Financial Management Practice Exam
Course Introduction
Financial Management is a foundational course that introduces students to the principles and practices involved in making effective financial decisions within an organization. It covers essential topics such as financial planning, analysis of financial statements, time value of money, risk and return, valuation of assets, capital budgeting, cost of capital, and working capital management. Through real-world examples and case studies, the course equips students with the analytical tools needed to assess financial health, allocate resources efficiently, and develop strategies to maximize shareholder value. By the end of the course, students will be prepared to tackle financial challenges faced by businesses and understand the broader role of finance in achieving organizational objectives.
Recommended Textbook
Essentials of Corporate Finance 7th Edition by Stephen A. Ross Westerfield
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Page 2
Chapter 1: Introduction to Financial Management
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Sample Questions
Q1) Corporate shareholders:
A) are proportionately liable for the firm's debts.
B) are protected from all losses.
C) have the ability to change the corporation's bylaws.
D) receive tax-free distributions since all profits are taxed at the corporate level.
E) have basically no control over the actual corporation.
Answer: C
Q2) Which one of the following is most apt to align management's priorities with shareholders' interests?
A) Increasing employee retirement benefits
B) Compensating managers with shares of stock that must be held for 3 years before the shares can be sold
C) Allowing a manager to decorate his or her own office once he or she has been in that office for a period of 3 years or more
D) Increasing the number of paid holidays that long-term employees are entitled to receive
E) Allowing employees to retire early with full retirement benefits
Answer: B
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3
Chapter 2: Financial Statements, Taxes, and Cash Flow
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Sample Questions
Q1) Which one of the following statements concerning market and book values is correct?
A) The market value of accounts receivable is generally higher than the book value of those receivables.
B) The market value tends to provide a better guide to the actual worth of an asset than does the book value.
C) The market value of fixed assets will always exceed the book value of those assets.
D) Book values represent the amount of cash that will be received if an asset is sold.
E) The current book value of equipment purchased last year is equal to the initial cost of the equipment.
Answer: B
Q2) How can a firm determine if its level of liquidity is appropriate?
Answer: If a firm has too little liquidity, it will encounter problems with its cash flow and at times have insufficient funds on hand to pay its debts. If a firm has too much liquidity, it will have extra cash that it never needs for its daily operations. Thus, the appropriate level of liquidity is somewhere in the middle between too little and too much.
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4
Chapter 3: Working With Financial Statements
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Sample Questions
Q1) Which one of the following actions will increase the current ratio, all else constant? Assume the current ratio is greater than 1.0.
A) Cash purchase of inventory
B) Cash payment of an account receivable
C) Cash payment of an account payable
D) Credit sale of inventory at cost
E) Cash sale of inventory at a loss
Answer: C
Q2) A firm has $42,900 in receivables and $211,800 in total assets. The total asset turnover rate is 1.45 and the profit margin is 4.2 percent. How long on average does it take the firm to collect its receivables?
A) 7.16 days
B) 9.45 days
C) 11.68 days
D) 31.25 days
E) 50.99 days
Answer: E
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Page 5
Chapter 4: Introduction to Valuation: The Time Value of Money
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Sample Questions
Q1) Today, Tony is investing $16,000 at 6.5 percent, compounded annually, for 4 years. How much additional income could he earn if he had invested this amount at 7 percent, compounded annually?
A) $323.22
B) $389.28
C) $401.16
D) $442.79
E) $484.08
Q2) Isaac only has $690 today but needs $800 to buy a new laptop. How long will he have to wait to buy the laptop if he earns 5.4 percent compounded annually on his savings?
A) 2.29 years
B) 2.48 years
C) 2.51 years
D) 2.77 years
E) 2.81 years
Q3) Explain the time value of money principle and also identify the underlying assumption of that principle.
Q4) Explain the Rule of 72.
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Chapter 5: Discounted Cash Flow Valuation
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Sample Questions
Q1) Travis is buying a car and will finance it with a loan which requires monthly payments of $265 for the next 4 years. His car payments can be described by which one of the following terms?
