Financial Management Exam Preparation Guide
Course Introduction
Financial Management is a comprehensive course that explores the fundamental principles and practices involved in planning, acquiring, and managing an organizations financial resources. The course covers key topics such as financial analysis, budgeting, capital structure, investment decision-making, risk assessment, and working capital management. Students learn to interpret financial statements, apply time value of money concepts, evaluate investment opportunities, and balance profitability with risk. Through case studies and real-world examples, the course equips students with the analytical skills and strategic frameworks necessary to make informed financial decisions in both corporate and personal finance contexts.
Recommended Textbook Fundamentals of Financial Management 14th Edition by Eugene F. Brigham
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Chapter 1: An Overview of Financial Management
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Q1) Which of the following statements is CORRECT?
A)If a lower level person in a firm does something illegal, like "cooking the books," to understate costs and thereby artificially increase profits because he or she was ordered to do so by a superior, the lower level person cannot be prosecuted but the superior can be prosecuted.
B)There are many types of unethical business behavior. One example is where executives provide information that they know is incorrect to outsiders. It is illegal to provide such information to federally regulated banks, but it is not illegal to provide it to stockholders because they are the owners of the firm.
C)If someone deliberately understates costs and thereby causes reported profits to increase, this can cause the stock price to rise above its intrinsic value. The stock will probably fall in the future. Both those who participated in the fraud and the firm itself can be prosecuted.
D)Ethical behavior is not influenced by training and auditing procedures. People are either ethical or they are not, and this is what determines ethical behavior in business. E)Ethics is not an important consideration in business and in business schools.
Answer: C
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Chapter 2: Financial Markets and Institutions
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Q1) Money markets are markets for
A)Foreign currencies.
B)Consumer automobile loans.
C)Common stocks.
D)Long-term bonds.
E)Short-term debt securities such as Treasury bills and commercial paper.
Answer: E
Q2) You recently sold 100 shares of Microsoft stock to your brother at a family reunion.At the reunion your brother gave you a check for the stock and you gave your brother the stock certificates.Which of the following best describes this transaction?
A)This is an example of a direct transfer of capital.
B)This is an example of a primary market transaction.
C)This is an example of an exchange of physical assets.
D)This is an example of a money market transaction.
E)This is an example of a derivative market transaction.
Answer: A
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4
Chapter 3: Financial Statements, cash Flow, and Taxes
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Q1) West Corporation has $50,000 that it plans to invest in marketable securities.The corporation is choosing between the following three equally risky securities: Alachua County tax-free municipal bonds yielding 8.5%; Exxon Mobil bonds yielding 10.5%; and GM preferred stock with a dividend yield of 9.25%.West's corporate tax rate is 35%.What is the after-tax return on the best investment alternative? (Assume the company chooses on the basis of after-tax returns.)
A)8.500%
B)8.925%
C)9.371%
D)9.840%
E)10.332%
Answer: A
Q2) Companies typically provide four basic financial statements: the fixed income statement,the current income statement,the balance sheet,and the cash flow statement.
A)True
B)False
Answer: False
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Chapter 4: Analysis of Financial Statements
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Q1) The return on common equity (ROE)is generally regarded as being less significant,from a stockholder's viewpoint,than the return on total assets (ROA).
A)True B)False
Q2) High current and quick ratios always indicate that the firm is managing its liquidity position well.
A)True B)False
Q3) Han Corp's sales last year were $425,000,and its year-end receivables were $52,500.The firm sells on terms that call for customers to pay 30 days after the purchase,but some delay payment beyond Day 30.On average,how many days late do customers pay? Base your answer on this equation: DSO Allowed credit period = Average days late,and use a 365-day year when calculating the DSO.
A)12.94
B)13.62
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Chapter 5: Time Value of Money
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Q1) Suppose the U.S.Treasury offers to sell you a bond for $747.25.No payments will be made until the bond matures 5 years from now,at which time it will be redeemed for $1,000.What interest rate would you earn if you bought this bond at the offer price?
A)4.37%
B)4.86%
C)5.40%
D)6.00%
E)6.60%
Q2) If we are given a periodic interest rate,say a monthly rate,we can find the nominal annual rate by dividing the periodic rate by the number of periods per year.
A)True
B)False
Q3) Some of the cash flows shown on a time line can be in the form of annuity payments while others can be uneven amounts.
A)True
B)False
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Chapter 6: Interest Rates
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Q1) Which of the following statements is CORRECT?
