1. The biggest disadvantage of the sole proprietorship is _________________. A. Total control
B. Double taxation C. Unlimited liability D. Limited access to capital
2. All of the following are advantages to organizing as a corporation except ____. A. Limited liability B. Double taxation C. Easy access to capital D. Easy to transfer ownership
3. From the perspective of access to capital, the best form of business organization is the _______. A. Corporation B. Partnership C. S Corporation
D. Sole proprietorship
4. From the perspective of ownership risk, the best form of business organization is the ______. A. Partnership B. Corporation C. S Corporation
D. Sole proprietorship
5. From the perspective of control, the best form of business organization is the __________. A. Partnership B. Corporation C. S Corporation
D. Sole proprietorship
6. The overall goal of the financial manager is to _________________. A. Minimize total costs B. Maximize net income C. Maximize earnings per share D. Maximize shareholder wealth
7. All of the following are an example of a fiduciary relationship except: A. a CEO manages the firm B. a bank employee manages deposits C. a financial advisor advises her clients D. the shareholder elects a board member
8. Which of the following statements is correct? A. Accountants are focused on what happened in the past. B. Financial managers are focused on what happened in the past. C. Financial managers double-check the accountant’s statements.
D. Both accountants and financial managers use total quality management systems to standardize data.
9. Maximizing owners’ equity value means carefully considering all of the following except _______. A. Which projects to invest in B. How best to increase the firm’s risk C. How to best bring additional funds into the firm
D. How best to return the profits from those projects to the owners over time
10. The most common type of business in the United States is the __________. A. Corporation B. Partnership C. Sole Proprietorship D. Hybrid organization such as a limited liability company
11. Attempting to maximizing shareholder value can lead to A. less pollution worldwide. B. minimizing bondholders’ wealth.
C. disasters, like the BP oil spill in the Gulf. D. a long-term outlook by a firm’s managers.
12. Which of the following statements is correct? A. Shareholder wealth maximization is achieved by minimizing costs or maximizing net profit. B. Shareholder wealth maximization may actually be beneficial for society in the long-run. C. Shareholder wealth maximization is achieved by maximizing market share. D. All of these statements are correct.
13. Unethical behavior by an organization may be from all of the following except; A. Agency costs between stockholders and the public B. poor personal ethics C. a low risk of getting caught D. A focus on long-term success.
14. An employee stock option plan is ________________. A. A plan that only partnerships can use to defer compensation to partners B. A perk usually only given to the board of directors as compensation C. A way to align the interests of employees with those of the owners D. None of these answers are correct
15. A legal duty between two parties where one party must act in the interest of the other party is known as a(n) ______________. A. Fiduciary B. Venture capitalist C. Restricted investor
D. Restricted capitalist
16. Restricted stock is: A. a special type of stock that is not transferable from the current holder to others until specific conditions are satisfied. B. a special type of stock that can be converted into corporate bonds after a specific amount of time has elapsed. C. a special type of stock that is a result of offering an employee stock ownership plan. D. None of these answers is correct.
17. All of the following are functions of the board of directors except ________. A. Hire the CEO B. Evaluate the CEO C. Provide reports to the auditors
D. Design compensation contracts for the CEO
18. The agency relationship in corporate finance refers to _______________________. A. when the corporate hires an advertising agency to market their new product/service B. when the shareholders hire a manager to run their company C. when the board of directors are elected to staggered terms D. when the board of directors oversee the CEO
19. The role of a credit analyst is to ______________. A. help firms access capital markets B. examine a firm’s financial strength for its debt holders C. monitor the business activities and report to the Securities Exchange Commission
D. follow a firm and conduct their own evaluations of the company’s business activities
20. All of the following are cash flows from financing activities except a(n) _________. A. Increase in accounts payable B. Stock Repurchases C. Paying dividends
D. Issuing stock
21. Cash flows available to pay the firm’s stockholders and debt holders after the firm has made the necessary working capital investments, fixed asset investments, and developed the necessary new products to sustain the firm’s ongoing operations is referred to as _________________. A. Net operating working capital B. Operating cash flow C. Free cash flow D. None of the above
22. All of the following are reasons that one should be cautious in interpreting financial statements except ____________. A. Firms can take steps to over- or understate earnings at various times. B. It is difficult to compare two firms that use different depreciation methods. C. Financial managers have quite a bit of latitude in using accounting rules to manage their reported earnings.
D. All of the above are reasons to be cautious in interpreting financial statements.
23. All of the following are cash flows from investing activities except a(n)___________. A. Increases in fixed assets B. Decreases in fixed assets C. Increases in marketable securities D. All of these items are cash flows from investing.
