Sample Questions_Finance

1. What should be the primary goal of the financial manager of a corporation? Why?
The primary goal should be to maximize the current value of the outstanding stock. This goal
focuses on enhancing the returns to stockholders who are the owners of the firm.


Chapter 4


2. A times interest earned ratio of 5.0 indicates that the firm:
A. pays 5 times its earnings in interest expense.
B. earns significantly more than its interest obligations.
C. has interest expense equal to 5% of EBIT.
D. has low tax liability.


3. What are the annual sales for a firm with $400,000 in debt, a total debt ratio of .4, and an asset
turnover of 3.0?














4. When Tri-C Corp. compares its ratios to industry averages, it has a higher current ratio, an
average quick ratio, and a low inventory turnover. What might you assume about Tri-C?
A. Its cash balance is too low.
B. Its cost of goods sold is too low.
C. Its current liabilities are too low.
D. Its inventory is too high.


Chapter 5


5. How much interest is earned in the third year on a $1,000 deposit that earns 7% interest
compounded annually?

100 x (1.07)
2
= $1,144.90 after 2 years.
$1,144.90 x .07 = $80.14


6. How much will accumulate in an account with an initial deposit of $100, and which earns 10%
interest compounded quarterly for three years?

FV = PV (1 + r)
2

100 (1.025)
12
= 134.49


7. Given a set future value, which of the following will contribute to a lower present value?
A. Higher discount rate
B. Fewer time periods
C. Less frequent discounting
D. Lower discount factor


8. The salesperson offers, "Buy this new car for $25,000 cash or, with appropriate down payment,
pay $500 per month for 48 months at 8% interest." Assuming that the salesperson does not offer a
free lunch, calculate the "appropriate" down payment.




A difference of $4,520.64 exists between cash price and loan value. This should be the down
payment.


9. Your car loan requires payments of $200 per month for the first year and payments of $400 per
month during the second year. The annual interest rate is 12% and payments begin in one month.
What is the present value of this two-year loan?




10. What is the expected real rate of interest for an account that offers a 12% nominal rate of
return when the rate of inflation is 6% annually?

1 + real interest rate = (1 + nominal interest rate)/(1 + inflation)
1 + real interest rate = 1.12/1.06
real interest rate = 5.66%


11. What APR is being earned on a deposit of $5,000 made ten years ago today if the deposit is
worth $9,948.94 today? The deposit pays interest semi-annually.

















12. If the effective annual rate of interest is known to be 16.08% on a debt that has quarterly
payments, what is the annual percentage rate?

(1.1608)
.25
= 1 + quarterly rate
1.0380 - 1 = quarterly rate
.0380 = quarterly rate
.1519 = quarterly rate x 4, so APR=15.19%


13. Suppose you begin saving for your retirement by depositing $2,000 per year in a bank
account. If the interest rate is 7.5%, how much will you have in 40 years? How much can you
withdraw from your account each year during your retired life if the return on alternative
investments is 5% then and you assume that you are going to live forever?

FV = 2,000(1.075
40
1)/0.075 = 454,513.04
454,513.04 = C/r = C / 0.05 = 22,725.65








Chapter 6


14. What is the coupon rate for a bond with three years until maturity, a price of $1,053.46, and a
yield to maturity of 6%?













15. Which of the following factors will change when interest rates change?

A. The expected cash flows from a bond
B. The present value of a bond's payments
C. The coupon payment of a bond
D. The maturity value of a bond


16. When the yield curve is upward-sloping, then:

A. short-maturity bonds offer high coupon rates.
B. long-maturity bonds are priced above par value.
C. short-maturity bonds yield less than long-maturity bonds.
D. long-maturity bonds increase in price when interest rates increase.


17. Why are long-term bonds more sensitive to changes in interest rates than short-term bonds?

A long-term bond is more sensitive to changes in interest rates simply because there are more
coupon payments and longer time periods for each cash flow to be affected by the changed
interest rate. Remembering that bond prices are determined by the sum of a present value of an
annuity and the present value of a future amount, when those formulas experience different
discount rates for longer periods, there is substantially more effect.


18. Why do investors pay attention to bond ratings and demand a higher interest rate for bonds
with low ratings?

Investors demand higher promised yields if there is a high probability that the borrower will run
into trouble and default. Credit risk implies that the promised yield to maturity on the bond is
higher than the expected yield. The additional yield investors require for bearing credit risk is
called the default premium. Bond ratings measure the bond's credit risk.

Chapter 7


19. A stock paying $5 in annual dividends sells now for $80 and has an expected return of 14%.
What might investors expect to pay for the stock one year from now?











20. What constant growth rate in dividends is expected for a stock valued at $32.00 if next year's
dividend is forecast at $2.00 and the appropriate discount rate is 13%?




21. ABC common stock is expected to have extraordinary growth of 20% per year for two years,
at which time the growth rate will settle into a constant 6%. If the discount rate is 15% and the
most recent dividend was $2.50, what should be the current share price?












22. A company with a return on equity of 15% and a plowback ratio of 60% would expect a
constant growth rate of:

g = .15 x .60
= .09 = 9%


23. According to the constant dividend growth model, a stock price should equal the:

A. sum of all future dividends.
B. sum of dividends to be received within the investor's holding period.
C. dividend yield plus the constant growth rate.
D. sum of all discounted future dividends.


