Financial Strategy Review Questions
Course Introduction
Financial Strategy explores the principles and techniques behind making long-term financial decisions that align with a companys overall objectives. The course covers topics such as capital budgeting, capital structure, dividend policy, corporate valuation, risk management, and mergers and acquisitions. Students will analyze real-world cases and learn how financial strategies impact firm value, competitive positioning, and growth. Through lectures and practical assignments, participants develop the analytical skills and strategic mindset necessary to make informed financial decisions in a dynamic business environment.
Recommended Textbook
Intermediate Financial Management 13th Edition by Eugene
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Page 2
F. Brigham
Chapter 1: An Overview of Financial Management and the Financial Environment
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Q1) Which of the following statements is CORRECT
A) in a regular partnership, liability for other partners' misdeeds is limited to the amount of a particular partner's investment in the business.
B) attracting large amounts of capital is more difficult for partnerships than for corporations because of such factors as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and selling) of partnership interests.
C) a slow-growth company, with little need for new capital, would be more likely to organize as a corporation than would a faster growing company.
D) the limited partners in a limited partnership have voting control, while the general partner has operating control over the business. also, the limited partners are individually responsible, on a pro rata basis, for the firm's debts in the event of bankruptcy.
E) a major disadvantage of all partnerships compared to all corporations is the fact that federal income taxes must be paid by the partners rather than by the firm itself.
Answer: B
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Chapter 2: Risk and Return-Part I
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Q1) If you randomly select stocks and add them to your portfolio, which of the following statements best describes what you should expect
A) adding more such stocks will increase the portfolio's expected rate of return.
B) adding more such stocks will reduce the portfolio's beta coefficient and thus its systematic risk.
C) adding more such stocks will have no effect on the portfolio's risk.
D) adding more such stocks will reduce the portfolio's market risk but not its unsystematic risk.
E) adding more such stocks will reduce the portfolio's unsystematic, or diversifiable, risk.
Answer: E
Q2) According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation. Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a well-diversified portfolio.
A)True
B)False
Answer: True
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Chapter 3: Risk and Return-Part II
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Q1) We will almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.
A)True
B)False
Answer: False
Q2) Which of the following statements is CORRECT?
A) richard roll has argued that it is possible to test the capm to see if it is correct.
B) tests have shown that the risk/return relationship appears to be linear, but the slope of the relationship is greater than that predicted by the capm.
C) tests have shown that the betas of individual stocks are stable over time, but that the betas of large portfolios are much less stable.
D) the most widely cited study of the validity of the capm is one performed by modigliani and miller.
E) tests have shown that the betas of individual stocks are unstable over time, but that the betas of large portfolios are reasonably stable over time.
Answer: E
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Chapter 4: Bond Valuation
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Q1) One year ago Lerner and Luckmann Co. issued 15-year, noncallable, 7.5% annual coupon bonds at their par value of $1,000. Today, the market interest rate on these bonds is 5.5%. What is the current price of the bonds, given that they now have 14 years to maturity?
A) $1,077.01
B) $1,104.62
C) $1,132.95
D) $1,162.00
E) $1,191.79
Q2) A zero coupon bond is a bond that pays no interest and is offered (and subsequently sells initially) at par. These bonds provide compensation to investors in the form of capital appreciation.
A)True
B)False
Q3) The desire for floating-rate bonds, and consequently their increased usage, arose out of the experience of the early 1980s, when inflation pushed interest rates up to very high levels and thus caused sharp declines in the prices of outstanding bonds.
A)True
B)False
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Page 6
Chapter 5: Financial Options
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Q1) Suppose you believe that Basso Inc.'s stock price is going to increase from its current level of $22.50 sometime during the next 5 months. For $3.10 you can buy a 5-month call option giving you the right to buy 1 share at a price of $25 per share. If you buy this option for $3.10 and Basso's stock price actually rises to $45, what would your pre-tax net profit be?
