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BAM 513
Financial Management
Text:
Principles of Managerial Finance
12th Edition, 2009
ISBN: 0-321-52413-6
Author(s):
Lawrence J. Gitman
Publisher:
Pearson Education
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ment
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Multiple Choice Questions (Enter your answers on the enclosed answer sheet)
1) Managerial finance
a. devotes the majority of its attention to the collection and presentation of financial
data.
b. involves tasks such as budgeting, financial forecasting, cash management, and funds
procurement.
c. involves the design and delivery of advice and financial products.
d. recognizes funds on an accrual basis.
2) Financial service
a. is concerned with the duties of the financial manager.
b. involves the design and delivery of advice and financial products.
c. handles accounting activities related to data processing.
d. provides guidelines for the efficient operation of the business.
3) A major weakness of a partnership is
a. difficulty liquidating or transferring ownership.
b. limited liability.
c. access to capital markets.
d. low organizational costs.
4) The primary economic principle used in managerial finance is
a. the crowding out effect.
b. the liquidity trap.
c. supply and demand.
d. marginal analysis.
5) Johnson, Inc. has just ended the calendar year making a sale in the amount of
$10,000 of merchandise purchased during the year at a total cost of $7,000. Al-
though the firm paid in full for the merchandise during the year, it has yet to collect
at year end from the customer. The net profit and cash flow from this sale for the year
are
a. $7,000 and -$3,000, respectively.
b. $3,000 and -$7,000, respectively.
c. $3,000 and $7,000, respectively.
d. $3,000 and $10,000, respectively.
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6) By concentrating on cash flows within the firm the financial manager should be able
to
a. control expenses.
b. avoid insolvency.
c. prepare tax returns.
d. speak authoritatively to stockholders.
7) A firm has just ended its calendar year making a sale in the amount of $200,000 of
merchandise purchased during the year at a total cost of $150,500. Although the
firm paid in full for the merchandise during the year, it has yet to collect at year end
from the customer. The possible problem this firm may face is
a. high leverage.
b. low profitabi I ity.
c. lack of cash flow.
d. inability to receive credit.
8) Included in the primary activities of the financial manager are
a. financial analysis and planning.
b. making financing decisions.
c. analyzing and planning cash flows.
d. making investment decisions.
e. all of the above
9) The financial manager may be responsible for any of the following EXCEPT
a. analyzing the effects of more debt on the firm’s capital structure.
b. determining whether to accept or reject a capital asset acquisition.
c. analyzing budget and performance reports.
d. monitoring of quarterly tax payments.
10) Managing the firm’s assets includes all of the following EXCEPT
a. notes payable.
b. accounts receivable.
c. fixed assets.
d. inventory.
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11) The primary goal of the financial manager is
a. maximizing profit.
b. minimizing return.
c. minimizing risk.
d. maximizing wealth.
12) The wealth of the owners of a corporation is represented by
a. share value.
b. profits.
c. earnings per share.
d. cash flow.
13) All of the following are functions of security exchanges EXCEPT
a. aiding in new financing.
b. holding demand deposits.
c. allocating scarce capital.
d. creating continuous markets.
14) The major securities traded in the capital markets are
a. commercial paper and Treasury bills.
b. bonds and commercial paper.
c. Treasury bills and certificates of deposit.
d. stocks and bonds.
15) The average tax rate of a corporation with ordinary income of $105,000 and a tax li-
ability of $24,200 is
a. 15 percent.
b. 46 percent.
c. 23 percent.
d. 34 percent.
16) The statement of retained earnings reports all of the following EXCEPT
a. interest.
b. net profits after taxes.
c. preferred stock dividends.
d. common stock dividends.
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17) Paid-in-capital in excess of par represents the amount of proceeds
a. from the original sale of stock.
b. at the current market value of common stock.
c. in excess of the par value from the original sale of common stock.
d. at the current book value of common stock.
18) The primary concern of creditors when assessing the strength of a firm is the firm’s
a. leverage.
b. profitability.
c. short-term liquidity.
d. share price.
