Introduction to Finance Exam Bank
Course Introduction
Introduction to Finance provides students with a foundational understanding of the principles and concepts essential to the financial decision-making process. The course covers key topics such as financial markets and institutions, time value of money, risk and return, valuation of assets, capital budgeting, and an overview of financial statements. Students will develop fundamental skills in financial analysis, budgeting, and planning, preparing them for more advanced studies in finance and related business fields. Through real-world examples and case studies, the course emphasizes the practical application of theoretical knowledge in personal and corporate financial contexts.
Recommended Textbook
Fundamentals of Corporate Finance 3rd Eition by Jonathan Berk
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Page 2
Chapter 1: Corporate Finance and the Financial Manager
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Q1) What is the general relation of the two types of prices quoted for a stock on a exchange?
Answer: The two prices are bid price and ask price. The ask price is higher than the bid price to deter a buyer from buying a stock and selling it back immediately, assuming everything else remains unchanged.
Q2) Which of the following best describes why the Valuation Principle is a key concept in making financial decisions?
A)It shows how to assign monetary value to intangibles such as good health and well-being.
B)It allows fixed assets and liquid assets to be valued correctly.
C)It gives a good indication of the net worth of a person, item, or company and can be used to estimate any changes in that net worth.
D)It shows how to make the costs and benefits of a decision comparable so that we can weigh them properly.
Answer: D
Q3) What is the term for the applicable price that the seller gets when he sells a stock on the exchange?
Answer: The seller gets the bid price when he sells a stock on the exchange.
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Chapter 2: Introduction to Financial Statement Analysis
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Q1) What role does Generally Accepted Accounting Principles (GAAP)play in the accounting process?
Answer: All firms quoted on a U.S. exchange are required to use GAAP in their financial reporting process. This standardization process makes it easier to adjust and/or compare the financial figures across different firms.
Q2) Gross profit is calculated as ________.
A)total sales - cost of sales - selling, general, and administrative expensesdepreciation and amortization
B)total sales - cost of sales - selling, general, and administrative expenses
C)total sales - cost of sales
D)none of the above
Answer: C
Q3) In general, a successful firm will have a market-to-book ratio that is substantially greater than 1.
A)True
B)False
Answer: True
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Chapter 3: Time Value of Money: an Introduction
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Q1) Which of the following statements is FALSE about valuing cash at different points in time?
A)The process of moving forward along the timeline to determine a cash flow's value in the future is known as compounding.
B)The effect of earning interest on interest is known as compound interest.
C)It is only possible to compare or combine values at the same point in time.
D)A dollar in the future is worth more than a dollar today.
Answer: D
Q2) Which of the following best explains why you cannot use the price of rolled oats at a local supermarket as the competitive market value of rolled oats?
A)You can buy the oats at the price posted by the store, but the store will not buy oats from you for the same price.
B)The posted prices of oats can vary widely between grocery stores, even within the same local area.
C)Grocery stores mark up the prices of their oats up to make a profit.
D)Grocery stores typically sell oats in different packaging, which results in different prices within the same store.
Answer: A
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Page 5
Chapter 4: Time Value of Money: Valuing Cash Flow
Streams
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Q1) You are given two choices of investments, Investment A and Investment B. Both investments have the same future cash flows. Investment A has a discount rate of 4%, and Investment B has a discount rate of 5%. Which of the following is true?
A)The present value of cash flows in Investment A is higher than the present value of cash flows in Investment B.
B)The present value of cash flows in Investment A is lower than the present value of cash flows in Investment B.
C)The present value of cash flows in Investment A is equal to the present value of cash flows in Investment B.
D)No comparison can be made-we need to know the cash flows to calculate the present value.
Q2) How do you calculate (mathematically)the present value (PV)of a(n):
(a)perpetuity
(b)annuity
(c)growing perpetuity
(d)growing annuity
Q3) Can we apply the growing perpetuity equation for negative growth as well?
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Page 6
Chapter 5: Interest Rates
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Q1) When the costs of an investment come before that investment's benefits, what will be the effect of a rise in interest rates on the attractiveness of that investment to potential investors?
A)It will make it more attractive, since it will increase the investment's net present value (NPV).
B)It will make it more attractive, since it will decrease the investment's net present value (NPV).
C)It will make it less attractive, since it will increase the investment's net present value (NPV).
D)It will make it less attractive, since it will decrease the investment's net present value (NPV).
