Financial Decision Making
Study Guide Questions
Course Introduction
Financial Decision Making explores the principles and practices essential for effective financial management within organizations. This course covers topics such as financial analysis, budgeting, investment appraisal, risk assessment, and capital structure decisions. Students will learn how to interpret financial statements, evaluate cash flows, and apply quantitative techniques to make informed financial choices. Emphasizing both theoretical foundations and real-world applications, the course prepares students to assess complex financial scenarios and develop strategies that enhance organizational value and sustainability.
Recommended Textbook
Fundamentals of Corporate Finance 7th Edition by Richard A. Brealey
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Page 2
Chapter 1: Goals and Governance of the Corporation
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Sample Questions
Q1) Which of the following statements more accurately describes the controller than the treasurer?
A) Likely to be the only financial executive in small firms
B) Monitors capital expenditures to make sure that they are not misappropriated
C) Responsible for investing the firm's spare cash
D) Responsible for arranging any issue of common stock
Answer: B
Q2) The primary goal of any company should be to maximize current period profits.
A)True
B)False
Answer: False
Q3) "Double taxation" refers to:
A) all partners paying equal taxes on profits.
B) corporations paying taxes on both dividends and retained earnings.
C) paying taxes on profits at the corporate level and dividends at the personal level.
D) the fact that marginal tax rates are doubled for corporations.
Answer: C
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Chapter 2: Financial Markets and Institutions
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Sample Questions
Q1) A share of IBM stock is purchased by an individual investor for $75 and later sold to another investor for $125.Who profits from this sale?
A) IBM.
B) The first investor.
C) The second investor.
D) Profit is split between IBM and the investor.
Answer: B
Q2) Which of the following statements is not characteristic of mutual funds?
A) They are financial institutions.
B) They raise money by selling shares to investors.
C) They pool the savings of many investors.
D) They offer professional management.
Answer: A
Q3) Almost all foreign exchange trading occurs on the floors of the FOREX exchanges in New York and London.
A)True
B)False
Answer: False
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Chapter 3: Accounting and Finance
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Sample Questions
Q1) The gathering of related revenues and expenses into the same period,regardless of when cash is actually received or paid,is:
A) cash-basis accounting.
B) market-value accounting.
C) book-value accounting.
D)accrual accounting.
Answer: D
Q2) Accrual accounting aims to provide a fairer measure of the firm's profitability.
A)True
B)False
Answer: True
Q3) If the market value of assets is high,then the market value of liabilities must be high also.
A)True
B)False
Answer: False
Q4) Expenditure on new capital equipment is a cash payment.
A)True
B)False
Answer: True
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Chapter 4: Measuring Corporate Performance
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Sample Questions
Q1) What are some potential pitfalls of ratio analysis based on accounting data?
Q2) A firm reports a net profit margin of 10.0% on sales of $3 million when ignoring the effects of financing.If taxes are $200,000,how much is EBIT?
A) $100,000
B) $300,000
C) $500,000
D) $800,000
Q3) The asset turnover ratio and inventory turnover ratio are both efficiency ratios.
A)True
B)False
Q4) Which of the following statements is most likely correct for a firm with an average collection period of 90 days?
A) Its average daily sales are low.
B) Its average daily sales are high.
C) Its current ratio will be high.
D) It is providing financing for approximately 25% of its annual sales.
Q5) How do measures such as market value added and economic value added help assess the firm's performance?
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Chapter 5: The Time Value of Money
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Q1) When an investment pays only simple interest,this means:
A) the interest rate is lower than on comparable investments.
B) the future value of the investment will be low.
C) the earned interest is nontaxable to the investor.
D) interest is earned only on the original investment.
Q2) After reading the fine print in your credit card agreement,you find that the "low" interest rate is actually an 18% APR,or 1.5% per month.Now,to make you feel even worse,calculate the effective annual interest rate.
Q3) What is the present value of $100 to be deposited today into an account paying 8%,compounded semiannually for 2 years?