A)The yield on a 2-year corporate bond should always exceed the yield on a 2-year Treasury bond.
B)The yield on a 3-year corporate bond should always exceed the yield on a 2-year corporate bond.
C)The yield on a 3-year Treasury bond should always exceed the yield on a 2-year Treasury bond.
D)If inflation is expected to increase, then the yield on a 2-year bond should exceed that on a 3-year bond.
E)The real risk-free rate should increase if people expect inflation to increase.
Q2) One of the four most fundamental factors that affect the cost of money as discussed in the text is the current state of the weather.If the weather is dark and stormy,the cost of money will be higher than if it is bright and sunny,other things held constant.
A)True
B)False
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Chapter 7: Bonds and Their Valuation
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Q1) Which of the following statements is CORRECT?
A)If a bond is selling at a discount to par, its current yield will be greater than its yield to maturity.
B)All else equal, bonds with longer maturities have less price risk than bonds with shorter maturities.
C)If a bond is selling at its par value, its current yield equals its capital gains yield.
D)If a bond is selling at a premium, its current yield will be less than its capital gains yield.
E)All else equal, bonds with larger coupons have less price risk than bonds with smaller coupons.
Q2) Radoski Corporation's bonds make an annual coupon interest payment of 7.35%.The bonds have a par value of $1,000,a current price of $1,130,and mature in 12 years.What is the yield to maturity on these bonds?
A)5.52%
B)5.82%
C)6.11%
D)6.41%
E)6.73%
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Chapter 8: Risk and Rates of Return
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Q1) Which of the following statements is CORRECT?
A)An investor can eliminate virtually all market risk if he or she holds a very large and well diversified portfolio of stocks.
B)The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio.
C)It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that includes the stock.
D)Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount.
E)An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.
Q2) The Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero,which is the risk-free rate.
A)True
B)False
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Chapter 9: Stocks and Their Valuation
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Q1) Two conditions are used to determine whether or not a stock is in equilibrium:
(1)Does the stock's market price equal its intrinsic value as seen by the marginal investor,and (2)does the expected return on the stock as seen by the marginal investor equal this investor's required return? If either of these conditions,but not necessarily both,holds,then the stock is said to be in equilibrium.
A)True
B)False
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 expected return on the stock is 5% a year.
B)The stock's dividend yield is 5%.
C)The price of the stock is expected to decline in the future.
D)The stock's required return must be equal to or less than 5%.
E)The stock's price one year from now is expected to be 5% above the current price.
Q3) The corporate valuation model cannot be used unless a company pays dividends.
A)True B)False
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Page 11
Chapter 10: The Cost of Capital
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Q1) Which of the following statements is CORRECT?
A)When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are deductible by the paying corporation.
B)When calculating the cost of preferred stock, companies must adjust for taxes, because dividends paid on preferred stock are deductible by the paying corporation.
C)Because of tax effects, an increase in the risk-free rate will have a greater effect on the after-tax cost of debt than on the cost of common stock as measured by the CAPM.
D)If a company's beta increases, this will increase the cost of equity used to calculate the WACC, but only if the company does not have enough retained earnings to take care of its equity financing and hence must issue new stock.
E)Higher flotation costs reduce investors' expected returns, and that leads to a reduction in a company's WACC.
Q2) The component costs of capital are market-determined variables in the sense that they are based on investors' required returns.
A)True
B)False
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Chapter 11: The Basics of Capital Budgeting
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Q1) Which of the following statements is CORRECT?
A)For a project with normal cash flows, any change in the WACC will change both the NPV and the IRR.
B)To find the MIRR, we first compound cash flows at the regular IRR to find the TV, and then we discount the TV at the WACC to find the PV.
C)The NPV and IRR methods both assume that cash flows can be reinvested at the WACC. However, the MIRR method assumes reinvestment at the MIRR itself.
D)If two projects have the same cost, and if their NPV profiles cross in the upper right quadrant, then the project with the higher IRR probably has more of its cash flows coming in the later years.
E)If two projects have the same cost, and if their NPV profiles cross in the upper right quadrant, then the project with the lower IRR probably has more of its cash flows coming in the later years.
Q2) The internal rate of return is that discount rate that equates the present value of the cash outflows (or costs)with the present value of the cash inflows.
A)True B)False
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Page 13
Chapter 12: Cash Flow Estimation and Risk Analysis
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Q1) The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the present value of the tax savings provided by depreciation will be higher,other things held constant.
