Principles of Finance
Textbook Exam Questions
Course Introduction
Principles of Finance is an introductory course that explores the fundamental concepts and practices governing financial management in businesses and organizations. The course covers essential topics such as the time value of money, risk and return, valuation of stocks and bonds, capital budgeting, cost of capital, and financial statement analysis. Students will also examine the roles of financial markets and institutions, financial planning, and ethical considerations in finance. Through case studies and problem-solving exercises, learners will develop practical skills for making informed financial decisions and understanding how financial principles apply to real-world situations.
Recommended Textbook
Fundamentals of Corporate Finance 10th Alternate Edition by Stephen A. Ross
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Chapter 1: Introduction to Corporate Finance
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Q1) Which one of the following is a working capital management decision?
A) determining the amount of equipment needed to complete a job
B) determining whether to pay cash for a purchase or use the credit offered by the supplier
C) determining the amount of long-term debt required to complete a project
D) determining the number of shares of stock to issue to fund an acquisition
E) determining whether or not a project should be accepted
Answer: B
Q2) Sally and Alicia currently are general partners in a business located in Atlanta,Georgia.They are content with their current tax situation but are both very uncomfortable with the unlimited liability to which they are each subjected.Which form of business entity should they consider to replace their general partnership assuming they wish to remain the only two owners of their business? Whichever organization they select,they wish to be treated equally.
A) sole proprietorship
B) joint stock company
C) limited partnership
D) limited liability company
E) corporation
Answer: D
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Page 3
Two: Financial Statements and Long-Term Financial Planning
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Q1) Which one of these is most apt to be a fixed cost?
A) raw materials
B) manufacturing wages
C) management bonuses
D) office salaries
E) shipping and freight
Answer: D
Q2) The cash flow related to interest payments less any net new borrowing is called the:
A) operating cash flow.
B) capital spending cash flow.
C) net working capital.
D) cash flow from assets.
E) cash flow to creditors.
Answer: E
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Chapter 3: Working With Financial Statements
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Q1) The Home Supply Co.has a current accounts receivable balance of $280,000.Credit sales for the year just ended were $1,830,000.How many days on average did it take for credit customers to pay off their accounts during this past year?
A) 54.29 days
B) 55.01 days
C) 55.50 days
D) 55.85 days
E) 61.00 days
Answer: D
Q2) Which one of the following is a source of cash?
A) repurchase of common stock
B) acquisition of debt
C) purchase of inventory
D) payment to a supplier
E) granting credit to a customer
Answer: B
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Chapter 4: Long-Term Financial Planning and Growthpart
Three: Valuation of Future Cash Flows
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Q1) The sustainable growth rate:
A) assumes there is no external financing of any kind.
B) assumes no additional long-term debt is available.
C) assumes the debt-equity ratio is constant.
D) assumes the debt-equity ratio is 1.0.
E) assumes all income is retained by the firm.
Q2) Identify the four primary determinants of a firm's growth and explain how each factor could either add to or limit the growth potential of a firm.
Q3) Which one of the following terms is defined as dividends paid expressed as a percentage of net income?
A) dividend retention ratio
B) dividend yield
C) dividend payout ratio
D) dividend portion
E) dividend section
Q4) Smith & Daughters is getting ready to compile pro forma statements for the next few years.How can the managers establish a reasonable range of growth rates that they should consider during this planning process?
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Chapter 5: Introduction to Valuation: the Time Value of Money
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Q1) You're trying to save to buy a new $160,000 Ferrari.You have $58,000 today that can be invested at your bank.The bank pays 6 percent annual interest on its accounts.How many years will it be before you have enough to buy the car? Assume the price of the car remains constant.
A) 16.67 years
B) 17.04 years
C) 17.41 years
D) 17.87 years
E) 18.02 years
Q2) Your older sister deposited $5,000 today at 8.5 percent interest for 5 years.You would like to have just as much money at the end of the next 5 years as your sister will have.However,you can only earn 7 percent interest.How much more money must you deposit today than your sister did if you are to have the same amount at the end of the 5 years?
A) $321.19
B) $360.43
C) $387.78
D) $401.21
E) $413.39
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Chapter 6: Discounted Cash Flow Valuation
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Q1) You buy an annuity that will pay you $24,000 a year for 25 years.The payments are paid on the first day of each year.What is the value of this annuity today if the discount rate is 8.5 percent?
