Introduction to Finance
Chapter Exam Questions
Course Introduction
Introduction to Finance provides students with a foundational understanding of the principles and concepts that underlie the field of finance. The course covers essential topics such as the time value of money, risk and return, financial markets and instruments, investment analysis, and the basics of corporate finance including capital budgeting, financial statement analysis, and funding strategies. Students will gain insights into how individuals and organizations make financial decisions and the impact of these decisions on value creation, resource allocation, and economic growth. By the end of the course, learners will be equipped with practical knowledge and analytical tools necessary for further studies in finance and for making informed financial decisions in their personal and professional lives.
Recommended Textbook
Corporate Finance A Focused Approach 5th Edition by Michael C. Ehrhardt
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Page 2
Chapter 1: An overview of financial management and the financial environment
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Q1) Recently, Hale Corporation announced the sale of 2.5 million newly issued shares of its stock at a price of $21 per share.Hale sold the stock to an investment banker, who in turn sold it to individual and institutional investors.This is a primary market transaction.
A)True
B)False
Answer: True
Q2) One of the functions of NYSE specialists is to facilitate trading by keeping an inventory of shares of the stocks in which they specialize, buying when investors want to sell and selling when they want to buy.They change the bid and ask prices of the securities so as to keep supply and demand in balance.
A)True
B)False Answer: True
Q3) One key value of limited liability is that it lowers owners' risks and thereby enhances a firm's value.
A)True
B)False
Answer: True
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Chapter 2: Financial statements, cash flow, and taxes
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Q1) Net operating profit after taxes (NOPAT)is the amount of net income a company would generate from its operations if it had no interest income or interest expense.
A)True
B)False
Answer: True
Q2) Olivia Hardison, CFO of Impact United Athletic Designs, plans to have the company issue $500 million of new common stock and use the proceeds to pay off some of its outstanding bonds.Assume that the company, which does not pay any dividends, takes this action, and that total assets, operating income (EBIT), and its tax rate all remain constant.Which of the following would occur?
A) The company would have to pay less taxes.
B) The company's taxable income would fall.
C) The company's interest expense would remain constant.
D) The company would have less common equity than before.
E) The company's net income would increase.
Answer: E
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Chapter 3: Analysis of financial statements
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Sample Questions
Q1) Lincoln Industries' current ratio is 0.5.Considered alone, which of the following actions would increase the company's current ratio?
A) Use cash to reduce long-term bonds outstanding.
B) Borrow using short-term notes payable and use the cash to increase inventories.
C) Use cash to reduce accruals.
D) Use cash to reduce accounts payable.
E) Use cash to reduce short-term notes payable.
Answer: B
Q2) Refer to Exhibit 3.1.What is the firm's equity multiplier?
A) 3.33
B) 3.50
C) 3.68
D) 3.86
E) 4.05
Answer: A
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Chapter 4: Time value of money
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Q1) You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows.Which of the following would lower the calculated value of the investment?
A) The discount rate decreases.
B) The cash flows are in the form of a deferred annuity, and they total to $100, 000.You learn that the annuity lasts for only 5 rather than 10 years, hence that each payment is for $20, 000 rather than for $10, 000.
C) The discount rate increases.
D) The riskiness of the investment's cash flows decreases.
E) The total amount of cash flows remains the same, but more of the cash flows are received in the earlier years and less are received in the later years.
Q2) The payment made each period on an amortized loan is constant, and it consists of some interest and some principal.The closer we are to the end of the loan's life, the greater the percentage of the payment that will be a repayment of principal.
A)True
B)False
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Chapter 5: Bonds, bond valuation, and interest rates
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Q1) Which of the following statements is CORRECT?
A) Other things held constant, a callable bond should have a lower yield to maturity than a noncallable bond.
B) Once a firm declares bankruptcy, it must then be liquidated by the trustee, who uses the proceeds to pay bondholders, unpaid wages, taxes, and lawyer fees.
C) Income bonds must pay interest only if the company earns the interest.Thus, these securities cannot bankrupt a company prior to their maturity, and this makes them safer to the issuing corporation than "regular" bonds.
D) A firm with a sinking fund that gave it the choice of calling the required bonds at par or buying the bonds in the open market would generally choose the open market purchase if the coupon rate exceeded the going interest rate.
E) One disadvantage of zero coupon bonds is that the issuing firm cannot realize any tax savings from the debt until the bonds mature.
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Chapter 6: Risk and return
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Q1) Assume that investors have recently become more risk averse, so the market risk premium has increased.Also, assume that the risk-free rate and expected inflation have not changed.Which of the following is most likely to occur?
A) The required rate of return will decline for stocks whose betas are less than 1.0.