24. What should be the current price of a share of stock if a $5 dividend was just paid, the stock
has a required return of 20%, and a constant dividend growth rate of 6%?

P = $5(1.06)/(.20 - .06)
P = 5.30/.14
P = $37.86


25. If a stock's price decreased during the past week, what is the most likely prediction about this
week's price change?

A. Price will reverse last week's loss and go up.
B. Price will continue last week's decline.
C. Price will stand still until new information is released.
D. Either direction of price change is equally likely.


26. An analyst who relies on past stock prices to make investment decisions is:

A. performing fundamental analysis.
B. relying upon the strong-form of market efficiency.
C. assuming that the market is not weak-form efficient.
D. relying upon the random walk of stock prices.


27. If investors can consistently profit from thorough reading of published financial information,
then the market can, at best, be characterized as:

A. weak-form efficient.
B. semi-strong-form efficient.
C. strong-form efficient.
D. inefficient.


28. Which of the following observations provides evidence against strong-form market
efficiency?

A. Some mutual funds outperformed the market in 1997.
B. Managers trading in their own stock obtain superior returns.
C. You cannot make superior profits by trading stocks after earnings reports are issued.
D. Stock prices follow a random walk.

29. Technical and fundamental analysts help keep the market efficient by:

A. searching for patterns in past stock prices.
B. analyzing accounting data and business prospects.
C. trying to earn superior returns in the stock market.
D. trading actively in the market.


30. LookGood, Inc. has just announced the bad news that its earnings have dropped by 30
percent. In fact, its investors had anticipated even worse results (a decrease of 40 percent). As a
result, LookGood's stock price:

A. increases.
B. remains the same.
C. decreases.
D. follows a random walk as usual.


Chapter 8


31. A project can have as many different internal rates of return as it has:

A. cash inflows.
B. cash outflows.
C. periods of cash flow.
D. changes in the sign of the cash flows.


32. Firms that make investment decisions based upon the payback rule may be biased toward
rejecting projects:

A. with short lives.
B. with long lives.
C. with early cash inflows.
D. that have negative NPVs.


33. When projects are mutually exclusive, selection should be made according to the project with
the:

A. longer life.
B. larger initial size.
C. highest IRR.
D. highest NPV.





34. When hard capital rationing exists, projects may be accurately evaluated by use of:

A. payback period.
B. mutually exclusive IRRs.
C. a profitability index.
D. borrowing, rather than lending, projects.


35. If a project's IRR is 13% and the project provides annual cash flows of $15,000 for four years,
how much did the project cost?




36. A polisher costs $10,000 and will cost $20,000 a year to operate and maintain. If the discount
rate is 10 percent and the polisher will last for 5 years, what is the equivalent annual cost of the
tool?

PV of Costs = $10,000 + [$20,000 x annuity factor(10%, 5 years)] = $85,815.74
The equivalent annual cost is the payment with the same present value: $22,637.98
[n = 5, i = 10, FV = 0; PV = (-)85,815.74; compute payment C]


37. A currently used machine costs $10,000 annually to run. What is the maximum that should be
paid to replace the machine with one that will last three years and cost only $4,000 annually to
run? The opportunity cost of capital is 12%.



The $6,000 represents the annual savings in maintenance costs.


38. The use of NPV as an investment criterion is said to be more reliable than using IRR. Discuss
potential problems with the use of IRR.

i. If the project has initial cash inflows rather than the more traditional outflows (e.g., if it is a
borrowing rather than a lending project) then the decision rule is reversed. Projects should then be
selected if the IRR is less than the opportunity cost.

ii. The IRR does not necessarily provide a unique solution, nor is it guaranteed to provide any
solution. The common problem here is that an additional potential solution develops for each time
in which the sign of the cash flows changes more than once (the "once" is traditionally between
the initial cost and the first inflow).

iii. The magnitude of investment can lead to puzzling interpretations; for example, a high IRR
on a small project is not likely to be superior to a small but acceptable IRR on a large-scale
project.

iv. When projects are mutually exclusive it is easy to make incorrect selections unless the IRR
of the incremental cash flows is calculated and compared to the opportunity cost. This problem is
especially evident when the projects have differing lives.


39. Why doesn't the payback rule always make shareholders better off?

The net present value rule and the rate of return rule both properly reflect the time value of
money. But companies sometimes use rules of thumb to judge projects. One is the payback rule,
which states that a project is acceptable if you get your money back within a specified period. The
payback rule takes no account of any cash flows that arrive after the payback period and fails to
discount cash flows within the payback period.

40. Sometimes, comparing project NPVs properly can be surprisingly tricky. What are three
important, but often challenging decisions of such?

The investment timing decision. Should you buy a computer now or wait and think again next
year? (Here today's investment is competing with possible future investments.) : Choose between
these alternatives by comparing their NPVs today.

The choice between long- and short-lived equipment. Should the company save money today by
installing cheaper machinery that will not last as long? (Here today's decision would accelerate a
later investment in machine replacement.) : Should put them on an equal footing by comparing
the equivalent annual annuity or benefit of the two projects.

The replacement decision. When should existing machinery be replaced? (Using it another year
could delay investment in more modern equipment.) : Should compare the cost of operating the
old one with the equivalent annual annuity of the new one.