19) is where the firm’s ratio values are compared to those of a key competitor or
group of competitors, primarily to identify areas for improvement.
a. Combined analysis
b. Benchmarking
c. Time-series analysis
d. None of the above
20) Cross-sectional ratio analysis is used to
a. reflect the symptoms of a possible problem.
b. correct expected problems in operations.
c. isolate the causes of problems.
d. provide conclusive evidence of the existence of a problem.
21) The ratios are primarily measures of return.
a. activity
b. profitability
c. debt
d. liquidity
22) The two categories of ratios that should be utilized to assess a firm’s true liquidity are
the
a. liquidity and profitability ratios.
b. current and quick ratios.
c. liquidity and activity ratios.
d. liquidity and debt ratios.
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23) The measures the percentage of each sales dollar remaining after ALL ex-
penses, including taxes, have been deducted.
a. operating profit margin
b. earnings available to common shareholders
c. gross profit margin
d. net profit margin
24) All of the following are outflows of cash EXCEPT
a. a decrease in notes payable.
b. a decrease in accounts receivable.
c. an increase in accounts receivable.
d. an increase in inventory.
25) NICO Corporation had net fixed assets of $2,000,000 at the end of 2006 and
$1,800,000 at the end of 2005. In addition, the firm had a depreciation expense of
$200,000 during 2006 and $180,000 during 2005. Using this information, NICO’s
net fixed asset investment for 2006 was
a. $400,000.
b. $380,000.
c. $0.
d. $20,000.
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Multiple Choice Questions (Enter your answers on the enclosed answer sheet)
1) If a person’s required return does not change when risk increases, that person is said
to be
a. risk-indifferent.
b. risk-aware.
c. risk-averse.
d. risk-seeki ng.
2) The of an asset is the change in value plus any cash distributions expressed
as a percentage of the initial price or amount invested.
a. return
b. risk
c. probability
d. value
3) Prime-grade commercial paper will most likely have a higher annual return than
a. a common stock.
b. a Treasury bill.
c. a preferred stock.
d. an investment-grade bond.
4) The of an event occurring is the percentage chance of a given outcome.
a. reliability
b. standard deviation
c. probability
d. dispersion
5) Since for a given increase in risk, most managers require an increase in return, they
are
a. risk-free.
b. risk-i nd ifferent.
c. risk-seeking.
d. risk-averse.
6) The the coefficient of variation, the the risk.
a. more stable; higher
b. lower; higher
c. lower; lower
d. higher; lower
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7) A(n) portfolio maximizes return for a given level of risk, or minimizes risk for
a given level of return.
a. efficient
b. continuous
c. coefficient
d. risk-i nd ifferent
8) Perfectly correlated series move exactly together and have a correlation co-
efficient of , while perfectly correlated series move exactly in op-
posite directions and have a correlation coefficient of _
a. negatively; +1; positively; -1
b. negatively; -1; positively; +1
c. positively; -1; negatively; + 1
d. positively; +1; negatively; -1
9) Combining negatively correlated assets having the same expected return results in a
portfolio with level of expected return and level of risk.
a. the same; a lower
b. the same; a higher
c. a higher; a lower
d. a lower; a higher
10) Combining two assets having perfectly negatively correlated returns will result in the
creation of a portfol io with an overall risk that
a. decreases to a level below that of either asset.
b. increases to a level above that of either asset.
c. remains unchanged.
d. stabilizes to a level between the asset with the higher risk and the asset with the
lower risk.
11) Risk that affects all firms is called
a. nondiversifiable risk.
b. total risk.
c. diversifiable risk.
d. management risk.
12) A beta coefficient of +1 represents an asset that
a. is unaffected by market movement.
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b. has the same response as the market portfolio.
c. is less responsive than the market portfolio.
d. is more responsive than the market portfol io.
13) The higher an asset’s beta,
a. the lower the expected return will be in an up market.
b. the more responsive it is to changing market returns.
c. the higher the expected return will be in a down market.
d. the less responsive it is to changing market returns.