24. Which of the following is incorrect with respect to the Sarbanes-Oxley Act? A. The act requires public and private firms to ensure that their boards’ audit committees have considerable experience in applying generally accepted accounting principles for financial statements. B. The act requires that the firm’s senior management sign off on the financial statements certifying the statements as accurate and representative of the firm’s financial condition. C. This act was passed as result of extreme earnings management. D. All of these statements are correct.
25. A firm currently uses straight-line depreciation but is considering changing to MACRS. If the firm implements the change, which of the following will occur as a result of this change? A. The firm’s taxable income will increase. B. The firm will pay more in taxes. C. The firm’s EBIT will increase. D. None of the above.
26. The following are reasons that firms report ‘accounting’ income, except: A. accounting income is less erratic than cash flow B. Accounting income is a proxy for economic income. C. Accounting income reduces taxes that must be paid.
D. accounting income assumes the firm is a ‘going concern’.
27. The board of directors _____________. A. are hired by the CEO B. are elected by shareholders C. have unlimited liability since they oversee the day-to-day operations of the firm D. are employed by the Securities Exchange Commission to ensure its rules and regulations have been met
28. Which of the following is not a reason to report accounting profit in addition to cash flow? A. Accounting profit has less dramatic swings
B. Accounting profit reflects the idea of a ‘going concern
C. Accounting profit is a better proxy for economic profit D. Accounting profit takes into account the time value of money E. Accounting profit requires firm’s to record transactions with no cash flow
29. Is it possible for a firm to have positive net income and yet it has cash flow problems? A. Yes, this can occur when a firm is growing very rapidly. B. No, this is impossible since net income increases the firm’s cash. C. No, this is impossible since net income and cash are highly correlated.
D. Yes, this is possible if the firm window-dressed its financial statements.
30. Choose the phrase that makes this statement true: Ratio analysis A. can provide useful information on a firm’s past but not current position. B. can provide useful information on a firm’s current position and hint at future performance. C. can provide useful information on a firm’s current position but should never be used to forecast future performance. D. can provide useful information on a firm’s past and current position, but should never be used to forecast future performance.
31. Which of the following is not true about ratio analysis? A. Ratio analysis tells us what we need to do to make the firm better. B. Ratio analysis may be done across firms or through time. C. Ratio analysis may require us to consider interrelationships between ratios. D. Ratio analysis can be used to compare small and large firms.
32. Which of the following statements is correct? A. In general, a firm should strive for a high average payment period because it wants to pay for its purchases as quickly as possible. B. If a firm has a very high fixed asset turnover, it means that the firm may be nearing its maximum production capacity. C. An extremely low average collection period will maximize net income. D. All of the statements above are correct.
33. Common-size financial statements: A. Are obtained by dividing all income statement accounts by net sales and all balance sheet accounts by total assets. B. Allow for an easy comparison of balance sheets and income statements across firms in the industry. C. Provide quantitative clues about the direction that the firm is moving. D. All of the above.
34. The main two sources of the time value of money are:
A. Interest Rates and Risk, B. Inflation and Interest Rates, C. Risk and timing of Consumption.
D. Inflation and timing of Consumption, 35. Which of the following will decrease a present value? A. Increasing the future value. B. Decreasing the interest rate. C. Decreasing the number of periods. D. None of the above will decrease a present value.
36. Compounding is _______. A. the process of adding interest earned every period on both the original investment and the reinvested earnings B. the process of adding interest earned every period on both the original investment and additional deposits C. the process of using time-value equations to compute the number of years
D. the process of finding a present value
37. Which of the following will increase the present value of an annuity? A. The discount rate increases. B. The discount rate decreases. C. The number of periods the annuity is received increases. D. Statements B and C are correct.
38. When there is deflation (falling prices), with the real interest rate held constant, the present value of a future cash flow will A. be higher than when there is inflation. B. be lower than when there is inflation. C. be the same as when there is inflation. D. will be higher than the future value.
39. In theory, a perpetuity’s value will be infinite A. always, B. if the interest rate is zero,
C. if the interest rate is 100%, D. when payments go on forever.
40. You just bought a new home and have a 30-year mortgage with monthly payments. Which statement regarding your mortgage is correct? A. The dollar amount of interest expense you pay each year will remain the same each year. B. The dollar amount of principal paid increases each month. C. Your monthly payments will decrease over time. D. All of these statements are correct.
41. Which of the following statements is incorrect? A. A negative free cash flow means that the firm’s operations are not producing any cash flows for investors and always indicates that the firm is mismanaged. B. A positive free cash flow means that the firm’s operations are producing cash flows for investors—both bondholders and shareholders. C. Free cash flows are the cash flows available to investors after the firm has made the necessary investments in the firm’s operations. D. All of these statements are correct.
