FINAL BASIC OF FINANCIAL

A. MCQs

1. Which one of the following is defined as a firm's short-term assets and its short-term liabilities?
A. Working capital (vốn lưu động)
B. Debt (nợ)
C. Investment capital (vốn đầu tư)
D. Net capital (vốn ròng)
E. Capital structure (cơ cấu vốn)

2. Which one of the following is an agency cost?

A. Accepting an investment opportunity that will add value to the firm
B. Increasing the quarter dividend
C. Investing in a new project that creates firm value
D. Hiring outside accountants to audit the company's financial statements.
E. Closing a division of the firm that is operating at a loss

3. Shareholders' equity
A. Increases in value anytime total assets increases
B. Is equal to total assets plus total liabilities
C. Decreases whenever new shares of stock are issued
D. Includes long-term debt, preferred stock, and common stock
E. Represents the residual value of the firm.

4. Interest earned on both the initial principal and the interest reinvested from prior periods is called:
A. Free interest
B. Dual interest
C. Simple interest
D. Interest on interest
E. Compound interest

5. All else constant, a bond will sell at...... when the coupon rate is the yield to maturity
A. A premium...less than
B. A premium...equal to
C. A discount...less than
D. A discount...higher than
E. Par...less than

6. The current yield is defined as the annual interest on a bond divided by which one of the following?
A. Coupon
B. Face value
C. Market price
D. Call price
E. Dirty price

7. Which one of the following statements is correct?

A. The capital gains yield is the annual rate of change in a stock's price
B. Preferred stocks have constant growth dividends
C. A constant dividend stock cannot be valued using the dividend growth model
D. The dividend growth model can be used to compute the current value of any stock.
E. An increase in the required return will decrease the capital gains yield.

8. The present value of an investment's future cash flows divided by the initial cost of the investment is called
A. Net present value
B. Internal rate of return
C. Average accounting return
D. Profitability index
E. Profile period

9. Which one of the following will decrease the net present value of a project?
A. Increasing the value of each of the project's discounted cash inlows
B. Moving each of the cash inflows forward to a sooner time period
C. Decreasing the required discount rate
D. Increasing the projects initial cost at time zero
E. Increasing the amount of the final cash flow
10. If a project has a net present value equal to zero, then:
A. The total of the cash inflows must equal the initial cost of the project
B. the project earns a return exactly equal to the discount rate
C. a decrease in the proiecéc initial cost will cause the project to have a negative NPV.
D. Any delay in receiving the projected cash inflows will cause the project to have a positive NPV
E. The project's PI must be also be equal to zero

11. Why is payback often used as the sole method of analyzing a proposed small project?
A. Payback considers the time value of money
B. All relevant cash flows are included in the payback analysis
C. It is only method where the benefits of the analysis outweigh the costs of that analysis
D. Payback is the most desirable of the various financial methods of analysis
E. Payback is focused on the long-term impact of a project

12. Which two methods of project analysis were the most widely used by CEO's as of 1999?
A. Net present value and payback.
B. Internal rate of return and payback
C. Net present clause and average accounting return
D. Internal rate of return and net present value

13. Textile Mills borrows money at a rate of 13.5 percent. This interest rate is referred to as the:
A. Compound rate.
B. Current yield.
C. Cost of debt.
D. Capital gains yield.
E. Cost of capital.

14. A firm's overall cost of equity is:

A. is generally less than the firm's WACC given a leveraged firm.
B. unaffected by changes in the market risk premium.
C. highly dependent upon the growth rate and risk level of the firm.
D. generally less than the firm's after tax cost of debt.
E. inversely related to changes in the firm's tax rate.
15. Lester's Frozen Foods just paid out $0.50 a share to its shareholders. The cash for these payments came from
a large sale of assets, not from any earnings of the firm.
What are these payments to shareholders called?
A. Dividends
B. Distributions
C. Repurchases
D. Payment-in-kind
E. Stock splits

16. An investor is more likely to prefer a high dividend payout if a firm:

A. has high flotation costs.
B. has few, if any, positive net present value projects.
C. has lower tax rates than the investor.
D. has stock price that is increasing rapidly.
E. offers substantial gains on its equities, which are taxed at a favorable rate.

