Sample Finance MCQ
1. Which of
the following could explain why a business might choose to organize as a
corporation rather than as a sole proprietorship or a partnership?
a.
Corporations generally face fewer regulations.
b.
Corporations generally face lower taxes.
c.
Corporations generally find it easier to raise capital.
d.
Corporations enjoy unlimited liability.
e.
Statements c and d are correct.
2. Which of
the following statements is most correct?
a. Due to
limited liability, unlimited lives, and ease of ownership transfer, the vast
majority of U.S. businesses (in terms of number of businesses) are organized as
corporations.
b. Most
businesses (by number and total dollar sales) are organized as proprietorships
or partnerships because it is easier to set up and operate in one of these
forms rather than
as a
corporation. However, if the business gets very large, it becomes advantageous
to convert to a corporation, primarily because corporations have important tax
advantages over
proprietorships
and partnerships.
c. Due to
legal considerations related to ownership transfers and limited liability, most
business (measured by dollar sales) is conducted by corporations.
d.
Statements a, b, and c are correct.
e. All of
the statements are false.
3.
Harmeling Enterprises experienced a decline in net operating profit after taxes
(NOPAT). Which of the following definitely cannot help explain this decline?
a. Sales
revenues decreased.
b. Costs of
goods sold increased.
c.
Depreciation increased.
d. Interest
expense increased.
e. Taxes
increased.
4. Which of
the following statements is most correct?
a. Cash
flows and accounting profit are not at all related since no common elements are
used in the calculation of either individual measure.
b.
Accounting profits are more important than free cash flow.
c. High
inflation can seriously distort firms' balance sheets, and
since
inflation also affects depreciation and inventory costs, profits can also be
affected.
d. When an
action is taken at one point in time, but its full effects cannot be accurately
measured until later, this has the potential to affect the firm's financial
statements. However, as long as the firm keeps the same standard accounting period
this timing problem can be avoided.
e. None of
the statements above is correct.
5. Which of
the following alternatives could potentially result in a net increase in a
company's free cash flow for the current year?
a. Reducing
the days-sales-outstanding ratio.
b.
Increasing the number of years over which fixed assets are depreciated.
c.
Decreasing the accounts payable balance.
d. All of
the answers above are correct.
e. Answers
a and b are correct.
6. You
observe that a firm’s profit margin is below the industry average, its debt
ratio is below the industry average, and its return on equity exceeds the
industry average. What can you conclude?
a. Return
on assets is above the industry average.
b. Total
assets turnover is above the industry average.
c. Total
assets turnover is below the industry average.
d. Both
statements a and b are correct.
e. None of
the statements above is correct.
7. The
percentage of sales method produces accurate results unless which of the
following conditions is (are) present?
a. Fixed
assets are "lumpy."
b. Strong
economies of scale are present.
c. Excess
capacity exists because of a temporary recession.
d. Answers
a, b, and c all make the percentage of sales methodinaccurate.
e. Answers
a and c make the percentage of sales method inaccurate, but, as the text
explains, the assumption of increasing economies of scale is built into the
percentage of sales method.
8. A firm
has the following balance sheet:
Cash $ 20
Accounts payable $ 20
Accounts
receivable 20 Notes payable 40
Inventory
20 Long-term debt 80
Fixed
assets 180 Common stock 80
Retained
earnings 20
Total
liabilities
Total
assets $240 and equity $240
Sales for
the year just ended were $400, and fixed assets were used at 80 percent of
capacity, but its current assets were at optimal levels. Sales are expected to
grow by 5 percent next year, the profit margin is 5 percent, and the dividend
payout ratio is 60 percent.
How much
additional funds (AFN) will be needed?
a. $4.6
b. –$6.4
(Surplus)
c. $2.4
d. –$4.6
(Surplus)
e. $0.8
9. Which of
the following statements is correct?
a. The New
York Stock Exchange is an organized auction market.
b. Money
markets include markets for consumer automobile loans.
c. If an
investor sells shares of stock through a broker, then it would be a primary
market ransaction.
d. Capital
market transactions involve only the purchase and sale of equity securities.
e. None of
the answers above is correct.