A) $85.48
B) $100.00
C) $116.00
D) $116.99
Q4) In 2002,the U.S.inflation rate was below 2% and a few countries were even experiencing deflation.
A)True
B)False
Q5) Discuss the statement,"Money has a time value."
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Chapter 6: Valuing Bonds
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Sample Questions
Q1) It would be realistic to read an asked price listed as 100:16 and a bid price of 100:18.
A)True
B)False
Q2) What happens to the price of a 3-year bond (with par value $1,000)with an 8% coupon when interest rates change from 8 to 6%?
A) A price increase of $51.54
B) A price decrease of $51.54
C) A price increase of $53.47
D) A price decrease of $53.47
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) What are the differences between the bond's coupon rate,current yield,and yield to maturity?
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Chapter 7: Valuing Stocks
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Sample Questions
Q1) A positive value for PVGO suggests that the firm has:
A) a positive return on equity.
B) a positive plowback ratio.
C) investment opportunities with superior returns.
D) a high rate of constant growth.
Q2) Securities with the same expected risk should offer the same expected rate of return.
A)True
B)False
Q3) In the calculation of rates of return on common stock,dividends are _______ and capital gains are _____.
A) guaranteed; not guaranteed
B) guaranteed; guaranteed
C) not guaranteed; not guaranteed
D) not guaranteed; guaranteed
Q4) What is the difference between a fundamental analyst and a technical analyst?
A) Only a fundamental analyst believes markets are inefficient.
B) A technical analyst focuses on financial statement analysis.
C) Only a technical analyst helps keep the market efficient.
D) A fundamental analyst analyzes such information as earnings and asset values.
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Chapter 8: Net Present Value and Other Investment Criteria
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Sample Questions
Q1) You can continue to use your less efficient machine at a cost of $8,000 annually for the next 5 years.Alternatively,you can purchase a more efficient machine for $12,000 plus $5,000 annual maintenance.At a cost of capital of 15%,you should:
A) Buy the new machine and save $600 in equivalent annual costs.
B) Buy the new machine and save $388 in equivalent annual costs.
C) Keep the old machine and save $388 in equivalent annual costs.
D)Keep the old machine and save $580 in equivalent annual costs.
Q2) The opportunity cost of capital is equal to:
A) the discount rate that makes project NPV equal zero.
B) the return offered by other projects of equal risk.
C) a project's internal rate of return.
D)the average rate of return for a firm's projects
Q3) A project's payback period is determined to be 4 years.If it is later discovered that additional cash flows will be generated in years 5 and 6,then:
A) the project's payback period will be reduced.
B) the project's payback period will be increased.
C) the project's payback period will be unchanged.
D)the discount rate must be known to determine whether the payback period changes.
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Chapter 9: Using Discounted Cash-Flow Analysis to Make Investment Decisions
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Q1) How is the company's tax bill affected by depreciation and how does this affect project value?
Q2) Assuming that an asset has been fully depreciated according to its MACRS class life,which of the following statements is correct concerning the value of the asset?
A) Its market value is zero.
B) Its book value is zero.
C) Its book value is the current market value.
D) It has neither book value nor market value.
Q3) Methods of accelerated depreciation:
A) allow more depreciation over the asset's life.
B) decrease the depreciation tax shield.
C) increase the depreciation tax shield.
D) allow assets to be depreciated more rapidly.
Q4) Upon the sale of equipment at the end of its useful life,tax liability will be incurred whenever the book value of the equipment exceeds the sales price.
A)True
B)False
Q5) 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) If a large proportion of costs is fixed,a shortfall in sales has a magnified effect on profits.From the previous statement we know that the risk of a project is affected by the degree of operating leverage.
A)True
B)False
Q2) The inputs that are most worth refining before you commit to a project are the ones that have the greatest potential to alter project NPV.
A)True
B)False
Q3) Define DOL and discuss what affects it and how to interpret it.