17. Which one of the following terms is defined as the management of a firm's long-term investments?
A. working capital management
B. financial allocation
C. agency cost analysis
D. capital budgeting
E. capital structure

18. Which one of the following is a capital budgeting decision?

A. determining how many shares of stock to issue
B. deciding whether or not to purchase a new machine for the production line
C. deciding how to refinance a debt issue that is maturing
D. determining how much inventory to keep on hand
E. determining how much money should be kept in the checking account

19. Which one of the following statements is correct?

A. A general partnership is legally the same as a corporation
B. Both sole proprietorship and partnership income is taxed as individual income
C. Partnerships are the most complicated type of business to form
D. All business organizations have bylaws
E. Only firms organized as sole proprietorships have limited lives.

20. Which one of the following is classified as an intangible fixed asset?

A. accounts receivable
B. production equipment
C. building
D. trademark
E. inventory

21. The book value of a firm is:

A. equivalent to the firm's market value provided that the firm has some fixed assets.
B. based on historical cost
C. generally greater than the market value when fixed assets are included
D. more of a financial than an accounting valuation
E. adjusted to the market value whenever the market value exceeds the stated book value.

22. Shelley won a lottery and will receive $1,000 a year for the next ten years. The value of her winnings today
discounted at her discount rate is called which one of the following?
A. single amount
B. future value
C. present value
D. simple amount
E. compounded value

23. Which one of the following transactions occurs in the primary market?
A. purchase of 500 shares of GE stock from a current shareholder
B. gift of 100 shares of stock to a charitable organization
C. gift of 200 shares of stock by a mother to her daughter
D. a purchase of newly issued stock from AT&T
E. IBM's purchase of GE stock
24. The length of time a firm must wait to recoup the money it has invested in a project is called the:
A. internal return period
B. payback period
C. profitability period
D. discounted cash period
E. valuation period

25. The internal rate of return:

A. may produce multiple rates of return when cash flows are conventional
B. is best used when comparing mutually exclusive projects
C. is rarely used in the business world today
D. is principally used to evaluate small dollar project
E. is easy to understand

26. The expected return on a stock given various states of the economy is equal to the:
A. highest expected return given any economic state
B. arithmetic average of the returns for each economic state
C. summation of the individual expected rates of return.
D. weighted average of the returns for each economic state
E. rectum for the economic state with the highest probability of occurrence

27. Unsystematic risk:

A. can be effectively eliminated by portfolio diversification
B. is compensated for by the risk premium
C. is measured by beta
D. is measured by standard deviation
E. is related to the overall economy

28. Which one of the following indicates a portfolio is being effectively diversified?
A. an increase in the portfolio beta
B. a decrease in the portfolio beta
C. an increase in the portfolio rate of return
D. an increase in the portfolio standard deviation
E. a decrease in the portfolio standard deviation

29. Total risk is measured by and systematic risk is measured by

A. beta; alpha
B. beta; standard deviation
C. alpha; beta
D. standard deviation; beta
E. standard deviation; variance

30. Which one of the following is the primary determinant of a firm's cost of capital?
A. debt-equity ratio
B. applicable tax rate
C. cost of equity
D. cost of debt
E. use of the funds

31. The capital structure weights used in computing the weighted average cost of capital:
A. are based on the book values of total debt and total equity
B. are based on the market value of the firm's debt and equity securities
C. are computed using the book value of the long-term debt and the book value of equity
D. remain constant over time unless the firm issues new securities
E. are restricted to the firm's debt and common stock

32. The flotation cost for a firm is computed as

A. the arithmetic average of the flotation costs of both debt and equity
B. the arithmetic average of the flotation costs of both debt and equity
C. the geometric average of the flotation costs associated with each form of financing
D. one-half of the flotation cost of debt plus one-half of the flotation cost of equity
E. a weighted average based on the book values of the firm's debt and equity

33. Pearson Electric recently registered 250,000 shares of stock under SEC Rule 415. The firm plans to sell
150,000 shares this year and the remaining 100,000 shares next year. What type of registration was this?
A. standby registration
B. shelf registration
C. Regulation A registration
D. Regulation Q registration
E. private placement registration

34. If an IPO is underpriced then the:

A. investors in the IPO are generally unhappy with the underwriters
B. issue is less likely to sell out
C. stock price will generally decline on the first day of trading
D. issuing firm is guaranteed to be successful in the long term
E. issuing firm receives less money than it probably should have

35. With firm commitment underwriting, the issuing firm:

A. is unsure of the total amount of funds it will receive until after the offering is completed
B. is unsure of the number of shares it will actually issue until after the offering is completed
C. knows exactly how many shares will be purchased by the general public during the offer period
D. retains the financial risk associated with unsold shares
E. knows up-front the amount of money it will receive from the stock offering

36. Blue Stone Builders recently offered to sell 45,000 newly issued shares of stock to the public.
The underwriters charged a fee of 8 percent and paid Blue Stone Builders $16.40 a share on 40,000 shares.
Which one of the following terms best describes this underwriting?
A. best efforts
B. shelf registration
C. direct right
 B. SHORT ANSWER

Question 1: According to CAPM, the expected return on a risky asset depends on three components. Describe
each component and explain its role in determining expected return.