A) Perpetuity
B) Annuity
C) Consol
D) Lump sum
E) Factor
Q2) A loan has an APR of 8.5 percent and an EAR of 8.5 percent. Given this, the loan must:
A) have a one-year term.
B) have a zero percent interest rate.
C) charge interest annually.
D) must be an interest-only loan.
E) require the accrued interest be paid in full with each monthly payment.
Q3) Jesse just won the state lottery. He has been given the option of receiving either $66.4 million today or $5 million a year for the next 30 years, with the first payment paid today. Describe the process that Jesse should use to determine which payment option he prefers. Ignore all taxes and assume that Jesse will live for at least 45 more years.
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7
Chapter 6: Interest Rates and Bond Valuation
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Sample Questions
Q1) Which one of the following bonds is most apt to have the smallest liquidity premium?
A) Treasury bill
B) Corporate bond issued by a new firm
C) Municipal bond issued by the State of New York
D) Municipal bond issued by a rural city in Alaska
E) Corporate bond issued by General Motors (GM)
Q2) Over the next three years, you expect the rate of inflation to decrease, but yet remain positive. After that, you expect inflation to increase steadily for the next several years. Draw a term structure of interest rates graph based on this assumption and identify all the components of that structure.
Q3) Jeffries, Inc. has 6 percent coupon bonds on the market that have 11 years left to maturity. The bonds make annual payments. If the YTM on these bonds is 7.4 percent, what is the current bond price?
A) $895.88
B) $897.08
C) $903.14
D) $921.42
E) $933.33
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Chapter 7: Equity Markets and Stock Valuation
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Sample Questions
Q1) The more actively traded large companies that are listed on NASDAQ are traded in which one of the NASDAQ markets?
A) National
B) Capital
C) Regional
D) Global Select
E) Global
Q2) Which one of the following statements is correct?
A) From a legal perspective, preferred stock is a form of corporate equity.
B) All classes of stock must have equal voting rights per share.
C) Common shareholders elect the corporate directors while the preferred shareholders vote on mergers and acquisitions.
D) Dividends are tax-free income for individual investors.
E) Shareholders prefer noncumulative dividends over cumulative dividends.
Q3) To be a member of the NYSE, you must:
A) be a primary dealer.
B) buy a seat.
C) own a trading license.
D) be registered as a floor trader.
E) be a specialist.
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Chapter 8: Net Present Value and Other Investment Criteria
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Sample Questions
Q1) A firm is reviewing a project that has an initial cost of $71,000. The project will produce annual cash inflows, starting with year 1, of $8,000, $13,400, $18,600, $33,100 and finally in year five, $37,900. What is the profitability index if the discount rate is 11 percent?
A) 0.92
B) 0.98
C) 1.02
D) 1.07
E) 1.12
Q2) The possibility that more than one discount rate can cause the net present value of an investment to equal zero is referred to as:
A) duplication.
B) the net present value profile.
C) multiple rates of return.
D) the AAR problem.
E) the dual dilemma.
Q3) Explain why the net present value is considered to be the best method of analyzing an investment.
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Chapter 9: Making Capital Investment Decisions
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Sample Questions
Q1) The Outpost currently sells short leather jackets for $349 each. The firm is considering selling long coats also. The coats would sell for $689 each and the company expects to sell 900 a year. If the firm decides to carry the long coat, management feels that the sales of the short jacket will decline from 1,420 to 1,265 units. Variable costs on the jacket are $210 and $445 on the long coat. The fixed costs for this project are $42,000, depreciation is $11,000 a year, and the tax rate is 33 percent. What is the projected operating cash flow for this project?
A) $108,187
B) $111,264
C) $112,212
D) $119,672
E) $120,418
Q2) A debt-free firm has net income of $128,400, taxes of $46,200, and depreciation of $21,300. What is the operating cash flow?
