Principles of Finance Test Bank
Course Introduction
Principles of Finance is an introductory course that explores the fundamental concepts and tools used in financial decision-making within organizations and markets. Topics include the time value of money, risk and return, financial statement analysis, valuation of stocks and bonds, capital budgeting, and the functioning of financial markets and institutions. The course also considers the ethical and regulatory environment of finance, providing students with a foundation for further study and practical decision-making in business, investment, and personal finance contexts.
Recommended Textbook
Corporate Finance Core Principles and Applications 4th Edition by Sheldon M. Ross
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Page 2
Chapter 1: Introduction to Corporate Finance
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Sample Questions
Q1) A proxy fight occurs when:
A)the board of directors solicits renewal of current members.
B)a firm files for bankruptcy.
C)a shareholder sells shares in the open market.
D)a group solicits votes to replace the board of directors.
E)a firm is declared insolvent.
Answer: D
Q2) What are some of the similarities between a general partnership and a sole proprietorship?
Answer: Similarities:
1.Each general partner or sole proprietor is personally responsible for 100 percent of the debts of the business.
2.Both types of firms have business lives that are dependent upon the owner's life and also the owner's willingness to be involved in the business.
3.Both types of firms are easy to form.
4.Both types of firms are limited in their ability to raise large amounts of external funding.
5.Both types of firms have their profits taxed as personal income.
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3
Chapter 2: Financial Statements and Cash Flow
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Sample Questions
Q1) The carrying value or book value of assets:
A)is always the best measure of a company's value to an investor.
B)represents an average market value over time.
C)is always higher than the replacement cost of the assets.
D)is determined under GAAP and is based on the cost of the assets.
E)is determined under GAPP and is based on the current market value of the assets.
Answer: D
Q2) Total assets are $1,500,fixed assets are $1,100,long-term debt is $600,and short-term debt is $300.What is the amount of net working capital?
A)$0
B)$100
C)$200
D)$300
E)$400
Answer: B
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Chapter 3: Financial Statements Analysis and Financial Models
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Sample Questions
Q1) Assume JustDoIt Co.increases its operating efficiency such that costs decrease while sales remain constant.As a result,given all else constant,the:
A)equity multiplier will decrease
B)return on assets will decrease.
C)profit margin will decline.
D)return on equity will increase.
E)total asset turnover will increase.
Answer: D
Q2) The return on equity can be calculated as:
A)Profit margin × 1/Capital intensity ratio × Equity multiplier.
B)Return on assets × b.
C)Profit margin × Total asset turnover × Debt-equity ratio
D)Profit margin × 1/Equity multiplier × (1 + Debt-equity ratio).
E)Return on assets × Debt-equity ratio
Answer: A
Q3) Identify the three parts of the DuPont identity and specify what each part measures.
Answer: ROE = Profit margin (Operating efficiency)× Total asset turnover (Asset use efficiency)× Equity multiplier (Financial leverage).
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Chapter 4: Discounted Cash Flow Valuation
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Q1) A growing annuity is a set of:
A)arbitrary cash flows occurring each time period for no more than ten years.
B)level cash flows occurring each time period forever.
C)steadily increasing cash flows occurring each time period for a fixed number of periods.
D)increasing cash flows occurring each time period forever.
E)level cash flows occurring each time period for a fixed period of time.
Q2) Which one of these statements concerning two annuities is correct? Assume both annuities have $1,000 annual cash flows for four years.
A)The ordinary annuity will pay on the first day of each time period.
B)The annuity due is more valuable than the ordinary annuity.
C)The annuity due will pay one more payment than the ordinary annuity.
D)The ordinary annuity will have the highest value at the end of Year 4.
E)Both annuities are of equal value given any discount rate.
Q3) What circumstances are required for an APR to equal an EAR?
Q4) What is the difference between an ordinary annuity and an annuity due? Which type of annuity would you prefer if you are making the payments? Explain your reasoning.
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Chapter 5: Interest Rates and Bond Valuation
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Q1) Which type of bond grants its holder the right to force repayment of the bond at a stated price prior to maturity?
A)Income
B)Call
C)Put
D)Structured note
E)Convertible
Q2) A Treasury bond is quoted at a price of 101.2462 with a current yield of 3.68 percent.What is the coupon rate?
A)3.61%
B)3.68%
C)3.73%
D)3.77%
E)3.82%
Q3) Assume you are the manager of a multi-million dollar portfolio of corporate bonds and you believe interest rates will rise in the near future.Other investors have not yet accepted your belief but you want to act based on your personal beliefs.What adjustments should you make to the portfolio?
