Course Introduction
Financial Decision Making
Exam Answer Key
Financial Decision Making examines the principles and tools essential for making informed financial choices in both personal and organizational contexts. The course covers topics such as budgeting, investment analysis, risk assessment, capital structure, and financial planning, emphasizing the application of quantitative and qualitative methods to evaluate alternatives and select optimal strategies. Through case studies and real-world examples, students learn to interpret financial statements, analyze market trends, assess various sources of financing, and understand the impact of financial decisions on organizational performance and value creation.
Recommended Textbook Fundamentals of Corporate Finance 5th Canadian Edition by Richard A Brealey
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Page 2
Chapter 1: Goals and Governance of the Firm
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Q1) What are the two critical decisions that have to be made by the financial manager?
A)Investment and financing.
B)Short term and long term.
C)Debt and equity.
D)All of the above.
Answer: A
Q2) When the management of a business is conducted by individuals other than the owners, the business is more likely to be a:
A)corporation.
B)Sole proprietorship.
C)Partnership.
D)General partner.
Answer: A
Q3) The shareholders in a sole proprietorship are represented by:
A)The owner of the firm.
B)The general partner of the firm.
C)The board of directors of the firm.
D)No one; sole proprietorships have no shareholders.
Answer: D
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Page 3
Chapter 2: Financial Markets and Institutions
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Q1) Why are secondary market transactions of importance to corporations?
Answer: Although corporations do not generate cash flows from secondary market transactions (other than those they initiate), it is the existence of secondary markets that made many investors comfortable enough to invest in their primary market offerings.In other words, if investors felt there would not be an organized, convenient market in which to alter their portfolio of securities, their original investment decisions might be quite different.Also, the secondary market acts as a form of "scorecard" for the decisions of management and the general prospects of the firm.Market values are, in most instances, much more important than book values, thus values in the secondary market give investors and analysts alike the ability to evaluate a firm.These evaluations will also affect future primary market offerings.
Q2) A primary market would be utilized when:
A)Investors buy or sell existing securities.
B)Shares of common stock are exchanged.
C)Securities are initially issued.
D)A commission must be paid on the transaction.
Answer: C
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Page 4
Chapter 3: Accounting and Finance
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Q1) Which of the firm's financial statements most clearly recognizes the payment for new equipment?
A)Balance Sheet
B)Income Statement
C)Statement of Cash Flows
D)Statement of Condition
Answer: C
Q2) What is the tax liability for an individual with $52,000 of income, which includes $2,000 of dividends, if the tax rate is 15 percent on income up to $25,350 and 28 percent on income over $25,350?
A)$11,704.50
B)$11,264.50
C)$14,000.00
D)$14,560.00
Answer: B
Q3) What are the firm's earnings before interest and taxes?
Answer: 11ea68e2_3ec4_6fe6_935e_31662b342463_TB1770_00
Q4) What is the firm's net income?
Answer: 11ea68e2_3ec4_be07_935e_5d193c37b745_TB1770_00
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Chapter 4: Measuring Corporate Performance
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Q1) Which of the following might be interpreted as a signal that stock price is currently too high?
A)An abnormally low dividend yield
B)A high E/P ratio
C)A low book value per share
D)A low P/E ratio
Q2) Last year's asset turnover ratio was 2.0.Sales have increased by 25% and average total assets have increased by 10% since that time.What is the current asset turnover ratio?
A)2.27
B)3.43
C)4.75
D)5.82 sales/average total assets = 2.0
Q3) Look at and compare the financial ratios across industries.The retail industry has a much higher turnover of receivables (a shorter collection period) than other industries, while software companies have high inventory turnover (low days in inventory).What do you think accounts for these differences?
Q4) Discuss some difficulties when comparing similar corporations from different countries.
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Chapter 5: The Time Value of Money
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Q1) The concept of compound interest refers to:
A)Earning interest on the original investment
B)Payment of interest on previously earned interest
C)Investing for a multi-year period of time
D)Determining the APR of the investment
Q2) Describe the process for determining the present and future values associated with multiple cash flows that are received or paid through time.
Q3) If interest is paid m times per year, then the per-period interest rate equals the:
A)Effective annual rate divided by m
B)Compound interest rate times m
C)Effective annual rate
D)Annual percentage rate divided by m
Q4) What will be the approximate population of the United States, if its current population of 275 million grows at a compound rate of 2 percent annually for 25 years?