14) An increase in the Treasury Bill rate the required rate of return of a common
stock.
a. has no effect on
b. decreases
c. increases
d. cannot be determined by
15) Nico wants to invest all of his money in just two assets: the risk free asset and the
market portfolio. What is Nico’s portfolio beta if he invests a quarter of his money in
the market portfol io and the rest in the risk free asset?
a. 1.00
b. 0.25
c. 0.00
d. 0.75
16) In the capital asset pricing model, the beta coefficient is a measure of risk
and an index of the degree of movement of an asset’s return in response to a change
in _
a. diversifiable; the prime rate
b. nondiversifiable; the market return
c. nondiversifiable; the Treasury bill rate
d. diversifiable; the bond index rate
17) As risk aversion increases
a. a firm’s beta will decrease.
b. investors’ required rate of return will increase.
c. investors’ required rate of return will decrease.
d. a firm’s beta will increase.
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18) The rate of interest is typically the required rate of return on a three-month
U.S. Treasury bill.
a. nominal
b. premium
c. risk-free
d. real
19) A yield curve that reflects relatively similar borrowing costs for both short-term and
long-term loans is called
a. flat yield curve.
b. normal yield curve.
c. inverted yield curve.
d. none of the above.
20) The theory suggesting that for any given issuer, long-term interest rates tends to be
higher than short-term rates is called
a. expectation hypothesis.
b. market segmentation theory.
c. liquidity preference theory.
d. none of the above.
21) At any time, the slope of the yield curve is affected by
a. liquidity preferences.
b. the comparative equilibrium of supply and demand in the short-term and long-term
market segments.
c. inflationary expectations.
d. all of the above.
22) A is a restrictive provision on a bond which provides for the systematic re-
tirement of the bonds prior to their maturity.
a. conversion feature
b. subordination clause
c. sinking-fund requirement
d. redemption clause
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23) Violation of any standard or restrictive provision by the borrower gives the lender the
right to do all of the following EXCEPT
a. seize the loan collateral.
b. demand immediate repayment.
c. increase the interest rate.
d. alter the terms of the initial agreement, for example accelerate the maturity date.
24) To compensate for the uncertainty of future interest rates and the fact that the longer
the term of a loan the higher the probability that the borrower will default, the lender
typically
a. charges a higher interest rate on long-term loans.
b. reserves the right to change the terms of the loan at any time.
c. reserves the right to demand immediate payment at any time.
d. includes excessively restrictive debt provisions.
25) Bonds are
a. a series of short-term debt instruments.
b. long-term debt instruments.
c. a form of equity financing that pays interest.
d. a hybrid form of financing used to raise large sums of money from a diverse group of
lenders.
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Multiple Choice Questions (Enter your answers on the enclosed answer sheet)
1) The first step in the capital budgeting process is
a. decision-making.
b. proposal generation.
c. implementation.
d. review and analysis.
2) All of the following are steps in the capital budgeting process EXCEPT
a. transformation.
b. decision-making.
c. implementation.
d. follow-up.
3) Cash flows that could be realized from the best alternative use of an owned asset are
called
a. opportunity costs.
b. incremental costs.
c. lost resale opportunities.
d. sunk costs.
4) An important cash inflow in the analysis of initial cash flows for a replacement project
is
a. installation cost.
b. the cost of the new asset.
c. the sale value of the old asset.
d. taxes.
5) A corporation is considering expanding operations to meet growing demand. With
the capital expansion, the current accounts are expected to change. Management
expects cash to increase by $20,000, accounts receivable by $40,000, and invento-
ries by $60,000. At the same time accounts payable will increase by $50,000, ac-
cruals by $10,000, and long-term debt by $100,000. The change in net working
capital is
a. a decrease of $40,000.
b. a decrease of $120,000.
c. an increase of $120,000.
d. an increase of $60,000.
6) A loss on the sale of an asset that is depreciable and used in business is ; a
loss on the sale of a non-depreciable asset is _
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a. not deductible; deductible only against capital gains
b. deductible from ordinary income; deductible only against capital gains
c. a credit against the tax liability; not deductible
d. deductible from capital gains income; deductible from ordinary income
7) A corporation has decided to replace an existing asset with a newer model. Two years
ago, the existing asset originally cost $30,000 and was being depreciated under
MACRS using a five-year recovery period. The existing asset can be sold for $25,000.