Q2) The effective annual rate (EAR)for a loan with a stated APR of 11% compounded quarterly is closest to ________.
A)12.61%
B)13.75%
C)11.46%
D)14.90%
Q3) How do we decide on opportunity cost when we have several opportunities that need to be foregone?
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Page 7
Chapter 6: Bonds
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Q1) Which of the following bonds will be most sensitive to a change in interest rates if all bonds have the same initial yield to maturity?
A)a ten-year bond with a $1,000 face value whose coupon rate is 5.8% APR paid semiannually
B)a ten-year bond with a $1,000 face value whose coupon rate is 7.4% APR paid semiannually
C)a 20-year bond with a $1,000 face value whose coupon rate is 5.8% APR paid semiannually
D)a 20-year bond with a $1,000 face value whose coupon rate is 7.4% APR paid semiannually
Q2) A company releases a five-year bond with a face value of $1000 and coupons paid semiannually. If market interest rates imply a YTM of 6%, what should be the coupon rate offered if the bond is to trade at par?
A)3%
B)5%
C)6%
D)7%
Q3) Under what situation can a zero-coupon bond be selling at a premium?
Q4) Under what situation can a zero-coupon bond be selling at par to its face value?
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Chapter 7: Stock Valuation
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Q1) Sultan Services has 1.2 million shares outstanding. It expects earnings at the end of the year of $6.0 million. Sultan pays out 60% of its earnings in total: 40% paid out as dividends and 20% used to repurchase shares. If Sultan's earnings are expected to grow by 5% per year, these payout rates do not change, and Sultan's equity cost of capital is 10%, what is Sultan's share price?
A)$12.00
B)$24.00
C)$36.00
D)$60.00
Q2) Owen Inc. has a current stock price of $15.00 and is expected to pay a $0.80 dividend in one year. If Owen's equity cost of capital is 12%, what price would its stock be expected to sell for immediately after it pays the dividend?
A)$11.20
B)$12.80
C)$16.80
D)$16.00
Q3) Can the dividend-discount model handle negative growth rates?
Q4) What is a major assumption about growth rate in the dividend-discount model?
Q5) How can the dividend-discount model handle changing growth rates?
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Chapter 8: Investment Decision Rules
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Q1) Jenkins Security has learned that a rival has offered to supply a parking garage with security for ten years for $45,000 up front and a further $15,000 per year. If Jenkins Security offers to provide security for eight years for an upfront cost of $60,000 and a separate yearly payment, by what maximum amount can this yearly payment be over $20,000, so that Jenkins' offer matches the equivalent annual annuity of their rival's offer? (Assume a cost of capital of 5%.)
A)-$89
B)-$94
C)-$100
D)-$111
Q2) Assuming that your capital is constrained, so that you only have $600,000 available to invest in projects, which project should you invest in and in what order?
A)CBFH
B)CBGF
C)BCFG
D)CBFG
Q3) Should personal preferences for cash today versus cash tomorrow play a role in the net present value (NPV)decision-making process?
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Page 10
Chapter 9: Fundamentals of Capital Budgeting
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Q1) A company planning to market a new model of motor scooter analyzes the effect of changes in the selling price of the motor scooter, the number of units that will be sold, the cost of making the motor scooter, the effect on Net Working Capital, and the cost of capital for the project. They predict that the break-even point for sales price for the motor scooter is $2,480. What does this mean?
A)If the motor scooter is sold for $2,480, then the project will make a profit.
B)If the motor scooter is sold for $2,480, then the net present value (NPV)for the product will be zero.
C)The predicted selling price of the motor scooter is $2,480.
D)The maximum that the motor scooter can sell for and still make the project have a positive net present value (NPV)is $2,480.
Q2) If a business owner is using the extra space at home for his business, does it imply a zero opportunity cost for the space?
Q3) What are the most difficult parts of capital budgeting?
Q4) A real option is the obligation to take a particular business action.
A)True B)False
Q5) How do we handle interest expense when making a capital budgeting decision?
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Chapter 10: Stock Valuation: a Second Look
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Q1) Which of the following statements concerning the valuation of firms using the method of comparables is FALSE?
A)If two different firms generate identical cash flows, the Law of One Price will imply that both firms have the same value.
B)Comparables adjust for scale differences when valuing similar firms.
C)Valuation multiples take into account differences in the risk and future growth between the firms being compared.
D)Two firms that sell very similar products or offer very similar services will have different values if they are of different sizes.
Q2) Which is the best valuation technique when using comparables?
