Financial Analysis
Midterm Exam
Course Introduction
Financial Analysis is an essential course that equips students with the skills to interpret, evaluate, and analyze financial statements and data to assess the financial health and performance of businesses. The course covers key concepts such as ratio analysis, cash flow analysis, trend analysis, and benchmarking, providing students with practical tools to make informed financial decisions. Emphasis is placed on using financial information for strategic planning, investment decisions, and risk management, enabling students to develop a critical understanding of both qualitative and quantitative aspects of financial reporting in real-world scenarios.
Recommended Textbook
Intermediate Financial Management 13th Edition by Eugene F. Brigham
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Page 2
Chapter 1: An Overview of Financial Management and the Financial Environment
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Q1) The form of organization for a business is not an important issue, as this decision has very little effect on the income and wealth of the firm's owners.
A)True
B)False
Answer: False
Q2) If a firm's goal is to maximize its earnings per share, this is the best way to maximize the price of the common stock and thus shareholders' wealth.
A)True
B)False
Answer: False
Q3) Money markets are markets for
A) foreign stocks.
B) consumer automobile loans.
C) u.s. stocks.
D) short-term debt securities.
E) long-term bonds.
Answer: D
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Page 3
Chapter 2: Risk and Return-Part I
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Q1) Which of the following statements is CORRECT?
A) portfolio diversification reduces the variability of returns on an individual stock.
B) risk refers to the chance that some unfavorable event will occur, and a probability distribution is completely described by a listing of the likelihood of unfavorable events.
C) the sml relates a stock's required return to its market risk. the slope and intercept of this line cannot be controlled by the firms' managers, but managers can influence their firms' positions on the line by such actions as changing the firm's capital structure or the type of assets it employs.
D) a stock with a beta of -1.0 has zero market risk if held in a 1-stock portfolio.
E) when diversifiable risk has been diversified away, the inherent risk that remains is market risk, which is constant for all stocks in the market.
Answer: C
Q2) A stock with a beta equal to -1.0 has zero systematic (or market) risk.
A)True
B)False
Answer: False
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Chapter 3: Risk and Return-Part II
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Sample Questions
Q1) You have the following data on three stocks: \(\begin{array}{lll}
\text { Stock }&\text { Standard Deviation }&\text { Beta }\\
\mathrm{A} & 0.15 & 0.79 \\ \mathrm{~B} & 0.25 & 0.61 \\ \mathrm{C} & 0.20 & 130 \end{array}\)
As a risk minimizer, you would choose Stock ____ if it is to be held in isolation and Stock ____ if it is to be held as part of a well-diversified portfolio.
A) a; b.
B) b; c.
C) c; a.
D) c; b.
E) a; a.
Answer: A
Q2) If the returns of two firms are negatively correlated, then one of them must have a negative beta.
A)True
B)False
Answer: True
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Page 5
Chapter 4: Bond Valuation
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Q1) For bonds, price sensitivity to a given change in interest rates is generally greater the longer before the bond matures.
A)True
B)False
Q2) Which of the following statements is CORRECT?
A) liquidity premiums are generally higher on treasury than corporate bonds.
B) the maturity premiums embedded in the interest rates on u.s. treasury securities are due primarily to the fact that the probability of default is higher on long-term bonds than on short-term bonds.
C) default risk premiums are generally lower on corporate than on treasury bonds.
D) reinvestment rate risk is lower, other things held constant, on long-term than on short-term bonds.
E) if the maturity risk premium were zero and interest rates were expected to decrease in the future, then the yield curve for u.s. treasury securities would, other things held constant, have an upward slope.
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6
Chapter 5: Financial Options
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Q1) 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
Q2) Suppose you believe that Florio Company's stock price is going to decline from its current level of $82.50 sometime during the next 5 months. For $5.10 you could buy a 5-month put option giving you the right to sell 1 share at a price of $85 per share. If you bought this option for $5.10 and Florio's stock price actually dropped to $60, what would your pre-tax net profit be?
A)$5.10
B) $19.90
C) $20.90
D) $22.50
E) $27.60
Q3) An option is a contract that gives its holder the right to buy or sell an asset at a predetermined price within a specified period of time.
A)True
B)False
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Chapter 6: Accounting for Financial Management
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Q1) Which of the following statements is CORRECT?
A) the statement of cash flows shows how much the firm's cash the total of currency, bank deposits, and short-term liquid securities (or cash equivalents) increased or decreased during a given year.
B) the statement of cash flows reflects cash flows from operations, but it does not reflect the effects of buying or selling fixed assets.