Q4) What happens to the NPV of a one-year project if fixed costs are increased from $400 to $600,the firm is profitable,has a 35% tax rate,and employs a 12% cost of capital?
A) NPV decreases by $200.00.
B) NPV decreases by $173.91.
C) NPV decreases by $130.00.
D) NPV decreases by $113.04.
Q5) Why is managerial flexibility important in capital budgeting?
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Page 12
Chapter 11: Introduction to Risk,Return,and the Opportunity
Cost
of Capital
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Sample Questions
Q1) What is the percentage return on a stock that was purchased for $40.00,paid no dividend after one year,and was then sold for $39.00?
A) -2.50%
B) 2.50%
C) 5.00%
D) 7.50%
Q2) When high growth is expected in the economy,an investor should receive higher returns from:
A) cyclical investments.
B) countercyclical investments.
C) stocks with negative correlations.
D) stocks with low standard deviations.
Q3) If a stock's returns are volatile,then the stock:
A) cannot be considered a negative risk asset.
B) can still be considered a negative risk asset.
C) has macro risk, but no unique risk.
D) does not offer diversification potential.
Q4) Stock market indexes are found in several countries outside the United States.
A)True
B)False
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Chapter 12: Risk,Return,and Capital Budgeting
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Sample Questions
Q1) What two elements are represented in security returns?
A) A premium for market risk and for unique risk
B) A premium for unique risk and a premium for firm-specific risk
C) A premium for diversification and a premium for portfolio risk
D) A premium for time value of money and a premium for market risk
Q2) If a stock consistently goes down (up)by 1.6% when the market portfolio goes down (up)by 1.2%,then its beta:
A) equals 1.04.
B) equals 1.24.
C) equals 1.33.
D) equals 1.40.
Q3) If Treasury bills are yielding 10% at a time when the market risk premium is 6%,then the:
A) market portfolio should yield 4%.
B) market portfolio should yield 6%.
C) market portfolio should yield 16%.
D) market portfolio should yield 22%.
Q4) A project should be accepted if its return plots above the security market line. A)True B)False
Page 14
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Chapter 13: The Weighted-Average Cost of Capital and Company Valuation
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Sample Questions
Q1) What decision should be made on a project of above-average risk if the project's IRR exceeds the WACC?
A) Accept the project; NPV is positive.
B) Reject the project; NPV is negative.
C) Decide after discounting at the IRR.
D) Decide after discounting at an appropriate rate.
Q2) Changing the capital structure by adding debt will not:
A) increase the return that shareholders require.
B) increase default risk.
C) decrease debtholder risk.
D) increase the cost of debt.
Q3) Suppose an analyst estimates that free cash flow will be $2.43 million in year 5.What is the present value of this free cash flow if the company cost of capital is 12%,the WACC is 10%,and the equity cost of capital is 15%?
A) 1.21 million
B) 1.38 million
C) 1.51 million
D) 2.43 million
Q4) Can WACC be used to value an entire business?
Page 15
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Chapter 14: Introduction to Corporate Financing
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Sample Questions
Q1) The majority of an established firm's capital is generated:
A) internally.
B) externally.
C) through issuance of new shares.
D) through funded debt.
Q2) If shareholders do not like the policies that management pursues,their easiest solution is to vote in a different board of directors.
A)True
B)False
Q3) Subordinated debt is an example of short-term debt for a firm.
A)True
B)False
Q4) A stock's par value is represented by:
A) the maturity value of the stock.
B) the price at which each share is recorded.
C) the price at which an investor could sell the stock.
D) the price received by the firm when the stock was issued.
Q5) In a situation of bankruptcy,only the funded debt will be repaid.
A)True
B)False
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Chapter 15: How Corporations Raise Venture Capital and Issue Securities
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Q1) What are some of the significant issues that arise when established firms make a general cash offer or a private placement of securities?
Q2) A major purpose of the prospectus is to:
A) inform investors of the security's rate of return.
B) advise investors of the security's potential risk.
C) distribute stock warrants to prospective investors.
