Financial Decision Making Exam
Review
Course Introduction
Financial Decision Making is a course that explores the principles, tools, and techniques used by individuals and organizations to make informed financial choices. Students learn to analyze financial statements, assess risk and return, evaluate investment and financing options, and apply techniques such as budgeting, forecasting, and capital budgeting. The course emphasizes critical thinking and quantitative analysis in real-world scenarios, enabling students to understand the impact of financial decisions on an organizations overall strategy and performance. Through case studies and practical exercises, students develop the skills necessary to make sound financial decisions in both personal and professional contexts.
Recommended Textbook
Contemporary Financial Management 12th Edition by R. Charles Moyer
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Chapter 1: The Role and Objective of Financial Management
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Q1) Accounting-based measures of performance ____ subject to short-term manipulation by managers; cash flows ____ subject to short-term manipulation.
A) are, are not
B) are not, are
C) are, are also
D) are not, also are not
Answer: A
Q2) Examples of agency costs incurred by shareholders to minimize agency problems are:
A) Expenditures associated with independent auditing.
B) Expenditures associated with SEC approval.
C) Expenditures associated with monitoring management's actions
D) Expenditures associated with inventory control.
Answer: C
Q3) The activities of the treasurer include all of the following except:
A) financial planning
B) tax preparation
C) credit analysis
D) pension fund management
Answer: B
Page 3
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Chapter 2: The Domestic and International Financial Marketplace
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Sample Questions
Q1) Securities not listed on exchanges are said to be traded
A) on the AMEX
B) as composite transactions
C) over the counter
D) on the regional exchanges
Answer: C
Q2) There are highly publicized hedge fund problems, for example Julian Robertson's Tiger fund or Long Term Capital Management. The impact that this has had on hedge funds is:
A) minimal. They have continued to grow in size and number.
B) huge. Hedge funds are being discontinued.
C) being felt in the overall reallocation of hedge funds into bonds.
D) inconsequential and irrelevant. Investors may rely on the due diligence of the fund managers.
Answer: A
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Page 4
Chapter 3: Evaluation of Financial Performance
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Sample Questions
Q1) If a firm has a total asset turnover of 8 times and a return on total assets of 15%, its net profit margin must be
A) 1.875%
B) 1.95%
C) 2.05%
D) 2.25%
Answer: A
Q2) A firm's return on equity is a function of its net profit margin, ____ and equity multiplier.
A) current ratio
B) cost of goods
C) total asset turnover
D) fixed asset turnover
Answer: C
Q3) Primary sources of comparative financial data include
A) Dun and Bradstreet
B) New York Times
C) Richard Moore, Inc.
D) Framingham Financial Library
Answer: A
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Chapter 4: Financial Planning and Forecasting
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Sample Questions
Q1) What information does a long-term financial plan offer?
Q2) Computerized financial planning models may be classified as any of the following except:
A) deterministic
B) optimistic
C) probabilistic
D) none of the above
Q3) Pro forma financial statements display the financial situation of a firm based on:
A) an actual event.
B) an assumed event.
C) a catastrophic event that recently happened to the firm.
D) the firm's worst sales year.
Q4) The financial plan that is a "blueprint" detailing where the firm wants to be at some future point in time is the:
A) Executive Manifest
B) Strategic Plan
C) FASB Plan
D) Operational plan
Q5) Explain the cash flow generation process:
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Chapter 5: The Time Value of Money
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Q1) A(n) ____ is a financial instrument that agrees to pay an equal amount of money per period into the indefinite future (i.e. forever)
A) annuity
B) annuity due
C) sinking fund
D) perpetuity
Q2) Which of the following statements is/are correct?
I. At 6% interest, the present value of: $400 for the first year, $600 for the second year, and $800 for the third year is $1,603.00.
II. The future value of the following mixed cash flow stream (if it is from an annuity due at 6% interest): $400 for the first year, $600 for the second year, and $800 for the third year is $1,999 (rounded).
A) I only
B) II only
C) Both I and II
D) Neither I nor II
Q3) Explain the sinking fund problem.
Q4) Explain the concept of interest and compare it to rate of interest.
Q5) Explain a perpetuity and list some investment vehicles that can be perpetuities.
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Chapter 6: Fixed Income Securities: Characteristics and Valuation
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Sample Questions
Q1) Equipment trust certificates are used mainly by
A) equipment manufacturers
B) oil drilling companies
C) state governments
D) trucking companies
Q2) The call feature of a long-term bond
A) is an optional retirement provision
B) states the call price
C) allows the issuer to replace a high coupon bond with one with a lower coupon bond
D) all the above are correct
Q3) An Exxon bond carries an 8 percent coupon, pays interest semiannually, and has 10 years to maturity. If this bond is currently selling for $925, what is the exact yield to maturity(to the nearest tenth of 1 percent)?
