Introduction to Finance
Exam Answer Key
Course Introduction
Introduction to Finance provides a foundational overview of financial principles and practices essential for both individuals and organizations. This course explores key concepts such as time value of money, risk and return, financial markets and institutions, and the fundamentals of financial statements. Students will learn how to analyze and interpret financial information, make informed investment decisions, and understand the roles of budgeting, saving, and borrowing in personal and corporate financial management. Through a combination of theoretical frameworks and real-world applications, this course equips students with the essential tools to navigate the modern financial environment.
Recommended Textbook Fundamentals of Corporate Finance 2nd Edition by Jonathan Berk
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Page 2
Chapter 1: Corporate Finance and the Financial Manager
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Q1) A corporate raider gains a controlling fraction of the shares of a poorly managed company and replaces the board of directors.How does the corporate raider hope to make a profit in this case?
A)by the sale of the assets held by the company that hold most of its value
B)by the rise in the value of the stock held by the raider when the new board of directors is judged to be superior to the ousted board of directors
C)by motivating the board of directors and other stakeholders in the company to make difficult short-term decisions that will increase the long-term viability of the company
D)by removing the employees expectations of the continued poor performance of the company
Answer: B
Q2) Raising new capital by issuing bonds is an example of a commercial banking activity.
A)True
B)False
Answer: False
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3
Chapter 2: Introduction to Financial Statement Analysis
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Q1) GenCorp has a total debt of $140 million and stockholders' equity of $50 million.It also has 25 million shares outstanding,with a market price of $3.50 per share.What is GenCorp's market debt-equity ratio?
A)0.36
B)0.63
C)1.02
D)1.60
Answer: D
Q2) Refer to the income statement above.Luther's return on assets (ROA)for the year ending December 31,2006 is closest to:
A)2.0%
B)6.5%
C)8.4%
D)12.7%
Answer: A
Q3) How does a firm select the date for preparation of its balance sheet?
Answer: The balance sheet is prepared on the fiscal closing date for the accounts of a firm that may or may not coincide with the calendar year-end of December 31st.
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4
Chapter 3: Time Value of Money: An Introduction
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Q1) The Law of One Price states that if equivalent goods or securities are traded simultaneously in different competitive markets,they will trade for the same price in each market.
A)True
B)False
Answer: True
Q2) What is one of the main obstacles in cost benefit analysis?
Answer: One of the main obstacles in cost benefit analysis is that not all benefits that are expected to occur in the future can be stated in dollar terms.
Q3) Owen expects to receive $20,000 at the end of next year from a trust fund.If a bank loans money at an interest rate of 7.5%,how much money can he borrow from the bank on the basis of this information?
A)$11,428
B)$15,000
C)$18,605
D)$21,500
Answer: C
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Chapter 4: Time Value of Money: Valuing Cash Flow
Streams
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Q1) The present value (PV)(at age 30)of your retirement savings is closest to:
A)$87,000
B)$108,000
C)$46,600
D)$75,230
Q2) Cash flows from an annuity occur every year in the future.
A)True
B)False
Q3) A homeowner in a sunny climate has the opportunity to install a solar water heater in his home for a cost of $2400.After installation the solar water heater will produce a small amount of hot water every day,forever,and will require no maintenance.How much must the homeowner save on water heating costs every year if this is to be a sound investment? (The interest rate is 9% per year. )
A)$216
B)$240
C)$248
D)$262
Q4) Can we apply the growth perpetuity equation for negative growth as well?
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Q5) In terms of present value (PV),how much will Joe receive for selling the family business?
Chapter 5: Interest Rates
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Q1) The highest effective rate of return you could earn on any of these investments is closest to:
A)6.250%
B)6.267%
C)6.300%
D)6.310%
Q2) An 8% APR with monthly compounding is closest to which of the following?
A)an EAR of 6.7%
B)an EAR of 7.72%
C)an EAR of 8.3%
D)an EAR of 8.5%
Q3) Is it possible to analyze cash flows that occur in time intervals that are not exactly equal to a year?
Q4) The present value (PV)of the lease payments for the delivery truck is closest to:
A)$206,900
B)$207,050
C)$207,680
D)$198,420
Q5) How are interest and return of principal handled in an amortizing loan payment?