C) the statement of cash flows shows where the firm's cash is located; indeed, it provides a listing of all banks and brokerage houses where cash is on deposit.
D) the statement of cash flows reflects cash flows from continuing operations, but it does not reflect the effects of changes in working capital.
E) the statement of cash flows reflects cash flows from operations and from borrowings, but it does not reflect cash obtained by selling new common stock.
Q2) To estimate the cash flow from operations, depreciation must be added back to net income because it is a non-cash charge that has been deducted from revenue.
A)True
B)False
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Chapter 7: Analysis of Financial Statements
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Q1) Which of the following statements is CORRECT?
A) "window dressing" is any action that improves a firm's fundamental, long-run position and thus increases its intrinsic value.
B) borrowing by using short-term notes payable and then using the proceeds to retire long-term debt is an example of "window dressing." offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is another example of "window dressing."
C) borrowing on a long-term basis and using the proceeds to retire short-term debt would improve the current ratio and thus could be considered to be an example of "window dressing."
D) offering discounts to customers who pay with cash rather than buy on credit and then using the funds that come in quicker to purchase additional inventories is an example of "window dressing."
E) using some of the firm's cash to reduce long-term debt is an example of "window dressing."
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Chapter 8: Basic Stock Valuation
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Q1) The last dividend paid by Wilden Corporation was $1.55. The dividend growth rate is expected to be constant at 1.5% for 2 years, after which dividends are expected to grow at a rate of 8.0% forever. The firm's required return (rs) is 12.0%. What is the best estimate of the current stock price?
A) $37.05
B) $38.16
C) $39.30
D) $40.48
E) $41.70
Q2) If a stock's dividend is expected to grow at a constant rate of 5% a year, which of the following statements is CORRECT? The stock is in equilibrium.
A) the stock's dividend yield is 5%.
B) the price of the stock is expected to decline in the future.
C) the stock's required return must be equal to or less than 5%.
D) the stock's price one year from now is expected to be 5% above the current price.
E) the expected return on the stock is 5% a year.
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Chapter 9: Corporate Valuation and Financial Planning
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Q1) 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
Q2) If Decker had a financing deficit, it could remedy the situation by
A) buying back common stock
B) paying a special dividend
C) paying down its long-term debt
D) borrowing on its line of credit
E) borrowing from retained earnings
Q3) A firm's AFN must come from external sources. Typical sources include short-term bank loans, long-term bonds, preferred stock, and common stock.
A)True
B)False
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11
Chapter 10: Corporate Governance
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Q1) Which one of the following statements is TRUE?
A) an example of an agency cost is when an outside investor is only willing to pay less for stockbecause she thinks the original owner will consume too many perquisites.
B) an example of an agency cost is when the board of directors pays a dividend to shareholders.
C) an example of an agency cost is when an attorney hires an expert witness for a trial.
D) the commission required by the federal housing agency for a small business loan is an example ofan agency cost.
E) an example of an agency cost is the salary of the agent hired to work for the principal.
Q2) Which of the following is NOT normally regarded as being a barrier to hostile takeovers?
A) targeted share repurchases.
B) shareholder rights provisions.
C) restricted voting rights.
D) poison pills.
E) abnormally high executive compensation.
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12
Chapter 11: Determining the Cost of Capital
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Q1) The cost of equity raised by retaining earnings can be less than, equal to, or greater than the cost of external equity raised by selling new issues of common stock, depending on tax rates, flotation costs, the attitude of investors, and other factors.
A)True
B)False
Q2) The cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on all outstanding debt.
A)True
B)False
Q3) The cost of perpetual preferred stock is found as the preferred's annual dividend divided by the market price of the preferred stock. No adjustment is needed for taxes because preferred dividends, unlike interest on debt, is not deductible by the issuing firm. A)True
B)False
Q4) "Capital" is sometimes defined as funds supplied to a firm by investors. A)True
B)False
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13
Chapter 12: Capital Budgeting: Decision Criteria
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Q1) Hart Corp. is considering a project that has the following cash flow data. What is the project's IRR? Note that a project's IRR can be less than the cost of capital or negative, in both cases it will be rejected.
\(\begin{array}{l}
\begin{array} { l }
\text { Year } \\
\text { Cash flows } \end{array}
\begin{array} { c c c c }
0 & 1 & 2 & 3 \\
\hline - \$ 1,000 & \$ 425 & \$ 425 & \$ 425 \end{array}
\end{array}\)
A) 12.55%
B) 13.21%
C) 13.87%
D) 14.56%
E) 15.29%
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Chapter 13: Capital Budgeting-Estimating Cash Flows and Analyzing Risk
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Q1) Any cash flows that can be classified as incremental to a particular project-i.e., results directly from the decision to undertake the project should be reflected in the capital budgeting analysis.