D) list the security's dividend payment dates.
Q3) Shelf registration allows firms to:
A) purchase securities for up to 2 years without registration.
B) incur only short time delays in selling securities.
C) wait for 2 years before paying for securities.
D) offer rights issues to nonexisting shareholders.
Q4) What percentage of direct expense is required to market stock if the issuer incurs $1 million in other expenses to sell 3 million shares at $40 each to an underwriter and the underwriter sells the shares at $43 each?
A) 6.98%
B) 7.19%
C) 7.75%
D) 8.33%
Page 17
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Chapter 16: Debt Policy
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Sample Questions
Q1) As a firm's debt-equity ratio approaches zero,the firm's expected return on equity approaches:
A) the expected return on debt.
B) the expected return on assets.
C) its maximum.
D) zero.
Q2) When there are no taxes and capital markets function well,the market value of a company does not depend on its capital structure.
A)True
B)False
Q3) Debt financing affects neither the operating risk nor the business risk of the firm.
A)True
B)False
Q4) Financial leverage describes debt financing's amplification of the effects of changes in operating income on the returns to stockholders.
A)True
B)False
Q5) Is financial slack always valuable?
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Chapter 17: Payout Policy
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Q1) The primary purpose of laws prohibiting a firm from paying dividends that include its legal capital is to:
A) reduce investors' tax liability.
B) ensure that the balance sheet balances.
C) prevent managers from paying out all the firm's assets.
D) prevent managers from paying large dividends.
Q2) Which of the following is correct for a firm with $400,000 in net earnings,20,000 shares,and a 30% payout ratio?
A) Retained earnings will increase by $120,000.
B) Each share will receive a $1.20 dividend.
C) $120,000 will be spent on new investment.
D) The dividend per share will equal $6.00.
Q3) An investor owns 300 shares of stock currently selling for $70 per share.What should the investor expect to have after the stock declares a three-for-two split?
A) 200 shares selling for $93.10 each
B) 200 shares selling for $105.00 each
C) 450 shares selling for $46.67 each
D) 450 shares selling for $93.10 each
Q4) Discuss the concept of dividend signaling.
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Chapter 18: Long-Term Financial Planning
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Q1) What is the required asset turnover for a firm with a 12% profit margin,50% equity,and a 40% dividend payout that wishes to grow at 6% without increasing financial leverage?
A) .42
B) .56
C) .63
D) 1.00
Q2) If factories are operating below full capacity,sales can increase without investment in fixed assets.However,beyond some sales level,new capacity must be added (and additional investment in fixed assets must be made).
A)True
B)False
Q3) Planners often recommend entering a market for "strategic" reasons because:
A) the company is facing too much competition in its original market.
B) the company may have valuable follow-on investments after establishing itself in the new market.
C) the immediate investment has a positive net present value.
D) all of these.
Q4) Why is it important that financial plans incorporate adaptability?
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Chapter 19: Short-Term Financial Planning
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Q1) When managers are continually short-term lenders they are said to follow a:
A) middle-of-the-road financing strategy.
B) restrictive financing strategy.
C) relaxed financing strategy.
D) permanent working-capital strategy.
Q2) Show the effect of the following transactions on cash,net working capital,and the current ratio.Assume that the current ratio exceeds 1.0 to begin.
a.The firm borrows $1,000 short term and pays $500 in accounts payable.
b.The firm factors $1,000 in receivables at a 5% discount.
c.The firm issues $1,000 in long-term bonds,using the proceeds to pay $800 in payables and purchase $200 in marketable securities.
Q3) What is the payable period for a firm with average accounts payable of $4 million and annual cost of goods sold of $44 million.
A) 20.0 days
B) 30.0 days
C) 35.6 days
D) 33.2 days
Q4) Describe in general a firm's cash conversion cycle.
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Page 21
Chapter 12: Risk, Return, and Capital Budgeting
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Q1) What credit decision is appropriate for a potential customer that offers an 80% chance of paying on a $10,000 (present value)sale that has an 80% (present value)cost?