According to CAPM Expected return = Risk free rate + Beta * Market Risk Premium

Risk free rate is usually the yield of 10 year maturity government bond. Risk free rate is rate of riskless return.

Beta is the covariance of market returns and portfolio returns divided by the variance of the market. Higher the
beta higher the impact of market returns. In case of Beta>1 expected return will increase with increase in Market
return and vice versa. Lower beta indicates lesser fluctuations of the expected returns with respect to market
returns.

Market risk premium is the market return minus risk free rate. Higher the market risk premium higher is the
expected rate in all case expect when beta less than or equal to 0.

Question 2: List and briefly describe the three general areas of responsibility for a financial manager.

The three basic areas are:

- 1. capital budgeting: the identification of investment opportunities that have a positive net| value
- 2. capital structure: the mix of long-term debt and equity used to finance a firm's operations
- 3. working capital management: the daily control of a firm's short-term assets and short-term liabilities

Question 3: Describe the key advantages associated with the corporate form of organization.

The advantages of the corporate form of organization are the ease of transferring ownership, the owners' limited
liability for business debts, the ability to raise large amounts of capital, and the potential for an unlimited life for
the organization.

Question 4: Why are so many businesses structured as sole proprietorships when the corporate form of business
offers more advantages?

A significant advantage of the sole proprietorship is that it is inexpensive and easy to form. If the sole proprietor
has limited capital to start with, it may not be desirable to spend part of that capital forming a corporation. Also,
limited liability for business debts may not be a significant advantage if the proprietor has most of his or her
personal assets tied up in the business already. Finally, for a typical small firm, having an unlimited life for the
business has no real advantage since the heart and soul of the business is the person who founded it, thereby
effectively limiting the life of the business to that of its founder
Question 5: What concerns might a loan officer have when loaning funds to a sole proprietorship that he or she
might not have when loaning funds to a corporation?

The existence and viability of a sole proprietor is dependent upon one individual. Should that individual die, the
entity would cease to exist. Likewise, should the owner lose interest in the business or become ill, the business
might also cease to exist. With a corporation, the company ownership could be sold in any one of those situations
such that the business entity would continue to exist.

Question 6: From a liability point of view, what is the difference between investing in a sole proprietorship and a
general partnership?

Both a sole proprietor and a general partner have unlimited liability for the firm's debts. However, as a sole
proprietor you should be totally aware of all the business dealings of the firm. In a general partnership, you may
or may not handle the financial transactions and thus are accepting the responsibility for actions taken not only by
yourself, but those of your partners.

Question 7: Give some examples of ways in which manager's goals can differ from those of shareholders.

The primary goal of a financial manager 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. However, managers
frequently are more concerned with their personal benefits from employment, the prestige of their position, and
the perks to which they feel entitled. There are numerous examples, some of which are excessive compensation
packages, large corporate offices, excessive staffing, and first-class travel and conference locations, to name a
few.

Question 8: How do the actual effects of the Sarbanes-Oxley Act of 2002 compared to the initial intent of that
Act?

Some of the key requirements of Sarbanes-Oxley are: the prohibition of personal loans from the company to its
officers, an annual report by management of the internal control and financial reporting within the firm along
with an independent auditor's assessment of that report, a review and sign off by the corporate officers of the
annual financial statements, and the responsibility for the accuracy of the financial reports placed directly on
senior management of the firm. While firms that have opted to remain publicly owned are complying with these
requirements, they are paying a cost to do so. This cost has caused other firms to "go dark" or to opt for listing on
a foreign exchange rather than a U.S. exchange. While some of the results do match the intent of the Act, the
costs, "going dark", and foreign listings were most likely not intended by the supporters of the Act.

Question 9: How might agency problems arise in partnerships?

Agency conflicts typically arise when there is a separation between the ownership and the management of a
business. In a general partnership, especially if the partnership is small, there is less of a chance of an agency
conflict if all the partners are involved with the business on a regular basis. However, in a limited partnership, the
opportunity exists for an agency problem to arise between the general and the limited partners.