A)413 million
B)430 million
C)451 million
D)466 million
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7
Chapter 6: Valuing Bonds
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Q1) A bond's face value can also be called its:
A)Coupon payment
B)Present value
C)Default value
D)Par value
Q2) When an investor purchases a $1,000 par value bond that was quoted at 97.16, the investor:
A)Receives 97.5 percent of the stated coupon payments
B)Receives $975 upon the maturity date of the bond
C)Pays 97.5 percent of face value for the bond
D)Pays $1,025 for the bond
Q3) A bond's yield to maturity takes into consideration:
A)Current yield but not price changes of a bond
B)Price changes but not current yield of a bond
C)Both current yield and price changes of a bond
D)Neither current yield nor price changes of a bond
Q4) Speculative-grade bonds have default risk; investment grade bonds do not.
A)True
B)False
Q5) Why do bonds exhibit interest rate risk?
Page 8
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Chapter 7: Valuing Stocks
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Q1) The study of published financial information on a company in order to make investment decisions is known as:
A)Technical analysis
B)Fundamental analysis
C)Efficiency analysis
D)Random pricing analysis
Q2) Which of the following describes a seasoned offering?
A)An IPO of common stock for a well-known firm
B)An IPO that is offered during the best buying season
C)An additional equity issue from a publicly traded firm
D)Any shares traded in the secondary market are seasoned offerings
Q3) Firms having a higher expected return have a higher:
A)Level of expected risk
B)Dividend yield
C)Market value of equity
D)Degree of certainty concerning their returns
Q4) The intent of technical analysis is to discover patterns in past stock prices.
A)True
B)False
Q5) How does competition among investors lead to efficient markets?
Page 9
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Chapter 8: Net Present Value and Other Investment Criteria
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Q1) The investment timing decision is aimed at analyzing whether the:
A)Cash flows occur at the beginning or end of a year
B)Payback period or NPV analysis should be used
C)Project is a borrowing or lending project
D)Investment should occur now or at some future point
Q2) Which of the following projects would you feel safest in accepting? Assume the opportunity cost of capital to be 12 percent for each project.
A)"A" has a small, but negative, NPV
B)"B" has a positive NPV when discounted at 10 percent
C)"C's" cost of capital exceeds its rate of return
D)"D" has a zero NPV when discounted at 14 percent
Q3) What is the maximum that should be invested in a project at time zero if the inflows are estimated at $40,000 annually for three years, and the cost of capital is 9 percent?
A)$101,251.79
B)$109,200.00
C)$117,871.97
D)$130,800.00 0 = $40,000
Q4) What is the net present value of an investment, and how do you calculate it?
Q5) Discuss three reasons why a firm may want to impose soft capital rationing.
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Chapter 9: Using Discounted Cash-Flow Analysis to Make Investment Decisions
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Q1) A new project requires an increase in both current assets and current liabilities of $125,000 each.What is the overall impact on net working capital investment?
A)An increase of zero
B)An increase of $125,000
C)An increase of $250,000
D)An increase of $62,500, when averaged over the life of the project
Q2) Allocations of overhead should not affect a project's incremental cash flows unless the:
A)Project actually increased overhead expenses
B)Overhead cannot be recovered at the end of the project
C)Overhead cannot be allocated to other projects
D)Accountant is required to allocate costs to this project
Q3) Which of the following represents a common reason for increases in net working capital with new projects?
A)Inventory can now be held at lower levels
B)Accounts receivable are often not paid on time
C)Inventory increases more than accounts payable increase
D)Accounts payable must be increased
Q4) How do changes in working capital affect project cash flows?
Page 11
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Chapter 10: Project Analysis
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Q1) What is the effect on break-even level of revenues for each dollar of increase in fixed costs plus depreciation for a firm with 70 percent variable costs?
A)An increase of $0.30.
B)An increase of $1.00.
C)An increase of $1.43.
D)An increase of $3.33 Break-even level of revenue =
Q2) Which of the following is not subtracted from sales revenues to determine pretax profit?
A)Depreciation
B)Fixed costs
C)Interest expense
D)Variable costs
Q3) The greater the DOL, the greater the protection against operating losses during economic downturns.
A)True
B)False
Q4) Briefly describe several factors that increase the difficulty in selecting appropriate capital budgeting proposals.
Q5) Why is managerial flexibility important in capital budgeting?
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Chapter 11: Introduction to Risk, Return, and the Opportunity
Cost of Capital
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Q1) If one portfolio's variance exceeds that of another portfolio, its standard deviation will also be greater than that of the other portfolio.
