1) An efficient market is one where the prices of the assets traded in that market fully
reflect all available information at any instant in time.
2) A company with a AAA bond rating will command a higher interest rate on its bonds
than a company with a lesser BBB bond rating.
3) Total debt must always be equal to the sum of temporary, permanent, and
spontaneous sources of financing.
4) A closely-held company whose owners are trying to maintain control would be less
likely to pay dividends so that all earnings may be retained to finance future growth.
5) Sensitivity analysis involves changing one variable at a time.
6) If the cash flows of an accepted investment project are negatively correlated with the
average cash flow of the firm’s existing assets, then the company’s total exposure to risk
can decrease.
7) The investor’s required rate of return will equal the firm’s cost of capital if corporate
transactions costs are taken into account.
8) The hedging principle is used to address the issue of how much short-term financing
a firm should use.
9) The objective of managing cash inflows is to decrease the float while the objective of
managing cash outflows is to increase the float.
10) Other things equal, if a firm increases its dividend payout ratio, its discretionary
financing needed will also increase.
11) A short-term T-bill’s rate of return should be used in the CAPM formula to
determine the cost of equity capital regardless of the length of the project under
consideration.
12) Reducing the probability of bankruptcy is a benefit of diversification.
13) Over the relevant range of output, fixed costs remain unchanged.
14) Flotation costs cause a corporation’s cost of capital to be lower than its investors’
required returns.
15) When several sign reversals in the cash flow stream occur, a project can have more
than one IRR.
16) The “perfect storm” of factors that contributed to the economic crisis of 2007
include
A) increases in the minimum wage rate, unchecked illegal immigration, and state
government deficits
B) financial deregulation, unchecked commodity prices, floating currency exchange
rates
C) poorly chosen mortgage loans, falling housing prices, and a contracting economy
D) agency costs, inefficient markets, and perfect capital markets
17) The December 31, 2009 balance sheet shows net fixed assets of $150,000 and the
December 31, 2010 balance sheet shows net fixed assets of $250,000. Depreciation
expense for 2009 is $25,000 and depreciation expense for 2010 is $35,000. Based on
this information, the cost of fixed assets purchased during 2010 is
A) $100,000
B) $110,000
C) $135,000
D) $160,000
18) Bill, a local inventor, developed a diet pill that he believes will solve the obesity
problem in the United States. Bill wants to create a new company, 50% owned by Bill
and 50% owned by a major drug company. Although he believes the pills are safe, Bill
is concerned about liability if someone becomes sick or dies. The best form of business
organization for the new company is ________.
A) sole proprietorship with Bill as owner and the drug company as creditor
B) general partnership with Bill and the drug company as equal partners
C) S-type corporation with Bill and the drug company owning equal shares
D) limited liability company with Bill and the drug company owning equal shares
19) Salamander Insurance Company tries to settle claims as quickly as possible. In
certain cases, agents can present payments to claimants which are cleared through the
banking system like a check, but must be passed through the Insurance Company for
approved prior to payment. This is an example of a
A) zero balance account
B) payable-through draft
C) insurance float voucher
D) post-dated check
20) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A
costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two.
Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in
year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.’s required rate
of return for these projects is 10%. The equivalent annual annuity amount for project B,
rounded to the nearest dollar, is
A) $17,385
B) $20,936
C) $22,789
D) $26,551
21) Which of the following is a reason for international investment?
A) to reduce portfolio risk
B) to increase P/E ratio
C) to gain an advantage in a foreign country
D) to gain access to foreign currency
22) Which of the following statements about combined (operating & financial) leverage
is true?
A) If a firm employs both operating and financial leverage, any percent change in sales
will produce a larger percent change in earnings per share
B) A firm that is in a capital-intensive industry should use a higher level of financial
leverage than a firm that employs low levels of operating leverage
C) Usage of both operating and financial leverage reduces a firm’s risk
D) High operating leverage and high financial leverage offset one another, meaning that
if sales increase by 10%, then EPS will also increase by 10%
23) Biff deposited $9,000 in a bank account, and 10 years later he closes out the
account, which is worth $18,000. What annual rate of interest has he earned over the 10
years?