A) $3.10
B) $16.90
C) $17.75
D) $22.50
E) $25.60
Q2) The current price of a stock is $22, and at the end of one year its price will be either $27 or $17. The annual risk-free rate is 6.0%, based on daily compounding. A 1-year call option on the stock, with an exercise price of $22, is available. Based on the binomial model, what is the option's value?(Hint: Use daily compounding.)
A) $2.43
B) $2.70
C) $2.99
D) $3.29
E) $3.62
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Chapter 6: Accounting for Financial Management
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Q1) TSW Inc. had the following data for last year: Net income = $800; Net operating profit after taxes (NOPAT) = $700; Total assets = $3,000; and Total operating capital = $2,000.
Information for the just-completed year is as follows: Net income = $1,000; Net operating profit after taxes (NOPAT) = $925; Total assets = $2,600; and Total operating capital = $2,500. How much free cash flow did the firm generate during the just-completed year?
A) $383
B) $425
C) $468
D) $514
E) $566
Q2) The income statement shows the difference between a firm's income and its costs i.e., its profits during a specified period of time. However, not all reported income comes in the form or cash, and reported costs likewise may not correctly reflect cash outlays. Therefore, there may be a substantial difference between a firm's reported profits and its actual cash flow for the same period.
A)True
B)False
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Page 8
Chapter 7: Analysis of Financial Statements
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Q1) Amram Company's current ratio is 1.9. Considered alone, which of the following actions would reduce the company's current ratio?
A) use cash to reduce accounts payable.
B) borrow using short-term notes payable and use the proceeds to reduce accruals.
C) borrow using short-term notes payable and use the proceeds to reduce long-term debt.
D) use cash to reduce accruals.
E) use cash to reduce short-term notes payable.
Q2) Refer to the data for Pettijohn Inc.What is the firm's P/E ratio?
A) 12.0
B) 12.6
C) 13.2
D) 13.9
E) 14.6
Q3) If a firm finances with only debt and common equity, and if its equity multiplier is 3.0, then its debt ratio must be 0.667.
A)True
B)False
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Chapter 8: Basic Stock Valuation
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Q1) Stocks A and B have the following data. Assuming the stock market is efficient and the stocks are in equilibrium, which of the following statements is CORRECT?
\(\begin{array}{lcc}
& \mathrm{A}& \underline{\mathrm{B}} \\
\text { Required return } & 10 \% & 12 \%\\
\text { Market price } & \$ 25 & \$ 40 \\
\text { Expected growth } & 7\%& 9\% \\
\end{array}\)
A) these two stocks must have the same dividend yield.
B) these two stocks should have the same expected return.
C) these two stocks must have the same expected capital gains yield.
D) these two stocks must have the same expected year-end dividend.
E) these two stocks should have the same price.
Q2) The constant growth dividend model used to evaluate the prices of common stocks is conceptually similar to the model used to find the price of perpetual preferred stock or other perpetuities.
A)True
B)False
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Page 10
Chapter 9: Corporate Valuation and Financial Planning
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Q1) 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
Q2) Firms pay a low interest rate on spontaneous liabilities so these funds are its cheapest source of capital. Consequently, the firm should make arrangements with its suppliers to use as much of this credit as possible.
A)True
B)False
Q3) Refer to the Judd Enterprises financial statements. What is Judd's projected retained earnings under this plan
A) $339
B) $377
C) $396
D) $415
E) $440
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11
Chapter 10: Corporate Governance
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Q1) Which one of the following statements is TRUE?
A) one tool of corporate governance is how the company's charter affects the likelihood of a takeover.
B) one tool of corporate governance is stock repurchases.
C) one tool of corporate governance is a company's tax avoidance strategy.
D) one tool of corporate governance is choosing a good investment banker.
E) creditors have a claim on a firm's earning stream through the dividend payments they receive.
Q2) Which one of the following statements is TRUE?
A) an agency relationship is when a principal hires an agent to perform a service and gives them decision-making authority.
B) an agency relationship is when a principal works for an agent.
C) in an agency relationship, the agent delegates authority to the principal.
D) an example of an agency relationship is when the ceo nominates a slate of candidates to be on the board of directors.