A)True
B)False
Q2) The TSX 300 index is:
A)The most representative of stock market indexes
B)An index of Canada's major corporations
C)An index of 300 major stocks
D)An equally weighted index of all stocks traded on the New York Stock Exchange
Q3) The historical record fails to show that investors have received a risk premium for holding risky assets.
A)True
B)False
Q4) Which of the following statements is incorrect concerning stock indexes?
A)They have been developed for foreign stocks
B)They have been developed for smaller companies
C)Indexes include all common stocks
D)Some indexes are equal-weighted
Q5) Discuss the statement, "Only market risk matters to a diversified investor."
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Chapter 12: Risk, Return, and Capital Budgeting
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Q1) Suppose you believe that the Beta of the firm is .4.How much is the firm worth if the risk-free rate is 5% and the expected rate of return on the market portfolio is 15%?
Q2) Beta measures a stock's sensitivity to market risks.
A)True
B)False
Q3) If Treasury bills yield 6.0% and the market risk premium is 9.0%, then a portfolio with a Beta of 1.5 would be expected to yield:
A)12.0%
B)17.0%
C)19.5%
D)21.5%
Q4) An investor divides her portfolio into thirds, with one part in Treasury bills, one part in a market index, and one part in a diversified portfolio with Beta of 1.50.What is the Beta of the investor's overall portfolio?
A)0.833
B)1.000
C)1.167
D)1.250
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Page 14
Chapter 13: The Weighted-Average Cost of Capital and Company Valuation
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Q1) Calculate a firm's WACC given that the total value of the firm is $2,000,000, $600,000 of which is debt, the cost of debt and equity is 10% and 15% respectively, and the firm pays no taxes:
A)9.0%
B)11.5%
C)13.5%
D)14.4% WACC = .10(600,000/2,000,0000) + .15(1,400,000/2,000,000) = )10(.3) + .15(.7)
Q2) What is the WACC for a firm with 50% debt and 50% equity that pays 12% on its debt, 20% on its equity, and has a 40% tax rate?
A)9.6%
B)12.0%
C)13.6%
D)16.0% WACC = (.5 x (.12 x .6)) + (.5 x .2) = 3)6% + 10%
Q3) With respect to the WACC:
A)It is the proper discount rate for everything the company does
B)It is used to value all new projects
C)This benchmark discount rate is adjusted for the riskiness of the project
Page 15
D)No adjustments need to be made when using it as the discount rate
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Chapter 14: Introduction to Corporate Financing and Governance
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Q1) Discuss generally the idea of bond ratings, including the difference between investment grade and junk bonds.
Q2) Since preferred stock dividends are not deductible for tax purposes, few corporations own preferred stock.
A)True
B)False
Q3) Discuss why more firms are turning to internally generated funds to finance new projects.
Q4) Protective covenants are offered for the benefit of:
A)Common shareholders
B)Preferred shareholders
C)Bondholders
D)Both common and preferred shareholders
Q5) When new shares are sold at a price greater than par value, the excess over par is recorded as:
A)Capital surplus
B)Retained earnings
C)Treasury stock
D)Authorized capital
Page 16
Q6) What are recent trends in a firm's use of different sources of finance?
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Page 17
Chapter 15: Venture Capital, Ipos, and Seasoned Offerings
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Q1) What is the expected stock price after the rights are issued?
Q2) Issue costs for equity are higher than those for debt for all of the following reasons except:
A)Equity issues have higher administrative costs
B)Underwriting stock is riskier than underwriting bonds
C)Equity issues involve significantly more time to sell
D)Equity issues have lower economies of scale
Q3) To be successful, a start-up business will require:
A)Taking a big risk, even if the payoff is only mediocre
B)Funds from a venture capitalist
C)Large amounts of debt financing
D)An initial public offering
Q4) Underwriters are used for all of the following except:
A)Selling securities to the public
B)Making initial public offerings
C)Assisting a company in raising cash
D)Providing equity capital for young businesses
Q5) What is a security?
Q6) What is venture capital?
Q7) What is the total amount of new money raised?
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Chapter 16: Debt Policy
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Q1) Which of the following lists presents the order of financing from most preferred to least preferred according to the pecking order theory?
