growth.
Q2) Gere Furniture forecasts a free cash flow of $40 million in Year 3, i.e., at t = 3, and it expects FCF to grow at a constant rate of 5% thereafter. If the weighted average cost of capital is 10% and the cost of equity is 15%, what is the horizon value, in millions at t = 3?
A) $840
B) $882
C) $926
D) $972
E) $1,021
Q3) The free cash flow valuation model cannot be used unless a company doesn't pay dividends.
A)True
B)False
Page 8
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Chapter 8: Financial Options and Applications in Corporate Finance
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Sample Questions
Q1) Which of the following statements is CORRECT?
A) As the stock's price rises, the time value portion of an option on a stock increases because the difference between the price of the stock and the fixed strike price increases.
B) Issuing options provides companies with a low cost method of raising capital.
C) The market value of an option depends in part on the option's time to maturity and also on the variability of the underlying stock's price.
D) The potential loss on an option decreases as the option sells at higher and higher prices because the profit margin gets bigger.
E) An option's value is determined by its exercise value, which is the market price of the stock less its striking price. Thus, an option can't sell for more than its exercise value.
Q2) The strike price is the price that must be paid for a share of common stock when it is bought by exercising a warrant.
A)True
B)False
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Page 9
Chapter 9: The Cost of Capital
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Sample Questions
Q1) The cost of debt is equal to one minus the marginal tax rate multiplied by the interest rate on new debt.
A)True
B)False
Q2) If investors' aversion to risk rose, causing the slope of the SML to increase, this would have a greater impact on the required rate of return on equity, r<sub>s</sub>, than on the interest rate on long-term debt, r<sub>d</sub>, for most firms. Other things held constant, this would lead to an increase in the use of debt and a decrease in the use of equity. However, other things would not stay constant if firms used a lot more debt, as that would increase the riskiness of both debt and equity and thus limit the shift toward debt.
A)True
B)False
Q3) The text identifies three methods for estimating the cost of common stock from reinvested earnings (not newly issued stock): the CAPM method, the dividend growth method, and the bond-yield-plus-risk-premium method. However, only the dividend growth method is widely used in practice.
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) 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
Q2) Conflicts between two mutually exclusive projects occasionally occur, where the NPV method ranks one project higher but the IRR method ranks the other one first. In theory, such conflicts should be resolved in favor of the project with the higher positive NPV.
A)True
B)False
Q3) The IRR of normal Project X is greater than the IRR of normal Project Y, and both IRRs are greater than zero. Also, the NPV of X is greater than the NPV of Y at the cost of capital. If the two projects are mutually exclusive, Project X should definitely be selected, and the investment made, provided we have confidence in the data. Put another way, it is impossible to draw NPV profiles that would suggest not accepting Project X.
A)True
B)False
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Page 11
Chapter 11: Cash Flow Estimation and Risk Analysis
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Sample Questions
Q1) Suppose Walker Publishing Company is considering bringing out a new finance text whose projected revenues include some revenues that will be taken away from another of Walker's books. The lost sales on the older book are a sunk cost and as such should not be considered in the analysis for the new book.
A)True
B)False
Q2) If a firm's projects differ in risk, then one way of handling this problem is to evaluate each project with the appropriate risk-adjusted discount rate.
A)True
B)False
Q3) Superior analytical techniques, such as NPV, used in combination with risk-adjusted cost of capital estimates, can overcome the problem of poor cash flow estimation and lead to generally correct accept/reject decisions.
A)True
B)False
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Chapter 12: Financial Planning and Forecasting Financial Statements
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Sample Questions
Q1) North Construction had $850 million of sales last year, and it had $425 million of fixed assets that were used at only 60% of capacity. What is the maximum sales growth rate North could achieve before it had to increase its fixed assets?
A) 54.30%
B) 57.16%
C) 60.17%
D) 63.33%
E) 66.67%
Q2) To determine the amount of additional funds needed (AFN), you may subtract the expected increase in liabilities, which represents a source of funds, from the sum of the expected increases in retained earnings and assets, both of which are uses of funds.
