EXERCISES ON CHAPTER ONE: OVERVIEW OF FINANCIAL MANAGEMENT

1. Which one of the following is not true?

A. Profit maximization decision rule doesn’t considers the time value of money
B. Wealth maximization focuses on cash flow instead of accounting income
C. Wealth maximization is all about maximizing of the value of a firm
D. Profit maximization is the better (ideal) approach for a firm
E. None of the above
2. All of the following could be the Goal of a Business Firm, except:
A. Avoiding financial distress and bankruptcy,
B. Beating competition,
C. Maximizing market share,
D. All of the above,
E. None of the above.
3. Which of the following statements best represents the "Agency Problem"?
A. Managers might attempt to benefit themselves in terms of salary and perquisites at
the expense of shareholders
B. The agency problem results from the separation of management and the
ownership of the firm
C. The agency problem may interfere with the implementation of maximizing
shareholder wealth
D. All of the above
E. None of the above
4. The major functions of financial management are
A. Investment decisions C. Dividend decisions
B. Financing decisions D. All the above
EXERCISES ON CHAPTER TWO: FINANCIAL STATEMENT ANALYSIS

5. Which of the following would NOT improve the current ratio?

A. Borrow short term to finance additional fixed assets.
B. Issue long-term debt to buy inventory.
C. Sell common stock to reduce current liabilities.
D. Sell fixed assets to reduce accounts payable.
E. None of the above
6. Addis Abeba Industries has a debt-to-equity ratio of 1.6 compared with the industry average
of 1.4. This means that the company
A. Will not experience any difficulty with its creditors.
B. Has less liquidity than other firms in the industry.
C. Will be viewed as having high creditworthiness
D. Has greater than average financial risk when compared to other firms in its
industry.
E. None of the above
 FINANCIAL MANAGEMENT I EXERCISES
7. Alula Company had sales last year of $265 million, including cash sales of $25 million. If its
average collection period was 36 days, its ending accounts receivable balance is closest to .
(Assume a 365-day year.)
A. Br.26.1 million D. Br.18.7 million
B. Br.23.7 million E. None of above
C. Br.7.4 million
8. A company can improve (lower) its debt-to-total assets ratio by doing which of the following?
A. Borrow more.
B. Shift short-term to long-term debt.
C. Shift long-term to short-term debt.
D. Sell common stock.
E. None of the above
9. Which of the following statements (in general) is correct?
A. A low receivables turnover is desirable.
B. The lower the total debt-to-equity ratio, the lower the financial risk for a firm.
C. An increase in net profit margin with no change in sales or assets means a poor
ROI.
D. The higher the tax rate for a firm, the lower the interest coverage ratio.
E. None of the above

10. The gross profit margin is unchanged, but the net profit margin declined over the same period.
This could have happened if
A. Cost of goods sold increased relative to sales.
B. Sales increased relative to expenses.
C. The Ethiopian Government increased the tax rate.
D. Dividends were decreased.
E. None of the above

11. Mekdela has 100,000 shares outstanding. EBIT is Br.1 million and interest paid is Br.400,000.
If the corporate tax rate is 40%, what is Mekdela’s earnings per share? Assume that dividend
paid to preferred stockholders is Br.100,000
A. Br.10.00 C. Br.2.60 E. None of the
B. Br.3.40 D. Br.5.28 above
12. A firm with net income of Br.500,000 pays 48% of net income out in dividends. If the firm has
150,000 shares of common stock outstanding, what is the dividend paid per share of stock?
A. Br.1.60 C. Br.0.30 E. Br.1.73
B. Br.1.44 D. Br.3.33
13. A firm has a time interest earned ratio of 4 and interest of Br.400.What is the operating profit
margin if its gross profit and cost of goods sold ratio are Br.600 and 75% respectively.
A. 0.67 C. 0.75 E. None of the
B. 0.25 D. 0.375 above
 FINANCIAL MANAGEMENT I EXERCISES