A)Debt issue, stock issue, internally generated funds
B)Internally generated funds, debt issue, stock issue
C)Stock issue, internally generated funds, debt issue
D)Internally generated funds, stock issue, debt issue
Q2) What is the after-tax cost of debt for a firm in the 35% tax bracket that pays 15% on its debt?
A)5.25%
B)9.75%
C)12.17%
D)20.25% After-tax cost of debt = (1-T<sub>c</sub>)r<sub>debt</sub><sub> </sub>= .65 x .15
Q3) At some debt-equity ratio, the costs of financial distress are expected to overcome the value of the tax shield for a firm.
A)True
B)False
Q4) Calculate the required return risk premium on the common stock before the refinancing.
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Chapter 17: Payout Policy
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Q1) In a financial lease, the lessee can always cancel his lease without penalty.
A)True
B)False
Q2) If the asset described in Question 57 had a CCA rate of 30%, with the usual half-year rule, and were leased for 5 years, how would the lessee treat the five years of CCA? The lessee tax rate is 40%.The asset class uses declining balance.
A)Lessee would calculate the CCA amounts for each of the five years, apply the tax rate against these amounts, and show these amounts as cash outflows
B)Lessee would calculate the CCA amounts for the entire life of the asset, and show those amounts as cash flows
C)Lessee would ignore the CCA, since it is the lessor's financial province
D)Lessee would treat the CCA calculations for each of the five years of the lease as cash inflows for the lessor
Q3) A sale and leaseback arrangement transfers ownership from a user to a lessor who then leases the asset back to the former owner.
A)True
B)False
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Page 20
Chapter 18: Long-Term Financial Planning
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Q1) A dividend does not accompany stocks that are purchased on the ex-dividend date.
A)True
B)False
Q2) A stock is currently priced at $65 per share and will pay a $4 dividend in one year.What must the stock sell for in one year to meet investors' expectations of a 15% after-tax yield if dividends are taxed at 28%? Ignore capital gains taxes due to investor timing.
A)$70.75
B)$71.87
C)$73.63
D)$76.00 After-tax return =
Q3) Why may a large increase in earnings not translate into a large increase in dividends?
A)The earnings will be taxed
B)Some investors may prefer capital gains
C)Managers wish to assess the earning's persistence
D)The earnings may already be a part of retained earnings
Q4) The effect of a stock repurchase is not equivalent to that of a cash dividend.
A)True
B)False
Page 21
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Chapter 19: Short-Term Financial Planning
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Q1) What is the sustainable growth rate for a firm with $250,000 in net income, $20,000 in preferred stock dividends, $80,000 in common stock dividends, and an average equity balance of $1 million?
A)8%
B)10%
C)15%
D)17% sustainable growth rate = plowback ratio x ROE = 60% x ($250,000/$1 million) = 60% x 25% = 15%
Q2) A firm has decided that its optimal capital structure is 100% equity financed.It perceives its optimal dividend policy to be 40% payout ratio.Asset turnover is 0.8.The net profit margin is 10%, and the firm has a target growth rate of 5%.
a.Is the firm's target growth rate consistent with its other goals?
b.By how much does the company need to change its asset turnover to achieve this goal?
c.By how much does the company need to increase the profit margin instead?
Q3) Why do current or fixed assets often not vary proportionately with sales?
Q4) How are financial planning models constructed?
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Chapter 20: Working Capital Management
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Q1) Ignoring defaults, what is the approximate effective cost of factoring if receivables are sold at a 2% discount and the average collection period is 1 month?
A)19.40%
B)24.00%
C)26.53%
D)27.40% $(100-98)/$98 = 2.04% per two-month period
Q2) The principle of "matched maturities" in finance refers to:
A)Finding sources of funds with the longest maturity, in order to avoid liquidity crises
B)Funding long-term assets with long-term sources, and vice versa
C)Using as much short-term financing as possible due to the lower cost of interest
D)Buying marketable securities when demand is high and borrowing short term when demand is low
Q3) In "field warehousing" the inventory is kept by the:
A)Borrowing firm
B)Lending institution
C)Independent warehousing company
D)Jointly by the firm and the lender
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Page 23
Chapter 21: Mergers, Acquisitions, and Corporate Control
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Q1) Short-term securities have high interest-rate risk.
A)True
B)False
Q2) Just-in-time inventory management is suitable for an aircraft manufacturer, like Boeing, whose production schedules are known well in advance.
A)True
B)False
Q3) Which of the following would not be considered a money market instrument?