Question 10: Compare and contrast the NYSE with NSADAQ.

The NYSE is an auction market where sell orders are matched with buy orders. The NYSE has a physical trading
floor located on Wall Street in New York City. NASDAQ is a dealer market which is solely electronic and
therefore has no physical trading floor.

Dealers buy and sell for their own inventory. The listing requirements of the NYSE are more stringent than those
of NASDAQ and thus the NYSE tends to list larger firms with smaller firms being listed on NASDAQ. Note
however, that larger firms can, and do, opt to remain on NASDAQ even though they qualify for NYSE listing.

Question 11: The managers of a firm wish to expand the firm's operations and are trying to determine the amount
of debt financing the firm should obtain versus the amount of equity financing that should be raised. The
managers have asked you to explain the effects that both of these forms of financing would have on the cash flows
of the firm. Write a short response to this request.

Debt financing will require cash outflows for both interest and principal payments. The interest outflow will be
partially offset by a decrease in the cash outflow for taxes. Should the firm accept additional debt, the liquidity of
the firm might have to be increased to ensure the debt obligations can be met in a timely manner. On the other
hand, equity financing does not create any requirement for future cash outflows as equity does not need to be
repaid nor are dividends required. However, if dividends are paid, they would not lower the firm's cash outflow
for taxes.

Question 12: Discuss the difference between book values and market values and explain which one is more
important to the financial manager and why.

The accounts on the balance sheet are generally carried at historical cost, not market values. Although the book
value of the current assets and the liabilities may closely approximate market values, the same cannot be said for
the rest of the balance sheet accounts. Market values are more relevant as they reflect today's values whereas the
balance sheet reflects historical costs as adjusted by various accounting methods. To determine the current value
of a firm, and its worth to the shareholders, financial managers must monitor market values.

Question 13: Assume you are a credit manager in charge of approving commercial loans to business firms.
Identify three aspects of a firm's cash flows you would review and explain the type of information you hope to
gain from reviewing each of those five aspects.

- Operating Cash Flow:

Assess revenue trends to evaluate the stability and growth of the business. Examine profitability to determine if
the firm generates enough profits to cover operational expenses and debt obligations. Ensure positive and
sustainable operating cash flow to support operations and loan repayment.
- Investing Cash Flow:

Evaluate investments to understand business expansion plans, asset quality, and potential returns. Review asset
sales to assess asset management and generate additional cash for debt repayment. Analyze profitability or risks
associated with investment activities that can impact financial stability and loan repayment capacity.

- Financing Cash Flow:

Assess the ability to generate cash for servicing existing debt obligations, including interest and principal
payments. Consider reliance on equity financing, which may impact financial stability. Review dividend
payments to understand their impact on available cash for debt servicing and loan repayment.

Question 14: Define liquidity risk, default risk, and taxability risk and explain how these risks relate to bonds and
bond yields.

Liquidity risk is the inability to quickly sell a bond for its full value. This risk exists primarily in thinly traded
issues. Default risk is the likelihood the issuer will default on its bond obligations and is the basis for bond
ratings. Taxability risk reflects the fact that bond interest can be taxed differently at the federal, state, and local
levels and that these tax rates can change. Each of these risks increase bond yields as investors require
compensation in exchange for risk acceptance.

Question 15: Inflation has remained low for the past three years but you have come to the conclusion that trend
is ending and inflation will increase significantly over the next 18 months. Assume you have reached this
conclusion prior to other investors reaching the same conclusion. What adjustments should you make to your
bond portfolio in light of your conclusions?

Increases in inflation will increase interest rates according to the term structure of interest rates. Therefore, you
should sell any long-term bonds you own and replace them with short-term bonds. You should also replace lower
coupon bonds with higher coupon bonds. These changes should be done promptly before other investors
commence taking the same actions.

Question 16: Explain the conditions that would need to exist for the Treasury yield curve to be downward sloping

A downward sloping Treasury yield curve exists when current inflation rates are high but are expected to decline
in the future. The decline in the inflation premium must be significant enough to overcome the rising interest rate
risk premium as the time to maturity increases.4. Describe the relationships that exist between the coupon rate,
the yield to maturity, and the current yield for both a discount bond and a premium bond.

- Discount bond: Yield to maturity > Current yield > Coupon rate
- Premium bond: Yield to maturity < Current yield < Coupon rate
Question 17: What are the primary differences and similarities between NASDAQ and the NYSE?

