True or False: Please indicate whether each statement is true or false. (2 points per question)

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Fin 1001 principles of finance mcqs n short problems

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1. In general, the role of the financial manager is to plan for the acquisition and use of funds so as to maximize the value of the firm.

2. The disadvantages associated with a proprietorship are similar to those under a partnership. One exception to this is due to the formal nature of the partnership agreement and the commitment of the partners’ personal assets. As a result, partnerships do not have difficulty raising large amounts of capital.

3. The current ratio and inventory turnover ratio measure the liquidity of a firm. The current ratio measures the relation of a firm’s current assets to its current liabilities and the inventory turnover ratio measures how rapidly a firm turns its inventory back into a “quick” asset or cash.

4. Selling new stock is an equity transaction; it does not affect any asset or liability account and therefore, does not appear on the statement of cash flows.

5. Financial asset markets deal with stocks, bonds, mortgages, and other claims on real assets with respect to the distribution of future cash flows.

6. The existence of financial intermediaries greatly increases the efficiency of financial markets because, without them, savers would have to provide funds directly to borrowers, which would be a much costlier process.

7. Of all the techniques used in finance, the least important is the concept of the time value of money.

8. The difference between an ordinary annuity and an annuity due is that each of the payments of the annuity due earns interest for one additional year (period).

9. The nominal rate of interest is defined as the sum of the nominal risk-free rate of return and the expected inflation rate.

10. An investor with a six-year investment horizon believes that interest rates are determined only by expectations about future interest rates, (i.e., this investor believes in the expectations theory). This investor should expect to earn the same rate of return over the 6-year time horizon if he or she buys a 6-year bond or a 3-year bond now and another 3-year bond three years from now (ignore transaction costs).

11. There is an inverse relationship between bond ratings and the required return on a bond. The required return is lowest for AAA rated bonds, and required returns increase as the ratings get lower (worse).

12. Although common stock represents a riskier investment to an individual than do bonds, in the sense of exposing the firm to the risk of bankruptcy, bonds represent a riskier method of financing to a corporation than does common stock.

13. The book value per share is computed by taking the sum of common stock, additional paid in capital, and retained earnings and dividing the number by the number of shares outstanding.

14. When management controls more than 50% of the shares of the firm, they must be concerned with the potential of a proxy fights than can lead to takeovers of the firm and the replacement of management.

15. Assume Stock A has a standard deviation of 0.21 while Stock B has a standard deviation of 0.10. If both Stock A and Stock B must be held in isolation, and if investors are risk averse, we can conclude that Stock A will have a greater required return. However, if the assets could be held in portfolios, it is conceivable that the required return could be higher on the low standard deviation stock.

Multiple Choice (2 points per question):

16. The primary goal of a financial manager should be to __________.

a.

minimize operating costs

b.

minimize interest payments

c.

minimize tax payments

d.

maximize operating income each year

e.

maximize the value of the firm’s stock

17. Which of the following statements about the corporate form of business organization is incorrect?

a.

The corporation is the easiest form of business organization to establish.

b.

In the United States, corporations generate a significantly greater percentage of total annual sales than either partnerships or proprietorships.

c.

Corporations generally are larger than either partnerships or proprietorships.

d.

One of the most important features of the corporate form of business organization is that stockholders have limited liability.

e.

None of the above.

18. Other things held constant, if a firm holds cash balances in excess of their optimal level in a non-interest bearing account, this will tend to lower the firm’s

a.

Profit margin.

b.

Total asset turnover.

c.

Return on equity.

d.

All of the above.

e.

Answers b and c above.

19. Bubbles Soap Corporation has a quick ratio of 1.0 and a current ratio of 2.0 implying that

a.

the value of current assets is equal to the value of inventory.

b.

the value of current assets is equal to the value of current liabilities.

c.

the value of current liabilities is equal to the value of inventory.

d.

All of the above.

e.

None of the above.

20. When a corporation wants to raise funds by issuing new stocks or bonds, it generally uses the services of

a.

an investment banker.

b.

a commercial lender.

c.

the Securities and Exchange Commission (SEC).

d.

the New York Stock Exchange (NYSE).

e.

None of the above.

21. Which of the following is usually cited as a disadvantage of issuing new common stock as a method of financing?

a.

Common stock does not have a maturity date, thus it is an open-end commitment of the firm’s earnings.

b.

Since sale of common stock increases the number of owners and the amount of capital at risk, the firm’s bond rating is usually negatively affected and its cost of debt rises.

c.

If the firm currently has more equity than its optimal capital structure dictates and it issues more equity, then the average cost of capital will most likely rise.

d.

Common stock is not an attractive option if the firm seeks to increase its reserve borrowing capacity.

22. You have determined the profitability of a planned project by finding the present value of all the cash flows form that project. Which of the following would cause the project to look more appealing in terms of the present value of those cash flows?

a.

The discount rate decreases.

b.

The cash flows are extended over a longer period of time, but the total amount of the cash flows remains the same.

c.

The discount rate increases.

d.

Answers b and c above.

e.

Answers a and b above.

23. Which of the following statements is correct?

a.

For all positive values of k and n, FVIFr, n 1.0 and PVIFAr, n n.

b.