10. Your
company has the following balance sheet (in millions of dollars):
Current
assets $4.0
Accounts payable $0.8
Net fixed
assets 4.0
Notes payable 1.0
Accrued wages
and taxes 0.2
Total
current liabilities $2.0
Long-term
debt 1.5
Common
equity 1.5
Retained
earnings 3.0
Total
assets $8.0
Total liabilities and equity $8.0
You have determined the following
facts: (1) last year's sales were $10 million; (2) the company will pay out 40
percent of earnings as dividends; (3) a profit margin of 3 percent is
projected; (4) fixed assets were used to full capacity; and (5) all assets as
well as spontaneous liabilities as shown on the balance sheet are expected to
grow proportionally with sales. Further, your boss estimates she will need to
raise $2 million externally by issuing new debt or common stock next year. If
the above assumptions hold, what rate
of sales
growth is your boss expecting? (Hint: You can use the AFN equation to help
answer this problem.)
a. 12.50%
b. 15.25%
c. 18.00%
d. 23.15%
e. 31.96%
11. Which
of the following statements is most correct?
a. The
slope of the security market line is beta.
b. A stock
with a negative beta must have a negative required rate of return.
c. If a
stock’s beta doubles its required rate of return must double.
d. If a
stock has a beta equal to 1.0, its required rate of return will be unaffected
by changes in the market risk premium.
e. None of
the above statements is correct.
12. Inflation,
recession, and high interest rates are economic events which are characterized
as
a.
Company-specific risk that can be diversified away.
b. Market
risk.
c.
Systematic risk that can be diversified away.
d.
Diversifiable risk.
e.
Unsystematic risk that can be diversified away.
13. Which
of the following statements is most correct?
a. An
efficient portfolio is one that provides the highest expected
rate of
return for a given amount of risk.
b. An
efficient portfolio is one that has the lowest amount of risk for a given
expected rate of return.
c. The set
of efficient portfolios is the same whether or not a risk free asset is
considered.
d. Both a
and b are correct.
e. Both a
and c are correct.
14. Which
of the following statements is most correct?
a. The
Capital Market Line (CML) is a curved line that connects the risk-free rate and
the market portfolio.
b. The
slope of the CML is ( k - k M RF)/
bM .
c. All
portfolios that lie on the CML to the right of ΦM are inefficient.
d. All
portfolios that lie on the CML to the left of ΦM are inefficient.
e. None of
the above statements are correct.
15. Which
of the following investments has the highest effective return (EAR)? (Assume
that all CDs are of equal risk.)
a. A bank
CD which pays 10 percent interest quarterly.
b. A bank
CD which pays 10 percent monthly.
c. A bank
CD which pays 10.2 percent annually.
d. A bank
CD which pays 10 percent semiannually.
e. A bank
CD which pays 9.6 percent daily (on a 365-day basis).
16. Assume
you are to receive a 20-year annuity with annual payments of $50. The first
payment will be received at the end of Year 1, and the last payment will be
received at the end of Year 20. You will invest each payment in an account that
pays 10 percent. What will be the value in your account at the end of Year 30?
a.
$6,354.81
b.
$7,427.83
c.
$7,922.33
d.
$8,591.00
e.
$6,752.46
17. A
10-year corporate bond has an annual coupon payment of 9 percent. The bond is
currently selling at par ($1,000). Which of the following statements is most
correct?
a. The
bond’s yield to maturity is 9 percent.
b. The
bond’s current yield is 9 percent.
c. If the
bond’s yield to maturity remains constant, the bond’s price will remain at par.
d. Both
answers a and c are correct.
e. All of
the answers above are correct.
18. Assume
that all interest rates in the economy decline from 10 percent to 9 percent.
Which of the following bonds will have the largest percentage increase in
price?
a. A
10-year bond with a 10 percent coupon.
b. An
8-year bond with a 9 percent coupon.
c. A
10-year zero coupon bond.
d. A 1-year
bond with a 15 percent coupon.
e. A 3-year
bond with a 10 percent coupon.
19. Which
of the following statements is most correct?
a. If a
market is strong-form efficient this implies that the returns on bonds and
stocks should be identical.
b. If a
market is weak-form efficient this implies that all public information is
rapidly incorporated into market prices.
c. If your
uncle earns a return higher than the overall stock market, this means the stock
market is inefficient.
d. Both
answers a and b are correct.
e. None of
the above answers is correct.