The NYSE has a physical trading floor in New York City, is primarily a broker market, relies on specialists for
liquidity under a single market maker system, utilizes the SuperOI system, and has stricter listing requirements.
NASDAQ is an electronic network of dealers and utilizes a multiple market maker system. NASDAQ is open to
ECNs but the NYSE is not. NASDAQ has no physical trading floor.

Question 18: Using the dividend growth model, explain why a firm would be hesitant to reduce the growth rate of
its dividends.

The dividend growth model states that Pt = Dt+1/(R - g).

A reduction in the growth rate will reduce both Dt+1 and g. Lowering the value of these variables will effectively
lower the value of the firm's stock, which is something firms are hesitant to do.

Question 19: Kelley wants to purchase shares in Classic Kars, Inc., but is torn between buying shares of common
stock or shares of preferred stock. What should he consider before determining the type of share he should
purchase?

Kelley needs to identify the reasons he wishes to purchase this stock. If he is looking for a steady stream of
income and preferential treatment should the company go bankrupt, then he should purchase preferred stock. On
the other hand, if he believes the company has a bright financial future and wishes to share in that success, then
he should buy common stock and enjoy the benefits of residual ownership associated with high profitability. In
addition, if he wishes to have a voice in company matters, he should purchase common stock to ensure that he
will have voting rights.

Question 20: Explain why small shareholders should prefer cumulative voting over straight voting.

With straight voting, a shareholder must control a majority (50 percent plus one) of the outstanding shares of
stock to gain access to a seat on the board of directors. With cumulative voting, a shareholder can control one seat
on the board by controlling a lesser number of shares. The number of shares needed to obtain one seat under
cumulative voting is computed as [1/(N+1)] percent + 1 of the outstanding shares, where N is the number of open
seats. If for example, three seats are open, a shareholder only needs to control 25 percent, or 1/4th, of the
outstanding shares plus one additional share to guarantee election to the board. Having a seat on the board allows
a shareholder to have some control over the direction and management of a firm.

Question 21: Ted, a wealthy individual, plans to purchase 30 percent of a firm's Class A shares of outstanding
stock. He believes that such a purchase will allow him to control the firm by electing his candidates to the board
over time as current board member's terms expire.
The firm has a cumulative voting process. What factors should Ted be considering and why to ensure he can gain
the control he desires?

Since the stock Ted plans to purchase is denoted as Class A, Ted should determine if the firm has other classes of
stock outstanding and if so, how that will affect the outcome of any election. Generally speaking, different classes
of stock are assigned different voting rights. It could be that shareholders of another class of stock effectively
control the firm.

He should also be concerned about the number of positions that are elected at one time as he needs to ensure that
his 30 percent ownership is sufficient to control at least one seat at each election.

Question 22. Explain the primary change that occurred in the structure of the NYSE in 2006 and how that change
affected the exchange members.

In 2006, the NYSE became a publicly owned corporation called NYSE Group, Inc.

Exchange members no longer purchase, or own, seats on the exchange nor do they own the firm based solely on
their membership. Members now purchase trading licenses which grant their owners the right to transact trades on
the floor of the exchange.

Ownership of the NYSE now lies in the hands of the NYSE Group, Inc.'s, shareholders.

Question 23. The profitability index (PI) of a project is 1.0. What do you know about the project's net present
value (NPV) and its internal rate of return (IRR)?

If the PI is equal to 1.0, then the NPV = 0 and the IRR = Required return.

Question 24. Explain how the internal rate of return (IRR) decision rule is applied to projects with financing type
cash flows.

For financing type projects, the decision rule is reversed so that projects are accepted when the project's IRR is
less than the required rate of return and rejected when the project's IRR is greater than the required return.

Question 25. Explain the differences and similarities between net present value (NPV) and the profitability index.

The NPV and PI both consider the time value of money and result in the same accept or reject decision when
considering an independent project. The main difference between the two is that the Pl may be useful in
determining which projects to accept if funds are limited; however, the PI may lead to incorrect decisions when
considering mutually exclusive investments.
Question 26. How does the net present value (NPV) decision rule relate to the primary goal of financial
management, which is creating wealth for shareholders?

The NPV rule states that a project should be accepted if the NPV is positive and rejected if the NPV is negative.
This aligns with the goal of creating wealth for a firm's shareholders as only projects which create wealth are
approved for acceptance. Managers are indifferent to projects with zero NPVs, which is okay because such
projects neither create nor destroy shareholder wealth