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Chapter 6: Stock Valuation
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Sample Questions
Q1) In a liquidation,the owners of 6 percent preferred stock are generally entitled to a liquidation payment of _____ a share as long as there is sufficient funds available.
A)$1
B)$6
C)$60
D)$100
E)$1,000
Q2) Assume you are using the total payout method for determining the price of a share of stock.When computing the total present value,the total payout is divided by the:
A)required rate of return minus the dividend growth rate.
B)average investor's required rate of return.
C)dividend growth rate.
D)sum of the dividend growth rate and the net income growth rate.
E)required rate of return minus the net income rate of growth.
Q3) Identify at least five features of preferred stock that are similar to bond features.
Q4) In general,would you expect more stocks to fit the constant growth or the differential growth model? Explain your reasoning.
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Chapter 7: Net Present Value and Other Investment Rules
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Q1) Rodriquez's Hot Rods is considering a new project with an initial cost of $26,410 and a discount rate of 8 percent.The project is expected to have one cash inflow of $42,500 in Year 2.What is the discounted payback period?
A).72 years
B)1.39 years
C).62 years
D)1.72 years
E)1.62 years
Q2) What is the primary shortcoming of the average accounting rate of return from a financial perspective?
A)The lack of use in the business world
B)The lack of a clear-cut decision rule
C)The degree of the calculation difficulty
D)The degree of estimation involved with the initial cost
E)The use of net income rather than cash flows
Q3) Academic theory states that net present value is the best capital budgeting model.Why is this the case?
Q4) What are the limitations of the IRR rule? Given these limitations,why is IRR so commonly used?
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Chapter 8: Making Capital Investment Decisions
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Sample Questions
Q1) Which of the following should be included in the analysis of a project?
I.Sunk costs
II.Opportunity costs
III.Erosion costs
IV.Incremental costs
A)I and II only
B)III and IV only
C)II and IV only
D)II,III,and IV only
E)I,II,and IV only
Q2) The pretax salvage value of an asset is equal to the:
A)book value if straight-line depreciation is used.
B)book value if MACRS depreciation is used.
C)market value minus the book value.
D)book value minus the market value.
E)market value.
Q3) Should financing costs be included as an incremental cash flow in capital budgeting analysis?
Q4) When is it appropriate to use the equivalent annual cost (EAC)methodology,and how do you make a decision using it?
10
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Chapter 9: Risk Analysis, Real Options, and Capital Budgeting
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Q1) Miller Tools is considering a new project that requires an initial investment of $82,600 for fixed assets,which will be depreciated straight-line to zero over the project's 4-year life.The project is expected to have fixed costs of $41,200 a year and a contribution margin of $22.80.The tax rate is 34 percent and the discount rate is 10 percent.What is the financial break-even point?
A)2,949.91 units
B)3,072.10 units
C)2,200.01 units
D)2,483.33 units
E)2,666.67 units
Q2) In financial break-even,the EAC is used to:
A)allocate depreciation over the life of a project.
B)determine the tax benefit of depreciation.
C)allocate the initial investment over the life of a project.
D)determine the ideal contribution margin.
E)ascertain the appropriate discount rate.
Q3) Explain how net present value analysis might cause managers to develop a false sense of security surrounding a project.
Q4) Explain the significance of the financial break-even point.
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Chapter 10: Risk and Return Lessons From Market History
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Sample Questions
Q1) One year ago,Stacey purchased 300 shares of IXC Tek stock at a price of $11.23 per share.The stock pays an annual dividend of $.23 per share.Today,Stacey sold all of her shares for $16.20 per share.What is her total dollar return on this investment?
A)$1,703
B)$1,560
C)$1,422
D)$1,389
E)$1,491
Q2) Deltona stock sold for $38.60 a share one year ago and pays an annual dividend of $1.55.What does the stock price need to be today for the annual capital gain to be 7.5 percent?
A)$39.95
B)$40.08
C)$41.50
D)$41.63
E)$43.18
Q3) What is the difference between an arithmetic and a geometric average? Is one preferred over the other?
Q4) How does the payment of a dividend affect the total return on a stock?
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Chapter 11: Return and Risk: the Capital Asset Pricing Model
Capm
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Sample Questions
Q1) KNF stock is quite cyclical.In a boom economy,the stock is expected to return 30 percent in comparison to 12 percent in a normal economy and a negative 17 percent in a recessionary period.The probability of a recession is 25%.There is a 15% chance of a boom economy.What is the standard deviation of the returns this stock?