A) $241,309
B) $245,621
C) $251,409
D) $258,319
E) $266,498
Q2) You are borrowing $17,800 to buy a car.The terms of the loan call for monthly payments for 5 years at 8.6 percent interest.What is the amount of each payment?
A) $287.71
B) $291.40
C) $301.12
D) $342.76
E) $366.05
Q3) Why might a borrower select an interest-only loan instead of an amortized loan,which would be cheaper?
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8
Chapter 7: Interest Rates and Bond Valuation
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Q1) The yield to maturity on a bond is currently 8.46 percent.The real rate of return is 3.22 percent.What is the rate of inflation?
A) 5.08 percent
B) 5.64 percent
C) 6.24 percent
D) 6.53 percent
E) 6.71 percent
Q2) Municipal bonds:
A) are totally risk-free.
B) generally have higher coupon rates than corporate bonds. C) pay interest that is federally tax-free.
D) are rarely callable.
E) are free of default-risk.
Q3) All else constant,a bond will sell at _____ when the coupon rate is _____ the yield to maturity.
A) a premium;less than B) a premium;equal to C) a discount;less than D) a discount;higher than E) par;less than
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Chapter 8: Stock Valuationpart Four: Capital Budgeting
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Q1) Last year,Hansen Delivery paid an annual dividend of $3.20 per share.The company has been reducing the dividends by 10 percent annually.How much are you willing to pay to purchase stock in this company if your required rate of return is 13 percent?
A) $1.92
B) $7.87
C) $12.52
D) $21.16
E) $24.08
Q2) Crystal Glass recently paid $3.60 as an annual dividend.Future dividends are projected at $3.80,$4.10,and $4.25 over the next 3 years,respectively.Beginning 4 years from now,the dividend is expected to increase by 3.25 percent annually.What is one share of this stock worth to you if you require a 12.5 percent rate of return on similar investments?
A) $42.92
B) $43.40
C) $45.12
D) $45.88
E) $46.50
Q3) What are the primary differences and similarities between NASDAQ and the NYSE?
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Page 10
Chapter 9: Net Present Value and Other Investment Criteria
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Q1) Which one of the following statements would generally be considered as accurate given independent projects with conventional cash flows?
A) The internal rate of return decision may contradict the net present value decision.
B) Business practice dictates that independent projects should have three distinct accept indicators before a project is actually implemented.
C) The payback decision rule could override the net present value decision rule should cash availability be limited.
D) The profitability index rule cannot be applied in this situation.
E) The projects cannot be accepted unless the average accounting return decision ruling is positive.
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
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Chapter 10: Making Capital Investment Decisions
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Q1) The Fluffy Feather sells customized handbags.Currently,it sells 18,000 handbags annually at an average price of $89 each.It is considering adding a lower-priced line of handbags that sell for $59 each.The firm estimates it can sell 7,000 of the lower-priced handbags but will sell 3,000 less of the higher-priced handbags by doing so.What is the amount of the sales that should be used when evaluating the addition of the lower-priced handbags?
A) $146,000
B) $275,000
C) $413,000
D) $623,000
E) $680,000
Q2) Which one of the following best illustrates erosion as it relates to a hot dog stand located on the beach?
A) providing both ketchup and mustard for its customer's use
B) repairing the roof of the hot dog stand because of water damage
C) selling fewer hot dogs because hamburgers were added to the menu
D) offering French fries but not onion rings
E) losing sales due to bad weather
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Chapter 11: Project Analysis and Evaluationpart Five: Risk and Return
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Q1) The Motor Works is considering an expansion project with estimated annual fixed costs of $71,000,depreciation of $38,500,variable costs per unit of $17.90 and an estimated sales price of $26.50 per unit.How many units must the firm sell to break-even on a cash basis?
A) 6,521 units
B) 8,256 units
C) 8,510 units
D) 9,667 units
E) 10,842 units
Q2) At an output level of 50,000 units,you calculate that the degree of operating leverage is 1.8.What will be the percentage change in operating cash flow if the new output level is 54,500 units?
A) 5.00 percent
B) 6.17 percent
C) 16.20 percent
D) 17.43 percent
E) 20.00 percent
Q3) What are the key features of the accounting,cash,and financial break-even points?
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Chapter 12: Some Lessons From Capital Market History
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Q1) Which of the following statements related to market efficiency tend to be supported by current evidence?