A) 6.45%
B) 7.18%
C) 9.10%
D) 10.0%
24) RBW Corp. has cash of $48,000; short-term notes payable of $35,000, accounts
receivable of $100,000; accounts payable of $120,000; inventories of $200,000; and
accruals of $90,000. What is RBW’s current ratio?
A) 1.57
B) 2.71
C) 1.42
D) 0.64
25) Waterford Industries is considering the purchase of a new machine. It will replace
an existing but obsolete machine that will be sold for $50,000. The existing machine is
8 years old, cost $200,000, had a 10-year useful life, and is being depreciated to zero
using the straight-line method. Waterford’s income tax rate is 35%. What is the after-tax
salvage value of the old machine?
A) $42,000
B) $46,500
C) $50,000
D) $53,500
26) Which of the following statements would be consistent with the bird-in-the-hand
dividend theory?
A) Investors are indifferent whether stock returns come from dividend income or capital
gains income
B) Dividends are more certain than capital gains income
C) Wealthy investors prefer corporations to defer dividend payments because capital
gains produce greater after-tax income
D) Dividends are less certain than capital gains
27) A textile manufacturer has cloth that has a $14 per yard carrying cost per year. This
cloth is used at a rate of 25,000 yards per year, and ordering costs are $10 per order.
a.What is the economic order quantity for this cloth?
b.What are the annual inventory costs for this firm if it orders in this quantity?
28) Use the “percent of sales method” of preparing pro forma financial statements to
determine the projection for next year’s cost of goods sold. Make the following
assumptions: current year’s sales are $27,800,000; current year’s cost of goods sold is
$17,528,000; sales are expected to rise by 30%. What is the projection for next year’s
cost of goods sold?
A) $20,481,000
B) $21,138,900
C) $21,459,200
D) $22,786,400
29) All of the following will improve a firm’s liquidity position EXCEPT
A) increase accounts receivable turnover
B) increase inventory turnover
C) increase the average collection period
D) increase long-term debt and invest the money in marketable securities
30) Based on the information in Table 4-2, the average collection period is
A) 70 days
B) 81 days
C) 89 days
D) 127 days
31) Which type of value is shown on the firm’s balance sheet?
A) book value
B) liquidation value
C) market value
D) intrinsic value
32) Which of the following sources of short-term financing is likely to have the highest
interest rate?
A) accounts receivable loan (pledging of accounts receivable)
B) line of credit
C) line of credit with a compensating balance
D) commercial paper
33) Which of the following would be considered the firm’s optimal capital structure?
A) Stock Price = $25, Earnings Per Share = $10, Cost of Equity Capital = 15%
B) Stock Price = $23, Earnings Per Share = $11, Cost of Equity Capital = 18%
C) Stock Price = $24, Earnings Per Share = $12, Cost of Equity Capital = 17%
D) Stock Price = $20, Earnings Per Share = $12, Cost of Equity Capital = 20%
34) ExxonMobil generates about $50 billion in cash annually from its operations and
invests about half of that on new exploration. Therefore, ExxonMobil is an example of
a(n)
A) savings surplus unit
B) savings deficit unit
C) investment banker
D) financial intermediary
35) A bakery company is considering one capital budgeting project involving the
replacement of a sophisticated brick oven, and another capital budgeting project
involving research and development into synthetic food substitutes. Which of the
following statements is MOST correct concerning the risk-adjusted discount rate(s) for
the projects?
A) The rate will likely be higher for the replacement project because the likelihood of
success is higher
B) The rate will likely be higher for the research and development project because of
the uncertainty involved with research and development projects
C) The rate should be the same for both projects because they are being considered by
one company with the same common shareholders
D) The rate should be higher for the replacement project because the company is more
certain of the returns from a project similar to their existing business
36) Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A
costs $95,000 and is expected to generate $65,000 in year one and $75,000 in year two.
Project B costs $120,000 and is expected to generate $64,000 in year one, $67,000 in
year two, $56,000 in year three, and $45,000 in year four. Lithium, Inc.’s required rate
of return for these projects is 10%. The equivalent annual annuity amount for project A
is
A) $12,989
B) $13,357
C) $15,024
D) $18,532
37) Which of the following differentiates the cost of retained earnings from the cost of
newly-issued common stock?