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Chapter 6: Bonds
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Q1) The above information is for a corporate bond issued by the Markel Corporation.What sort of bond is this?
A)a high-risk bond
B)an investment grade bond
C)a speculative bond
D)a high-yield bond
Q2) How much will the coupon payments be of a 30-year $10,000 bond with a 4.5% coupon rate and semiannual payments?
A)$30
B)$225
C)$350
D)$450
Q3) Prior to its maturity date,the price of a zero-coupon bond is its face value.
A)True
B)False
Q4) A bond is said to mature on the date when the issuer repays its notional value.
A)True
B)False
Q5) Under what situation can a zero-coupon bond be selling at a premium?
Q6) Under what situation can a zero-coupon bond be selling at par to its face value?
Page 8
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Chapter 7: Stock Valuation
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Q1) Aaron Inc.has 316 million shares outstanding.It expects earnings at the end of the year to be $602 million.The firm's equity cost of capital is 11.5%.Aaron pays out 50% of its earnings in total: 30% paid out as dividends and 20% used to repurchase shares.If Aaron's earnings are expected to grow at a constant 6% per year,what is Aaron's share price?
A)$8.66
B)$17.32
C)$25.98
D)$34.64
Q2) Jumbuck Exploration has a current stock price of $2.00 and is expected to sell for $2.10 in one year's time,immediately after it pays a dividend of $0.26.Which of the following is closest to Jumbuck Exploration's equity cost of capital?
A)9%
B)12%
C)18%
D)22%
Q3) What is a major assumption about growth rate in the dividend-discount model?
Q4) What role do dividends play in stock investing?
Q5) Can the dividend-discount model handle negative growth rates?
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Chapter 8: Investment Decision Rules
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Q1) The profitability index for project A is closest to:
A)0.12
B)21.65
C)0.17
D)12.04
Q2) If the appropriate discount rate for this project is 15%,then the net present value (NPV)is closest to:
A)$6000
B)-$867
C)$1420
D)$867
Q3) What is the present value (PV)of an investment?
A)the amount that an investment would yield if the benefit were realized today
B)the difference between the cost of the investment and the benefit of the investment in dollars today
C)the amount you need to invest at the current interest rate to re-create the cash flow from the investment
D)the amount by which the cash flow of an investment exceeds or falls short of the cash flow generated by the same amount of money invested at market rate
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Chapter 9: Fundamentals of Capital Budgeting
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Q1) Which of the following best defines incremental earnings?
A)cash flows arising from a particular investment decision
B)the amount by which a firm's earnings are expected to change as the result of an investment decision
C)the earnings arising from all projects that a company plans to undertake in a fixed timespan
D)the net present value (NPV)of earnings that a firm is expected to receive as the result of an investment decision
Q2) A maker of computer games expects to sell 500,000 games at a price of $49 per game.These units cost $12 to produce.Selling,general,and administrative expenses are $1.2 million and depreciation is $280,000.What is the EBIT break-even point for the number of games sold in this case?
A)$24,865
B)$30,192
C)$30,204
D)$40,000
Q3) Why does the option to abandon a project have value?
Q4) If a business owner is using the extra space at home for his business,does it imply a zero opportunity cost for the space?
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Chapter 10: Stock Valuation: A Second Look
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Q1) On a particular day,a mining company reveals that,due to new extraction technology,the extractable yield from several of its nickel/lead mines has risen by 15%.Which of the following is the LEAST likely consequence of such an announcement?
A)The price of the stock would rise due to the pressure to buy
B)Investors would determine that the estimates of the firm's value on the date prior to the announcement were too high.
C)Investors would increase their forecast of future cash flows in that firm.
D)Investors would revise their estimates of the net present value (NPV)of the firm.
Q2) Aerelon Airways,a commercial airline,suffers a major crash.As a result,passengers are considered to be less likely to choose Aerelon as their carrier,and it is expected free cash flows will fall by $20 million per year for five years.If Aerelon has 65 million shares outstanding,an equity cost of capital of 12%,and no debt,by how much would Aerelon's shares be expected to fall in price as a result of this accident?
A)$0.98
B)$1.11
C)$1.28
D)$1.45
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Chapter 11: Risk and Return in Capital Markets
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Q1) What is the excess return for the S&P 500?