A)True
B)False
Q3) As long as a firm does not pay out 100% of its earnings, the firm's annual profit that is retained in the business (i.e., the addition to retained earnings) is another source of funds for a firm's expansion.
A)True
B)False
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Chapter 13: Corporate Valuation, Value-Based
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Sample Questions
Q1) A poison pill is also known as a corporate restructuring. A)True
B)False
Q2) The CEO of D'Amico Motors has been granted some stock options that have provisions similar to most other executive stock options. If D'Amico's stock underperforms the market, these options will necessarily be worthless.
A)True
B)False
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.
Q4) ESOPs were originally designed to help improve worker productivity, but today they are also used to help prevent hostile takeovers.
A)True
B)False
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Chapter 14: Distributions to Shareholders: Dividends and Repurchases
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Sample Questions
Q1) Rohter Galeano Inc. is considering how to set its dividend policy. It has a capital budget of $3,000,000. The company wants to maintain a target capital structure that is 15% debt and 85% equity. The company forecasts that its net income this year will be $3,500,000. If the company follows a residual dividend policy, what will be its total dividend payment?
A) $205,000
B) $500,000
C) $950,000
D) $2,550,000
E) $3,050,000
Q2) The capital budget of Creative Ventures Inc. is $1,000,000. The company wants to maintain a target capital structure that is 30% debt and 70% equity. The company forecasts that its net income this year will be $800,000. If the company follows a residual dividend policy, what will be its total dividend payment?
A) $100,000
B) $200,000
C) $300,000
D) $400,000
E) $500,000
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Chapter 15: Capital Structure Decisions
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Sample Questions
Q1) Based on the information below for Benson Corporation, what is the optimal capital structure?
A) Debt = 50%; Equity = 50%; EPS = $3.05; Stock price = $28.90.
B) Debt = 60%; Equity = 40%; EPS = $3.18; Stock price = $31.20.
C) Debt = 80%; Equity = 20%; EPS = $3.42; Stock price = $30.40.
D) Debt = 70%; Equity = 30%; EPS = $3.31; Stock price = $30.00.
E) Debt = 40%; Equity = 60%; EPS = $2.95; Stock price = $26.50.
Q2) The Miller model begins with the MM model with corporate taxes and then adds personal taxes.
A)True
B)False
Q3) It is possible that two firms could have identical financial and operating leverage, yet have different degrees of risk as measured by the variability of EPS.
A)True
B)False
Q4) The Miller model begins with the MM model without corporate taxes and then adds personal taxes.
A)True
B)False
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Chapter 16: Working Capital Management
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Sample Questions
Q1) The longer its customers normally hold inventory, the longer the credit period supplier firms normally offer. Still, suppliers have some flexibility in the credit terms they offer. If a supplier lengthens the credit period offered, this will shorten the customer's cash conversion cycle but lengthen the supplier firm's own CCC.
A)True B)False
Q2) Newsome Inc. buys on terms of 3/15, net 45. It does not take the discount, and it generally pays after 60 days. What is the nominal annual percentage cost of its non-free trade credit, based on a 365-day year?
A) 25.09%
B) 27.59%
C) 30.35%
D) 33.39%
E) 36.73%
Q3) Accruals are "free" capital in the sense that no explicit interest must normally be paid on accrued liabilities.
A)True B)False
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Chapter 17: Multinational Financial Management
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Sample Questions
Q1) A foreign currency will, on average, depreciate against the U.S. dollar at a percentage rate approximately equal to the amount by which its inflation rate exceeds that of the United States.
A)True
B)False
Q2) Suppose 6 months ago a Swiss investor bought a 6-month U.S. Treasury bill at a price of $9,708.74, with a maturity value of $10,000. The exchange rate at that time was 1.420 Swiss francs per dollar. Today, at maturity, the exchange rate is 1.324 Swiss francs per dollar. What is the annualized rate of return to the Swiss investor?
A) 7.92%
B) 4.13%
C) 6.00%
D) 8.25%
E) 12.00%
Q3) 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
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