I.Markets tend to respond quickly to new information.
II.It is difficult for investors to earn abnormal returns.
III.Short-run prices are difficult to predict accurately based on public information.
IV.Markets are most likely weak form efficient.
A) I and III only
B) II and IV only
C) I and IV only
D) I,III,and IV only
E) I,II,and III only
Q2) Shawn earned an average return of 14.6 percent on his investments over the past 20 years while the S&P 500,a measure of the overall market,only returned an average of 13.9 percent.Explain how this can occur if the stock market is efficient.
Q3) How can an investor lose money on a stock while making money on a bond investment if there is a reward for bearing risk? Aren't stocks riskier than bonds?
Q4) Define and explain the three forms of market efficiency.
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Six: Cost of Capital and Long-Term Financial Policy
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Q1) Which one of the following risks is irrelevant to a well-diversified investor?
A) systematic risk
B) unsystematic risk
C) market risk
D) nondiversifiable risk
E) systematic portion of a surprise
Q2) A stock has a beta of 1.2 and an expected return of 17 percent.A risk-free asset currently earns 5.1 percent.The beta of a portfolio comprised of these two assets is 0.85.What percentage of the portfolio is invested in the stock?
A) 71 percent
B) 77 percent
C) 84 percent
D) 89 percent
E) 92 percent
Q3) Which one of the following statements is correct?
A) The unexpected return is always negative.
B) The expected return minus the unexpected return is equal to the total return.
C) Over time,the average return is equal to the unexpected return.
D) The expected return includes the surprise portion of news announcements.
Page 15
E) Over time,the average unexpected return will be zero.
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Chapter 14: Cost of Capital
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Q1) The dividend growth model can be used to compute the cost of equity for a firm in which of the following situations?
I.firms that have a 100 percent retention ratio
II.firms that pay a constant dividend
III.firms that pay an increasing dividend
IV.firms that pay a decreasing dividend
A) I and II only
B) I and III only
C) II and III only
D) I,II,and III only
E) II,III,and IV only
Q2) Explain how the use of internal equity rather than external equity affects the analysis of a project.
Q3) Give an example of a situation where a firm should adopt the pure play approach for determining the cost of capital for a project.
Q4) What role does the weighted average cost of capital play when determining a project's cost of capital?
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Chapter 15: Raising Capital
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Q1) Barstow Industrial Supply has decided to raise $27.52 million in additional funding via a rights offering.The firm will issue one right for each share of stock outstanding.The offering consists of a total of 860,000 new shares.The current market price of the stock is $38.Currently,there are 5.16 million shares outstanding.What is the value of one right?
A) $0.97
B) $0.86
C) $0.48
D) $0.52
E) $0.60
Q2) Which one of the following statements concerning venture capital financing is correct?
A) Venture capitalists desire shares of common stock but avoid preferred stock.
B) Venture capital is relatively easy to obtain.
C) Venture capitalists rarely assume active roles in the management of the financed firm.
D) Venture capitalists often require at least a forty percent equity position as a condition of financing.
E) Venture capital is relatively inexpensive in today's competitive markets.
Q3) Explain why there is a tendency for IPOs to be underpriced.
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Page 17
Chapter 16: Financial Leverage and Capital Structure Policy
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Q1) Lamont Corp.uses no debt.The weighted average cost of capital is 11 percent.The current market value of the equity is $38 million and there are no taxes.What is EBIT?
A) $3,423,000
B) $3,508,600
C) $3,781,100
D) $3,898,700
E) $4,180,000
Q2) L.A.Clothing has expected earnings before interest and taxes of $48,900,an unlevered cost of capital of 14.5 percent,and a tax rate of 34 percent.The company also has $8,000 of debt that carries a 7 percent coupon.The debt is selling at par value.What is the value of this firm?
A) $222,579.31
B) $223,333.33
C) $224,108.16
D) $225,299.31
E) $225,476.91
Q3) Explain how a firm loses value during the bankruptcy process from both a creditors and a shareholders perspective.
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Chapter 17: Dividends and Payout Policypart Seven: Short-Term
Financial Planning and Management
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Q1) Which of the following shareholders tend to favor a high dividend policy?
I.retired individuals
II.endowment funds
III.corporate investors
IV.investors with high dividend tax rates but low capital gains tax rates
A) I and III only
B) II and IV only
C) I,II,and III only
D) II,III,and IV only
E) I,II,III,and IV
Q2) Which one of the following dates is used to determine the names of shareholders who will receive a dividend payment?