A)5.7%
B)7.0%
C)0%
D)8.4%
Q2) What is the expected payoff for Little Cure's ten drugs?
A)$500 million
B)$100 million
C)$1 billion
D)$0
Q3) Assume that you purchased Ford Motor Company stock at the closing price on December 31,2004 and sold it after the dividend had been paid at the closing price on January 26,2005.Your capital gains rate (yield)for this period is closest to:
A)0.70%
B)0.75%
C)-8.80%
D)-8.15%
Q4) Is volatility a reasonable measure of risk when evaluating large portfolios?
Q5) Which type of investment has historically had the highest volatility?
Q6) What are the two components of realized return from a stock investment?
Page 13
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Chapter 12: Systematic Risk and the Equity Risk Premium
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Q1) A portfolio has 50% of its value in IBM shares and the rest in Microsoft (MSFT).The volatility of IBM and MSFT are 39% and 35%,respectively,and the correlation between IBM and MSFT is 0.What is the standard deviation of the portfolio?
A)22..7%
B)29.5%
C)37.5%
D)26.2%
Q2) A portfolio comprises Coke (beta of 1.2)and Wal-Mart (beta of 0.9).The amount invested in Coke is $20,000 and in Wal-Mart is $30,000.What is the beta of the portfolio?
A)1.02
B)1.15
C)1.26
D)1.19
Q3) The volatility on Home Depot's returns is closest to:
A)35%
B)31%
C)42% D)18%
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14
Chapter 13: The Cost of Capital
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Q1) When calculating the WACC,it is standard practice to subtract ________ to compute the net debt outstanding.
A)equity
B)dividends
C)cash and risk-free securities
D)coupons
Q2) What is the difference between the effective cost of debt and the cost of debt?
Q3) Your estimate of the market risk premium is 7%.The risk-free rate of return is 4% and General Motors has a beta of 1.5.What is General Motors' cost of equity capital?
A)13.5%
B)14.5%
C)13.9%
D)14.8%
Q4) When we use the WACC to assess a project,we assume that the ________ ratio does not change.
A)reward to systematic risk
B)risk to reward
C)debt to equity
D)volatility to systematic risk
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Chapter 14: Raising Equity Capital
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Q1) Which of the following statements is NOT true regarding angel investors?
A)They are typically arranged as limited partnerships.
B)For many start-ups,the first round of outside private equity financing is often obtained from them.
C)Because their capital investment is often large relative to the amount of capital already in place at the firm,they typically receive a sizeable equity share in the business in return for their funds.
D)These investors are frequently friends or acquaintances of the entrepreneur.
Q2) Which of the following best describes a firm commitment IPO?
A)The underwriter purchases the entire issue at a small discount and then resells it at the offer price.
B)The underwriter sells new issues directly to the public in an online auction.
C)The underwriter tries to sell the stock for the best possible price but does not guarantee that the stock will be sold.
D)The underwriter solicits bids from investors and chooses the highest price at which there is sufficient demand to sell the entire issue.
Q3) What are some of the highlights of Google's IPO process?
Q4) How does IPO pricing puzzle financial economists?
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Page 16
Chapter 15: Debt Financing
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Q1) Which of the following statements is FALSE?
A)With registered bonds,on each coupon payment date,the bond issuer consults its list of registered owners and mails each owner a check (or directly deposits the coupon payment into the owner's brokerage account).
B)If a coupon bond is issued at a discount,it is called an original issue discount bond.
C)The face value or principal amount of the bond is denominated in standard increments,most often $10,000.
D)In a public offering,the indenture lays out the terms of the bond issue.
Q2) A bond has a face value of $10,000 and a conversion ratio of 560.The stock is currently trading at $16.30.What is the conversion price?
A)$6.13
B)$16.30
C)$17.86
D)$56.00
Q3) What are secured debt?
Q4) What is yield to call?
Q5) What is yield to maturity?
Q6) What are notes?
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Chapter 16: Capital Structure
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Q1) Which of the following statements is FALSE?
A)With no debt,the WACC is equal to the unlevered equity cost of capital.
B)With perfect capital markets,a firm's WACC is dependent of its capital structure and is equal to its equity cost of capital only if the firm is unlevered.
C)As the firm borrows at the low cost of capital for debt,its equity cost of capital rises,but the net effect is that the firm's WACC is unchanged.