A)True
B)False
Q2) The two cardinal rules that financial analysts should follow to avoid errors are: (1)in the NPV equation,the numerator should use income calculated in accordance with generally accepted accounting principles,and (2)all incremental cash flows should be considered when making accept/reject decisions for capital budgeting projects.
A)True
B)False
Q3) Estimating project cash flows is generally the most important,but also the most difficult,step in the capital budgeting process.Methodology,such as the use of NPV versus IRR,is important,but less so than obtaining a reasonably accurate estimate of projects' cash flows.
A)True B)False
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14
Chapter 13: Real Options and Other Topics in Capital
Budgeting
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Q1) Chrustuba Inc.is evaluating a new project that would cost $9 million at t = 0.There is a 50% chance that the project would be highly successful and generate annual after-tax cash flows of $6 million during Years 1,2,and 3.However,there is a 50% chance that it would be less successful and would generate only $1 million for each of the 3 years.If the project is highly successful,it would open the door for another investment of $10 million at the end of Year 2,and this new investment could be sold for $20 million at the end of Year 3.Assuming a WACC of 10.0%,what is the project's expected NPV (in thousands)after taking into account this growth option?
A)$2,776
B)$3,085
C)$3,393
D)$3,733
E)
Q2) The following are all examples of real options that are discussed in the text: (1)natural resource options,(2)flexibility options,(3)timing options,and (4)abandonment options.
A)True B)False
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Chapter 14: Capital Structure and Leverage
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Q1) Firms U and L each have the same amount of assets,investor-supplied capital,and both have a return on investors' capital (ROIC)of 12%.Firm U is unleveraged,i.e.,it is 100% equity financed,while Firm L is financed with 50% debt and 50% equity.Firm L's debt has an after-tax cost of 8%.Both firms have positive net income and a 35% tax rate.Which of the following statements is CORRECT?
A)The two companies have the same times interest earned (TIE) ratio.
B)Firm L has a lower ROA than Firm U.
C)Firm L has a lower ROE than Firm U.
D)Firm L has the higher times interest earned (TIE) ratio.
E)Firm L has a higher EBIT than Firm U.
Q2) According to Modigliani and Miller (MM),in a world with corporate income taxes the optimal capital structure calls for approximately 100% debt financing.
A)True
B)False
Q3) If a firm borrows money,it is using financial leverage.
A)True
B)False
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Chapter 15: Distributions to Shareholders: Dividends and Share Repurchases
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Q1) Mortal Inc.expects to have a capital budget of $500,000 next year.The company wants to maintain a target capital structure with 30% debt and 70% equity,and its forecasted net income is $400,000.If the company follows the residual dividend model,how much in dividends,if any,will it pay?
A)$45,125
B)$47,500
C)$50,000
D)$52,500
E)$55,125
Q2) Which of the following would be most likely to lead to a decrease in a firm's dividend payout ratio?
A)Its earnings become more stable.
B)Its access to the capital markets increases.
C)Its research and development efforts pay off, and it now has more high-return investment opportunities.
D)Its accounts receivable decrease due to a change in its credit policy.
E)Its stock price has increased over the last year by a greater percentage than the increase in the broad stock market averages.
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Chapter 16: Working Capital Management
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Q1) If a firm has set up a revolving credit agreement with a bank,the risk to the firm of being unable to obtain funds when needed is lower than if it had an informal line of credit.
A)True
B)False
Q2) Refer to Exhibit 15.1.If the firm adopts a restricted policy,how much lower would its interest expense be than under the relaxed policy?
A)$ 8,418
B)$ 8,861
C)$ 9,327
D)$ 9,818
E)$10,309
Q3) The maturity of most bank loans is short term.Bank loans to businesses are frequently made as 90-day notes which are often rolled over,or renewed,rather than repaid when they mature.However,if the borrower's financial situation deteriorates,then the bank may refuse to roll over the loan.
A)True
B)False
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Chapter 17: Financial Planning and Forecasting
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Q1) Errors in the sales forecast can be offset by similar errors in costs and income forecasts.Thus,as long as the errors are not large,sales forecast accuracy is not critical to the firm.
A)True
B)False
Q2) Two firms with identical capital intensity ratios are generating the same amount of sales.However,Firm A is operating at full capacity,while Firm B is operating below capacity.If the two firms expect the same growth in sales during the next period,then Firm A is likely to need more additional funds than Firm B,other things held constant.
