Principles of Finance Exam Bank
Course Introduction
Principles of Finance provides an introduction to the fundamental concepts and tools used in financial decision making within organizations and markets. The course covers topics such as the time value of money, risk and return, asset valuation, financial statement analysis, capital budgeting, cost of capital, and the functioning of financial markets. Students will develop analytical skills to evaluate investment opportunities, understand financial instruments, and make informed decisions about financing and managing assets. This course lays the groundwork for advanced finance studies and practical application in both corporate and personal financial environments.
Recommended Textbook
Fundamentals of Corporate Finance 4th Edition Jonathan Berk
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Page 2
Chapter 1: Corporate Finance and the Financial Manager
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Q1) Stock markets provide liquidity for a firm's shares.
A)True
B)False
Answer: True
Q2) 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
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) International Financial Reporting Standards are taking root throughout the world. However, it is unlikely that the U.S. will report according to IFRS before the second half of the twenty-first century.
A)True
B)False
Answer: False
Q2) Which of the following statements regarding the balance sheet is INCORRECT?
A) The balance sheet provides a snapshot of a firm's financial position at a given point in time.
B) The balance sheet lists a firm's assets and liabilities.
C) The balance sheet reports stockholders' equity on the right-hand side.
D) The balance sheet reports liabilities on the left-hand side.
Answer: A
Q3) The management of public companies is not legally required to disclose any off-balance sheet transactions.
A)True
B)False
Answer: False
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4
Chapter 3: Time Value of Money: an Introduction
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Q1) An investment will pay you $120 in one year and $200 in two years. If the interest rate is 4%, what is the present value of these cash flows?
A) $304.91
B) $307.69
C) $300.29
D) $320.00
Answer: C
Q2) If an arbitrage opportunity exists, an investor can act quickly in the hope of making a risk-free profit.
A)True
B)False
Answer: True
Q3) Why should you approach every problem by drawing a timeline?
A) A timeline allows you to quickly sum cash flows over time.
B) A timeline eliminates the majority of flawed financial decisions.
C) A timeline can be used to schedule events which are yet to occur.
D) A timeline identifies events in a transaction or investment which might otherwise be easily overlooked.
Answer: D
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Page 5
Chapter 4: Time Value of Money: Valuing Cash Flow
Streams
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Q1) An annuity pays $10 per year for 98 years. What is the present value (PV) of this annuity given that the discount rate is 7%?
A) $85.60
B) $171.20
C) $142.67
D) $199.74
Q2) A bank is negotiating a loan. The loan can either be paid off as a lump sum of $80,000 at the end of four years, or as equal annual payments at the end of each of the next four years. If the interest rate on the loan is 6%, what annual payments should be made so that both forms of payment are equivalent?
A) $14,630
B) $18,287
C) $25,602
D) $29,259
Q3) Cash flows from an annuity occur every year in the future.
A)True
B)False
Q4) Can we apply the growing perpetuity equation for negative growth as well?
Page 6
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Chapter 5: Interest Rates
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Q1) Given that the inflation rate in 2006 was about 3.24%, while a short-term municipal bond offered a rate of 2.9%, which of the following statements is correct?
A) The purchasing power of investors in these bonds grew over the course of the year.
B) The real interest rate for investors in these bonds was greater than the rate of inflation.
C) Investors in these bonds were able to buy less at the end of the year than they could have purchased at the start of the year.
D) The nominal interest rate offered by these bonds gave the true increase in purchasing power that resulted from investing in these bonds.
Q2) What is the net present value (NPV) of an investment that costs $2,500 and pays $1,000 at the end of one, three, and five years?
Q3) Inflation is calculated as the rate of change in the _______.
A) unemployment rate
B) Gross Domestic Product
C) Consumer Price Index
D) risk-free rate
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Chapter 6: Bonds
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Q1) Which of the following statements regarding bonds and their terms is FALSE?
A) Zero-coupon bonds are also called pure discount bonds.
B) The internal rate of return (IRR) of an investment opportunity is the discount rate at which the net present value (NPV) of the investment opportunity is equal to zero.
C) The yield to maturity for a zero-coupon bond is the return you will earn as an investor from holding the bond to maturity and receiving the promised face value payment.