Q3) If you value a stock using a range of stock valuation methods and these valuations indicate a stock price that is greater than its actual market price, it is most likely that the stock is under-valued.
A)True
B)False
Q4) What are the implications of the efficient markets hypothesis for corporate managers regarding accounting earnings?
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Chapter 11: Risk and Return in Capital Markets
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Q1) Suppose you invested $60 in the Ishares Dividend Stock Fund (DVY)a month ago. It paid a dividend of $0.63 today and then you sold it for $65. What was your return on the investment?
A)6.57%
B)7.51%
C)9.38%
D)10.32%
Q2) Which type of investment has historically had the highest volatility?
Q3) Big Cure and Little Cure are both pharmaceutical companies. Big Cure presently has a potential "blockbuster" drug before the Food and Drug Administration (FDA)waiting for approval. If approved, Big Cure's blockbuster drug will produce $1 billion in net income for Big Cure. Little Cure has ten separate, less important drugs before the FDA waiting for approval. If approved, each of Little Cure's drugs would produce $100 million in net income. The probability of the FDA approving a drug is 40%. What is the expected payoff for Big Cure's blockbuster drug?
A)$100 million
B)$0
C)$1 billion
D)$400 million
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Page 13
Chapter 12: Systematic Risk and the Equity Risk Premium
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Q1) What diversification, if any, is achieved if two stocks in a portfolio are perfectly positively correlated?
Q2) The volatility of Home Depot Share prices is 50% and that of General Motors shares is 50%. When I hold both stocks in my portfolio and the stocks returns have zero correlation, the overall volatility of returns of the portfolio is ________.
A)more than 25%
B)less than 50%
C)more than 50%
D)less than 25%
Q3) Correlation is the degree to which the returns of two stocks share common risks. A)True
B)False
Q4) What role does the correlation of two assets play in computation of the expected return of the two asset portfolio?
Q5) The beta of the market portfolio is ________.
A)0
B)-1
C)2
D)1
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Chapter 13: The Cost of Capital
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Q1) Verano Inc. has two business divisions-a software product line and a waste water clean-up product line. The software business has a cost of equity capital of 10% and the waste water clean-up business has a cost of equity capital of 8%. Verano has 50% of its revenue from software and the rest from the waste water business. Verano is considering a purchase of another company in the waste water business using equity financing. What is the appropriate cost of capital to evaluate the business?
A)10.0%
B)8.0%
C)9.0%
D)11.0%
Q2) Should a firm with high retained earnings have a lower cost of equity?
Q3) SIROM Scientific Solutions has $10 million of outstanding equity and $5 million of bank debt. The bank debt costs 5% per year. The estimated equity beta is 2. If the market risk premium is 9% and the risk-free rate is 3%, compute the weighted average cost of capital if the firm's tax rate is 30%.
A)15.17%
B)15.93%
C)16.68%
D)17.44%
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Page 15
Chapter 14: Raising Equity Capital
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Q1) Neutrino Industries stock trades at $49 per share and there are 120 million shares outstanding. The management would like to raise $400 million in an SEO. If the underwriter charges 6% of gross proceeds, how many shares must it sell?
A)7.38 million
B)7.82 million
C)8.25 million
D)8.68 million
Q2) Braynerd Chemicals sells 40 million shares of stock in an SEO-25 million being primary shares issued by the company and 15 million being secondary shares sold by investors in the company. At the time of the sale, Braynerd's stock was selling at $21.00 per share. If the underwriter charges 5% of the gross proceeds as a fee, how much money was raised in the sale?
A)$374.06 million
B)$423.94 million
C)$498.75 million
D)$573.56 million
Q3) What are some of the disadvantages of going public?
Q4) What are some of the highlights of Google's IPO process?
Q5) What are some of the advantages of going public?
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Chapter 15: Debt Financing
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Q1) Bond covenants tend to increase a bond issuer's borrowing costs.
A)True
B)False
Q2) A callable bond will typically have a ________ yield than an otherwise identical bond without a call feature because ________.
A)lower, the firm loses flexibility with a callable bond
B)higher, the firm loses flexibility with a callable bond
C)lower, the option to call a bond is valuable
D)higher, the option to call a bond is valuable
Q3) A firm issues $525 million in straight bonds at an original issue discount of 2% and a coupon rate of 5%. The firm pays fees of 2% on the face value of the bonds. What is the net amount of funds that the debt issue will provide for the firm?