A)True
B)False
Q3) 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
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19
Chapter 18: Derivatives and Risk Management
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Q1) Lissa Co.'s stock price is currently $30.25.A 6-month call option on Lissa's stock has a strike price of $25 and has an expected volatility of 40% (i.e.,expected standard deviation = 40%).The risk-free rate is 6%.According to the Black-Scholes option pricing model,what is the value of the option?
A)$5.06
B)$5.62
C)$6.24
D)$6.94
E)$7.63
Q2) Suppose a CBOT 10-year U.S.Treasury note futures contract has a quoted price of 103-18.If annual interest rates go up by 1.00 percentage point,what is the gain or loss on the futures contract? (Assume a $1,000 par value,round the new interest rate to 4 decimal places when written as a decimal,and round the change in price up to the nearest whole dollar.)
A) $61.00
B) $64.00
C) $67.00
D) $71.00
E) $75.00
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Page 20
Chapter 19: Multinational Financial Management
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Q1) When considering the risk of a foreign investment,a higher risk might arise from exchange rate risk and political risk while lower risk might result from international diversification.
A)True
B)False
Q2) Suppose one British pound can purchase 1.82 U.S.dollars today in the foreign exchange market,and currency forecasters predict that the U.S.dollar will depreciate by 12.0% against the pound over the next 30 days.How many dollars will a pound buy in 30 days?
A)$1.4860
B)$1.6511
C)$1.8346
D)$2.0384
E)$2.2422
Q3) Individuals and corporations can buy or sell forward currencies to hedge their exchange rate exposure.Essentially,the process involves simultaneously selling the currency expected to appreciate in value and buying the currency expected to depreciate.
A)True
B)False
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Chapter 20: Hybrid Financing: Preferred Stock, leasing, warrants,
and Convertibles
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Q1) Ellis Enterprises is considering whether to lease or buy some necessary equipment it needs for a project that will last the next 3 years.If the firm buys the equipment,it will borrow $4,800,000 at 8% interest.The firm's tax rate is 35% and the firm's before-tax cost of debt is 8%.Annual maintenance costs associated with ownership are estimated to be $300,000 and the equipment will be depreciated on a straight-line basis over 3 years.What is the annual end-of-year lease payment (in thousands of dollars)for a 3-year lease that would make the firm indifferent between buying or leasing the equipment? (Suggestion: Delete 3 zeros from dollars and work in thousands.)
A)$1,950
B)$2,052
C)$2,160
D)$2,268
E)$2,382
Q2) A detachable warrant is a warrant that can be removed from the security with which it was issued and traded separately from it.Most traded warrants are originally attached to bonds or preferred stocks.
A)True B)False
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Chapter 21: Mergers and Acquisitions
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Q1) Gekko Properties is considering purchasing Teldar Properties.Gekko's analysts project that the merger will result in incremental after-tax cash flows of $2 million,$4 million,$5 million,and $10 million over the next four years.The horizon value of the firm's operations,as of Year 4,is expected to be $107 million.Assume all cash flows occur at the end of the year.The acquisition would be made immediately,if it is undertaken.Teldar's post-merger beta is estimated to be 2.0,and its post-merger tax rate would be 35%.The risk-free rate is 6%,and the market risk premium is 5.5%.What is the value of Teldar to Gekko Properties?
A)$66,680,846
B)$70,190,364
C)$73,699,883
D)$77,384,877
E)$81,254,121
Q2) Discounted cash flow methods are not appropriate for evaluating mergers because the cash flows are uncertain and the discount rate can only be determined after the merger is consummated.
A)True B)False
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Page 23
Chapter 22: Continuous Compounding and Discounting
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Q1) You have $5,436.60 in an account that pays 10% interest,compounded continuously.If you deposited some funds 10 years ago,how much was your original deposit?
A)$1,900
B)$2,000
C)$2,100
D)$2,205
E)$2,315
Q2) You need a down payment of $19,000 in order to purchase your first home 4 years from today.You currently have $14,014 to invest.In order to achieve your goal,what nominal interest rate,compounded continuously,must you earn on this investment?
A)7.61%
B)7.99%
C)8.39%
D)8.81%
E)9.25%
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Chapter 23: Zero Coupon Bonds
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Q1) Schiffauer Electronics plans to issue 10-year,zero coupon bonds with a par value of $1,000 and a yield to maturity of 9.5%.The company has a tax rate of 30%.How much extra in taxes would the company pay (or save)the second year (at t = 2)if it goes ahead and issues the bonds?