D) When prices are quoted in the bond market, they are conventionally quoted in increments of $1,000.
Q2) How can the financial calculator be used to calculate the price of a coupon bond from its yield to maturity?
Q3) A $5000 bond with a coupon rate of 5.7% paid semiannually has ten years to maturity and a yield to maturity of 6.4%. If interest rates fall and the yield to maturity decreases by 0.8%, what will happen to the price of the bond?
A) The price of the bond will fall by $293.50.
B) The price of the bond will fall by $352.20.
C) The price of the bond will rise by $410.90.
D) The price of the bond will rise by $293.50.
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Chapter 7: Stock Valuation
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Q1) Rylan Industries is expected to pay a dividend of $5.70 year for the next four years. If the current price of Rylan stock is $31.27, and Rylan's equity cost of capital is 12%, what price would you expect Rylan's stock to sell for at the end of the four years?
A) $21.96
B) $39.53
C) $17.57
D) $61.49
Q2) Stocks that do not pay a dividend must have a value of $0.
A)True
B)False
Q3) Chittenden Enterprises has 643 million shares outstanding. It expects earnings at the end of the year to be $960 million. The firm's equity cost of capital is 9%. Chittenden pays out 30% of its earnings in total: 20% paid out as dividends and 10% used to repurchase shares. If Chittenden's earnings are expected to grow at a constant 3% per year, what is Chittenden's share price?
A) $3.74
B) $2.24
C) $7.47
D) $14.94
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Page 9
Chapter 8: Investment Decision Rules
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Questions
Q1) A security company offers to provide CCTV coverage for a parking garage for ten years for an initial payment of $50,000 and additional payments of $30,000 per year. What is the equivalent annual annuity of this deal, given a cost of capital of 5%?
A) -$21,885
B) -$25,533
C) -$29,180
D) -$36,475
Q2) A car dealership offers a car for $14,000, with up to one year to pay for the car. If the interest rate is 5%, what is the net present value (NPV) of this offer to buyers who elect not to pay for the car for one year?
A) $667
B) $1333
C) $13,333
D) $14,000
Q3) The Net Present Value rule implies that we should compare a project's net present value (NPV) to zero.
A)True
B)False
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Chapter 9: Fundamentals of Capital Budgeting
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Q1) Which of the following is usually NOT a factor that must be considered when estimating the revenues and costs arising from a new product?
A) the fluctuations in the cost of capital over the period in question
B) the sales of a new product will typically accelerate, plateau, and ultimately decline over time
C) the prices of technology products generally fall over time
D) competition tends to reduce profit margins over time in most industries
Q2) The graph above shows the break-even analysis for the cost of making a certain good. Based on this chart, which of the following is true?
A) The net present value (NPV) of the project increases with increased cost of goods sold.
B) The project should not be undertaken if the predicted cost of goods sold is less than $110.
C) The net present value (NPV) of the project will be positive if the cost of goods sold is greater than $110.
D) If the good costs $110 to make, the net present value (NPV) of the project will be zero.
Q3) What do you understand by break-even analysis?
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Page 11
Chapter 10: Stock Valuation: a Second Look
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Q1) The table above shows the stock prices and multiples for a number of firms in the newspaper publishing industry. Which of the following ratios would most likely be the most reliable in determining the stock price of a comparable firm?
A) P/E
B) Price/Book
C) Enterprise Value/Sales
D) Enterprise Value/EBITDA
Q2) Several methods should be used to provide an estimate of a stock's value since no single method provides a definitive value.
A)True
B)False
Q3) If you want to value a firm that consistently pays out its earnings as dividends, the simplest model for you to use is the ________.
A) enterprise value model
B) method of comparables
C) dividend-discount model
D) discounted free cash flow model
Q4) Which is the best valuation technique when using comparables?
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Chapter 11: Risk and Return in Capital Markets
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Q1) Suppose you invested $79 in the Ishares Dividend Stock Fund (DVY) a month ago. It paid a dividend of $0.41 today and then you sold it for $66. What was your return on the investment?
A) -20.72%
B) -$15.94%
C) -18.33%
D) -17.53%
Q2) Which type of investment has historically had the lowest volatility?