D)Although debt has a lower cost of capital than equity,leverage does not lower a firm's WACC.
Q2) Equity-debt holder conflicts are more likely to arise if the risk of financial distress is high.
A)True
B)False
Q3) A bankruptcy process is complex,time-consuming,and costly.The costs of bankruptcy include
A)dividend payments.
B)raw material costs.
C)costs of hiring legal experts,appraisers,and auctioneers.
D)taxes.
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Chapter 17: Payout Policy
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Q1) Repurchases and special dividends are useful for making ________ and ________ distributions to shareholders.
A)small,frequent
B)small,infrequent
C)large,infrequent
D)large,frequent
Q2) Prada has nine million shares outstanding,generates free cash flows of $ 40 million each year and has a cost of capital of 10%.It also has $30 million of cash on hand.Prada wants to decide whether to repurchase stock or invest the cash in a project that generates free cash flows of $5 million each year.Should Prada invest or repurchase the shares?
A)indifferent between options
B)repurchase
C)invest
D)cannot say for sure
Q3) Long-term investors can defer capital gains tax until they sell,and therefore,there is a tax advantage for share repurchases over dividends.
A)True
B)False
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Page 19
Chapter 18: Financial Modeling and Pro Forma Analysis
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Q1) The asset and liability side of a pro forma balance sheet projection will not balance,in general,unless we make assumptions about how ________ and ________ will grow with sales.
A)dividends,equity
B)coupons,debt
C)debt,equity
D)dividends,preferred stock
Q2) The market size for Loppins is 60 million units.If SPI Inc.has a market share of 20% and the average sales price is $3 per Loppin,what is the dollar amount of sales of SPI?
A)$32 million
B)$36 million
C)$38 million
D)$42 million
Q3) The goal of the financial manager is to maximize the value of the shareholder's stake in the firm.
A)True
B)False
Q4) Is total net working capital or incremental net working capital more relevant for calculation of free cash flow?
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Chapter 19: Working Capital Management
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Q1) The difference between a firm's operating cycle and its cash cycle is
A)its account receivable days.
B)its accounts payable days.
C)its inventory days.
D)There is no difference between the cash and operating cycles.
Q2) What is a transactions balance?
A)the cash a firm holds to counter the uncertainty surrounding its future cash needs
B)the cash a firm places into short-term investments
C)the cash a firm holds in order to pay its bills
D)the cash a firm holds to gain tax advantages
Q3) What is cash discount?
Q4) Evertz Metals buys and stockpiles dolomite to use in its smelting processes.Before all this dolomite is used,however,they alter their smelting process so that calcite limestone is used instead.How is the inventory cost of the unused dolomite best categorized?
A)an acquisition cost
B)a carrying cost
C)an order cost
D)a holding cost
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Chapter 20: Short-Term Financial Planning
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Q1) Which of the following best describes an conservative financing policy?
A)financing part or all of the permanent working capital with short-term debt
B)financing part or all of the permanent working capital with long-term debt
C)financing part or all of the temporary working capital with short-term debt
D)financing part or all of the temporary working capital with long-term debt
Q2) Inventory can be used as collateral for all the following EXCEPT:
A)a public warehousing arrangement
B)a private warehousing arrangement
C)a trust receipt
D)a factoring arrangement
Q3) Which of the following statements is FALSE?
A)Regardless of the loan structure,the bank may include a compensating balance requirement in the loan agreement that reduces the usable loan proceeds.
B)Another common type of fee is a loan origination fee,which a bank charges to cover credit checks and legal fees.
C)Firms frequently use lines of credit to finance seasonal needs.
D)The commitment fee associated with a committed line of credit is designed to decreases the effective cost of the loan to the firm.
Q4) What is single,end-of-period payment loan?
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Chapter 21: Option Applications and Corporate Finance
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Q1) How many of the January 2009 call options are in-the-money?
A)2
B)4
C)1
D)3
Q2) Debt holders can be thought as owning the firm but having ________ a call option on the assets of the firm with a strike price equal to ________.
A)sold,face value of debt
B)bought,face value of debt
C)sold,value of equity
D)bought,value of equity
Q3) When is an option in-the-money?
Q4) What is the short position of an options contract?