A)$580 million
B)$554.4 million
C)$529 million
D)$504 million
Q4) What are debentures?
Q5) What is yield to call?
Q6) What is an original issue discount bond?
Page 17
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Chapter 16: Capital Structure
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Q1) What are direct costs of financial distress?
Q2) After the repurchase, how many shares will Luther have outstanding?
A)0.75 billion
B)1.0 billion
C)1.1 billion
D)1.2 billion
Q3) The market value of Luther's non-cash assets is closest to ________.
A)$20 billion
B)$19 billion
C)$25 billion
D)$24 billion
Q4) A firm requires an investment of $20,000 and will return $26,500 after one year. If the firm borrows $6000 at 7%, what is the return on levered equity?
A)35%
B)52%
C)43%
D)61%
Q5) What are some implications of market imperfections?
Q6) What are the issues in determining the optimal leverage for a firm?
Q7) What are indirect costs of financial distress?
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Chapter 17: Payout Policy
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Q1) Omicron Technologies has $60 million in excess cash and no debt. The firm expects to generate additional free cash flows of $48 million per year in subsequent years and will pay out these future free cash flows as regular dividends. Omicron's unlevered cost of capital is 9% and there are 12 million shares outstanding. Omicron's board is meeting to decide whether to pay out its $60 million in excess cash as a special dividend or to use it to repurchase shares of the firm's stock. Assume that Omicron uses the entire $60 million in excess cash to pay a special dividend. Omicron's cum-dividend price is closest to ________.
A)$39.56
B)$59.33
C)$98.89
D)$49.44
Q2) What is the general trend of share repurchase as a percentage of total payout over the last few decades?
Q3) What are the characteristics of special dividend?
Q4) What is the bird-in-the-hand fallacy in dividend theory under perfect capital markets?
Q5) What are the ways in which a firm can pay out its free cash flow?
Q6) What is the effect on the stock price when a firm repurchases its shares?
Page 19
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Chapter 18: Financial Modeling and Pro Forma Analysis
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Q1) ________ is the amount of additional external financing needed to fund planned increases in assets.
A)Net new financing
B)Equity issuance
C)Debt issuance
D)Preferred stock issuance
Q2) The amount of the decrease in net working capital for Ideko in 2011 is closest to ________.
A)$4,090
B)$4,685
C)$3,410
D)$5,230
Q3) With the proper changes it is believed that Ideko's credit policies will extend a 60 days credit period to accounts receivables. The forecasted accounts receivable for Ideko in 2013 is closest to ________.
A)$14,525
B)$19,690
C)22,710
D)$16,970
Q4) What is net new financing?
Page 20
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Chapter 19: Working Capital Management
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Q1) The cash conversion cycle (CCC)is defined as ________.
A)Inventory Days + Accounts Receivable Days - Accounts Payable Days
B)Inventory Days - Accounts Receivable Days - Accounts Payable Days
C)Inventory Days + Accounts Receivable Days + Accounts Payable Days
D)Inventory Days + Accounts Payable Days - Accounts Receivable Days
Q2) Your firm purchases goods from its supplier on terms of 1/10 net 30. The effective annual cost to your firm if it chooses not to take advantage of the trade discount offered is closest to ________.
A)16.8%
B)44.6%
C)20.1%
D)13.0%
Q3) 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
Q4) Can a firm's cash cycle be longer than a firm's operating cycle?
Q5) What are the advantages of holding inventory?
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Chapter 20: Short-Term Financial Planning
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Q1) Bradford Maintenance, a firm which provides lawn care services, has some seasonal variations in its cash flow needs, since much of the demand for its services is in the summer months. It uses long-term sources of funds to finance its assets such as its fleet of vehicles and lawn-care equipment and for the permanent funds that it must have at all times. For its peak seasonal needs it uses long-term sources and some short-term debt. What best describes the financial policy being followed by Bradford?
A)matching
B)conservative
C)integrated
D)seasonal
Q2) What do we understand by positive cash flow shocks?
Q3) In which quarter are Hasbeen's seasonal working capital needs the smallest?
Q4) What are loan origination fees and what effect does it have on the loan?
Q5) What is single, end-of-period payment loan?
Q6) What do we understand by seasonality?
Page 22
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Chapter 21: Option Applications and Corporate Finance
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Q1) Suppose that a stock sells at a price of $60 on the expiration date. Compute the payoff to the seller of a put option if the option strike price is $20.