E) an example of an agency relationship is when a supervisor hires a forklift operator.
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Chapter 11: Determining the Cost of Capital
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Q1) A company's perpetual preferred stock currently sells for $92.50 per share, and it pays an $8.00 annual dividend. If the company were to sell a new preferred issue, it would incur a flotation cost of 5.00% of the issue price. What is the firm's cost of preferred stock?
A) 7.81%
B) 8.22%
C) 8.65%
D) 9.10%
E) 9.56%
Q2) Refer to the data for the Collins Group. Based on the CAPM, what is the firm's cost of common stock?
A) 11.15%
B) 11.73%
C) 12.35%
D) 13.00%
E) 13.65%
Q3) "Capital" is sometimes defined as funds supplied to a firm by investors.
A)True
B)False
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Chapter 12: Capital Budgeting: Decision Criteria
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Q1) Which of the following statements is CORRECT?
A) one defect of the irr method versus the npv is that the irr does not take account of the time value of money.
B) one defect of the irr method versus the npv is that the irr does not take account of the cost of capital.
C) one defect of the irr method versus the npv is that the irr values a dollar received today the same as a dollar that will not be received until sometime in the future.
D) one defect of the irr method versus the npv is that the irr does not take proper account of differences in the sizes of projects.
E) one defect of the irr method versus the npv is that the irr does not take account of cash flows over a project's full life.
Q2) In theory, capital budgeting decisions should depend solely on forecasted cash flows and the opportunity cost of capital. The decision criterion should not be affected by managers' tastes, choice of accounting method, or the profitability of other independent projects.
A)True
B)False
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Chapter 13: Capital Budgeting-Estimating Cash Flows and Analyzing Risk
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Q1) It is extremely difficult to estimate the revenues and costs associated with large, complex projects that take several years to develop. This is why subjective judgment is often used for such projects along with discounted cash flow analysis.
A)True
B)False
Q2) Which of the following is NOT a relevant cash flow and thus should not be reflected in the analysis of a capital budgeting project?
A) shipping and installation costs.
B) cannibalization effects.
C) opportunity costs.
D) sunk costs that have been expensed for tax purposes.
E) changes in net working capital.
Q3) A firm that bases its capital budgeting decisions on either NPV or IRR will be more likely to accept a given project if it uses accelerated depreciation than if it uses straight-line depreciation, other things being equal.
A)True
B)False
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Page 15
Chapter 14: Real Options
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Q1) Which of the following is NOT a real option?
A) the option to buy shares of stock if its price goes up.
B) the option to expand into a new geographic region.
C) the option to abandon a project.
D) the option to switch the type of fuel used in an industrial furnace.
E) the option to expand production if the product is successful.
Q2) Refer to the data for Nationwide Pharmaceutical Corporation (NPC). Assuming that all cash flows are discounted at 10%, if NPC chooses to wait a year before proceeding, how much will this increase or decrease the project's expected NPV in today's dollars (i.e., at t = 0), relative to the NPV if it proceeds today?
A) $77.23
B) $85.81
C) $95.34
D) $105.94
E) $116.53
Q3) Real options are options to buy real assets, like stocks, rather than interest-bearing assets, like bonds.
A)True
B)False
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Page 16
Chapter 15: Distributions to Shareholders-Dividends and Repurchases
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Q1) One implication of the bird-in-the-hand theory of dividends is that a given reduction in dividend yield must be offset by a more than proportionate increase in growth in order to keep a firm's required return constant, other things held constant.
A)True
B)False
Q2) Underlying the dividend irrelevance theory proposed by Miller and Modigliani is their argument that the value of the firm is determined only by its basic earning power and its business risk.
A)True
B)False
Q3) MM's dividend irrelevance theory says that while dividend policy does not affect a firm's value, it can affect the cost of capital.
A)True
B)False
Q4) A reverse split reduces the number of shares outstanding.