20. Which
of the following statements is false?
a. When a
corporation's shares are owned by a few individuals who are associated with or
are the firm's management, we say that the firm is "closely held."
b. A
publicly owned corporation is simply a company whose shares are held by the
investing public, which may include other corporations and institutions as well
as individuals.
c. Going
public establishes a true market value for the firm and ensures that a liquid
market will always exist for the firm's shares.
d. When
stock in a closely held corporation is offered to the public for the first time
the transaction is called "going public" and the market for such
stock is called the new issue market.
e. It is
possible for a firm to go public, and yet not raise any additional new capital.
21. Which
of the following is not considered a capital component for the purpose of
calculating the weighted average cost of capital as it applies to capital
budgeting?
a.
Long-term debt.
b. Common
stock.
c.
Short-term debt used to finance seasonal current assets.
d.
Preferred stock.
e. All of
the above are considered capital components for WACC and capital budgeting
purposes.
22. In
applying the CAPM to estimate the cost of equity capital, which of the
following elements is not subject to dispute or controversy?
a. The
expected rate of return on the market, kM.
b. The
stock's beta coefficient, bi.
c. The
risk-free rate, kRF.
d. The
market risk premium (RPM).
e. All of
the above are subject to dispute.
23. Which
of the following is not a barrier to a hostile takeover?
a.
Nonpecuniary benefits.
b. Targeted
share repurchases.
c.
Shareholder rights provision.
d.
Restricted voting rights.
e. Poison
pill.
24. A
company forecasts free cash flow of $40 million in three years. It expects the
free cash flow to grow at a constant rate of 5 percent thereafter. If the
weighted average cost of capital is 10 percent and the cost of equity is 15
percent, what is the horizon value, to the nearest million?
a. $280
million
b. $400
million
c. $420
million
d. $800
million
e. $840
million
25. Which
of the following statements is most correct?
a. The NPV
method assumes that cash flows will be reinvested at the cost of capital while
the IRR method assumes reinvestment at the IRR.
b. The NPV
method assumes that cash flows will be reinvested at the risk-free rate while
the IRR method assumes reinvestment at the IRR.
c. The NPV
method assumes that cash flows will be reinvested at the cost of capital while
the IRR method assumes reinvestment at the risk-free rate.
d. The NPV
method does not consider the inflation premium.
e. The IRR
method does not consider all relevant cash flows, and particularly cash flows
beyond the payback period.
26. Using
the corporate valuation model, the value of a company’s operations is $750
million. The company’s balance sheet shows $50 million in short-term
investments that are unrelated to operations. The balance sheet also shows $100
million in accounts payable, $100 million in notes payable, $200 million in
long-term debt, $40 million in common stock (par plus paid-in-capital), and
$160 million in retained earnings. What is your best estimate for the market
value
of equity?
a. $200
million
b. $300
million
c. $400
million
d. $500
million
e. $600
million
27. When
evaluating a new project, the firm should consider all of the following factors
except:
a. Changes
in working capital attributable to the project.
b. Previous
expenditures associated with a market test to
determine
the feasibility of the project, if the expenditures have been expensed for tax
purposes.
c. The
current market value of any equipment to be replaced.
d. The
resulting difference in depreciation expense if the project involves
replacement.
e. All of
the statements above should be considered.
28. Which
of the following statements is most correct?
a. The MIRR
method will always arrive at the same conclusion as the NPV method.
b. The MIRR
method can overcome the multiple IRR problem, while the NPV method cannot.
c. The MIRR
method uses a more reasonable assumption about reinvestment rates than the IRR
method.
d.
Statements a and c are correct.
e. All of
the above statements are correct.
29. The
value of an option depends on the stock's price, the risk-free rate, and the
a. Exercise
price.
b.
Variability of the stock price.
c. Option's
time to maturity.
d. All of
the above.
e. None of
the above.
30. Warnes
Motors’ stock is trading at $20 a share. Call options that expire in three
months with an exercise price of $20 have a price of $1.50. Which of the
following will occur if the stock price increases 10 percent to $22 a share?
a. The
price of the call option will increase by $2.
b. The
price of the call option will increase by more than $2.
c. The
price of the call option will increase by less than $2, and the percentage
increase in price will be less than 10 percent.
d. The
price of the call option will increase by less than $2, but the percentage
increase in price will be more than 10 percent.
e. The
price of the call option will increase by more than $2, but the percentage increase
in price will be less than 10 percent.