A)10.15%
B)12.60%
C)15.43%
D)17.46%
E)25.04%
Q2) If a stock portfolio is well diversified,then the portfolio variance:
A)must be equal to or greater than the variance of the least risky stock in the portfolio.
B)will be a weighted average of the variances of the individual securities in the portfolio.
C)will equal the variance of the most volatile stock in the portfolio.
D)will be an arithmetic average of the variances of the individual securities in the portfolio.
E)may be less than the variance of the least risky stock in the portfolio.
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Page 13
Chapter 12: Risk, Cost of Capital, and Valuation
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Sample Questions
Q1) The Lumber Shack just paid an annual dividend of $1.23 a share.The dividend growth rate is 4 percent,the tax rate is 34 percent,and the common stock sells for $38 a share.What is the cost of equity?
A)7.24%
B)7.09%
C)7.18%
D)7.37%
E)7.32%
Q2) An all-equity firm has a beta of .98.The firm is evaluating a project that will increase the output of the firm's existing product.The market risk premium is 7.3 percent and the risk-free rate is 3.4 percent.What discount rate should be assigned to this expansion project?
A)8.39%
B)7.22%
C)7.15%
D)10.55%
E)11.37%
Q3) Identify the three key determinants of beta and identify a situation for each of those determinants that will tend to produce a high beta value.
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Chapter 13: Efficient Capital Markets and Behavioral Challenges
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Sample Questions
Q1) In an efficient market,the price of a security will:
A)react immediately to new information with no further price adjustments related to that information.
B)react to new information over a two-day period after which time no further price adjustments related to that information will occur.
C)rise sharply when new information is first released and then decline to a new stable level by the following day.
D)always rise immediately upon the release of new information with no further price adjustments related to that information.
E)be slow to react for the first few hours after new information is released allowing time for that information to be reviewed and analyzed.
Q2) Explain why in an efficient market investments have an expected net present value (NPV)of zero.
Q3) Why do you think it is difficult for researchers to agree on principles related to behavioral finance?
Q4) What are the basic principles behind behavioral finance?
Q5) What key item should managers look for when considering an acquisition?
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Chapter 14: Capital Structure: Basic Concepts
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Q1) In an EPS-EBI graphical relationship,why does the debt line have a lower vertical intercept point than the no debt line?
A)The debt line has a negative slope while the no debt line has a positive slope.
B)The break-even point is higher with debt.
C)The debt line is horizontal while the no debt line has a positive slope.
D)With debt,a fixed interest charge is paid out of earnings.
E)The debt line has less of a slope than the no debt line.
Q2) The Outlet has an unlevered cost of capital of 14.2 percent,a tax rate of 35 percent,and expected earnings before interest and taxes of $23,400.The company has $23,000 in bonds outstanding that have a coupon rate of 7 percent.The bonds are selling at par.What is the cost of equity?
A)14.31%
B)15.08%
C)14.59%
D)14.64%
E)15.37%
Q3) Explain homemade leverage and why it matters.
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Chapter 15: Capital Structure: Limits to the Use of Debt
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Q1) A firm is technically insolvent when:
A)the value of its stock declines by more than 50 percent in any given 12-month period.
B)the value of the firm's assets is less than the value of the firm's liabilities.
C)it files the legal forms petitioning for bankruptcy protection.
D)it is unable to meet its financial obligations.
E)it has a negative net worth on its balance sheet.
Q2) The legal proceeding for liquidating or reorganizing a firm operating in default is called a:
A)tender offer.
B)bankruptcy.
C)merger.
D)takeover.
E)proxy fight.
Q3) Establishing a capital structure for a firm is not simple.Although financial theory guides the process,there is no quantifiable formula to follow.However,there are key factors which should be considered as they affect the target ratio.List and explain three such factors.
Q4) How might business risk affect the capital structure of a firm?
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Chapter 16: Dividends and Other Payouts
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Q1) Alpha Company is paying a $1.50 per share dividend today.There are 200,000 shares outstanding with a par value of $1 per share.As a result of this dividend,the:
A)retained earnings will decrease by $300,000.
B)retained earnings will decrease by $150,000.
C)common stock account will decrease by $300,000.
D)common stock account will decrease by $150,000.
E)capital in excess of par value account will decrease by $150,000.