A) $82,200
B) $103,500
C) $107,100
D) $149,700
E) $195,900
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Page 11
Chapter 10: Some Lessons From Capital Market History
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Sample Questions
Q1) Over the past six years, a stock had annual returns of 14 percent, -3 percent, 8 percent, 21 percent, -16 percent, and 4 percent, respectively. What is the standard deviation of these returns?
A) 11.27 percent
B) 13.05 percent
C) 13.59 percent
D) 15.08 percent
E) 14.40 percent
Q2) Which one of the following is the most apt to have the largest risk premium in the future based on the historical record for 1926-2008?
A) U.S. Treasury bills
B) Large-company stocks
C) Long-term government debt
D) Small-company stocks
E) Long-term corporate debt
Q3) For the period 1926-2008, small-company stocks had a risk premium of 12.6 percent. What does the term "risk premium" mean? Is the risk premium on these stocks considered to be relatively high or relative low as compared to other investment classes? Explain why.
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Page 12
Chapter 11: Risk and Return
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Sample Questions
Q1) Based on the capital asset pricing model, which one of the following must increase the expected return on an individual security, all else constant?
A) An increase in the risk level of that security as measured by the standard deviation
B) An increase in the risk-free rate given a security beta of 1.42
C) A decrease in the market rate of return given a security beta of 1.13
D) A decrease in the market rate of return given a security beta of .78
E) A decrease in the risk-free rate given a security beta of 1.06
Q2) Stock A comprises 28 percent of Susan's portfolio. Which one of the following terms applies to the 28 percent?
A) Portfolio variance
B) Portfolio standard deviation
C) Portfolio weight
D) Portfolio expected return
E) Portfolio beta
Q3) Explain the relationships among the reward-to-risk ratio, risk-free rate of return, market rate of return, market risk premium, beta, and the security market line.
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Chapter 12: Cost of Capital
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Sample Questions
Q1) All else constant, which of the following will increase the aftertax cost of debt for a firm? I. increase in the yield to maturity of the firm's outstanding debt
II) decrease in the yield to maturity of the firm's outstanding debt
III) increase in the firm's tax rate
IV) decrease in the firm's tax rate
A) I only
B) I and III only
C) I and IV only
D) II and III only
E) II and IV only
Q2) Which one of the following is the pre-tax cost of debt?
A) Average coupon rate on the firm's outstanding bonds
B) Coupon rate on the firm's latest bond issue
C) Weighted average yield-to-maturity on the firm's outstanding debt
D) Average current yield on the firm's outstanding debt
E) Annual interest divided by the market price per bond for the latest bond issue
Q3) Explain the concept of the subjective approach to assigning a required return to a project.
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Chapter 13: Leverage and Capital Structure
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Sample Questions
Q1) Gabella's is an all-equity firm that has 21,000 shares of stock outstanding at a market price of $40 a share. The firm has earnings before interest and taxes of $84,000 and has a 100 percent dividend payout ratio. Ignore taxes. Gabella's has decided to issue $160,000 of debt at a rate of 12 percent and use the proceeds to repurchase shares. Travis owns 500 shares of Gabella's stock and has decided to continue holding those shares. How will Gabella's debt issue affect Travis' annual dividend income?
A) Decrease from $2,400 to $1,840
B) Increase from $2,400 to $2,160
C) Decrease from $2,000 to $1,906
D) Increase from $2,000 to $2,094
E) No change
Q2) A firm has a cost of debt of 7.5 percent and a cost of equity of 16.2 percent. The debt-equity ratio is 0.45. There are no taxes. What is the firm's weighted average cost of capital?
A) 11.75 percent
B) 12.29 percent
C) 13.50 percent
D) 14.47 percent
E) 16.20 percent
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Page 15
Chapter 14: Dividends and Dividend Policy
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Sample Questions
Q1) The common stock of Gallaghan's closed at $36.80 a share today. Tomorrow morning, the stock goes ex-dividend. The dividend that is being paid this quarter is $1.40 a share. The tax rate on dividends is 15 percent. All else equal, what should the opening stock price be tomorrow morning?