You may use the PVIF tables to find the present value of an uneven series of payments. However, the PVIFA tables can never be of use, even if some of the payments constitute an annuity (for example, $100 each year for Years 3, 4, and 5), because the entire series does not constitute an annuity.

c.

If a bank uses quarterly compounding for saving accounts, the simple rate will be greater than the effective annual rate.

d.

The present value of a future sum decreases as either the simple interest rate or the number of discount periods per year increases.

e.

All of the above statements are false.

24. If the yield curve is downward sloping, what is the yield to maturity on a 10-year Treasury coupon bond, relative to that on a 1-year T-bond?

a.

The yield on the 10-year bond is less than the yield on a 1-year bond.

b.

The yield on a 10-year bond will always be higher than the yield on a 1-year bond because of maturity premiums.

c.

It is impossible to tell without knowing the coupon rates of the bonds.

d.

The yields on the two bonds are equal.

e.

It is impossible to tell without knowing the relative risks of the two bonds.

25. Assume that the current yield curve is upward sloping, or normal. This implies that

a.

Short-term interest rates are more volatile than long-term rates.

b.

Inflation is expected to subside in the future.

c.

The economy is at the peak of a business cycle.

d.

Long-term bonds are a better buy than short-term bonds.

e.

None of the above statements is necessarily implied by the yield curve given.

26. Which of the following are generally considered advantages of term loans over publicly issued bonds?

a.

Lower flotation costs.

b.

Speed, or how long it takes to bring the issue to market.

c.

Flexibility, or the ability to adjust the bond’s terms after it has been issued.

d.

All of the above.

e.

Only answers b and c above.

27. Which of the following types of debt are backed by some form of specific property?

a.

Debenture.

b.

Mortgage bond.

c.

Subordinated debt.

d.

All of the above.

e.

None of the above.

28. In international markets, excluding stocks sold in the United States, what is any stock that is traded in a country other than the issuing company’s home country called?

a.

ADRs

b.

Yankee stock

c.

Euro stock

d.

Class A stock

e.

Preferred stock

29. A firm expects to pay dividends at the end of each of the next four years of $2.00, $1.50, $2.50, and $3.50. If growth is then expected to level off at 8 percent, and if you require a 14 percent rate of return, how much should you be willing to pay for this stock?

a.

$67.81

b.

$22.49

c.

$58.15

d.

$31.00

e.

$43.97

30. Choose the correct answer for the following: (1) Which is the best measure of risk for choosing an asset which is to be held in isolation? (2) Which is the best measure for choosing an asset to be held as part of a diversified portfolio?

a.

Variance; correlation coefficient.

b.

Standard deviation; correlation coefficient.

c.

Beta; variance.

d.

Coefficient of variation; beta.

e.

Beta; beta.

Problems:

31. The Amer Company has the following characteristics:

Sales:

$1,000

Total Assets:

$1,000

Total Debt/Total Assets:

35%

EBIT:

$ 200

Tax rate:

40%

Interest rate on total debt:

4.57%

What is Amer’s ROE? (5 points)

32. The Meryl Corporation’s common stock currently is selling at $100 per share, which represents a P/E ratio of 10. If the firm has 100 shares of common stock outstanding, a return on equity of 20 percent, and a debt ratio of 60 percent, what is its return on total assets (ROA)? (5 points)

33. You deposited $1,000 in a savings account that pays 8 percent interest, compounded quarterly, planning to use it to finish your last year in college. Eighteen months later, you decide to go to the Rocky Mountains to become a ski instructor rather than continue in school, so you close out your account. How much money will you receive? (5 points)

34. Assume that you can invest to earn a stated annual rate of return of 12 percent, but where interest is compounded semiannually. If you make 20 consecutive semiannual deposits of $500 each, with the first deposit being made today, what will your balance be at the end of Year 20? (5 points)

35. In its first year of operations, 1999, the Gourmet Cheese Shoppe had earnings per share (EPS) of $0.26. Four years later, in 2003, EPS was up to $0.38, and 7 years after that, in 2010, EPS was up to $0.535. It appears that the first 4 years represented a supernormal growth situation and since then a more normal growth rate has been sustained. What are the rates of growth for the earlier period and for the later period? (5 points)

36. Treasury securities that mature in 6 years currently have an interest rate of 8.5%. Inflation is expected to be 5% each of the next three years and 6% each year after the third year. The maturity risk premium is estimated to be 0.1%(t – 1), where t is equal to the maturity of the bond (i.e., the maturity risk premium of a one-year bond is zero). The real risk-free rate is assumed to be constant over time. What is the real risk-free rate of interest? (5 points)

37. Assume that you wish to purchase a 20-year bond that has a maturity value of $1,000 and makes semiannual interest payments of $40. If you require a 10 percent simple yield to maturity on this investment, what is the maximum price you should be willing to pay for the bond? (5 points)

38. Blow Glass Corporation has 100,000 shares of stock outstanding, each with a par value of $2.50 per share. Blow Glass also has another 400,000 shares of stock that are shelf registered. Blow Glass has retained earnings of $9,000,000 and additional paid-in capital of $1,000,000. What is Blow Glass’s book value per share? (5 points)

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