Investment Analysis
Exam Answer Key
Course Introduction
Investment Analysis is a comprehensive course designed to introduce students to the fundamental principles and techniques used in evaluating various investment opportunities. The course covers key topics such as risk and return analysis, portfolio theory, security valuation, asset pricing models, and market efficiency. Students will learn how to assess stocks, bonds, and alternative investments, use financial statements to inform investment decisions, and apply quantitative methods to analyze market trends. Practical case studies and real-world examples enhance understanding, equipping students with the analytical tools necessary to make informed investment choices in diverse financial markets.
Recommended Textbook
Corporate Finance Core Principles and Applications 4th Edition by Sheldon M. Ross
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Page 2
Chapter 1: Introduction to Corporate Finance
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Sample Questions
Q1) Which one of the following actions by a financial manager least meets the goal of financial management?
A)Increasing current costs in order to increase the market value of the stockholders' equity
B)Agreeing to expand the company at the expense of stockholders' value
C)Refusing to lower selling prices if doing so will reduce the net profits
D)Agreeing to pay bonuses based on the market value of the company stock
E)Refusing to borrow money when doing so will create losses for the firm
Answer: B
Q2) What should be the primary goal of a financial manager of a corporation? Why?
Answer: The primary goal of financial management is to maximize the current market value of the outstanding stock.This goal focuses on enhancing the returns to current stockholders who are the owners of the firm.
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3
Chapter 2: Financial Statements and Cash Flow
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Q1) Assume both current and deferred taxes are positive values.Given this,deferred taxes will:
A)reduce the current tax expense and thus increase net income.
B)increase expenses and increase operating cash flows.
C)increase expenses and lower operating cash flows.
D)reduce net income but not affect the operating cash flows.
E)reduce both net income and operating cash flows.
Answer: D
Q2) Pete's Boats has beginning long-term debt of $180 and ending long-term debt of $210.The beginning and ending total debt balances are $340 and $360,respectively.The interest paid is $30.What is the amount of the cash flow to creditors?
A)-$10
B)$0
C)$10
D)$40
E)$50
Answer: B
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Page 4
Chapter 3: Financial Statements Analysis and Financial Models
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Q1) Which one of these combinations will provide sufficient information to determine the sustainable growth rate of a firm?
A)Profit margin,total asset turnover and the price-earnings ratio
B)Profit margin,dividend payout ratio,debt-equity ratio,and total asset turnover
C)Return on assets and the retention ratio
D)Return on assets,capital intensity ratio,and the retention ratio
E)Profit margin,total asset turnover,return on assets,and debt-equity ratio
Answer: B
Q2) Ratio analysis works best when evaluating the financial statements of two firms:
A)in the same industry but located in different countries.
B)of differing sizes in the same industry.
C)with one being in a single-line of business while the other is a conglomerate.
D)of the same size in differing industries.
E)when both are conglomerates with varying lines of business.
Answer: B
Q3) Identify the three parts of the DuPont identity and specify what each part measures. Answer: ROE = Profit margin (Operating efficiency)× Total asset turnover (Asset use efficiency)× Equity multiplier (Financial leverage).
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Chapter 4: Discounted Cash Flow Valuation
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Sample Questions
Q1) Lew's Tours is just about to pay an annual dividend of $1.20 a share.The dividend is expected to increase by 2 percent annually and the applicable discount rate is 13 percent.Which one of these is the correct formula for computing the current value of this stock?
A)$1.20 + [$1.20/1.13 + .02]
B)($1.20 × 1.02)/1.13
C)($1.20 × 1.02)/.13
D)($1.20 × 1.02)/(.13 - .02)
E)$1.20 + ($1.20 × 1.02)/(.13 - .02)
Q2) A 4.25 percent preferred stock has a liquidating value of $100 a share.What is one share of this stock currently worth to an investor who desires a 14.5 percent annual rate of return?
A)$31.09
B)$24.25
C)$29.31
D)$34.12
E)$28.16
Q3) There are three factors that affect the present value of an annuity.Explain what these three factors are and discuss how an increase in each will impact the present value of the annuity.
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Chapter 5: Interest Rates and Bond Valuation
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Q1) A bond that pays interest annually yields a rate of return of 7.25 percent.The inflation rate for the same period is 2.31 percent.What is the actual real rate of return on this bond?
A)4.79%
B)4.87%
C)4.83%
D)4.94%
E)4.91%
Q2) You own a fixed-rate bond that has a coupon rate of 6.5 percent and matures in 12 years.You purchased this bond at par value when it was originally issued.If the current market rate for this type and quality of bond is 6.8 percent,then you would expect:
A)the bond issuer to increase the amount of each interest payment.
B)the yield to maturity to remain constant due to the fixed coupon rate.