Q3) Consider an economy with two types of firms, S and I. S firms always move together, but I firms move independently of each other. For both types of firms there is a 40% probability that the firm will have a 20% return and a 60% probability that the firm will have a -30% return. The standard deviation for the return on an individual firm is closest to ________.
A) 24.49%
B) -10.00%
C) 12.25%
D) 9.80%
Q4) On average, stocks have delivered higher returns than bonds in the long run. A)True B)False
Page 13
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Chapter 12: Systematic Risk and the Equity Risk Premium
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Q1) Suppose you invest $20,000 by purchasing 200 shares of Abbott Labs (ABT) at $50 per share, 200 shares of Lowes (LOW) at $30 per share, and 100 shares of Ball Corporation (BLL) at $40 per share. Suppose over the next year Ball has a return of 12.3%, Lowes has a return of 23%, and Abbott Labs has a return of -10%. The value of your portfolio over the year is ________.
A) $21,916
B) $19,828
C) $20,872
D) $22,959
Q2) A stock market comprises 4600 shares of stock A and 1600 shares of stock B. Assume the share prices for stocks A and B are $15 and $30, respectively. If you have $15,000 to invest and you want to hold the market portfolio, how much of your money will you invest in Stock A?
A) $10,615.38
B) $8846.15
C) $6153.85
D) $5307.69
Q3) Since total risk is greater than systematic risk, should standard deviation be always greater than beta?
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Page 14
Chapter 13: The Cost of Capital
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Q1) Why do we use leverage if it increases the risk of a firm?
Q2) Assume SAP Inc. received a $1 million grant under its Small Business Innovation program. SAP invested the grant money and developed a system to remove metal contaminants from storm water in shipyards. The firm estimates that each shipyard spends $500,000 a year on storm water clean-up efforts. If SAP is able to sign up and retain four shipyards from the first year onwards, what is the present value (PV) of the project (net of investment) if the cost of capital for SAP is 20% per year? Assume a cost of operations and other costs for SAP equal 60% of revenue.
A) $3.00 million
B) $3.30 million
C) 3.60 million
D) $3.90 million
Q3) A firm incurs $40,000 in interest expenses each year. If the tax rate of the firm is 30%, what is the effective after-tax interest rate expense for the firm?
A) $21,000.00
B) $22,400.00
C) $23,800.00
D) $28,000.00
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15
Chapter 14: Raising Equity Capital
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Q1) What are venture capital firms?
Q2) In a best-efforts IPO, the underwriter guarantees that all stock will be sold.
A)True
B)False
Q3) What are the advantages of a rights offer over a cash offer when issuing new shares?
A) It enables a firm to attract new investors from outside its current owners.
B) It enables a firm to issue equity without imposing a loss on current shareholders.
C) It enables a firm to access new sources of capital to fund its growth.
D) It enables a firm to attract new investors by offering them a windfall from the difference between the price of the issued stock and the price of stock after the offering.
Q4) Which of the following best describes those shares sold when a company goes public which raise new capital?
A) primary offering
B) secondary offering
C) tertiary offering
D) preliminary offering
Q5) What are some of the disadvantages of going public?
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Chapter 15: Debt Financing
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Q1) Smithfield Enterprises issues debt with a maturity of 7 years. In the case of bankruptcy, holders of this debt may only claim those assets of the firm that are not already pledged as collateral on other debt. Which of the following best describes this type of corporate debt?
A) a note
B) a mortgage bond
C) an asset-backed bond
D) debenture
Q2) Which of the following terms best describes a loan where a larger line of credit or lower interest rate has been obtained by providing collateral to back that loan?
A) a term loan
B) a revolving line of credit
C) an asset-backed line of credit
D) a private placement
Q3) Private debt cannot be in the form of bonds.
A)True
B)False
Q4) What are bond covenants?
Q5) What is yield to call?
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Chapter 16: Capital Structure
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Q1) Which of the following statements is FALSE?
A) If we can identify a comparison firm whose assets have the same risk as the project being evaluated, and if the comparison firm is levered, then we can use its cost of debt as the cost of capital for the project.
B) We can calculate the cost of capital of a firm's assets by computing the weighted average of the firm's equity and debt cost of capital, which we refer to as the firm's weighted average cost of capital.