A)True
B)False
Q2) Because of differences in the expected returns on different investments, the standard deviation is not always an adequate measure of risk. However, the coefficient of variation adjusts for differences in expected returns and thus allows investors to make better comparisons of investments' stand-alone risk.
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 14: Real Options
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Q1) Real options exist when managers have the opportunity, after a project has been implemented, to make operating changes in response to changed conditions that modify the project's cash flows.
A)True
B)False
Q2) Refer to data for Steppingstone Incorporated. Based on the above information, what is the Z 90's expected net present value?
A)$6,678
B)$3,251
C) $15,303
D) $20,004
E) $45,965
Q3) Which of the following will NOT increase the value of a real option?
A) an increase in the volatility of the underlying source of risk.
B) an increase in the risk-free rate.
C) an increase in the cost of obtaining the real option.
D) a decrease in the probability that a competitor will enter the market of the project in question.
E) lengthening the time in which a real option must be exercised.
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Page 16
Chapter 15: Distributions to Shareholders-Dividends and Repurchases
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Q1) Consider two very different firms, M and N. Firm M is a mature firm in a mature industry. Its annual net income and net cash flows are both consistently high and stable. However, M's growth prospects are quite limited, so its capital budget is small relative to its net income. Firm N is a relatively new firm in a new and growing industry. Its markets and products have not stabilized, so its annual operating income fluctuates considerably. However, N has substantial growth opportunities, and its capital budget is expected to be large relative to its net income for the foreseeable future. Which of the following statements is correct?
A) firm m probably has a higher dividend payout ratio than firm n.
B) if the corporate tax rate increases, the debt ratio of both firms is likely to decline.
C) the two firms are equally likely to pay high dividends.
D) firm n is likely to have a clientele of shareholders who want to receive consistent, stable dividend income.
E) firm m probably has a lower debt ratio than firm n.
Q2) A reverse split reduces the number of shares outstanding.
A)True
B)False
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Page 17
Chapter 16: Capital Structure Decisions
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Q1) Companies HD and LD have identical tax rates, total assets, and return on invested capital (ROIC), and their ROIC exceeds their after-tax cost of debt, (1-T) rd. However, Company HD has a higher debt ratio and thus more interest expense than Company LD. Which of the following statements is CORRECT?
A) company hd has a lower roa than company ld.
B) company hd has a lower roe than company ld.
C) the two companies have the same roa.
D) the two companies have the same roe.
E) company hd has a higher net income than company ld.
Q2) If a firm utilizes debt financing, an X% decline in earnings before interest and taxes (EBIT) will result in a decline in earnings per share that is larger than X.
A)True
B)False
Q3) A firm's capital structure does not affect its calculated free cash flows, because FCF reflects only operating cash flows.
A)True
B)False
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Page 18
Chapter 17: Dynamic Capital Structures and Corporate Valuation
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Q1) MM showed that in a world without taxes, a firm's value is not affected by its capital structure.
A)True
B)False
Q2) Which of the following statements about valuing a firm using the compressed adjusted present value (CAPV) approach is most CORRECT?
A) the horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the cost of debt.
B) the horizon value is calculated by discounting the expected earnings at the wacc.
C) the horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the wacc.
D) the horizon value must always be more than 20 years in the future.
E) the horizon value is calculated by discounting the free cash flows beyond the horizon date and any tax savings at the levered cost of equity.
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19
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Q1) Which of the following statements about listing on a stock exchange is most CORRECT?
A) any firm can be listed on the nyse as long as it pays the listing fee.
B) listing provides a company with some "free" advertising, and it may enhance the firm's prestige and help it do more business.
C) listing reduces the reporting requirements for firms, because listed firms file reports with the exchange rather than with the sec.
D) the otc is the second largest market for listed stock, and it is exceeded only by the nyse.
E) listing is a decision of more significance to a firm than going public.
Q2) The term "equity carve-out" refers to the situation where a firm's managers give themselves the right to purchase new stock at a price far below the going market price. Since this dilutes the value of the public stockholders, it "carves out" some of their value.
A)True
B)False
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Page 20
Chapter 19: Lease Financing
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Q1) In the lease versus buy decision, leasing is often preferable
A) because, generally, no down payment is required, and there are no indirect interest costs.
B) because lease obligations do not affect the firm's risk as seen by investors.
C) because the lessee owns the property at the end of the least term.