C)the current yield today to be less than 6.5 percent.
D)today's market price to exceed the face value of the bond.
E)to realize a capital loss if you sold the bond at the market price today.
Q3) Identify at least five factors that affect the yield on a corporate bond.For each factor identified,explain how the factor affects the prices of bonds with varying maturities.
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Chapter 6: Stock Valuation
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Sample Questions
Q1) Snider's Hardwoods adheres to a 40 percent dividend payout policy and has a return on assets of 11.3 percent.The firm's debt-equity ratio is .45.What is the firm's rate of growth?
A)6.78%
B)7.39%
C)9.83%
D)6.55%
E)4.10%
Q2) XanEx is a new firm that just paid an annual dividend of $1 a share.The firm plans to increase its dividend by 20 percent a year for the next four years and then decrease the growth rate to 5 percent annually.If the required rate of return is 10.25 percent,what is one share of this stock worth today?
A)$33.04
B)$38.19
C)$41.05
D)$31.19
E)$34.81
Q3) Identify at least five features of preferred stock that are similar to bond features. To view all questions and flashcards with answers, click on the resource link above. Page 8
Chapter 7: Net Present Value and Other Investment Rules
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Sample Questions
Q1) A project has an initial cost of $32,000 and a 4-year life.The company uses straightline depreciation to a book value of zero over the life of the project.The projected net income from the project is $1,200,$2,200,$3,500,and $2,700 a year for Years 1 to 4,respectively.What is the average accounting return?
A)3.55%
B)14.13%
C)4.28%
D)7.11%
E)15.00%
Q2) A project is expected to have annual cash flows of $22,400,$13,600 and -$4,200 for Years 1 to 3,respectively.The initial cash outlay is $27,500 and the discount rate is 12 percent.What is the modified IRR?
A)13.12%
B)13.22%
C)2.73%
D)8.67%
E)9.75%
Q3) Explain the differences and similarities between net present value (NPV)and the profitability index (PI).
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Page 9
Chapter 8: Making Capital Investment Decisions
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Sample Questions
Q1) The book value of an asset is primarily used to compute the:
A)annual depreciation tax shield.
B)amount of tax due on the sale of an asset.
C)amount of tax saved annually due to the depreciation expense.
D)amount of cash that can be received from the sale of an asset.
E)change in depreciation needed to reflect the market value of the asset.
Q2) A project will produce operating cash flows of $42,000 a year for four years.During the life of the project,inventory will be lowered by $12,000,accounts receivable will increase by $15,000,and accounts payable will increase by $10,000.The project requires $120,000 of new equipment that will be depreciated straight-line to a zero book value over four years.At the end of the project,net working capital will return to its normal level and the equipment will be sold for $25,000,after taxes.What is the net present value given a required return of 14 percent?
A)$13,483.48
B)$18,117.05
C)$20,033.36
D)$12,037.86
E)$14,322.49
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Chapter 9: Risk Analysis, Real Options, and Capital Budgeting
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Q1) Southern Goods is analyzing a proposed project using standard sensitivity analysis.The company expects to sell 4,500 units,±11 percent.The expected variable cost per unit is $13 and the expected fixed costs are $12,000.Cost estimates are considered accurate within a ± 5 percent range.The depreciation expense is $5,000.The sale price is estimated at $22 a unit,±2 percent.
What is the amount of the fixed cost per unit under the pessimistic case scenario?
A)$2.55
B)$3.00
C)$3.15
D)$4.02
E)$4.55
Q2) To determine the lowest net present value that is likely to occur given a range of values for all of the relevant variables,a firm should conduct which type of analysis?
A)Sensitivity
B)Scenario
C)Present value break-even
D)Financial break-even
E)Cash flow break-even
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Chapter 10: Risk and Return Lessons From Market History
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Sample Questions
Q1) Which of the following statements are correct concerning the variance of the annual returns on an investment?
I.The larger the variance,the more the actual returns differ from the average return.
II.The larger the variance,the larger the standard deviation.
III.The larger the variance,the greater the risk of the investment.
IV.The larger the variance,the higher the expected return.
A)I and III only
B)II,III,and IV only
C)I,III,and IV only
D)I,II,and III only
E)I,II,III,and IV
Q2) During the 2008 financial crisis,the Icelandic stock exchange temporarily halted trading.What was the reaction of that market when trading resumed a few days later?
A)Increase in excess of 50 percent
B)Increase between 25 and 50 percent
C)Change between -25 and +25 percent
D)Decrease between 25 and 50 percent
E)Decrease in excess of 75 percent
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12
Chapter 11: Return and Risk: the Capital Asset Pricing Model
Capm
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Sample Questions
Q1) Which one of the following is an example of a nondiversifiable risk?