A)-$20
B)-$10
C)0
D)$40
Q2) A call option gives the owner the right to ________ an asset at a fixed price at some future date.
A)sell
B)buy
C)hold
D)none of the above
Q3) Suppose that a stock sells at a price of $10 on the expiration date. Compute the price of a call option if the option strike price is $20.
A)$20
B)$30
C)$40
D)$0
Q4) What are European options?
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Chapter 22: Mergers and Acquisitions
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Q1) Mayo Corporation is currently trading at $30 per share. There are 10 million shares outstanding, and the company has no debt. You believe that the value of the company would increase by 50% if the management were replaced. How much would you gain from acquiring 50% of Mayo's shares by borrowing, attaching the debt to the company and replacing the management?
A)$150 million
B)$225 million
C)$300 million
D)$10 million
Q2) Consider a case in which existing shareholders do not have to invest time and effort, but still participate in the gains from a takeover, while the bidder who puts in the time and effort is forced to give up substantial profits. This situation is called ________.
A)the free rider problem
B)a toehold
C)a leveraged buyout
D)a freezeout merger
Q3) If Martin pays no premium to acquire Luther, what will the earnings per share be after the merger?
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Chapter 23: International Corporate Finance
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Q1) One British pound can be purchased for $1.80. What is the exchange rate in terms of pounds per dollar?
A)£0.451
B)£0.491
C)£0.526
D)£0.556
Q2) The spot exchange rate for the British pound is 0.5 pounds/dollar. The one-year interest rate in the United States is 4% and the one-year interest rate in Britain is 5%. Based on these rates, what one-year forward exchange rate is consistent with the absence of arbitrage?
A)0.606 pounds/dollar
B)0.612 pounds/dollar
C)0.617 pounds/dollar
D)0.505 pounds/dollar
Q3) What is floating rate?
Q4) Exchange rate risk exists if the firm's free cash flows are correlated with the spot exchange rate.
A)True
B)False
Q5) What is a currency forward contract?
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Chapter 24: Leasing
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Q1) A lease that gives the lessee the option to purchase the asset at its fair market value at the termination of the lease is called a ________.
A)fair market value cap lease
B)fair market value lease
C)$1.00-out lease
D)fixed price lease
Q2) Calculate the monthly lease payments for a four year fixed price lease that allows the lessee to buy the Bulldozer at the end of the lease for $8,000.
Q3) What is the amount of the lease-equivalent loan for the CT Scanner?
A)$74,890.28
B)$1,749,890.28
C)$3,487,027.19
D)$2,367,559.51
Q4) Is St. Martin's better off leasing the CT scanner or financing the purchase of the CT scanner with a lease-equivalent loan and by how much is St Martin's better off?
Q5) In the chapter, the lease versus buy decision was called an unfair comparison. Why? What is the correct comparison?
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Chapter 25: Insurance and Risk Management
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Q1) Which of the following statements is FALSE?
A)Firms generally do not possess better information than outside investors regarding the risk of future commodity price changes, nor can they influence that risk through their actions.
B)Cash flows are exchanged on a monthly basis, rather than waiting until the end of the contract, through a procedure called marking to market.
C)The firm may speculate by entering into contracts that do not offset its actual risks.
D)When a firm authorizes managers to trade contracts to hedge, it opens the door to the possibility of speculation.
Q2) The risk that the firm will not have, or be able to raise, the cash required to meet the margin calls on its hedges is called ________.
A)liquidity risk
B)basis risk
C)commodity price risk
D)speculation risk
Q3) What is the actuarially fair cost of full insurance?
Q4) What are some of the disadvantages of long-term supply contracts?
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Chapter 26: Corporate Governance
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Q1) Which of the following statements is FALSE?
A)The substantial use of stock and option grants in the 1990s greatly increased managers' pay-for-performance sensitivity.
B)The optimal level of sensitivity of managers' compensation to the performance of their firms depends on the managers' level of risk aversion, which is hard to measure.
C)While decreasing managers' risk exposure, increasing the sensitivity of managerial pay and wealth to firm performance does have some negative effects.
D)In the absence of monitoring, the other way the conflict of interest between managers and owners can be mitigated is by closely aligning their interests through the managers' compensation policy.
Q2) What is the role of takeovers in corporate governance?
Q3) Which of the following countries has employees appoint some board members?
A)Canada
B)the United States
C)Turkey
D)Germany
Q4) Describe the "stakeholder" model of corporate governance.
Q5) How does a pyramid structure work?
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