A) the cost of the pre-emptive rights held by existing shareholders
B) the greater marginal tax rate faced by the now-larger firm
C) the flotation costs incurred when issuing new securities
D) the larger dividends paid to the new common stockholders
38) Corporation A decides to borrow $1,000,000 and use the money to buy back
$1,000,000 of its common stock. The corporation pays 6% interest on its borrowed
funds which exactly equals the amount of the dividend it used to pay on the common
stock it repurchased. Therefore
A) Corporation A’s operating income will decrease due to higher interest expense
B) Corporation A’s net income will increase due to the tax deductibility of interest
expense
C) Corporation A will have no change in its operating income since the interest expense
exactly offsets the prior dividend payment
D) Corporation A’s gross profit will decrease
39) The spot exchange rate is 1.57 dollars per pound. The 30-day forward exchange rate
is .6211 pounds per dollar. Therefore, pounds in the forward market are selling at a
________ to the current spot rate.
A) .958 discount
B) .958 premium
C) .04 discount
D) .04 premium
40) Your firm is considering an investment that will cost $920,000 today. The
investment will produce cash flows of $450,000 in year 1, $270,000 in years 2 through
4, and $200,000 in year 5. The discount rate that your firm uses for projects of this type
is 11.25%. What is the investment’s internal rate of return?
A) 27.28%
B) 21.26%
C) 20.53%
D) 15.98%
41) Executive compensation in the United States
A) is dominated by performance-based compensation that ensures fair and just pay for
corporate executives
B) is dominated by performance-based compensation designed to reduce agency
problems
C) cannot be linked to stock prices as this would create a conflict of interest with
existing shareholders
D) is well below levels in Europe and Asia
42) If Cathy deposits $12,000 into a bank account that pays 6% interest compounded
quarterly, what will the account balance be in seven years?
A) 18,001
B) 18,207
C) 19,112
D) 19,344
43) The “percent of sales method” is a method of preparing pro forma financial
statements. All of the following would be examples of how the “percent of sales
method” is developed EXCEPT?
A) Forecast expenses by applying a percent of projected sales, using last year’s
expenses as a percent of last year’s sales
B) Forecast assets by applying a percent of projected sales, using current year’s assets as
a percent of current year’s sales
C) Approximate liabilities by applying a percent of projected sales, using the last
five-year average of liabilities as a percent of sales
D) Forecast retained earnings by applying a percent of projected sales, using current
year’s retained earnings as a percent of current year’s sales
44) To measure value, the concept of time value of money is used
A) to determine the interest rate paid on corporate debt
B) to bring the future benefits and costs of a project, measured by its expected profits,
back to the present
C) to bring the future benefits and costs of a project, measured by its cash flows, back
to the present
D) to ensure that expected future profits exceed current profits today
45) Ethical behavior
A) is the fifth basic principles of finance
B) cannot be a concern to managers who are expected to maximize shareholder value
C) in the corporate world means not breaking any laws
D) is essential in business because unethical behavior destroys trust and business
relationships
46) Which of the following statements is MOST correct?
A) Because the cost of debt is lower than the cost of equity, value-maximizing firms
maintain debt ratios of close to 100%
B) Corporations that are 100% equity financed will have a much lower weighted
average cost of capital because the lack of debt lowers their risk of bankruptcy
C) The source of capital with the lowest after-tax cost is preferred stock, because it is a
hybrid security, part debt and part equity
D) The cost of a particular source of capital is equal to the investor’s required rate of
return after adjusting for the effects of both flotation costs and corporate taxes
47) When comparing inventory turnover ratios, other things being equal
A) a lower inventory turnover is preferred in order to keep inventory costs low
B) a higher inventory turnover is preferred to improve liquidity
C) higher inventory turnover results from old or obsolete inventory increasing the
inventory balance on the balance sheet
D) higher inventory turnover results from an increase in the selling price of the product
48) According to the clientele effect
A) companies should have dividend payout ratios of either 100% or 0%
B) companies should avoid making capricious changes in their dividend policies
C) companies should change their dividend policies to please their target group of
investors
D) even if capital markets are perfect, dividend policy still matters