A)A poorly managed firm suddenly goes out of business due to lack of sales
B)A well managed firm reduces its work force and automates several jobs
C)A key employee of a firm suddenly resigns and accepts employment with a key competitor
D)A well respected chairman of the Federal Reserve suddenly resigns
E)A well respected president of a firm suddenly resigns
Q2) The market has an expected rate of return of 12.8 percent.The long-term government bond is expected to yield 4.5 percent and the U.S.Treasury bill is expected to yield 3.4 percent.The inflation rate is 3.1 percent.What is the market risk premium?
A)3.4%
B)9.7%
C)6.3%
D)8.3%
E)9.4%
Q3) If an optimal portfolio of risky assets can be identified,why should investors mix that portfolio with risk-free securities?
Q4) Why are some risks diversifiable and some nondiversifiable? Give an example of each.
Page 13
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Chapter 12: Risk, Cost of Capital, and Valuation
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Q1) Which one of these statements is correct?
A)The asset beta will equal the equity beta for a levered firm.
B)Leverage increases the asset beta.
C)A portfolio beta is the summation of the betas of each of the individual securities held in the portfolio.
D)The equity beta refers to the beta of an all-equity firm.
E)Financial leverage refers to a firm's use of debt and its related fixed costs of finance.
Q2) A firm has a beta of 1.3 and a debt-to-equity ratio of .4.The market rate of return is 11.6 percent,the tax rate is 32 percent,and the risk-free rate is 3.3 percent.The pretax cost of debt is 7.2 percent.What is the firm's WACC?
A)11.46%
B)8.90%
C)10.41%
D)9.96%
E)12.12%
Q3) Identify the three key determinants of beta and identify a situation for each of those determinants that will tend to produce a high beta value.
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Page 14
Chapter 13: Efficient Capital Markets and Behavioral Challenges
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Sample Questions
Q1) Efficient markets require which one of these?
A)Dart thrower investors
B)Only rational investors
C)Overly optimistic amateur investors
D)Countervailing irrationalities
E)Investors adhering to the conservatism principle
Q2) Insider trading does not offer any advantages if the financial markets are:
A)inefficient.
B)semiweak form efficient.
C)semistrong form efficient.
D)strong form efficient.
E)weak form efficient.
Q3) Why do you think it is difficult for researchers to agree on principles related to behavioral finance?
Q4) Explain why in an efficient market investments have an expected net present value (NPV)of zero.
Q5) What key item should managers look for when considering an acquisition?
15
Q6) What are the basic principles behind behavioral finance?
Q7) Define the three forms of market efficiency.
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Chapter 14: Capital Structure: Basic Concepts
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Q1) A general rule for managers to follow is to establish a firm's capital structure such that the firm's:
A)cost of equity is minimized.
B)bondholders are fully secured.
C)value is maximized.
D)dividend payout is maximized.
E)assets are minimized.
Q2) The Border Crossing has no debt and a cost of capital of 11.2 percent.Assume the firm switches to a debt-to-equity ratio of .25 and issues bonds at par with a 6.3 percent coupon.What will be its cost of equity after the switch? Ignore taxes.
A)11.71%
B)12.33%
C)11.54%
D)9.98%
E)12.43%
Q3) Identify and explain the Modigliani-Miller proposition that supports the concept that adding debt to a firm's capital structure increases the value of that firm.
Q4) Explain homemade leverage and why it matters.
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Page 16
Chapter 15: Capital Structure: Limits to the Use of Debt
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Q1) Burger Queen has a value of $26,000 in a good economy and $17,000 in a recession.The firm has $20,000 of debt.The probability of a recession is 50 percent.The firm is considering a project that would change the firm values to $27,000 in a good economy and $15,000 in a recession.Will shareholders be willing to accept this project? Why or why not?
A)No;Because the project will lower firm value by $500
B)No;Because the project will lower shareholder value by $500
C)No;Because the firm will be worth less in a recession than it is currently
D)Yes;Because the project will increase both firm and shareholder value by $500
E)Yes;Because shareholder value will increase $500 at a cost of $1,000 to the bondholders
Q2) A firm that has a negative net worth is said to be:
A)experiencing accounting insolvency.
B)in legal bankruptcy.
C)experiencing technical insolvency.
D)experiencing a business failure.
E)in Chapter 11 bankruptcy reorganization.
Q3) Explain a Section 363 bankruptcy and identify its primary benefit over a traditional bankruptcy.
Q4) How might business risk affect the capital structure of a firm?
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Chapter 16: Dividends and Other Payouts
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Q1) The Retail Outlet has 9,000 shares of stock outstanding with a par value of $1 per share.The current market value of the firm is $420,000.The balance sheet shows a balance in the capital in excess of par value of $136,000 and retained earnings of $234,000.The company just announced a 3-for-2 stock split.What will be the common stock account balance after the split?