31. Which
of the following would increase the likelihood that a company would increase
its debt ratio in its capital structure?
a. An
increase in costs incurred when filing for bankruptcy.
b. An
increase in the corporate tax rate.
c. An
increase in the personal tax rate.
d. A
decrease in the firm’s business risk.
e.
Statements b and d are correct.
32. Company
A and Company B have the same total assets, operating income (EBIT), tax rate,
and business risk. Company A, however, has a much higher debt ratio than
Company B. Company A’s basic earning power (BEP) exceeds its cost of debt
financing (kd). Which of
the
following statements is most correct?
a. Company
A has a higher return on assets (ROA) than Company B.
b. Company
A has a higher times interest earned (TIE) ratio than Company B.
c. Company
A has a higher return on equity (ROE) than Company B, and its risk, as measured
by the standard deviation of ROE, is also higher than Company B’s.
d.
Statements b and c are correct.
e. All of
the statements above are correct.
33. The
trade-off theory provides several insights to financial managers concerning
optimal capital structure. Which of the following insights is false?
a. Other
things equal, firms with large amounts of marketable fixed assets should use
more debt financing than firms whose value stems mostly from intangible assets.
b. Other
things equal, firms with high corporate tax rates should use less debt
financing than firms with low tax rates.
c. Other things
equal, firms with high business risk should use less debt financing than firms
with low business risk.
The
following information applies to the next problem.
The
Kimberly Corporation is a zero growth firm with an expected EBIT of $100,000
and a corporate tax rate of 30 percent. Kimberly uses $500,000 of 12.0 percent
debt financing, and the cost of equity to an unlevered firm in the same risk
class is 16.0 percent.
34. What is
the value of the firm according to MM with corporate taxes?
a. $400,000
b. $437,500
c. $587,500
d. $625,000
e. $775,000
35. Which
of the following would not have an influence on the optimal dividend policy?
a. The
possibility of accelerating or delaying investment projects.
b. A strong
shareholders' preference for current income versus capital gains.
c. Bond
indenture constraints.
d. The
costs associated with selling new common stock.
e. All of
the statements above can have an effect on dividend policy.
36. Which
of the following is not an advantage of going public?
a. It allows
a firm's founders to diversify their holdings.
b. It
increases the liquidity of the stock.
c. It
establishes a value for the firm.
d. It makes
it easier to raise new equity capital in the future.
e. All of
the above are advantages of going public.
37. McGwire
Company's pension fund projected that a significant number of its employees
would take advantage of an early retirement program the company plans to offer
in five years.
Anticipating
the need to fund these pensions, the firm bought zero coupon U.S. Treasury
Trust Certificates maturing in five years. When these instruments were
originally issued, they were 12
percent
coupon, 30-year U.S. Treasury bonds. The stripped Treasuries are currently
priced to yield 10 percent. Their total maturity value is $6,000,000. What is
their total cost (price) to
McGwire
today?
a. $
553,776
b.
$5,142,600
c.
$3,404,561
d.
$4,042,040
e.
$3,725,528
38. Reading
Railroad's common stock is currently priced at $30, and its 8 percent
convertible debentures (issued at par, or $1,000) are priced at $850. Each
debenture can be converted into 25 shares of common stock at any time before
2005. What is the conversion price, CP, and
the
conversion value of the bond?
a. $25.00;
$1,000
b. $25.00;
$ 750
c. $40.00;
$ 750
d. $40.00;
$ 850
e. $40.00;
$1,000
39. Which
of the following is typically part of the cash budget?
a. Payments
lag.
b. Payment
for plant construction.
c.
Cumulative cash.
d. All of
the above.
e. Only
answers a and c above.
40. Assume
that Sunshine Products Inc. has an agreement with Shady Finance Company to
factor its receivables. Shady charges a flat commission of 2 percent of the
receivables factored, plus 6 percent a year interest on the outstanding
balance. It also deducts a reserve of 10 percent for returned and damaged
materials. Interest and commission are paid in advance. No interest is charged
on the reserve or the commission. If the average level of outstanding receivables
is $700,000, and if they are turned over 4 times a year (hence the commission
is paid 4 times a year), then what is the effective quarterly interest rate
charged by Shady for this arrangement?
a. 6.05%
b. 3.83%
c. 7.52%
d. 9.31%
e. 10.56%