The new asset will cost $75,000 and will also be depreciated under MACRS using a
five-year recovery period. If the assumed tax rate is 40 percent on ordinary income
and capital gains, the initial investment is _
a. $42,000
b. $54,240
c. $52,440
d. $50,000
8) A corporation is evaluating the relevant cash flows for a capital budgeting decision
and must estimate the terminal cash flow. The proposed machine will be disposed
of at the end of its usable life of five years at an estimated sale price of $15,000.
The machine has an original purchase price of $80,000, installation cost of
$20,000, and will be depreciated under the five-year MACRS. Net working capital is
expected to decline by $5,000. The firm has a 40 percent tax rate on ordinary in-
come and long-term capital gain. The terminal cash flow is
a. $24,000.
b. $14,000.
c. $26,000.
d. $16,000.
9) All of the following are weaknesses of the payback period EXCEPT
a. only an implicit consideration of the timing of cash flows.
b. the difficulty of specifying the appropriate payback period.
c. a disregard for cash flows after the payback period.
d. it uses cash flows, not accounting profits.
10) Payback is considered an unsophisticated capital budgeting because it
a. gives explicit consideration to risk exposure due to the use of the cost of capital as a
discount rate.
b. gives explicit consideration to the timing of cash flows and therefore the time value of
money.
c. gives consideration to cash flows that occur before the payback period.
d. none of the above
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11) What is the payback period for Tangshan Mining company’s new project if its initial
after tax cost is $5,000,000 and it is expected to provide after-tax operating cash
inflows of $1,800,000 in year 1, $1,900,000 in year 2, $700,000 in year 3 and
$1,800,000 in year 4?
a. 3.33 years.
b. 4.33 years.
c. 2.33 years.
d. None of the above
12) Should Tangshan Mining company accept a new project if its maximum payback is
3.5 years and its initial after tax cost is $5,000,000 and it is expected to provide af-
ter-tax operating cash inflows of $1,800,000 in year 1, $1,900,000 in year 2,
$700,000 in year 3 and $1,800,000 in year 4?
a. No.
b. Yes.
c. It depends.
d. None of the above
13) What is the N PV for the followi ng project if its cost of capital is 0 percent and its
initial after tax cost is $5,000,000 and it is expected to provide after-tax operating
cash inflows of $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3
and $1,300,000 in year 4?
a. $371,764.
b. $137,053.
c. $1,700,000.
d. None of the above
14) What is the IRR for the following project if its initial after tax cost is $5,000,000
and it is expected to provide after-tax operati ng cash flows of ($1,800,000) in year 1,
$2,900,000 in year 2, $2,700,000 in year 3 and $2,300,000 in year 4?
a. 11.44.
b. 9.67.
c. 5.83.
d. None of the above
15) Consider the following projects, X and Y where the firm can only choose one. Project
X costs $600 and has cash flows of $400 in each of the next 2 years. Project Y also
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costs $600, and generates cash flows of $500 and $275 for the next 2 years, respec-
tively. Which investment should the firm choose if the cost of capital is 25 percent?
a. Project Y.
b. Project X.
c. Neither.
d. Not enough information to tell.
16) The is the compound annual rate of return that the firm will earn if it in-
vests in the project and receives the given cash inflows.
a. discount rate
b. opportunity cost
c. cost of capital
d. internal rate of return
17) In comparing the internal rate of return and net present value methods of evaluation,
a. net present value is theoretically superior, but financial managers prefer to use inter-
nal rate of return.
b. financial managers prefer net present value, because it measures benefits relative to
the amount invested.
c. financial managers prefer net present value, because it is presented as a rate of re-
turn.
d. internal rate of return is theoretically superior, but financial managers prefer net pres-
ent value.
18) In the context of capital budgeting, risk generally refers to
a. the chance that the net present value will be greater than zero.
b. the degree of variability of the initial investment.
c. the chance that the internal rate of return will exceed the cost of capital.
d. the degree of variabi I ity of the cash inflows.