A)True
B)False
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Chapter 16: Capital Structure Decisions
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Q1) The graphical probability distribution of ROE for a firm that uses financial leverage would tend to be more peaked than the distribution if the firm used no leverage, other things held constant.
A)True
B)False
Q2) Which of the following statements is CORRECT?
A) there is no reason to think that changes in the personal tax rate would affect firms' capital structure decisions.
B) a firm with high business risk is more likely to increase its use of financial leverage than a firm with low business risk, assuming all else equal.
C) if a firm's after-tax cost of equity exceeds its after-tax cost of debt, it can always reduce its wacc by increasing its use of debt.
D) suppose a firm has less than its optimal amount of debt. increasing its use of debt to the point where it is at its optimal capital structure will decrease the costs of both debt and equity financing.
E) in general, a firm with low operating leverage also has a small proportion of its total costs in the form of fixed costs.
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Page 18
Chapter 17: Dynamic Capital Structures and Corporate Valuation
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Q1) Gators Incorporated has the following information for the current year and projected for next year. Calculate its projected free cash flow to equity. \(\begin{array}{lrr}
&\text { Current }\\
&\text { year } & \text { Projected } \\
\text { FCF }&\text { NA } & 1,000 \\
\text { Total debt }& 400 & 600 \\
\text { Interest rate on debt }& 6 \% & 6 \% \\
\text { Tax rate }& 25 \% & 250
\end{array}\)
A) $1,066
B) $1,173
C) $1,290
D) $1,419
E) $1,561
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Q1) Which of the following statements is most CORRECT?
A) private placements occur most frequently with stocks, but bonds can also be sold in a private placement.
B) private placements are convenient for issuers, but the convenience is offset by higher flotation costs.
C) the sec requires that all private placements be handled by a registered investment banker.
D) private placements can generally bring in funds faster than is the case with public offerings.
E) in a private placement, securities are sold to private (individual) investors rather than to institutions.
Q2) The term "equity carve-out" refers to the situation where a firm's managers give themselves the right to purchase new stock at a price far below the going market price. Since this dilutes the value of the public stockholders, it "carves out" some of their value.
A)True
B)False
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Page 20
Chapter 19: Lease Financing
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Q1) Heavy use of off-balance sheet lease financing will tend to
A) make a company appear less risky than it actually is because its stated debt ratio will appear lower.
B) affect a company's cash flows but not its degree of risk.
C) have no effect on either cash flows or risk because the cash flows are already reflected in the income statement.
D) affect the lessee's cash flows but only due to tax effects.
E) make a company appear more risky than it actually is because its stated debt ratio will be increased.
Q2) A sale and leaseback arrangement is a type of financial, or capital, lease.
A)True
B)False
Q3) Operating leases often have terms that include
A) full amortization over the life of the lease.
B) very high penalties if the lease is canceled.
C) restrictions on how much the leased property can be used.
D) much longer lease periods than for most financial leases.
E) maintenance of the equipment by the lessor.
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Chapter 20: Hybrid Financing Preferred Stock-Warrants and Convertibles
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Q1) Mikkleson Mining stock is selling for $40 per share and has an expected dividend in the coming year of $2.00, and has an expected constant growth rate of 5.00%. The company is considering issuing a 10-year convertible bond that would be priced at its $1,000 par value. The bonds would have an 8.00% annual coupon, and each bond could be converted into 20 shares of common stock. The required rate of return on an otherwise similar nonconvertible bond is 10.00%. What is the estimated floor price of the convertible at the end of Year 3?
A) $794.01
B) $835.81
C) $879.80
D) $926.10
E) $972.41
Q2) A warrant is an option, and as such it cannot be used as a "sweetener."
A)True
B)False
Q3) A convertible debenture can never sell for more than its conversion value or less than its bond value.
A)True
B)False
Page 22
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Chapter 21: Supply Chains and Working Capital Management
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Q1) Data on Liu Inc. for the most recent year are shown below, along with the inventory conversion period (ICP) of the firms against which it benchmarks. The firm's new CFO believes that the company could reduce its inventory enough to reduce its ICP to the benchmarks' average. If this were done, by how much would inventories decline? Use a 365-day year.