A)$12.59
B)$12.91
C)$13.23
D)$13.56
E)$13.90
Q2) Recycler Battery Corporation (RBC)issued zero coupon bonds 5 years ago at a price of $214.50 per bond.RBC's zeros had a 20-year original maturity,with a $1,000 par value.The bonds were callable 10 years after the issue date at a price 7% over their accrued value on the call date.If the bonds sell for $240 in the market today,what annual rate of return should an investor who buys the bonds today expect to earn on them?
A)9.01%
B)9.48%
C)9.98%
D)10.48%
E)11.00%
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Chapter 24: Bankruptcy and Reorganization
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Q1) What would be the priority of the claims as to the distribution of assets in a liquidation under Chapter 7 of the Bankruptcy Act?
1)Trustees' costs to administer and operate the firm.
2)Common stockholders.
3)General,or unsecured,creditors.
4)Secured creditors who have claim to the proceeds from the sale of a specific property pledged for a mortgage.
5)Taxes due to federal and state governments.
A)1, 4, 3, 5, 2
B)5, 4, 1, 3, 2
C)4, 1, 5, 3, 2
D)5, 1, 4, 2, 3
E)1, 5, 4, 3, 2
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Chapter 25: Calculating Beta Coefficients
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Q1) Which of the following statements is CORRECT?
A)The CAPM is an ex ante model, which means that all of the variables should be historical values that can reasonably be projected into the future.
B)The beta coefficient used in the SML equation should reflect the expected volatility of a given stock's return versus the return on the market during some future period.
C)The general equation: Y = a + bX + e, is the standard form of a simple linear regression where b = beta, and X equals the independent return on an individual security being compared to Y, the return on the market, which is the dependent variable.
D)The rise-over-run method is not a legitimate method of estimating beta because it measures changes in an individual security's return regressed against time.
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Chapter 26: Using the Capm to Estimate the Risk-Adjusted Cost of Capital
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Q1) Assume you are the director of capital budgeting for an all-equity firm.The firm's current cost of equity is 16%; the risk-free rate is 10%; and the market risk premium is 5%.You are considering a new project that has 50% more beta risk than your firm's assets currently have,that is,its beta is 50% larger than the firm's existing beta.The expected return on the new project is 18%.Should the project be accepted if beta risk is the appropriate risk measure? Choose the correct statement.
A)Yes; its expected return is greater than the firm's WACC.
B)Yes; the project's risk-adjusted required return is less than its expected return.
C)No; a 50% increase in beta risk gives a risk-adjusted required return of 24%.
D)No; the project's risk-adjusted required return is 2% above its expected return.
E)No; the project's risk-adjusted required return is 1% above its expected return.
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Chapter 27: Techniques for Measuring Beta Risk
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Q1) Northern Conglomerate has two divisions,Division A and Division B.Northern looks at competing pure-play firms to estimate the betas of each of the two divisions.After this analysis,Northern concludes that Division A has a beta of 0.8 and Division B has a beta of 1.5.The two divisions are the same size.The risk-free rate is 5% and the market risk premium is 6%.Assume that Northern is 100% equity financed.What is the overall composite WACC for Northern Conglomerate?
A)10.74%
B)11.31%
C)11.90%
D)12.50%
E)13.12%
Q2) Which of the following methods involves calculating an average beta for comparable firms and using that beta to determine a project's beta?
A)Risk premium method
B)Pure play method
C)Accounting beta method
D)CAPM method
E)Discounted cash flow model
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Chapter 28: Degree of Leverage
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Sample Questions
Q1) Coats Corp.generates $10,000,000 in sales.Its variable costs equal 85% of sales and its fixed costs are $500,000.Therefore,the company's operating income (EBIT)equals $1,000,000.The company estimates that if its sales were to increase 10%,its net income and EPS would increase 17.5%.What is the company's interest expense?
A)$122,482
B)$128,929
C)$135,714
D)$142,857
E)$150,000
Q2) Which of the following is a key benefit of using the degree of leverage concept in financial analysis?
A)It allows decision makers a relatively clear assessment of the consequences of alternative actions.
B)It establishes the optimal capital structure for the firm.
C)It shows how a given change in leverage will affect sales.
D)It identifies, with certainty, the future net income based upon sales projections about the future.
E)None of the above statements is correct.
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