D) because the lessee may have greater flexibility in abandoning the project in which the leased property is used than if the lessee bought and owned the asset.
E) because it has no effect on the firm's ability to borrow to make other investments.
Q2) Leasing is often referred to as off-balance sheet financing because lease payments are shown as operating expenses on a firm's income statement and, under certain conditions, leased assets and associated liabilities do not appear on the firm's balance sheet.
A)True
B)False
Q3) The full amount of a lease payment is tax deductible provided the contract qualifies as a true lease under IRS guidelines.
A)True
B)False
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Chapter 20: Hybrid Financing Preferred Stock-Warrants and Convertibles
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Q1) Firms generally do not call their convertibles unless the conversion value is greater than the call price.
A)True
B)False
Q2) A detachable warrant is a warrant that can be detached and traded separately from the bond with which it was issued. Most traded warrants are originally attached to bonds or preferred stocks.
A)True
B)False
Q3) The problem of dilution of stockholders' earnings never results from the sale of call options, but it can arise if warrants are used.
A)True
B)False
Q4) Preferred stock can provide a financing alternative for some firms when market conditions are such that they cannot issue either pure debt or common stock at any reasonable cost.
A)True B)False
Page 22
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Chapter 21: Supply Chains and Working Capital Management
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Q1) Which of the following is NOT a situation that might lead a firm to increase its holdings of short-term marketable securities?
A) the firm is going from its peak sales season to its slack season, so its receivables and inventories will experience a seasonal decline.
B) the firm is going from its slack season to its peak sales season, so its receivables and inventories will experience seasonal increases.
C) the firm has just sold long-term securities and has not yet invested the proceeds in operating assets.
D) the firm just won a product liability suit one of its customers had brought against it. E) the firm must make a known future payment, such as paying for a new plant that is under construction.
Q2) Determining a firm's optimal investment in working capital and deciding how that investment should be financed are critical to working capital management.
A)True
B)False
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Chapter 22: Providing and Obtaining Credit
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Q1) Sunnydale Organics, Inc. harvests crops in roughly 90-day cycles based on a 360-day year. The firm receives payment from its harvests sometime after shipment. Due in part to the firm's rapid growth, it has been borrowing to finance its harvests using 90-day bank notes on which the firm pays 12 percent discount interest. If the firm requires $60,000 in proceeds from each note, what must be the face value of each note?
A) $61,856
B) $67,531
C) $60,000
D) $68,182
E) $67,423
Q2) Refer to Exhibit Reese Brothers. What would be the incremental bad losses if the change were made?
A) $315,000
B) $260,500
C) $260,500 (bad debt losses would decline)
D)$315,000 (bad debt losses would decline)
E) $0 (no change would occur)
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Page 24
Chapter 23: Other Topics in Working Capital Management
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Q1) Refer to Exhibit Duckett Group. What will be the total cost to Duckett of maintaining the optimal average cash balance, as determined by the Baumol model?
A) $35,356
B) $7,071
C) $18,493
D) $70,711
E) $53,190
Q2) Gemini Inc.'s optimal cash transfer amount, using the Baumol model, is $60,000. The firm's fixed cost per cash transfer of marketable securities to cash is $180, and the total cash needed for transactions annually is $960,000. On what opportunity cost of holding cash was this analysis based?
A) 19.2%
B) 10.4%
C) 6.3%
D) 12.1%
E) 9.6%
Q3) If a company increases its safety stock, then its EOQ will go up.
A)True
B)False
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Chapter 24: Enterprise Risk Management
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Q1) Company A can issue floating-rate debt at LIBOR + 1% and can issue fixed rate debt at 9%. Company B can issue floating-rate debt at LIBOR + 1.5% and can issue fixed-rate debt at 9.4%. Suppose A issues floating-rate debt and B issues fixed-rate debt, after which they engage in the following swap: A will make a fixed 7.95% payment to B, and B will make a floating-rate payment equal to LIBOR to A. What are the resulting net payments of A and B?
A) a pays a fixed rate of 9%, b pays libor + 1.5%.
B) a pays a fixed rate of 8.95%, b pays libor + 1.45%.
C) a pays libor plus 1%, b pays a fixed rate of 9.4%.
D) a pays a fixed rate of 7.95%, b pays libor.
E) none of the above answers is correct.
Q2) One objective of risk management can be to reduce the volatility of a firm's cash flows.
A)True
B)False
Q3) Interest rate swaps allow a firm to exchange fixed for floating-rate payments, but a swap cannot reduce actual net interest expenses.