A) 9.2%
B) 8.8%
C) 9.8%
D) 10.2%
Q4) Explain a sinking fund.
Q5) List the advantages and disadvantages of long-term debt financing:
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Chapter 7: Common Stock: Characteristics, Valuation, and Issuance
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Sample Questions
Q1) The book value of an asset represents A) the market value
B) the discounted cash flow value
C) the historic acquisition cost of the asset
D) stockholders' acquisition value
Q2) In the valuation of common stock, the simple annuity and perpetuity formulas used in the valuation of bonds and preferred stock are not generally applicable because: A) Investors buy common stock for much different reasons than they buy bonds or preferred stock.
B) Returns accruing to common stock should never be capitalized (discounted) in order to determine a price.
C) Unlike bonds and preferred stock, common-stock is a short term investment.
D) Common stock dividends are normally expected to grow over time, rather than being constant as are payments on most bonds and most preferred stock.
Q3) What are the advantages and disadvantages of common stock financing?
Q4) Why do closely held firms need to have an outside appraiser to determine their value? What are the reasons for valuation?
Q5) List the responsibilities of investment bankers.
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Chapter 8: Analysis of Risk and Return
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Sample Questions
Q1) Assume that the rate of return on Calengry common stock over the coming year is normally distributed with an expected value of 16% and a standard deviation of 20%. What is the probability of earning a negative rate of return? (Note: Table V is required to work this problem.)
A) 10.56%
B) 40.13%
C) 21.19%
D) 3.59%
Q2) Total risk of a security can be viewed as consisting of two parts. Which of the following apply?
I. verifiable risk
II. non-verifiable risk
A) I only
B) II only
C) Both I and II
D) Neither I nor II
Q3) Explain marketability risk and marketability premium.
Q4) List types of events that influence systematic (non-diversifiable) risk.
Q5) How can standard deviation, a statistical measure of dispersion, be used in investment analysis?
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Chapter 9: Capital Budgeting and Cash Flow Analysis
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Sample Questions
Q1) Jim Bo's currently has annual cash revenues of $240,000 and annual operating expenses of $185,000 including $35,000 in depreciation. The firm's marginal tax rate is 40 percent. A new cutting machine can be purchased for $120,000 will increase revenues by $50,000 per year while operating expenses would increase to $205,000, including $42,000 in depreciation. Compute Jim Bo's annual incremental after-tax net cash flows.
A) $25,000
B) $20,800
C) $93,000
D) $19,000
Q2) Which of the following is not a major difficulty in implementing the basic capital budgeting model?
A) determining the schedule of available projects before a decision on any one project can be made
B) accounting for the risk of individual projects.
C) projecting the cost of funds over the investment decision horizon
D) choosing an appropriate criterion for selecting among various investment alternatives
Q3) Why should sunk costs not be considered when evaluating a project?
Q4) List the steps that a firm uses in the capital budgeting process:
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Chapter 10: Capital Budgeting: Decision Criteria and Real Option Considerations
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Q1) What is the internal rate of return for a project that has a net investment of $370,000 and net cash flows of $60,000 in year 1, $75,000 in year 2, and $85,000 in years 3 through 8?
A) 15.5%
B) 13.6%
C) 17.4%
D) none of the above are correct
Q2) What is the net present value of a project that requires a net investment of $76,000 and produces net cash flows of $22,000 per year for 7 years? Assume the cost of capital is 15 percent.
A) $ 91,520
B) $ 15,520
C) $ 78,000
D) $167,474
Q3) Which of the following is not a technique to handle the capital rationing problem?
A) linear programming
B) goal programming
C) ranking projects according to payback
D) ranking projects according to profitability index
Page 12
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Chapter 11: Capital Budgeting and Risk
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Sample Questions
Q1) The subjective approach to determining risk-adjusted discount rates
A) uses the risk-free rate for average-risk projects
B) explicitly considers the probability distribution of a project's cash flows
C) always leads to the correct investment decisions
D) groups projects into risk classes and evaluates all projects in a particular risk class at the same risk- adjusted discount rate
Q2) The net present value of a project is normally distributed with an expected value of $52,000 and a standard deviation of $31,515. Determine the probability that the project will have a net present value of less than zero.
A) 1.65%
B) 95.1%
C) 4.95%
D) cannot be determined
Q3) The risk of an investment project is defined in terms of the potential ____ of its returns.