\(\begin{array}{lr}
\text { Cost of goods sold }= & \$ 85,000 \\
\text { Inventory }= & \$ 20,000 \\
\text { Inventory conversion period (ICP) }= & 85.88 \\
\text { Benchmark inventory conversion period }(\mathrm{ICP})= & 38.00 \end{array}\)
A) $7,316
B) $8,129
C) $9,032
D) $10,036
E) $11,151
Q2) Because money has time value, a cash sale is always more profitable than a credit sale.
A)True
B)False
Page 23
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Chapter 22: Providing and Obtaining Credit
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Q1) Refer to Exhibit Brother's Loan. What is the nominal annual add-on interest rate on this loan?
A) 10.00%
B) 16.47%
C) 18.83%
D) 20.00%
E) 24.00%
Q2) Refer to Exhibit Reese Brothers. What would be the incremental cost of carrying receivables if this change were made?
A) $108,750
B) $116,250 (carrying costs would decline)
C) $157,900
D) $225,000 (carrying costs would decline)
E) $260,500
Q3) Credit standards refer to the financial strength and importance of a potential customer to the firm required in order to qualify for credit.
A)True
B)False
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Chapter 23: Other Topics in Working Capital Management
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Q1) Which of the following is true of the EOQ model?Note that the optimal order quantity, Q, will be called EOQ.
A) if the annual sales, in units, increases by 20%, then eoq will increase by 20%.
B) if the average inventory increases by 20%, then the total carrying costs will increase by 20%.
C) if the average inventory increases by 20% the total order costs will increase by 20%.
D) the eoc is the same for all companies.
E) if the fixed per order cost increases by 20%, then eoq will increase by 20%.
Q2) Refer to Exhibit Cartwright Computing. If the lead time for placing an order is 5 days, and Cartwright holds a safety stock equal to a 30-day supply of chips, then at what inventory level should an order be placed?
A) 15,570
B) 3,175
C) 12,250
D) 13,675
E) 8,124
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Chapter 24: Enterprise Risk Management
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Q1) Suppose the December CBOT Treasury bond futures contract has a quoted price of 80'07. 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, and round to the nearest whole dollar.)
A) $78.00
B) $82.00
C) $86.00
D) $90.00
E) $95.00
Q2) The two basic types of hedges involving the futures market are long hedges and short hedges, where the words "long" and "short" refer to the maturity of the hedging instrument. For example, a long hedge might use Treasury bonds, while a short hedge might use 3-month T-bills.
A)True
B)False
Q3) One objective of risk management can be to reduce the volatility of a firm's cash flows.
A)True
B)False
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Chapter 25: Bankruptcy-Reorganization and Liquidation
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Q1) Bankruptcy plays no role in settling labor disputes and product liability suits. Such issues are outside the bounds of bankruptcy law and are covered by other statutes.
A)True
B)False
Q2) Chapter 7 of the Bankruptcy Act is designed to do which of the following?
A) establish the rules of reorganization for firms with projected cash flows that eventually will be sufficient to meet debt payments.
B) ensure that the firm is viable after emerging from bankruptcy.
C) allow the firm to negotiate with each creditor individually.
D) provide safeguards against the withdrawal of assets by the owners of the bankrupt firm and allow insolvent debtors to discharge all of their obligations and to start over unhampered by a burden of prior debt.
E) protect shareholders against creditors.
Q3) One of the actions that can be taken in bankruptcy under the standard of feasibility is to replace existing management with a new team if the quality of management is judged to have been substandard.
A)True
B)False
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Chapter 26: Mergers and Corporate Control
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Q1) Merger activity is likely to heat up when interest rates are high because target firms can expect to receive an especially high premium over the pre-announcement stock price.
A)True
B)False
Q2) Post-merger control and the negotiated price paid by the acquirer are two of the most important issues in agreeing on the terms of a merger.
A)True
B)False
Q3) The present value of the free cash flows discounted at the unlevered cost of equity is the value of the firm's operations if it had no debt.