Q2) Corner Mart has 150,000 shares of stock outstanding with a par value of $1 per share.The market value is $28.30 per share.The balance sheet shows $2,922,500 in the capital in excess of par account,$150,000 in the common stock account,and $1,322,700 in the retained earnings account.The firm just announced a 10 percent (small)stock dividend.What will the market price per share be after the dividend?
A)$27.20
B)$25.73
C)$28.30
D)$31.44
E)$31.13
Q3) Identify at least four pros of paying dividends.
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Chapter 17: Options and Corporate Finance
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Q1) A _____ is a derivative security that gives the owner the right,but not the obligation,to buy an asset at a fixed price during a specified period of time.
A)Call option
B)Futures contract
C)Put option
D)Swap
E)Forward contract
Q2) Shareholders in a leveraged firm might wish to accept a negative net present value project if it:
A)lowers the risk level of the firm.
B)lowers the variance of the returns on the firm's assets.
C)increases the standard deviation of the returns on the firm's assets.
D)decreases the risk that a firm will default on its debt.
E)diversifies the cash flows of the firm.
Q3) Assume you purchased a stock for $42 a share.The stock is currently worth $48 a share.You just wrote a $50 call option on the stock with an option price of $.50.What value are you placing on this stock?
Q4) What is a protective put and what does it protect?
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Chapter 18: Short-Term Finance and Planning
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Q1) A restrictive short-term financial policy tends to:
A)grant credit to more customers.
B)reduce total ordering costs as compared to a more flexible policy.
C)encourage credit sales over cash sales.
D)incur more carrying costs than a flexible policy does.
E)reduce future sales more so than a flexible policy.
Q2) Countrywide Machine Parts is considering a proposal whereby customers who pay their bills on time will receive a 2 percent rebate on their purchases.Those who pay cash will receive a 5 percent rebate.All rebates will be applied to the next order placed by the customer.Explain the impact of this proposal on the firm.
Q3) Dywer Metals has an inventory turnover of 16 and an accounts receivable turnover of 10.The accounts payable period is 51 days.What is the length of the cash cycle?
A)8.31 days
B)9.57 days
C)-41.00 days
D)-25.00 days
E)12.79 days
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Chapter 19: Raising Capital
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Q1) Which stage of venture capital financing provides the funding needed to develop a working model of a new product?
A)Start-up
B)First-round
C)Mezzanine
D)Seed money
E)Second-round
Q2) The difference between the price an underwriter pays to a securities' issuer and the price at which the securities are offered for sale is called the:
A)markup.
B)commission.
C)spread.
D)rights price.
E)private price.
Q3) Why might an eligible firm choose a Rule 415 registration of securities?
Q4) Provide two arguments in favor of IPO underpricing and two arguments against IPO underpricing.
Q5) Explain how a Dutch auction operates and why a firm might choose to sell its securities in this manner.
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Chapter 20: International Corporate Finance
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Q1) Today,you can exchange $1 for £.6229.Last week,£1 was worth $1.61.Assume you converted £100 into dollars last week and then converted your dollars back to pounds this week.What is your net profit or loss in pounds?
A)£.2708
B)£.2869
C)£.3018
D)£.2585
E)£.2942
Q2) You want to invest in a riskless project in Sweden.The project has an initial cost of SKr380,000 and is expected to produce cash inflows of SKr210,000 a year for 2 years.The project will be worthless after two years.The expected inflation rate in Sweden is 2.6 percent while it is 2.1 percent in the U.S.A risk-free security is paying 3.8 percent in the U.S.The current spot rate is $1 = SKr6.56.What is the net present value of this project in U.S dollars using the foreign currency approach?
A)$1,811.70
B)$13,799.21
C)$2,192.65
D)$3,684.44
E)$14,383.78
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Chapter 21: Mergers and Acquisitions Web Only
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Q1) Which one of these statements is true?
A)The NPV of a merger can only be shared with the target firm's shareholders if the merger is financed with cash.
B)A cash acquisition affects the control of a bidder firm.
C)An acquisition financed with shares of stock is generally a tax-free transaction for all involved shareholders.
D)A cash acquisition causes the shareholders of the target firm to share in any merger losses.
E)A cash acquisition is less expensive than a stock acquisition to the shareholders of the acquiring firm when a merger produces a negative NPV.
Q2) XYZ has a market value of $287,400.ABC has a market value of $611,900.ABC believes it can create $57,000 of synergy if it acquires XYZ for $300,000 in cash.What is the value of ABC following the merger? Assume both firms are all-equity financed.
A)$656,300
B)$998,900
C)$956,300
D)$668,900
E)$368,900
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