A)Canadian Treasury bill with 91 days until maturity
B)Commercial paper with 180 days until maturity
C)Certificate of deposit with 15 months until maturity
D)A repurchase agreement, backed by U.S.government securities, with less than one week until maturity
Q4) What is the bank's ledger balance?
Q5) Calculate the EOQ given the following information:
A)50,000 units
B)40,000 units
C)30,000 units
D)20,000 units
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Chapter 22: International Financial Management
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Q1) Which of the following strategies would continue to be effective if a cash-strapped firm determines that the effective interest rate charged on trade credit is lower than the bank's interest rate?
A)Take the discount but pay after the discount period
B)Borrow from the bank and take the discount
C)Ignore the discount, pay at the end of the period
D)Take the discount and hope for longer payment float
Q2) Which of the following typically justifies the offering of season dating?
A)The firm earns interest on the receivables
B)Product demand is increased during the low-sales months of the year
C)The firm is experiencing cash flow difficulties
D)The firm develops repeat business
Q3) It may be possible for firms to reduce the time and expense necessary to collect delinquent debts under a(n):
A)Promissory note
B)Conditional sale
C)Open account
D)EOM billing
Q4) How do firms decide whether to grant credit to a customer?
Q5) How do firms decide whether it makes sense to grant credit to a customer?
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Chapter 23: Options
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Q1) The shareholders of firm A have offered one million shares valued at $10 each to acquire firm B After the merger is announced, stock A trades for $9 per share.Which of the following statements is not correct?
A)Firm A appears to have overbid for firm B
B)The NPV of the merger may differ from expectations
C)Shareholders of A absorb all additional "cost"
D)A's stockholders are better off than if the merger were cash financed for $10 million
Q2) One indication that investors expect no synergy from a merger would be that:
A)Total market value of the merged firms does not change
B)The P/E ratio of the merged firms changes
C)The acquiring firm financed the merger with cash
D)The merged firms are from different industries
Q3) For firms in a mature stage of life with free cash flow, do you accept the charge that there might be some actual incentive to waste cash?
Q4) How are the gains from mergers distributed between the shareholders of the acquired and acquiring firms?
Q5) Why are firms with free cash flow attractive acquisition candidates?
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Chapter 24: Risk Management
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Q1) A foreign manufacturer must make a $2 million payment to its Canadian supplier in 60 days.Which of the following is correct?
A)The firm hopes that the Canadian Dollar appreciates within the 60 days
B)The firm's exchange rate risk is hedged
C)The firm faces contractual exchange rate risk
D)The current spot exchange rate is likely to be trading at a premium
Q2) History has shown a positive relationship between higher interest rates and higher subsequent rates of inflation.
A)True
B)False
Q3) Transaction risk arises when a firm is committed either to pay or receive a known amount of foreign currency.
A)True
B)False
Q4) Explain the international Fisher Effect.
Q5) The direct exchange rate quotes the number of Canadian Dollars required to buy one unit of a foreign currency.
A)True
B)False
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Chapter 25: Conclusion
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Q1) As a stock's market price increases, the value of its call option will increase also.
A)True
B)False
Q2) What is the option buyer's total profit or loss per share if a call option is purchased for a $5 premium, has a $50 exercise price, and the stock is valued at $53 at expiration?
A)($5)
B)($2)
C)$3
D)$8 Value of call option = stock price - exercise price
Total profit of call = value of call option - premium paid Then:
Value of call option = $53 - 50 = $3
Q3) Stock price volatility is beneficial to option holders.
A)True
B)False
Q4) What options may be provided in financial securities?
Q5) What options may be present in capital investment proposals?
Q6) Which graph represents a buying a put option?
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Chapter 26: What We Do and Do Not Know About Finance
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Q1) Which of the following statements is correct?
A)An option seller makes more profits than an option buyer
B)A futures seller makes more profits than a futures buyer
C)A futures buyer's profit will be equal to the futures seller's loss
D)Both futures buyer and seller make profit
Q2) What must happen to prices over the course of a contract for the seller of a futures contract to maximize benefits of the hedge?
A)Prices must decrease
B)Prices must increase
C)Prices must remain constant
D)The seller will profit on the hedge regardless of the direction of price movements
Q3) Which of the following would not be regulated in a standardized futures contract?
A)Quantity of asset to be traded
B)Quality of asset to be traded
C)The spot price
D)Date of settlement
Q4) Use the ordering of chicken wings to explain a forward contract.
Q5) 120.Provide a brief explanation of a currency and interest rate swap.
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