A) certainty
B) size
C) variability
D) timing
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Chapter 12: The Cost of Capital
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Sample Questions
Q1) What is Bodacious Bodywear's weighted average cost of capital under the following conditions:
* The firm has 30% debt, 10% preferred stock, and 60% equity
*The cost of common equity is 14% and the cost of preferred stock is 9%
* The firm's debt has a before-tax cost of debt of 10% (including flotation costs)
* The firm is in the 40% tax bracket
A) 11.1%
B) 8.5%
C) 12.3%
D) 10.5%
Q2) If a firm will use only equity funds during the current capital budgeting period then the ____ is the correct capital cost to use for computing the cost of funds for the firm.
A) cost of equity capital
B) weighted cost of funds
C) historical cost of funds
D) all of these answers are correct
Q3) Firms can raise capital in two ways. Why is it that internal funding does not have a zero cost?
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Chapter 13: Capital Structure Concepts
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Sample Questions
Q1) Investors' required returns and the cost of equity capital ____ as the relative amount of debt used to finance the firm ____.
A) increase, increases
B) increase, decreases
C) remain constant, increases
D) remain constant, decreases
Q2) The process of simultaneously buying and selling the same or equivalent securities in different markets to take advantage of price differences and make a profit is called:
A) option pricing
B) diversification
C) arbitrage
D) margining
Q3) The mix of debt, preferred stock, and common equity that minimizes the weighted cost of capital to the firm is known as the
A) optimal corporate structure
B) target financial structure
C) optimal capital structure
D) optimal degree of combined leverage
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Chapter 14: Capital Structure Management in Practice
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Q1) Crown Data(CD) has a current capital structure that consists of $120 million in common equity (15 million shares) and $80 million in long-term debt with an average interest rate of 11 percent. CD is considering an expansion project that will cost $22 million. The project will be financed either by issuing long-term debt at a cost of 12.5 percent, or the sale of new common stock at $35 per share. The firm's marginal tax rate is 40%. What is the EBIT indifference point between the two financing options.
A) $71.5 million
B) $77.2 million
C) $68.3 million
D) $ 1.0 million
Q2) If a firm sees its EPS increase 27% on a 12% increase in sales, what is the firm's DOL. During the same period the firm saw its EBIT increase only 8%.
A) 1.50
B) 3.38
C) 1.34
D) 0.67
Q3) List the five steps developed to assist financial managers in making capital structure decisions.
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Chapter 15: Dividend Policy
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Q1) Leigh Fibers has 6 million shares outstanding. This year Leigh will have operating income (EBIT) of $36.4 million, interest expenses of $5.8 million, and depreciation expenses of $6.2 million. What will be Leigh's dividend per share if the company has a payout ratio of 30%? Assume a marginal tax rate of 40%.
A) $0.92
B) $0.73
C) $1.09
D) $0.61
Q2) Dividend reinvestment plans involve the purchase of
A) newly issued stock
B) existing stock
C) letter stock
D) both newly issued and existing stock
Q3) What effect does a stock split have on outstanding shares of stock and what is its purpose?
Q4) What are the procedures for repurchasing stock?
Q5) What is the signaling effect of dividend payments?
Q6) Explain the "clientele effect".
Q7) What are the factors that determine the dividend policy of a firm?
Page 17
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Chapter 16: Working Capital Policy and Short-term Financing
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Q1) Which of the following working capital financing policies subjects the firm to the greatest risk?
A) financing fluctuating current assets with long-term debt
B) financing permanent current assets with long-term debt
C) financing permanent current assets with short-term debt
D) financing fluctuating current assets with short-term debt
Q2) Efficient current assets management refers to the firm's ability to economize on which of the following?
I. Inventory
II. Marketable securities
A) I only
B) II only
C) Both I and II
D) Neither I nor II
Q3) The firm's inventory conversion period (measured in days) is equal to its average inventory divided by its ____.
A) cost of sales
B) sales
C) cost of sales/365
D) none of the above
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Chapter 17: The Management of Cash and Marketable Securities
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Q1) MLX has annual sales of $320 million per year and has calculated that the collection float is 12 days. If MLX is currently paying 9.35 percent on its line of credit, what amount of interest expense could be saved if the collection float is reduced by 3 days? Assume 365 days per year.
A) $249,333
B) $573,808
C) $299,200
D) $245,918
Q2) The objective of cash collection and disbursement policies is to
A) minimize storage costs
B) speed up collections and slow down disbursements
C) maximize the return on near cash equivalents
D) avoid using float
Q3) Cash management involves the determination of:
A) the best locations for lockboxes
B) setting up decentralized collection centers
C) both a and b
D) neither a nor b
Q4) When and why is it best to use lockboxes? Explain when should alternative methods be used.