B) The required rate of return on the market, rM, will not change as a result of these changes.
C) The required rate of return for each individual stock in the market will increase by an amount equal to the increase in the market risk
D) The required rate of return on a riskless bond will decline.
E) The required rate of return for an average stock will increase by an amount equal to the increase in the market risk premium.
Q2) If a stock's expected return as seen by the marginal investor exceeds this investor's required return, then the investor will buy the stock until its price has risen enough to bring the expected return down to equal the required return.
A)True
B)False
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Chapter 7: Valuation of stocks and corporations
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Q1) A stock is expected to pay a year-end dividend of $2.00, i.e., D? = $2.00.The dividend is expected to decline at a rate of 5% a year forever (g = -5%).If the company is in equilibrium and its expected and required rate of return is 15%, which of the following statements is CORRECT?
A) The company's dividend yield 5 years from now is expected to be 10%.
B) The constant growth model cannot be used because the growth rate is negative.
C) The company's expected capital gains yield is 5%.
D) The company's expected stock price at the beginning of next year is $9.50.
E) The company's current stock price is $20.
Q2) If D? = $1.75, g (which is constant)= 3.6%, and P? = $32.00, what is the stock's expected total return for the coming year?
A) 8.37%
B) 8.59%
C) 8.81%
D) 9.03%
E) 9.27%
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Chapter 8: Financial options and applications in corporate finance
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Q1) BLW Corporation is considering the terms to be set on the options it plans to issue to its executives.Which of the following actions would decrease the value of the options, other things held constant?
A) The exercise price of the option is increased.
B) The life of the option is increased, i.e., the time until it expires is lengthened.
C) The Federal Reserve takes actions that increase the risk-free rate.
D) BLW's stock price becomes more risky (higher variance).
E) BLW's stock price suddenly increases.
Q2) Because of the time value of money, the longer before an option expires, the less valuable the option will be, other things held constant.
A)True
B)False
Q3) The exercise value is the positive difference between the current price of the stock and the strike price.The exercise value is zero if the stock's price is below the strike price. A)True
B)False
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Chapter 9: The cost of capital
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Q1) If a firm's marginal tax rate is increased, this would, other things held constant, lower the cost of debt used to calculate its WACC.
A)True
B)False
Q2) To help them estimate the company's cost of capital, Smithco has hired you as a consultant.You have been provided with the following data: D? = $1.45; P? = $22.50; and g = 6.50% (constant).Based on the DCF approach, what is the cost of common from reinvested earnings?
A) 11.10%
B) 11.68%
C) 12.30%
D) 12.94%
E) 13.59%
Q3) The cost of debt is equal to one minus the marginal tax rate multiplied by the average coupon rate on all outstanding debt.
A)True
B)False
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Chapter 10: The basics of capital budgeting: evaluating cash flows
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Q1) Which of the following statements is CORRECT?
A) If the cost of capital declines, this lowers a project's NPV.
B) The NPV method is regarded by most academics as being the best indicator of a project's profitability; hence, most academics recommend that firms use only this one method.
C) A project's NPV depends on the total amount of cash flows the project produces, but because the cash flows are discounted at the WACC, it does not matter if the cash flows occur early or late in the project's life.
D) The NPV and IRR methods may give different recommendations regarding which of two mutually exclusive projects should be accepted, but they always give the same recommendation regarding the acceptability of a normal, independent project.
E) The NPV method was once the favorite of academics and business executives, but today most authorities regard the MIRR as being the best indicator of a project's profitability.
Q2) One advantage of the payback method for evaluating potential investments is that it provides information about a project's liquidity and risk.
A)True B)False
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Chapter 11: Cash flow estimation and risk analysis
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Q1) Which of the following rules is CORRECT for capital budgeting analysis?
A) Only incremental cash flows, which are the cash flows that would result if a project is accepted, are relevant when making accept/reject decisions.
B) Sunk costs are not included in the annual cash flows, but they must be deducted from the PV of the project's other costs when reaching the accept/reject decision.
C) A proposed project's estimated net income as determined by the firm's accountants, using generally accepted accounting principles (GAAP), is discounted at the WACC, and if the PV of this income stream exceeds the project's cost, the project should be accepted.
D) If a product is competitive with some of the firm's other products, this fact should be incorporated into the estimate of the relevant cash flows.However, if the new product is complementary to some of the firm's other products, this fact need not be reflected in the analysis.
E) The interest paid on funds borrowed to finance a project must be included in estimates of the project's cash flows.
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Chapter 12: Corporate valuation and financial planning
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Q1) A rapid build-up of inventories normally requires additional financing, unless the increase is matched by an equally large decrease in some other asset.