Q5) Suppose that a stock sells at a price of $40 on the expiration date.Compute the payoff to the seller of a put option if the option strike price is $50.
A)-$20
B)-10
C)0
D)$40
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Chapter 22: Mergers and Acquisitions
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Q1) Which of the following statements is false?
A)SEC rules make it difficult for investors to buy much more than about 10% of a firm in secret.After an acquirer acquires such an initial stake in the target,called a toehold,they would have to make their intentions public by informing investors of his large stake.
B)With the availability of both the freezeout merger and the leveraged buyout as acquisition strategies,most of the value added accrues to the acquiring shareholders.
C)The laws on tender offers allow the acquiring company to freeze existing shareholders out of the gains from merging by forcing non-tendering shareholders to sell their shares for the tender offer price.
D)Premiums in LBO transactions are often quite substantial-while they can avoid the free-rider problem acquirers must still get board approval to overcome other defenses such as poison pills,as well as outbid other potential acquirers.
Q2) On average,when a bid is announced,the stock price of the target drops.
A)True
B)False
Q3) What is a white knight?
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Chapter 23: International Corporate Finance
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Q1) One British pound can be purchased for $1.90.What is the exchange rate in terms of pounds per dollar?
A)0.451
B)0.491
C)0.526
D)0.543
Q2) Exchange rate risk exists if the firm's free cash flows are correlated with the spot exchange rate.
A)True
B)False
Q3) ________ asserts that because a forward contract and a cash-and-carry strategy accomplish the same conversion,they must result in the same exchange rate.
A)Covered interest parity
B)Forward premium puzzle
C)Forward discount puzzle
D)None of the above
Q4) What is foreign exchange market?
Q5) What are internationally integrated capital markets?
Q6) What is covered interest parity?
Page 25
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Chapter 24: Leasing
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Q1) A lease where the lessee has the option to purchase the asset at the end of the lease for a set price that is set upfront in the lease contract is called a A)fixed price lease.
B)$1.00 out lease.
C)fair market value lease.
D)fair market value cap lease.
Q2) A lease where ownership of the asset transfers to the lessee at the end of the lease for a nominal cost is called a A)fair market value cap lease.
B)fixed price lease.
C)$1.00 out lease.
D)fair market value lease.
Q3) Suppose that the bulldozer can be leased with a $1.00-out lease.The lease payments will be closest to:
A)2,114
B)1,825
C)2,030
D)2,103
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Chapter 25: Insurance and Risk Management
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Q1) A manufacturer of breakfast cereal is concerned about corn prices.The firm anticipates needing 1 million bushels of corn in one month.The current price of corn is $6.50 per bushel and the futures price for delivery in one month is $7.00 per bushel.The cost to store the corn for 1 month is $100,000.What should the firm do?
A)Hedge with futures for a total cost of $7,000,000.
B)Hedge with futures for a total cost of $6,900,000.
C)Buy the corn now and store for 1 month,for a total cost of $6,500,000.
D)Buy the corn now and store for 1 month,for a total cost of $6,600,000.
Q2) Which of the following statements regarding futures contracts is false?
A)Both the buyer and the seller can get out of the contract at any time by selling it to a third party at the current market price.
B)Futures prices are not prices that are paid today.Rather,they are prices agreed to today,to be paid in the future.
C)Futures contracts are traded anonymously on an exchange at a publicly observed market price and are generally very illiquid.
D)Traders are required to post collateral,called margin,when buying or selling commodities using futures contracts.
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Chapter 26: Corporate Governance
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Q1) Which of the following statements is false?
A)An active takeover market is part of the system through which the threat of dismissal is maintained.
B)When internal governance systems such as ownership,compensation,board oversight,and shareholder activism fail,the one remaining way to remove poorly performing managers is by mounting a hostile takeover.
C)Likely because hostile takeovers and internal governance systems are substitute mechanisms,researchers have found that boards are less likely to fire managers for poor performance during active takeover markets than they are during lulls in takeover activity.
D)The effectiveness of the corporate governance structure of a firm depends on how well protected its managers are from removal in a hostile takeover.
Q2) How does a pyramid structure work?
Q3) Which of the following countries has employees appoint some board members?
A)Canada
B)the United States
C)Turkey
D)Germany
Q4) What is the role of takeovers in corporate governance?
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