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Chapter 18: Management of Accounts Receivable and Inventories
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Q1) Technico manufactures about 800,000 solar calculators per year. The computer chip used in the calculator cost $4.80 each and the cost of placing an order is $65. If the carrying costs are 16%, what is the EOQ for the chips.
A) 25,495
B) 3,162
C) 8, 229
D) 11,637
Q2) All of the following are reliable sources of the creditworthiness of a customer EXCEPT:
A) Credit reporting organizations
B) Company's experience
C) Banks
D) General credit application
Q3) The primary goal of accounts receivable management should be
A) minimizing lost sales
B) maximizing shareholder wealth
C) increasing market share
D) minimizing receivables investment
Q4) What are the "five Cs of credit"and how are they used?
Q5) What are seasonal datings as it applies to credit terms?
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Chapter 19: Lease and Intermediate-term Financing
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Q1) A sale and leaseback agreement
A) is usually an operating lease
B) is rarely used in today's leasing agreements
C) is a method of providing liquidity for the lessee
D) frequently is used for machinery financing, but rarely used in real estate
Q2) Index Laboratories is considering leasing a thermoplastic molder. The lease would require 7 beginning of the year payments of $122,000 each. If Index capitalizes this lease for financial reporting purposes at a 12% rate, what asset amount will be reported initially on its balance sheet?
A) $623,625
B) $969,046
C) $556,808
D) $854,000
Q3) Leasing offers a number of potential advantages. All of the following are advantages except
A) flexibility
B) effective depreciation of land
C) generally lower costs
D) may be the only source of financing available to the marginally profitable firm
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Chapter 20: Financing With Derivatives
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Q1) A debenture of the Allegro Company (par value $1,000) is convertible into the company's common stock at a price of $50 per share. The convertible bond has a coupon interest rate of 7% and matures in 10 years. Straight debt of equivalent risk and maturity is yielding 8%. The company's common stock is currently selling for $60 per share. Determine the conversion value and straight-bond value of Allegro Company's convertible bonds.
A) $1,200; $1,000
B) $1,000; $933
C) $1,200; $933
D) $1,000; $1,000
Q2) ____ earnings per share are calculated based on the assumption that all dilutive securities are converted into common shares.
A) Primary
B) Full primary
C) Fully diluted
D) First class
Q3) Which companies are the primary issuers of convertible securities and why do they do it?
Q4) What variables affect the call option valuation?
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Chapter 21: Risk Management
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Q1) An example of hedging in order to control risk would be:
A) Car makers reducing the number of models that will be manufactured this year.
B) Toy stores placing orders in December for toys needed by Christmas.
C) Airline companies attempting to lock in the price paid for fuel.
D) Fashion designers offering showings of their new clothing line in several major cities.
Q2) Financial derivatives can be used to manage all of the following risks EXCEPT:
A) earnings risks
B) currency risks
C) pricing risks
D) interest rate risks
Q3) A "clearinghouse" operated by the futures exchange handles:
A) the offices of the future contract buyers.
B) the location of the future contract sellers.
C) the payments between buyers and sellers.
D) the actual products bought and sold.
Q4) List some nonhedging risk management strategies.
Q5) List five hedging strategies for risk management
Q6) What options does the buyer of a futures contract have at the time the futures contract matures?
Page 23
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Chapter 22: International Financial Management
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Q1) The 6 month interest rate on 180 day U.S. Treasury Bills is 7.5 percent. In the foreign exchange markets, the spot rate between U.S. dollars and Australian dollars is 1 Australian dollar = $0.452 and the 180 day (6 month) forward rate is 1 mark = $0.46. Determine the expected rate of interest on 6 month Australian government debt securities, assuming that the interest rate parity between the U.S. dollar and Australian dollar exists.
A) 7.35%
B) 1.77%
C) 5.63%
D) 3.82%
Q2) Primary sources of demand for British pounds in the foreign exchange market include
A) foreign buyers of British exports who must pay for their purchases in pounds
B) foreign investors who desire to make investments in physical or financial assets in Great Britain
C) speculators who expect British pounds to increase in value relative to other currencies
D) all of these answers are correct
Q3) How does a firm manage economic exposure due to changes in exchange rates?
Q4) How do market forces support the relative purchasing power parity?
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Chapter 23: Corporate Restructuring
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Q1) The ____ is the number of acquiring company shares received per share of acquiring company stock owned.