14. Which one of the following is the limitation of ratio analysis?

A. Inflation may distort ratios
B. Ratios do not enhance the usefulness of financial information
C. Ratios are very complex to be calculated
D. Ratios focus on cash flows
E. None of the above
15. A company has current liabilities of Br.400,000 and its current ratio is 2.5. If this firm’s quick
ratio is 2, how much inventory does it have?
A. Br.200,000 D. Br.500,000
B. Br.800,000 E. None of the above
C. Br.1,000,000
16. A company has $ 200 billion of sales and $10 billion of net income. Its assets are $100 billion,
financed half by debit and half by common equity. What is its net profit margin? What is its
ROE? (Respectively)
A. 20%, 29% C. 20%, 30%
B. 20%, 5% D. 8%, 15% E. None
17. ____________ are designed to determine a firm's long-run ability to meet its obligations.
A. Liquidity ratios D. Financial leverage ratios
B. Asset-utilization ratios E. Market value ratios
C. Profitability ratios
18. ABAY Incorporated has Br.5 million worth of total assets, and its tax rate is 20%. The firm, to
finance investments in assets, took out a loan amounting Br.4, 000,000 (currently interest on
such loans is 10% per year). Calculate the time interest earned ratio assuming that the firm’s
ROA is 5%.
E. 1.78 F. 2.78 G. 0.56 H. None
19. Tekeze Company has Br.1, 312,500 in current assets and Br.525, 000 in current liabilities. Its
initial inventory level is Br.375, 000, and it will raise funds as additional notes payable and use
them to increase inventory. How much can its short-term debt (notes payable) increase without
pushing its current ratio below 2.0?
A. Br 525,000 B. Br 262,500 C. Br 131,250 D. None

EXERCISES ON CHAPTER THREE: TIME VALUE OF MONEY

20. Suppose you deposit Br.200, 000 in account today that pay 6% interest, compounded annually. How
long does it takes the balance in your account is Br. 1,000,000?
21. How much will be in account at the end of the fifth year, if the amount deposited today is Br.30, 000
and interest is 8% per year, compounded semi-annually?
22. Suppose you want to have Br.600, 000 saved by the time you reach the age of 30 and suppose that you
are now 20 years old today. If you can earn 5% on your fund, how much would you have to invest
today to reach your goal.
 FINANCIAL MANAGEMENT I EXERCISES

23. Imagine that you are trying to evaluate the economics of purchasing an automobile. Assume that you
expect the car to provide annual after tax cash benefits of $1200 and that you can sell the car for after
tax proceeds of $5000 at the end of the planned five year ownership period. All funds for purchasing the
car will be drawn from your savings, which are currently earning 6% after taxes. What is the maximum
price you would be willing to pay to acquire the car?
24. If you need to have a balance of Birr 80,000 nine years from now; how much should you deposited today
in an account paying 8% per annum compounded quarterly:
A. ETB 3,921 C. ETB 39,218
B. ETB 6,400 D. ETB 8,000
25. Interest paid (earned) on both the original principal borrowed (lent) and previous interest earned is often
referred to as:
A. Present value C. Future value
B. Simple interest D. Compound interest
26. Assume you have $1,000 invested at 10 percent in Awash bank and the same amount was invested in
Dashen bank that pays 5 percent interest. After 10 years; the investment will be ___________and
__________respectively.
A. $2,594 and $1,629. C. $1,594 and $ 629.
B. $1,629 and $2,594 D. $ 629 and $1,594
27. Tuba co. plans to deposit Br 1,000 at the end of each of the next 10 years in a bank account that pays
12% interest compounded quarterly. Calculate the balance of the account at the end of year 10? (To the
nearest whole number)
A. Br 23,117 B. Br 75,401 C. Br 3,262 D. Br 307
28. Assume you have borrowed $2.470 and must repay $4,000 in exactly 8 years from today. Interest is
compounded annually. What is the interest rate of the loan?
A. 5.6% B. 4.6% C. 6.8% D. 6.2%
29. If you can buy a security with a 12% interest rate at price of $2,000 today, how long will it take for your
investment to return $10, 000?
A. 14.2 years C. 12 years
B. 10.2 years D. 11 years
30. What is the present value of a Br1000 ordinary annuity that earns 8% annually for an infinite number of
periods?
A. Br 80 B. Br 800 C. Br 1,000 D. Br 12,500
31. Which one of the following specific cost of capital needs tax adjustment?
A. Cost of capital of debt
B. Cost of capital of preferred stock
C. Cost of capital of common stock
D. Cost of capital of retained earning
32. If you need to have a balance of Birr 80,000 nine years from now; how much should you deposited today
in an account paying 8% per annum compounded quarterly:(To the nearest whole number)
A. Br 3,921 C. Br 39,218
B. Br 6,400 D. Br 8,000
33. On Jan. 1, 2005 Abay co. Purchased equipment promising to pay Br 1,000 at the end of each of the next
8 years. Determine the real cost (present value) of the equipment, if the interest rate is 10% compounded
annually? (To the nearest whole number)
A. Br 467 B. Br 11, 436 C. Br 5,335 D. Br 2,144