A) ex-rights date
B) ex-dividend date
C) date of record
D) date of payment
E) declaration date
Q3) Explain how cash dividends affect individual shareholders differently than an equal amount of funds spent on a repurchase.
Q4) Explain the meaning of the dividend clientele effect and why it is important.
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Chapter 18: Short-Term Finance and Planning
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Q1) Juno Industrial Supply has a $150,000 line of credit with a 7.5 percent interest rate.The loan agreement requires a 2 percent compensating balance,which is based on the total amount borrowed,and which will be held in an interest-free account.What is the effective interest rate if the firm borrows $90,000 on the line of credit for one year?
A) 5.42 percent
B) 5.50 percent
C) 7.30 percent
D) 7.50 percent
E) 7.65 percent
Q2) Which of the following are uses of cash?
I.collecting a receivable
II.increasing inventory
III.obtaining a bank loan
IV.paying a supplier for previous purchases
A) I and III only
B) II and IV only
C) I and II only
D) I,II,and IV only
E) II,III,and IV only
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Chapter 19: Cash and Liquidity Management
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Q1) The Hobby Shop has a checking account with a ledger balance of $692.The firm has $1,063 in uncollected deposits and $930 in outstanding checks.What is the amount of the disbursement float on this account?
A) $0
B) $217
C) $930
D) $990
E) $1,063
Q2) The Presque Isle Center has branch operations in three states.Each branch deals with a local bank.However,all excess funds in these branch bank accounts are transferred on a daily basis to the firm's primary bank located near the firm's home office.This routine of transferring cash to the primary bank on a regular basis is referred to as:
A) cash concentration.
B) strategic cash disbursement.
C) transfer flotation.
D) payables management.
E) float management.
Q3) Explain how a lockbox system operates and why a firm might consider implementing such a system.
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Topics in Corporate Finance
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Q1) Which one of the following statements is correct?
A) If the majority of a firm's new customers become repeat customers then there is a strong argument against extending credit even if the default rate is low.
B) A customer's past payment history reveals little information in relation to his or her future tendency to pay.
C) A suggested policy for offering credit to new customers is to limit the amount of their initial credit purchase.
D) The risk of issuing credit is the same for a new customer as it is for an existing customer.
E) The recommended credit policy for new customers is to extend the maximum amount of credit you will ever be willing to offer as an enticement to get their business.
Q2) Which one of the five Cs of credit refers to a firm's financial reserves?
A) character
B) capacity
C) collateral
D) conditions
E) capital
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22
Chapter 21: International Corporate Finance
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Q1) You are analyzing a project with an initial cost of £130,000.The project is expected to return £20,000 the first year,£50,000 the second year and £90,000 the third and final year.There is no salvage value.The current spot rate is £0.6211.The nominal risk-free return is 5.5 percent in the U.K.and 6 percent in the U.S.The return relevant to the project is 14 percent in the U.S.Assume that uncovered interest rate parity exists.What is the net present value of this project in U.S.dollars?
A) -$19,062
B) -$5,409
C) $5,505
D) $9,730
E) $18,947
Q2) Which one of the following states that the expected percentage change in the exchange rate between two countries is equal to the difference in the countries' interest rates?
A) unbiased forward rates condition
B) uncovered interest parity
C) international Fisher effect
D) purchasing power parity
E) interest rate parity
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Page 23
Chapter 22: Behavioral Finance: Implications for Financial Management
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Q1) Roger's Meat Market is a chain of retail stores that limits its sales to fresh-cut meats.The stores have been very profitable in northern cities.However,when two stores were opened in the south,both lost money and had to be closed.Roger,the owner,has now concluded that no southern-based store should be opened as it would not be profitable.Which one of the following applies to Roger?
A) confirmation bias
B) endowment effect
C) money illusion
D) affect heuristic
E) representativeness heuristic
Q2) Stewart is a fellow finance student at your school who is addicted to day trading and thus buys and sells stocks between classes and over his lunch break.He never has time to really analyze a security so just trades the stock symbols that other investors appear to be trading.Stewart is which one of the following?
A) noise trader
B) arbitrageur
C) crasher
D) regret averter
E) myopic loss averter
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Chapter 23: Enterprise Risk Management
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Q1) Futures contracts:
A) are identical to forward contracts except for the size of the contract.