19) Two approaches for dealing with project risk to capture the variability of cash inflows
and NPVs are
a. scenario analysis and simulation.
b. sensitivity analysis and scenario analysis.
c. sensitivity analysis and simulation.
d. none of the above.
20) A behavioral approach for dealing with project risk that uses several possible values
for a given variable such as cash inflows to assess that variable’s impact on NPV is
called
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a. sensitivity analysis.
b. simulation analysis.
c. scenario analysis
d. none of the above.
21) The reflects the return that must be earned on the given project to compen-
sate the firm’s owners adequately according to the project’s variability of cash flows.
a. cost of capital
b. internal rate of return
c. risk-adjusted discount rate
d. average rate of return
22) The theoretical basis from which the concept of risk-adjusted discount rates is de-
rived is
a. simulation theory.
b. the Gordon model.
c. the capital asset pricing model.
d. the basic cost of money.
23) The approach is used to convert the net present value of unequal-lived proj-
ects into an equivalent annual amount (in net present value terms).
a. investment opportunities schedule
b. annualized net present value
c. internal rate of return
d. risk-adjusted discount rate
24) Major types of real options include all of the following except the
a. growth option.
b. conversion option.
c. timing option.
d. abandonment option.
25) The is the rate of return a firm must earn on its investments in projects in
order to maintain the market value of its stock.
a. cost of capital
b. internal rate of return
c. gross profit margin
d. net present value
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Multiple Choice Questions (Enter your answers on the enclosed answer sheet)
1) At the operating breakeven point, equals zero.
a. variable operating costs
b. sales revenue
c. earnings before interest and taxes
d. fixed operati ng costs
2) Breakeven analysis is used by the firm
a. to determine the level of operations necessary to cover all operating costs.
b. to evaluate the profitability associated with various levels of sales.
c. Both A and B.
d. none of the above
3) If a firm’s variable costs per unit increase, the firm’s operating breakeven point will
a. decrease.
b. remain unchanged.
c. change in an undetermined direction.
d. increase.
4) Noncash charges such as depreciation and amortization the firm’s breakev-
en point.
a. decrease
b. understate
c. overstate
d. do not affect
5) leverage is concerned with the relationship between sales revenues and
earnings before interest and taxes.
a. Total
b. Financial
c. Variable
d. Operating
6) The three basic types of leverage are
a. operating, production, and total.
b. operating, financial, and total.
c. production, financial, and total.
d. operating, production, and financial.
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7) is the potential use of fixed costs, both operating and financial, to magnify
the effect of changes in sales on the firm’s earnings per share.
a. Total leverage
b. Debt service
c. Operating leverage
d. Financial leverage
8) With the existence of fixed operating costs, an increase in sales will result in
___ increase in EBIT.
a. a less than proportional
b. a proportional
c. an equal
d. a more than proportional
9) All of the followi ng affect busi ness risk EXCEPT
a. cost stability.
b. interest rate stability.
c. revenue stability.
d. operati ng leverage.
10) A corporation has $5,000,000 of 10 percent bonds and $3,000,000 of 12 percent
preferred stock outstanding. The firm’s financial breakeven (assuming a 40 percent
tax rate) is
a. $860,000.
b. $716,000.
c. $1,400,000.
d. $1,100,000.
11) Operating and financial constraints placed on a corporation by loan provision are
a. agencyco~stothe lende~
b. interest rate costs to the firm.
c. necessary to control the risk of the firm.
d. agency costs to the firm.
12) In order to enhance the wealth of stockholders and to send positive signals to the
market, corporations generally raise funds using the following order:
a. Equity, retained earnings, debt.
b. Debt, retained earnings, equity.
c. Retained earnings, equity, debt.
d. Retained earnings, debt, equity.
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13) According to the traditional approach to capital structure, the value of the firm will be
maximized when
a. the financial leverage is maximized.
b. the weighted average cost of capital is minimized.
c. the cost of debt is minimized.
d. the dividend payout is maximized.