42. Which of the following statements is correct? A. The use of debt in the capital structure results in tax benefits to the firm. B. Debt is referred to as “financial leverage” because it magnifies returns to shareholders. C. Debt management ratios evaluate whether a firm is financing its assets with a reasonable amount of debt versus equity financing. D. All of these statements are correct.
43. Which of the following is NOT a factor that the sustainable growth rate is dependent upon? A. Current ratio
B. Profit margin C. Total asset turnover D. Average payment period
44. All the following are cautions managers and investors should consider when evaluating a firm using ratio analysis EXCEPT: A. The financial statement is historical and may not reflect future performance. B. Firms often window-dress their financial statements. C. Firms use different accounting procedures.
D. Many firms operate in only one industry.
45. Which of the following statements is correct? A. Performing cross-sectional analysis is easy since industries are usually clustered with firms that are identical. B. Time-series analysis is useless in assessing improvement or deterioration of ratios since the data is historical. C. Performing cross-sectional ratio analysis refers to assessing how a firm performed over a certain section of time. D. To interpret financial ratios, users should analyze the performance of the firm over time and the performance of the firm against one or more companies in the same industry.
46. A strong liquidity position means that ______________. A. the firm pays out a large portion of its net income in the form of dividends B. the firm is able to meet its short-term obligations C. the firm uses little debt in its capital structure D. the firm pays its creditors on-time
47. A firm has an average collection period of 13 days. The industry average ACP is 27 days. Which of the following statements is true given this information? A. The firm could probably increase its sales by relaxing its strict accounts receivable policy. B. The firm is maximizing its net income by minimizing its losses in accounts receivable. C. The firm has an excellent accounts receivable policy. D. Both statements b and c are correct.
48. Which of the following activities will increase a firm’s current ratio? A. Purchase inventory using cash. B. Accrued wages and taxes increase. C. Accounts receivable are paid in cash. D. Buy equipment with a short-term bank loan. E. None of these statements will increase a firm’s current ratio.
49. A firm may not want to strive to match industry average ratios when:
A. Firms in the industry are shifting into different directions.
B. Many of the competitor firms are foreign.
C. They are a leader in the industry.
D. All of the above.
50. Which of the following will increase a firm’s quick ratio assuming no other accounts change? A. An increase in inventory. B. A reduction in accounts payable. C. An increase in accounts receivable. D. All of these statements will increase a firm’s quick ratio.
51. Which of the following bonds will have the largest percentage increase in value if interest rates decrease by 1%? A. 30-year, 10% coupon bond B. 2-year, 5% coupon bond C. 10-year, zero coupon D. 30-year, zero coupon
52. If a bond is selling at a discount, which of the following statements is correct? A. The coupon rate must be greater than the yield to maturity. B. The current yield must be greater than the coupon rate. C. The bond must have a low bond rating. D. All of the statements are correct.
53. Which statement is true? A. Extremely high levels of liquidity guard against liquidity crises, but at the cost of lower returns on assets
B. The less liquid assets a firm holds, the less likely it is that the firm will experience financial distress. C. The lower the liquidity ratios, the less liquidity risk a firm has. D. Liquid assets generate profits for the firm.
54. Under what conditions is a bond likely to be called? A. The firm is in financial duress. B. The firm wants to increase its debt ratio.
C. Interest rates have significantly declined. D. The firm is planning a massive expansion and needs to raise a lot of capital.
55. Which of the following statements is correct? A. Long-term bonds have more reinvestment rate risk than short-term bonds. B. Long-term bonds have more interest rate risk than short-term bonds. C. Short-term bonds with high coupons have high interest rate risk. D. A zero coupon bonds do not have interest rate risk.
56. Under which conditions will an investor demand a larger return (yield) on a bond? A. The bond issue is upgraded from A to AA. B. The bond issue is downgraded from A to BBB. C. Interest rates decrease due to decline in inflation. D. None of these conditions will cause an increase in the bond’s yield.
57. Laura is considering two investments: Stock A and B. Both stocks have a P/E ratio of 19. Stock A has an expected growth rate of 5% and stock B has an expected growth rate of 13%. Which is the better stock to invest in and why? A. Stock A is better because it is expected to grow at a slower rate and therefore will be less risky than Stock B. B. Since the P/E ratios are the same, Laura would be indifferent between the two stocks. C. Stock B is better because it is considered to be cheaper than Stock A. D. None of these statements is correct.