B) provides an option to purchase an asset at a specified price on the settlement date.
C) are marked to the market on a daily basis.
D) cannot be resold.
E) are limited to contracts on financial assets.
Q2) A swap dealer in the U.S.:
A) acts solely as a seller of swap contracts.
B) matches buyers to sellers.
C) only deals if its book is matched.
D) is frequently a commercial bank.
E) trades electronically via NASDAQ.
Q3) A bakery generally enters into a forward contract in wheat as a:
A) hedger.
B) speculator.
C) spot trader.
D) broker.
E) spectator.
Q4) Explain why a swap is effectively a series of forward contracts.
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Chapter 24: Options and Corporate Finance
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Q1) An increase in which of the following will increase the value of a call?
I.time to expiration
II.underlying stock price
III.risk-free rate of return
IV.price volatility of the underlying stock
A) I and III only
B) II,III,and IV only
C) I,III,and IV only
D) I,II,and III only
E) I,II,III,and IV
Q2) Which one of the following describes the lower bound of a call's value?
A) strike price or zero,whichever is greater
B) stock price minus the exercise price or zero,whichever is greater
C) strike price or the stock price,whichever is lower
D) strike price or zero,whichever is lower
E) stock price minus the exercise price or zero,whichever is lower
Q3) Circle Stores stock is priced at $28 a share.A $40 call on this stock has five months until expiration and a call price of $0.15.Why would an investor purchase a call that is so far out of the money?
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Chapter 25: Option Valuation
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Q1) Give an example of a protective put and explain how this strategy reduces investor risk.
Q2) J&N,Inc.stock has a current market price of $46 a share.The one-year call on this stock with a strike price of $55 is priced at $0.05 while the one-year put with a strike price of $55 is priced at $8.24.What is the risk-free rate of return?
A) 1.49 percent
B) 1.82 percent
C) 3.10 percent
D) 3.64 percent
E) 4.21 percent
Q3) Explain why the equity ownership of a firm is equivalent to owning a call option on the firm's assets.
Q4) In the Black-Scholes model,the symbol " " is used to represent the standard deviation of the:
A) option premium on a call with a specified exercise price.
B) rate of return on the underlying asset.
C) volatility of the risk-free rate of return.
D) rate of return on a risk-free asset.
E) option premium on a put with a specified exercise price.
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Chapter 26: Mergers and Acquisitions
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Q1) A proposed acquisition may create synergy by:
I.increasing the market power of the combined firm.
II.improving the distribution network of the acquiring firm.
III.providing the combined firm with a strategic advantage.
IV.reducing the utilization of the acquiring firm's assets.
A) I and III only
B) II and III only
C) I and IV only
D) I,II,and III only
E) I,II,III,and IV
Q2) Melvin was attempting to gain control of Western Wood Products until he realized that the existing shareholders in the firm had the right to purchase additional shares at a below-market price given his hostile takeover attempt.Thus,Melvin decided to forego investing in this firm.What term applies to the tactic used by Western Wood Products to stave off this takeover attempt?
A) pac-man defense
B) shark repellent plan
C) golden parachute provision
D) greenmail provision
E) share rights plan
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Chapter 27: Leasing
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Sample Questions
Q1) The Wildcat Oil Company is trying to decide whether to lease or buy a new computer-assisted drilling system for its oil exploration business.Management has decided that it must use the system to stay competitive;it will provide $1.2 million in annual pretax cost savings.The system costs $6.7 million and will be depreciated straight-line to zero over 4 years.Wildcat's tax rate is 35 percent,and the firm can borrow at 11 percent.Lambert Leasing Company has offered to lease the drilling equipment to Wildcat for payments of $1,700,000 per year.Lambert's policy is to require its lessees to make payments at the start of the year.Lambert requires Wildcat to pay a $270,000 security deposit at the inception of the lease.What is the NAL of leasing the equipment?
A) $541,287
B) $658,844
C) $660,318
D) $661,828
E) $664,719
Q2) Why might a firm opt to sell and leaseback an asset which it currently owns?
Q3) Explain the differences between purchasing an asset and leasing an asset.
Q4) What are some "good" reasons for opting to lease rather than purchase an asset?
Q5) Explain the "leasing paradox" and also explain why leasing is or is not a "zero sum game".
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