EXERCISES ON CHAPTER FOUR: RISK AND RETURN

34. You have Br.35, 000 to invest in a stock portfolio. Your choices are Stock X with expected
returns of 15% and Stock Y with an expected return of 8%. If your goal is to create a portfolio
with an expected return of 12%, how much money will you invest in Stock X and in Stock Y,
respectively?
A. Br.20,000 and Br.15,000
B. Br.17,000 and Br. 18,000
C. Br.18,000 and Br. 17,000
D. Br.21,000 and Br. 14,000

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 FINANCIAL MANAGEMENT I EXERCISES

35. Which one of the following is incorrect?

A. If there were no market risk (beta = 0.0) on an asset, its expected return would be the
expected return on the risk-free asset.
B. The greater the β, the greater the expected return.
C. If the asset’s risk is similar to the risk of the market as a whole (beta =1.0), that asset’s
expected return is the return on the market portfolio.
D. If investors hold well-diversified portfolios, the only risk they have is diversifiable risk.
E. None
36. Which one of the following statements is incorrect?
A. The reward for bearing risk depends only on systematic risk.
B. Risk premium is based on a theory that investors are risk averse that is they expect an
average to be compensated for the risk that they assume when making investment
C. As a result of diversification, the standard deviation of a portfolio typically greater than
the standard deviation of each of the individual investment.
D. Principles of Diversification states that, spreading an investment across a number of
assets will eliminate some, but not all, of the risks.
E. Beta (B) greater than one implies that: The asset has the high systematic risk as overall
market.
37. Suppose you observe the following situation:
Security Beta Expected Return
X 1.5 20%
Y 2 25
What would the risk-free rate have to be if they are correctly priced?
A. 15% C. 5%
B. 7.5% D. 2.5%
38. Suppose the expected return of the company was 11.6 percent, the average inflation rate over
this period was 3.5 percent and the average T-bill rate over the period (180 days) was 4.2
percent. What was the average real return and risk premium, respectively?
A. 7% and 7.4% C. 7% and 0.74%
B. 0.7% and 0.74% D. 0.7% and 7.4%
39. A stock market analyst is able to identify mispriced stocks by comparing the average price for
the last 10 days to the average price for the last 60 days. What form of efficient market
hypothesis is this?
A. Weak form Efficient Market Hypothesis
B. Strong form Efficient Market Hypothesis
C. Semi - Strong form Efficient Market Hypothesis
D. All of the above
40. Securities A, B, and C have betas of 1.2, 1.3, and 1.7 respectively. What is the beta of an
equally weighted portfolio of all three?

A. 1.15 C. 1.4
B. 1.55 D. 1.60
41. Using Capital Asset Pricing Model, the expected return of Asset A is 13% and the beta of Asset
A is 1.5.If the expected return on the market is 10%, the market risk premium would be:

A. 2% C. 5%
B. 4% D. 6%

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FINANCIAL MANAGEMENT I EXERCISES