58. Which of the following is an electronic stock market without a physical trading floor? A. Mercantile Exchange B. Nasdaq Stock Market C. American Stock Exchange
D. New York Stock Exchange 59. To list a stock on the NYSE, a company must meet minimum requirements that include all of the following except ____________________. A. Firm size B. P/E Ratio C. Level of trading volume D. Total number of stockholders
60. Which of the following indices best reflects the ten sectors of the economy? A. Dow Jones Industrial Average B. Standard & Poor’s 500 C. Nasdaq Composite D. None of the above
61. Which of the following is incorrect with respect to preferred stock? A. Preferred stock is largely owned by other companies rather than individual investors. B. Preferred stock takes preference over common stock in bankruptcy proceedings. C. Preferred stock dividends do not grow. D. None of these statements is incorrect.
62. Which of the following statements is incorrect? A. Trading at the New York Stock Exchange and the American Stock Exchange are done by open outcry. B. The Dow Jones Industrial Average includes 35 of the largest companies in the U.S. C. Dealers create market liquidity in the Nasdaq’s electronic market. D. The Nasdaq contains many very large technology firms.
63. Which of the following statements is incorrect? A. Preferred stockholders have higher precedence for payment in the event of firm liquidation from bankruptcy. B. Preferred stock prices fluctuate with market interest rates and behave like corporate bond prices. C. Common stock price changes with the value of the company’s underlying business. D. None of these statements is incorrect.
64. Sally has researched GLE and wants to pay no more than $50 for the stock. Currently, GLE is trading in the market for $54. Sally would be best served to: A. use the bid-ask spread to her advantage. B. buy using a market order. C. buy using a limit order. D. None of the above.
BFIN3321 MIDTERM ANSWER KEY FALL 2013 PROBLEMS
1. (5 points) ACA Computer Systems’s balance sheet lists net fixed asset as $32 million. The fixed assets could currently be sold for $28 million. ACA’s current balance sheet shows current liabilities of $12 million and net working capital of $8 million. If all the current accounts were liquidated today, the company would receive $6 million cash after paying $12 million in liabilities. What is the book value of ACA’s assets today? What is the market value of these assets?
2. (2 points) Last year a firm had an ROA of 8% and a dividend payout ratio of 40%. What is the internal growth rate?
3. (2 points) Last year a firm had an ROE of 11% and a dividend payout ratio of 80%. What is the sustainable growth rate?
4. (3 points) What is the future value in 4 years of $1,000 deposited today, earning a 5% interest rate annually?
5. (2 points) What is the present value of a $1,000 payment received in two years with a discount rate of 6%?
6. (2 points) Approximately, how many years does it take to double a $5,000 investment when interest rates are 6% per year?
7. (3 points) A stock investor deposited $300 five years ago in a non dividend paying stock. Today the account is valued at $529. What annual rate of return has this investor earned?
8. (4 points) A friend wants to retire in 35 years when he is 60. At age 25, he can invest $100/month that earns 6% each year. But he is thinking of waiting ten years, and then investing $200/month to catch up, earning the same 6% per year. He feels that by investing twice as much for 25 years instead of 35 years he will have more. What is the future value of each of these options at age 60, and under which scenario would he accumulate more money?
9. (2 points) Compute the present value of a onetime payment of $1,000 paid in four years using the following discount rates: 4% in year 1, 5% in year 2, 4% in year 3, and 2.5% in year 4.
10. (4 points) You invested $200 in the stock market one year ago. Today, the investment is valued at $170.
What return did you earn?
What return must you earn next year for your investment to reach the original $500?
11. (2 points) Fred’s Furniture is advertising a deal, in which you buy a living room set for $3,526 (including tax) with two years before you need to pay (no interest is incurred if you pay by the end of the two years). How much would you need to deposit each month in a savings account earning 2.0% APR, compounded monthly, to be able to pay the $3,526 bill in two years?
12. (5 points) You purchase a house for $250,000 by getting a mortgage for $200,000 and paying a $50,000 down payment (20%). If you get a 15-year mortgage with a 3.5% interest rate, what would the loan balance be in 5 years?
13. (2 points) If the present value of an ordinary, 20 year annuity is $5,000 and interest rates are 4%, what is the present value of the same annuity due?
14. (3 points) A credit card is offered with monthly payments and a 21.99% APR. What is the loan’s effective annual rate (EAR)?
15. (4 points) Calculate the price of a 8%, $1,000 coupon bond with 15 years left to maturity and a market interest rate of 5%. (Assume interest payments are semiannual.) Is this a discount or premium bond?
16. (2 points) On August 27, 2013, the Dow Jones Industrial Average closed at $14,776.13, which was down from $14,946.46 the day before. What was the return (in percent) of the stock market that day?
17. (3 points) Financial analysts forecast MNO Inc.’s growth for the future to be 5%. MNO’s recent annual dividend was $4.00. What is the value of MNO stock when the required return is 8%?