14) In the EBIT-EPS approach to capital structure, risk is represented by
a. shifts in the times-interest-earned ratio.
b. shifts in the cost of debt capital.
c. the slope of the capital structure line.
d. shifts in the cost of equity capital.
15) Nico Trading Company must choose its optimal capital structure. Currently, the firm
has a 20 percent debt ratio and the firm expects to generate a dividend next year of
$5.44 per share. Dividends are expected to remain at this level indefinitely. Stock-
holders currently require a 12.1 percent return on their investment. Nico is consider-
ing changing its capital structure if it would benefit shareholders. The firm estimates
that if it increases the debt ratio to 30 percent, it wi II increase its expected dividend
to $5.82 per share. Again, dividends are expected to remain at this new level indefi-
nitely. However, because of the added risk, the required return demanded by stock
holders will increase to 12.6 percent. Based on this information, should Nico make
the change?
a. Yes
b. No
c. It’s irrelevant
d. Not enough information
16) At the quarterly meeting of Tangshan Mining Corporation, held on September 10th,
the directors declared a $1.00 per share dividend for the firm’s 100,000 shares of
common stock outstanding. The net effect of declaring and paying this dividend
would be to
a. increase total assets by $100,000 and decrease stockholders equity by $100,000.
b. increase total assets by $100,000 and increase stockholders equity by $100,000.
c. decrease total assets by $100,000 and decrease stockholders equity by $100,000.
d. decrease total assets by $100,000 and increase stockholders equity by $100,000.
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17) Tangshan Mining has common stock at par of $200,000, paid in capital in excess
of par of $400,000, and retained earnings of $280,000. In states where the firm’s
legal capital is defined as the par value of common stock, the firm could payout
___ in cash dividends without impairing its capital.
a. $200,000
b. $880,000
c. $600,000
d. $680,000
18) Shareholder wealth considerations in the payment of dividends include all of the
following EXCEPT
a. the criminal status of the firm’s owners.
b. the tax status of the firm’s owners.
c. the investment opportunities of the firm’s owners.
d. the potential dilution of ownership on behalf of the firm’s owners.
19) Gordon’s “bird-in-the-hand” argument suggests that
a. shareholders are generally risk averse and attach less risk to current dividends.
b. dividends are irrelevant.
c. firms should have a 100 percent payout policy.
d. the market value of the firm is unaffected by dividend policy.
20) A firm that has a large percentage of investors may payout a lower percent-
age of its earnings as dividends.
a. wealthy
b. business
c. middle-income
d. pension fund
21) A firm has current after-tax earnings of $1,000,000 and has declared a cash dividend
of $400,000. The firm’s dividend payout ratio is
a. 4.0 percent.
b. 2.0 percent.
c. 2.5 percent.
d. 40 percent.
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22) The advantage of using the low-regular-and-extra dividend policy is that
a. cyclical shifts in earnings may be avoided.
b. the extra dividend may become a regular event.
c. the firm avoids giving the shareholders false hopes.
d. if the firm’s earnings drop, so does the dividend payment.
23) Mr. R. owns 20,000 shares of ABC Corporation stock. The company is planning to
issue a stock dividend. Before the dividend Mr. R. owned 10 percent of the outstand-
ing stock, which had a market value of $200,000, or $10 per share. Upon receiving
the 10 percent stock dividend the value of his shares is
a. $210,000.
b. $200,000.
c. $220,000.
d. greater, but cannot be determined.
24) The accounting in a stock split will transfer funds
a. from the Retained Earnings account to the Paid in Capital account.
b. from the Common Stock and Paid in Capital accounts to the Retained Earnings ac-
count.
c. from the Paid in Capital account to the Retained Earnings account.
d. from the Retained Earnings account to the Preferred Stock account.
e. none of the above
25) When purchasing outstanding shares of common stock a firm can utilize all of the fol-
lowing methods EXCEPT
a. a tender offer at a specified price.
b. a purchase on the open market at market prices.
c. a tender offer at varying prices.
d. by purchasing a large block on a negotiated basis.