A) stock equity ratio
B) exchange ratio
C) dividend exchange ratio
D) interest parity ratio
Q2) Employee Stock Ownership Plans (ESOPs) are useful instruments for financing leveraged buyouts because in an ESOP transaction
A) employees have a greater voice in the final decision
B) lenders can offer below market interest rates
C) ESOPs can be used only when employees take over management functions
D) ESOPs attract greater external equity investments
Q3) A firm is technically insolvent when: it is unable to meet it current obligations and:
A) the value of its assets exceeds the value of its liabilities.
B) the value of its assets is less than the value of its liabilities.
C) it files a bankruptcy petition.
D) it merges with another firm.
Q4) Explain the motivation for a company to divest through a spin-off or equity carve-out.
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Chapter 24: Continuous Compounding and Discounting
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Q1) Brad deposited $5,250 into an account that earns 7% interest compounded continuously. How much money will he have in 15 years?
A) $15,002.67
B) $12,175.90
C) $13,957.14
D) $14,964.25
Q2) What is the value of $10,000 invested for 5 years at 8% compounded continuously?
A) $14,693
B) $14,928
C) $14,918
D) $13,064
Q3) With continuous compounding, why is the effective rate higher than the nominal rate?
Q4) What continuously compounded effective rate of interest will yield the same present value of a future cash flow as an annual rate of interest of 8.25%?
A) 8.60%
B) 7.93%
C) 8.25%
D) 7.70%
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Chapter 25: Mutually Exclusive Investments Having Unequal Lives
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Q1) Quorex is evaluating two mutually exclusive projects. Project A has a net investment of $48,000 and net cash flows over a six year period of $12,500 per year. Project B also has a net investment of $48,000 but its net cash flows of $8,640 per year will occur over a 12 year period. If Quorex has a cost of capital of 14% for these projects, which project, if either, should be chosen and what is its NPV?
A) A, $862
B) A, $1,800
C) B, $2,475
D) B, $902
Q2) The importance of time discrepancies depends on several items when making capital budgeting decisions. State those items:
Q3) Using a replacement chain, which project should be chosen? Assume that in 5 years, Project A will still cost $120,000 and produce 5 more years of $37,000 annual net cash flows.
A) Project B. NPV of A is negative
B) Project A. NPV of B is negative
C) Project B. NPV is $492 higher
D) Project A. NPV is $6,468 higher
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Chapter 26: Breakeven Analysis
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Q1) What are the possible uses for breakeven analysis?
Q2) The Foggy Futures Weather Network offers an annual almanac for sale each year with information about predicted weather patterns, severe storm safety tips and a tracking chart. The finished product sells for $35 with a variable cost per unit of $21. The company has operating costs of $1,050,000. Using 100,000 units as a base, what is the degree of operating leverage?
A) 6.2
B) 5.7
C) 7.9
D) 4.0
Q3) Breakeven analysis is normally performed for a planning period of:
A) five years
B) one year or less
C) ten years
D) one month
Q4) Breakeven analysis can be used:
A) when planning renovations
B) when planning expansions
C) when planning financial resources
D) when planning new product development
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Chapter 27: Bond Refunding Analysis
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Q1) In a bond refunding analysis, the net investment calculation includes
A) aftertax call premium
B) flotation cost of new debt
C) overlapping interest
D) all of the above
Q2) Wood River Power Company is considering refunding a $100 million 12% coupon debenture issue with a 9% coupon, 20-year debenture. The 12% issue also matures in 20 years and is now callable at 109% of par. The unamortized flotation cost on the old issue is $360,000 and the flotation cost of the new issue is 0.775%. Wood River estimated that there would be a 4 week period where both bonds would be outstanding. The company has a weighted cost of capital of 11% and a 40% marginal tax rate. Should Wood River sell the refunding issue? (Note: PVIFA<sub>0.054,20 </sub>= 12.050)
A) yes, NPV is approximately $15.21 million
B) yes, NPV is approximately $9.86
C) yes, NPV is approximately 6.485 million
D) No, NPV is negative $0.554 million
Q3) Why is the after-tax cost of debt used in bond refunding analysis?
Q4) Why would a corporation consider bond refunding?
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Chapter 28: Taxes
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Sample Questions
Q1) ____ received by corporations are normally entitled to a 70 percent exclusion from federal income taxes.
A) Capital gains income
B) Dividend income
C) Loss carrybacks and carryforwards
D) none of the above
Q2) Capital losses are
A) taxed at the same marginal rate as ordinary income
B) taxed at the 20% rate
C) deductible only against capital gains
D) used to reduce interest payments
Q3) For a corporation with ordinary taxable income of $425,000, what is the additional tax liability if $30,000 in dividends is received from shares it holds in another corporation?
A) $7,140
B) $10,200
C) $11,700
D) $3,060
Q4) How does a tax loss affect a corporation as it applies to past and future income?
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