C) The portfolio of a firm's equity and debt replicates the returns we would earn if the firm were unlevered.
D) When evaluating any potential investment project, we must use a discount rate that is appropriate given the risk of the project's free cash flow.
Q2) What are some implications of market imperfections?
Q3) What effect does debt have on a firm's weighted average cost of capital?
Q4) The presence of financial distress costs can explain why firms choose debt levels that are too low to exploit the interest tax shield.
A)True
B)False
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Chapter 17: Payout Policy
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Q1) Homemade dividend refers to the process by which an investor ________.
A) can take on more debt
B) chooses between equity and debt
C) can sell shares to create a dividend policy to suit his preferences
D) reinvests dividend payments
Q2) Different investor groups have differing tax preferences that create clientele effects in which dividend policy of a firm is optimized for the tax preferences of its investors.
A)True
B)False
Q3) A firm has a total market value of assets of $300 million that includes $60 million of cash and 8 million shares outstanding. If the firm uses $30 million of its cash to repurchase shares, what is the new price per share?
A) $37.50
B) $30.00
C) $45.00
D) $52.50
Q4) What is the general trend over the last few decades of total payouts by firms to shareholders be it through share repurchase or dividends?
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Page 19
Chapter 18: Financial Modeling and Pro Forma Analysis
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Q1) Compute the value of a firm with free cash flows of $1,000, $2,500, and $3,000 over the next three years, a terminal firm value of $40,000 after three years, and the unlevered cost of capital is 15%. Assume that the interest rate tax shield is zero.
A) $26,191
B) $27,234
C) $31,033
D) $39,343
Q2) Total working capital rather than changes in working capital has implications for cash flows.
A)True
B)False
Q3) Compute the after-tax interest expense for a firm with Interest on Excess Cash = $1,000, Interest on Debt = $5,000, and a tax rate of 30%.
A) $2,500
B) $2,800
C) $3,100
D) $3,300
Q4) What is common starting point for forecasting?
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Page 20
Chapter 19: Working Capital Management
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Q1) Which of the following is NOT a benefit of holding inventory?
A) minimizes the risk that the firm will not be able to obtain an input it needs for production
B) seasonality of demand, meaning that customer purchases often do not match the most efficient production cycle, leading to a buildup of inventory in off-peak periods
C) minimizes order cost from placing multiple orders throughout the year
D) minimizes risks involved in spoilage and obsolescence
Q2) Luther's Accounts Payable days is closest to ________.
A) 39 days
B) 32 days
C) 59 days
D) 42 days
Q3) Which of the following are the "5-C's of Credit"?
A) Character, Capacity, Compensation, Collateral, Conditions
B) Character, Cash, Credit, Collateral, Collectability
C) Character, Capacity, Capital, Collateral, Conditions
D) Cash, Capacity, Capital, Compensation, Collectability
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) Which of the following statements is FALSE?
A) When following a conservative financing policy, a firm would use long-term sources of funds to finance its fixed assets, permanent working capital, and some of its seasonal needs.
B) An aggressive financing policy also increases the possibility that managers of the firm will use this excess cash nonproductively-for example, on perquisites for themselves.
C) A firm could finance its short-term needs with long-term debt, a practice known as a conservative financing policy.
D) To implement a conservative financing policy effectively, there will necessarily be periods when excess cash is available-those periods when the firm requires little or no investment in temporary working capital.
Q2) A short-term bank loan that is often used until a firm can arrange for long-term financing is called ________.
A) a committed line of credit
B) a short-term mortgage loan
C) a bridge loan
D) a single, end-of-period-payment loan
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Page 22
Chapter 21: Option Applications and Corporate Finance
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Q1) Suppose that a stock sells at a price of $40 on the expiration date. Compute the price of a put option if the option strike price is $20.
A) $0
B) $10
C) $20
D) $30
Q2) This graph depicts the payoffs of a ________.
A) long position in a put option at expiration
B) short position in a call option at expiration
C) short position in a put option at expiration
D) long position in a call option at expiration
Q3) KD Industries stock is currently trading at $32 per share. Consider a put option on KD stock with a strike price of $30. The intrinsic value of this put option is ________.