A)True
B)False
Q4) Most defensive mergers occur as a result of managers' actions to maximize shareholders' wealth.
A)True
B)False
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28
Chapter 27: Multinational Financial Management
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Q1) In Japan, 90-day securities have a 4% annualized return and 180-day securities have a 5% annualized return. In the United States, 90-day securities have a 4% annualized return and 180-day securities have an annualized return of 4.5%. All securities are of equal risk, and Japanese securities are denominated in terms of the Japanese yen. Assuming that interest rate parity holds in all markets, which of the following statements is most CORRECT?
A) the yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 180-day forward market.
B) the yen-dollar exchange rate in the 90-day forward market equals the yen-dollar exchange rate in the 180-day forward market.
C) the spot rate equals the 90-day forward rate.
D) the spot rate equals the 180-day forward rate.
E) the yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market.
Q2) If the United States is running a deficit trade balance with China, then in a free market we would expect the value of the Chinese yuan to depreciate against the U.S. dollar.
A)True
B)False
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Page 29
Chapter 28: Time Value of Money
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Sample Questions
Q1) Which of the following statements is CORRECT, assuming positive interest rates and holding other things constant?
A) banks a and b offer the same nominal annual rate of interest, but a pays interest quarterly and b pays semiannually. deposits in bank b will provide the higher future value if you leave your funds on deposit.
B) the present value of a 5-year, $250 annuity due will be lower than the pv of a similar ordinary annuity.
C) a 30-year, $150,000 amortized mortgage will have larger monthly payments than an otherwise similar 20-year mortgage.
D) a bank loan's nominal interest rate will always be equal to or greater than its effective annual rate.
E) if an investment pays 10% interest, compounded quarterly, its effective annual rate will be greater than 10%.
Q2) Time lines can be constructed in situations where some of the cash flows occur annually but others occur quarterly.
A)True
B)False
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Chapter 29: Basic Financial Tools: A review
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Q1) Which of the following statements is CORRECT?
A) if some cash flows occur at the beginning of the periods while others occur at the ends, then we have what the textbook defines as a variable annuity.
B) the cash flows for an ordinary (or deferred) annuity all occur at the beginning of the periods.
C) if a series of unequal cash flows occurs at regular intervals, such as once a year, then the series is by definition an annuity.
D) the cash flows for an annuity due must all occur at the ends of the periods.
E) the cash flows for an annuity must all be equal, and they must occur at regular intervals, such as once a year or once a month.
Q2) If you plotted the returns of a company against those of the market and found that the slope of your line was negative, the CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well-diversified investor, assuming that the observed relationship is expected to continue in the future.
A)True
B)False
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Chapter 30: Pension Plan Management
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Q1) Which of the following statements about defined contribution plans is incorrect?
A) in general, employees can choose the investment vehicle under a defined contribution plan. thus, highly risk-averse employees can choose low-risk investments, while more risk-tolerant employees can choose high-risk investments.
B) in a defined contribution plan, the employer must make larger-than-average contributions to the pension plan when investment returns have been below expectations.
C) defined benefit plans are used more often by large corporations than by small companies.
D) the pbgc insures a portion of pension benefits.
E) a defined contribution plan places the risk of poor pension portfolio performance on the employee.
Q2) From a pure cost standpoint, a firm with a defined contribution plan would be more likely to hire older workers than a firm with a defined benefit plan.
A)True
B)False
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Chapter 31: Financial Management in Not for Profit
Businesses
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Q1) The net present social value model formally recognizes that not-for-profit firms must consider the social value along with the financial value of proposed new projects.
A)True
B)False
Q2) Not-for-profit firms have fund capital in place of equity capital. Since fund capital does not have to provide a return to stockholders, the appropriate cost of fund capital in a cost of capital estimate is zero.
A)True
B)False
Q3) The primary goal of investor-owned firms is shareholder wealth maximization, while the primary goal of not-for-profit firms is typically stated in terms of some mission; for example, to provide health care services to the communities served.
A)True
B)False
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