A) $35.19
B) $35.40
C) $35.52
D) $35.61
E) $35.70
Q2) Martin & Martin, Inc. stock is currently selling for $19 per share. The firm just made an offer to one of its major shareholders to repurchase all the shares owned by that shareholder for $25 per share. What type of offer is being made?
A) Rights offer
B) Secondary issue
C) Targeted repurchase
D) Tender offer
E) Private issue
Q3) Explain why a firm might prefer a stock repurchase rather than an increase in the firm's regular dividend.
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Page 16
Chapter 15: Raising Capital
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Sample Questions
Q1) What are some of the key factors an individual should consider before selecting a first-stage venture capitalist?
Q2) Which one of the following describes a Green Shoe provision?
A) Determination of underwriters' fees
B) Guarantee of sale for all offered shares
C) Price auction
D) Overallotment option
E) Description of issue excluding the offer price
Q3) Which one of the following is an intended result of a lockup agreement?
A) Temporarily supporting the market price of IPO shares
B) Maximizing the return to a firm's original owners from an initial spike in the market price of IPO shares
C) Increasing the volume of trading for shares of a recent IPO
D) Limiting the price volatility of recent IPO shares caused by day trading
E) Guaranteeing a minimum number of sold shares for an IPO
Q4) Explain how a Dutch auction operates and why a firm might choose to sell its securities in this manner.
Q5) Provide two arguments in favor of IPO underpricing and two arguments against IPO underpricing.
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Chapter 16: Short-Term Financial Planning
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Sample Questions
Q1) The Corner Store is a small-sized, general store which stocks a minimal level of basic supplies and offers gasoline to a rural community. Which one of the following types of credit is probably best-suited for financing this store's inventory?
A) Trust receipt financing
B) Receivables factoring
C) Field warehousing
D) Blanket inventory lien
E) Receivables assignment
Q2) Which one of the following statements about the operating cycle is correct?
A) The operating cycle illustrates the sources and uses of cash.
B) The operating cycle is equal to the cash cycle plus the accounts receivable period.
C) The operating cycle begins when a product is sold to a customer.
D) The operating cycle is based on a 360-day year.
E) The operating cycle describes how a product moves through the current asset accounts.
Q3) How can a firm benefit from preparing a short-term financial plan?
Q4) Identify and briefly explain three ways in which a firm can finance its short-term assets.
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Page 18
Chapter 17: Working Capital Management
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Sample Questions
Q1) Which one of the following is the need to hold cash simply as a financial reserve?
A) Precautionary motive
B) Opportunistic motive
C) Speculative motive
D) Activity motive
E) Transaction motive
Q2) A firm uses the extended economic order quantity approach to inventory management. Which one of the following inventory levels is considered to be the minimum inventory level given this approach?
A) Zero inventory
B) Reorder point level
C) Safety stock level
D) 50 percent of the reorder quantity
E) Safety stock plus the reorder quantity
Q3) Identify some of the specific costs firms incur if their current asset levels are either too high or too low.
Q4) What are some of the pros and cons of a JIT inventory management system?
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Chapter 18: International Aspects of Financial Management
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Sample Questions
Q1) Interest rate parity defines the relationships among which of the following?
A) Spot exchange rates, future exchange rates, interest rates, and inflation rates
B) Real and nominal interest rates across countries
C) Real interest and inflation rates
D) Forward exchange rates, relative interest rates, and spot exchange rates
E) Spot exchange rates, forward exchange rates, nominal interest rates, and real interest rates
Q2) Short-run exposure to exchange rate risk is best illustrated by which one of the following?
A) Change in book value when the market value of an asset remains constant
B) Daily fluctuations in the spot rate
C) Increases in the forward rate as the time to settlement increases
D) Changes in relative economic conditions between two countries
E) Unrealized foreign exchange gains
Q3) Explain how the forward exchange market can help reduce short-run exposure to exchange rate risk.
Q4) Explain how a firm can structure its operations such that it creates its own internal hedge to long-run exposure to exchange rate risk.
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Page 20