A)$3,000
B)$4,500
C)$9,000
D)$11,000
E)$12,000
Q2) Of the following factors,which one is considered to be the primary factor affecting a firm's dividend decision?
A)The personal taxes company stockholders incur on dividend distributions
B)Maintaining consistency with the historical dividend policy
C)Attracting retail investors
D)Attracting institutional investors
E)Sustainable changes in earnings
Q3) Summarize at least four key points that are known about dividends and share repurchases.
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Page 18
Chapter 17: Options and Corporate Finance
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Q1) Wilt's has a stock price of $54 a share.The 3-month options have a strike price of $55.The risk-free rate is 3.6 percent,the standard deviation is 26 percent,N(d<sub>1</sub>)is .49724 and N(d<sub>2</sub>)is .44555.
What is the call price?
A)$2.68
B)$2.57
C)$2.73
D)$2.91
E)$2.46
Q2) Jeanette just purchased 100 shares of HE stock along with a $30 put option contract on HE.The minimum value of her combined holdings is ______ and the maximum value is ______.
A)$0;$1,500
B)$0;$3,000
C)$1,500;$3,000
D)$0;Unlimited
E)$3,000;Unlimited
Q3) What would you expect to occur if a call were to sell for less than its intrinsic value? Ignore taxes and transaction costs.
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Page 19
Chapter 18: Short-Term Finance and Planning
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Q1) Jupiter stores had a Quarter 2 beginning cash balance of $430.Sales for Quarters 1 through 3 are estimated at $600,$800,and $900,respectively.The cost of goods sold is equal to 70 percent of sales.Goods are purchased one quarter prior to the month of sale.The accounts payable period is 30 days and the accounts receivable period is 15 days.The firm had quarterly cash expenses of $180.What was the cash balance at the end of Quarter 2? Assume a 360 day year.
A)$350.00
B)$366.67
C)$410.00
D)$710.00
E)$680.00
Q2) True Blue Stores had a beginning accounts payable balance of $56,900 and an ending accounts payable balance of $62,800.Sales for the period were $675,000 and costs of goods sold were $448,000.What is the payables turnover rate?
A)6.98 times
B)7.49 times
C)8.23 times
D)11.28 times
E)12.01 times
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Page 20
Chapter 19: Raising Capital
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Q1) DJ's stock currently sells for $29 a share.The firm has a rights offer outstanding for new equity shares.To purchase one new share you must submit four rights and $25.What is the ex-rights stock price?
A)$29.00
B)$28.64
C)$28.45
D)$28.20
E)$27.36
Q2) Arnold's Construction is an all-equity firm with 120,000 shares of stock outstanding.The book value per share is $14 and the market value per share is $54.The current net income is $385,000.The firm is considering a new project that will cost $2.1 million and increase net income by $120,000.The current earnings per share are ____ and they will be ____ if the project is accepted.
A)$3.21;$3.12
B)$3.86;$3.24
C)$3.86;$3.82
D)$3.21;$3.18
E)$3.21;$3.24
Q3) Why might an eligible firm choose a Rule 415 registration of securities?
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Page 21
Chapter 20: International Corporate Finance
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Q1) Assume the inflation rate in the U.S.is 3.6 percent.The spot rate for a foreign currency is 5.872 while the 3-year forward rate is 6.084.What is the approximate rate of inflation in the foreign country?
A)4.68%
B)2.37%
C)2.42%
D)2.41%
E)4.79%
Q2) The forward rate market is dependent upon:
A)current forward rates exceeding current spot rates.
B)current spot rates exceeding current forward rates over time.
C)current spot rates equaling current forward rates on average over time.
D)current spot rates equaling the actual future spot rates on average over time.
E)forward rates equaling the actual future spot rates on average over time.
Q3) How many Singapore dollars can you get for $4,500 if the direct quote is .8136?
A)S$3,661.20
B)S$4,911.15
C)S$5,530.97
D)S$3,711.54
E)S$4,222.01
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Chapter 21: Mergers and Acquisitions Web Only
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Q1) Which term is applied to the situation where a bidding firm agrees to a limitation on its holdings in the target firm?
A)Shark repellent
B)Countertender offer
C)Standstill agreement
D)Poison pill annulment
E)Fair price provision
Q2) Which one of these defines the maximum price that a bidder should pay for a target firm?
A)An amount equal to the premium created by a merger of the bidder and target firms
B)Target firm's market value less the value of its long-term debt
C)Target firm's total market value as a stand-alone entity
D)Summation of the target firm's market value plus the merger premium minus any long-term debt
E)Summation of the target firm's market value plus the value of the synergy created by the merger
Q3) Explain a golden parachute and justify why a firm's shareholders may be willing to agree to such an arrangement.
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