A)True
B)False
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Page 26
Chapter 25: Bankruptcy-Reorganization and Liquidation
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Q1) Bankruptcy laws have been used to help reach settlements in major product liability lawsuits. By using financial projections to show that contingent claims against the company jeopardize its existence, agreements are reached, partially satisfying claimants, and allowing the firm to continue operating.
A)True
B)False
Q2) A central question that must be addressed in bankruptcy proceedings is whether the firm's inability to meet scheduled interest payments results from a temporary cash flow problem or from a potentially permanent problem caused by falling asset values.
A)True
B)False
Q3) One of the actions that can be taken in bankruptcy under the standard of feasibility is to replace existing management with a new team if the quality of management is judged to have been substandard.
A)True
B)False
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Chapter 26: Mergers and Corporate Control
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Q1) Which of the following are legal and acceptable reasons for the high level of merger activity in the U.S. during the 1980s
A) a profitable firm acquires a firm with large accumulated tax losses that may be carried forward.
B) attempts to stabilize earnings by diversifying.
C) purchase of assets below their replacement costs.
D) reduction in competition resulting from mergers.
E) synergistic benefits arising from mergers.
Q2) Any goodwill created in a merger must be amortized over its expected life, usually 40 years, for shareholder reporting purposes.
A)True
B)False
Q3) Since managers' central goal is to maximize stock price, managerial control issues do not interfere with mergers that would benefit the target firm's stockholders.
A)True
B)False
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Chapter 27: Multinational Financial Management
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Q1) A Eurodollar is a U.S. dollar deposited in a bank outside the United States.
A)True
B)False
Q2) The interest rate paid on Eurodollar deposits depends on the particular bank's lending rate and on rates available on U.S. money market instruments.
A)True
B)False
Q3) If it takes $0.71 U.S. dollars to purchase one Swiss franc, how many Swiss francs can one U.S. dollar buy?
A) 0.50
B) 0.71
C) 1.00
D) 1.41
E) 2.81
Q4) 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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Page 29
Chapter 28: Time Value of Money
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Q1) How much would $1, growing at 3.5% per year, be worth after 75 years?
A) $12.54
B) $13.20
C) $13.86
D) $14.55
E) $15.28
Q2) Which of the following statements is CORRECT?
A) if some cash flows occur at the beginning of the periods while others occur at the ends, then we have what the textbook defines as a variable annuity.
B) the cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods.
C) if a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity.
D) the cash flows for an annuity due must all occur at the beginning of the periods.
E) the cash flows for an annuity may vary from period to period, but they must occur at regular intervals, such as once a year or once a month.
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Chapter 29: Basic Financial Tools: A review
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Sample Questions
Q1) Suppose a Google.com bond will pay $4,500 ten years from now. If the going interest rate on safe 10-year bonds is 4.25%, how much is the bond worth today?
A) $2,819.52
B) $2,967.92
C) $3,116.31
D) $3,272.13
E) $3,435.74
Q2) Managers should under no conditions take actions that increase their firm's risk relative to the market, regardless of how much those actions would increase the firm's expected rate of return.
A)True
B)False
Q3) All other things held constant, the present value of a given annual annuity decreases as the number of periods per year increases.
A)True
B)False
Q4) Diversification will normally reduce the riskiness of a portfolio of stocks.
A)True
B)False
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Chapter 30: Pension Plan Management
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Q1) Ms. Lloyd, who is 25 and expects to retire at age 60, has just been hired by the Chambers Corporation. Ms. Lloyd's current salary is $30,000 per year, but her wages are expected to increase by 5 percent annually over the next 35 years. Chambers has a defined benefit pension plan in which workers receive 2 percent of their final year's wages for each year of employment. Assume a world of certainty. Further, assume that all payments occur at year-end. What is Ms. Lloyd's expected annual retirement benefit, rounded to the nearest thousands of dollars?
A) $35,000
B) $57,000
C) $89,000
D) $116,000
E) $132,000
Q2) Under a defined contribution plan, employees agree to contribute some percentage of their salaries, up to 20 percent, to the firm's pension fund.
A)True
B)False
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Chapter 31: Financial Management in Not for Profit
Businesses
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Q1) The net present social value model formally recognizes that not-for-profit firms must consider the social value along with the financial value of proposed new projects.
A)True
B)False
Q2) The primary goal of investor-owned firms is shareholder wealth maximization, while the primary goal of not-for-profit firms is typically stated in terms of some mission; for example, to provide health care services to the communities served.
A)True
B)False
Q3) Since not-for-profit firms do not pay taxes, they receive no tax benefits whatsoever from using debt financing.
A)True
B)False
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