A)True
B)False
Q2) The capital intensity ratio is generally defined as follows:
A) The percentage of liabilities that increase spontaneously as a percentage of sales.
B) The ratio of sales to current assets.
C) The ratio of current assets to sales.
D) The amount of assets required per dollar of sales, or A0*/S0.
E) Sales divided by total assets, i.e., the total assets turnover ratio.
Q3) A firm will use spontaneous funds to the extent possible; however, due to credit terms, contracts with workers, and tax laws there is little flexibility in their usage.
A)True B)False
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Chapter 13: Agency conflicts and corporate governance
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Q1) ESOPs were originally designed to help improve worker productivity, but today they are also used to help prevent hostile takeovers.
A)True
B)False
Q2) Which of the following is NOT normally regarded as being a barrier to hostile takeovers?
A) Targeted share repurchases.
B) Shareholder rights provisions.
C) Restricted voting rights.
D) Poison pills.
E) Abnormally high executive compensation.
Q3) Two important issues in corporate governance are (1)the rules that cover the board's ability to fire the CEO and (2)the rules that cover the CEO's ability to remove members of the board.
A)True
B)False
Q4) A poison pill is also known as a corporate restructuring.
A)True
B)False
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Chapter 14: Distributions to shareholders: dividends and repurchases
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Q1) McCann Publishing has a target capital structure of 35% debt and 65% equity.This year's capital budget is $850, 000 and it wants to pay a dividend of $400, 000.If the company follows a residual dividend policy, how much net income must it earn to meet its capital budgeting requirements and pay the dividend, all while keeping its capital structure in balance?
A) $904, 875
B) $952, 500
C) $1, 000, 125
D) $1, 050, 131
E) $1, 102, 638
Q2) If a firm adopts a residual distribution policy, distributions are determined as a residual after funding the capital budget.Therefore, the better the firm's investment opportunities, the lower its payout ratio should be.
A)True
B)False
Q3) A reverse split reduces the number of shares outstanding.
A)True
B)False
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Chapter 15: Capital structure decisions
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Q1) Serendipity Inc.is re-evaluating its debt level.Its current capital structure consists of 80% debt and 20% common equity, its beta is 1.60, and its tax rate is 35%.However, the CFO thinks the company has too much debt, and he is considering moving to a capital structure with 40% debt and 60% equity.The risk-free rate is 5.0% and the market risk premium is 6.0%.By how much would the capital structure shift change the firm's cost of equity?
A) -5.20%
B) -5.78%
C) -6.36%
D) -6.99%
E) -7.69%
Q2) Which of these items will not generally be affected by an increase in the debt ratio?
A) Total risk.
B) Financial risk.
C) Market risk.
D) The firm's beta.
E) Business risk.
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Chapter 16: Supply chains and working capital management
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Q1) The calculated cost of trade credit for a firm that buys on terms of 2/10 net 30 is lower (other things held constant)if the firm plans to pay in 40 days than in 30 days.
A)True
B)False
Q2) Freeman Builders, Inc.buys on terms of 2/15, net 30.It does not take discounts, and it typically pays 60 days after the invoice date.Net purchases amount to $720, 000 per year.What is the nominal annual percentage cost of its non-free trade credit, based on a 365-day year?
A) 10.86%
B) 12.07%
C) 13.41%
D) 14.90%
E) 16.55%
Q3) If a firm takes actions that reduce its days sales outstanding (DSO), then, other things held constant, this will lengthen its cash conversion cycle (CCC).
A)True
B)False
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Chapter 17: Multinational financial management
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Q1) Suppose 1 U.S.dollar equals 1.60 Canadian dollars in the spot market.6-month Canadian securities have an annualized return of 6% (and thus a 6-month periodic return of 3%).6-month U.S.securities have an annualized return of 6.5% and a periodic return of 3.25%.If interest rate parity holds, what is the U.S.dollar-Canadian dollar exchange rate in the 180-day forward market?
A) 1 U.S.dollar = 0.6235 Canadian dollars
B) 1 U.S.dollar = 0.6265 Canadian dollars
C) 1 U.S.dollar = 1.0000 Canadian dollars
D) 1 U.S.dollar = 1.5961 Canadian dollars
E) 1 U.S.dollar = 1.6039 Canadian dollars
Q2) Suppose a carton of hockey pucks sell in Canada for 105 Canadian dollars, and 1 Canadian dollar equals 0.71 U.S.dollars.If purchasing power parity (PPP)holds, what is the price of hockey pucks in the United States?
A) $14.79
B) $63.00
C) $74.55
D) $85.88
E) $147.88
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