A) $0
B) -$2
C) $2
D) $30
Q4) What is the long position of an options contract?
Q5) When is an option in-the-money?
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Chapter 22: Mergers and Acquisitions
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Q1) Which of the following statements is FALSE?
A) There are two primary mechanisms by which ownership and control of a public corporation can change: Either another corporation or group of individuals can acquire the target firm, or the target firm can merge with another firm.
B) Merger activity is greater during economic contractions than during expansions.
C) Mergers and acquisitions are part of what is often referred to as "the market for corporate control."
D) The takeover market is also characterized by merger waves-peaks of heavy activity followed by quiet troughs of few transactions.
Q2) The period of the ________ is known for known for "strategic" or "global" deals that were more likely to be friendly and to involve companies in related businesses; these mergers often were designed to create strong firms on a scale that would allow them to compete globally.
A) 1960s
B) 1970s
C) 1980s
D) 1990s
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Chapter 23: International Corporate Finance
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Q1) If a firm purchases its inputs and sells its goods in the same foreign market, evaluation of the project ________.
A) requires us to consider the exchange rate risk of output only
B) requires us to consider exchange rate risk of inputs only
C) does not require consideration of exchange rate risk
D) none of the above
Q2) Consider the following equation: S × [(Foreign Cash Flow) / (1 + r<sub>FC</sub>] = (Forward Rate × Foreign Cash Flow) / (1 + r<sub>$</sub>)
The term r<sub>$</sub> in this equation is ________.
A) the dollar discount rate
B) the risk-free rate for a foreign investor
C) the risk-free rate for a U.S. investor
D) the foreign currency discount rate
Q3) What is floating rate?
Q4) What is cash-and-carry strategy?
Q5) What is a currency timeline?
Q6) What is foreign exchange market?
Q7) What are internationally segmented capital markets?
Q8) What are internationally integrated capital markets?
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Chapter 24: Leasing
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Q1) 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
Q2) Which of the following statements is FALSE?
A) In a leveraged lease the lessor borrows from a bank or other lender to obtain the initial capital for the purchase, using the lease payments to pay interest and principal on the loan.
B) In some circumstances, the lessor is not an independent company but rather a separate business partnership, called a special-purpose entity (SPE), which is created by the lessor for the sole purpose of obtaining the lease.
C) In a direct lease, the lessor is not the manufacturer, but is often an independent company that specializes in purchasing assets and leasing them to customers.
D) SPEs are commonly used in synthetic leases, which are designed to obtain specific accounting and tax treatment.
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Chapter 25: Insurance and Risk Management
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Q1) In reality market imperfections exist that can raise the cost of insurance above the actuarially fair price and offset some of these benefits. These insurance market imperfections include all of the following EXCEPT ________.
A) adverse selection
B) agency costs
C) administrative and overhead costs
D) taxation of insurance payments
Q2) Insurance for large risks that cannot be well diversified has a(n) ________, which increases its cost.
A) positive beta
B) moral hazard clause
C) negative beta
D) actuarially-biased risk
Q3) Farmville Industries is a major agricultural firm and is concerned about the possibility of drought impacting corn production over the next year. In the event of a drought, Farmville Industries anticipates a loss of $75 million. Suppose the likelihood of a drought is 10% per year, and the beta associated with such a loss is 0.4. If the risk-free interest rate is 5% and the expected return on the market is 10%, then what is the actuarially fair insurance premium?
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Chapter 26: Corporate Governance
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Q1) Directors who are employees, former employees, or family members of employees are called ________.
A) managing directors
B) independent directors
C) inside directors
D) gray directors
Q2) What is the difference between inside, gray, and outside directors?
Q3) Which of the following statements is FALSE?
A) Recently, shareholders have started organizing "no" votes. That is, when they are dissatisfied with a board, they simply refuse to vote to approve the slate of nominees for the board.
B) One early study of proxy contests found that the announcement of a contest increased firm stock price by 8% on average, even if the challenge was eventually unsuccessful and the incumbents won reelection.
C) Shareholders' only real role in governance is in electing the directors of the company.
D) Perhaps the most extreme form of direct action that disgruntled shareholders can take is to hold a proxy contest and introduce a rival slate of directors for election to the board.
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