A) Grant credit since expected profit is $3,200.
B) Grant credit since expected profit is $800.
C) Refuse credit since expected profit is zero.
D) Refuse credit since expected loss is $3,000.
Q2) An East Coast firm should establish a lock-box service on the West Coast:
A) if the firm has a large number of customers.
B) if it has banking facilities in West Coast.
C) if West Coast customers are currently mailing their checks to an East Coast address.
D) if West Coast banks are more efficient.
Q3) What are the expected annual savings from a lock-box system that collects 150 checks per day averaging $500 each,and reduces mailing and processing times by 2.5 and 1.5 days,respectively,if the annual interest rate is 7%?
A) $5,250
B) $13,125
C) $21,000
D) $300,000
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Chapter 21: Mergers, Acquisitions, and Corporate Control
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Q1) Which of the following is not a method of changing the management of a firm?
A) Proxy contest
B) Merger and acquisition
C) LBO
D) MBO
Q2) In 2010,how has the dynamic of the proxy contest changed?
Q3) Today's buyouts are generally smaller and not leveraged as aggressively as the deals of the 1980s.
A)True
B)False
Q4) A tender offer is one in which the firm's:
A) management offers to sell the company to an acquirer.
B) board of directors offers to sell the company to the public.
C) shareholders are propositioned to sell their shares to outsiders.
D) management offers to buy all outstanding shares of the corporation.
Q5) Diversification is often a poor motive for mergers because:
A) vertical integration is rarely successful.
B) investors can diversify on their own account.
C) it does not produce economies of scale.
D) the increase in taxes overcomes gains in earnings.
Page 23
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Chapter 22: International Financial Management
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Q1) Interest rate parity suggests that you may assume that it is cheaper to borrow in a currency with a low nominal rate of interest.
A)True
B)False
Q2) Which of the following is correct when foreign currency is contracted in the forward market?
A) A fixed amount is paid when initiating the contract.
B) A fixed amount is paid at the end of the contract.
C) The amount to be paid is determined and paid at the end of the contract.
D) The amount to be paid is determined periodically and paid in installments during the contract.
Q3) Current 1-year interest rates are 4% and 8% in the United States and Spain,respectively.The anticipated inflation in the United States is 2%.If International Fisher effect holds,what is the expected inflation in Spain?
A) 4.00%
B) 4.04%
C) 5.92%
D) 6.00%
Q4) What are some simple strategies to protect the firm against exchange rate risk?
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Chapter 23: Options
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Q1) What price risk is an investor exposed to if he owns a share of stock and has purchased a put option on the stock?
Q2) An investor who is buying a put option is expecting:
A) stock prices to go up.
B) stock prices to go down.
C) interest rates to go up.
D) interest rates to go down.
Q3) When does a change in the value of a call option come the closest to matching the price change in a share of stock?
A) When the stock is priced far above the strike price.
B) When the stock is priced far below the strike price.
C) When the stock is priced very near the strike price.
D) Changes in call value always come close to matching changes in stock price.
Q4) What options may be provided in financial securities?
Q5) A writer of a call option expects the stock price to: A) decrease.
B) increase.
C) split.
D) produce quarterly cash dividends.
Q6) How,in general,is value derived from options on real assets?
Page 25
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Chapter 24: Risk Management
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Q1) Which of the following characteristics is similar in both futures and forward contracts?
A) Future asset transactions are conducted at an agreed price.
B) Contracts are sold through organized exchanges.
C) Contract terms are standardized.
D) Price changes are settled daily.
Q2) The derivatives market is characterized by:
A) stability.
B) innovation.
C) riskiness.
D) private deals.
Q3) All companies work hard to hedge their exposure to price fluctuations.
A)True
B)False
Q4) The profit from a futures contract is the difference between the initial futures price and the spot price at expiration.
A)True
B)False
Q5) What is the basic difference in strategy between buying and selling a futures contract?
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