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FINANCE QUESTIO

FINANCE QUESTIO.

 1. Determining the best way to raise money to fund a firm’s long-term investments is called:
a. the capital budgeting decision
b. the money flow processing decision
c. the portfolio decision
d. the capital structure decision
2. Which of the following is NOT true regarding mortgaged-backed securities (MBS)?
a. Securitization provides liquidity to the mortgage market and makes it possible for banks to
loan more money to home buyers.
b. MBS are sold to investors who can hold them as an investment or resell them to other
investors.
c. The MBS process allows the mortgage bank or other financial institution that made the
original mortgage loan to get its money back out of the loan and lend it to someone else.
d. All of the above.
3. To measure value, the concept of time value of money is used:
a. to bring the future benefits and costs of a project, measured by its cash flows, back to the
present
b. to determine the interest rate paid on corporate debt
c. to bring the future benefits and costs of a project, measured by its expected profits, back
to the present
d. to ensure that expected future profits exceed current profits today
4. An investor is considering two equally risky investments. Investment A is expected to return
$1,000 per year for the next 5 years. Investment B is expected to return $6,000 at the end of
5 years. Which of the following statements is MOST correct if both investments A and B have
the same cost?
a. A risk averse investor will select investment A because it provides cash earlier than
investment B.
b. A risk averse investor will select investment B because it is expected to provide the most
cash ($6,000 > $5,000).
c. The investor will select investment A only if the cost is less than $1,000.
d. The investor may select investment A or investment B depending on the opportunity cost
of money. 5. Assume that you won the Lotta Dough Lotto jackpot for $20 million. Further assume that you
were offered a choice to receive the $20 million today, or receive it in equal installments of
$1 million per year for 20 years. According to one of the principles of finance, which would
you take?
a. You would be indifferent as to when you would receive the $20 million since the total
number of dollars received is the same either way.
b. You would take the $20 million in equal installments of $1 million per year for 20 years
because it would be worth more than if you would receive it today.
c. You would take the $20 million in equal installments of $1 million per year for 20 years
because you would be afraid of spending it all right away.
d. You would take the $20 million today because it would be worth more than if you would
receive it in equal installments of $1 million per year for 20 years.
6. Maximization of shareholder wealth:
a. is achieved only if cash flows exceed accounting profits
b. represents a zero sum game in which one corporation gains at the expense of others
c. is not a practical goal since it cannot be measured effectively
d. provides benefits to society as scarce resources are directed to their most productive use
7. Which of the following securities will likely have the highest liquidity premium?
a. U.S. Treasury Bond maturing in 2027
b. U.S. Treasury Bill
c. AAA-rated corporate bond maturing in 2015 not actively traded
d. BBB-rated corporate bond maturing in 2020 actively traded on a major exchange
8. Private placements usually have several advantages associated with them, but also tend
to suffer from specific disadvantages. Which of the following is a disadvantage of a private
placement when compared to other methods of selling new securities?
a. higher interest costs
b. reduced flotation costs
c. avoidance of registration with the SEC
d. strictly standardized features/terms
9. Common examples of financial intermediaries include all of the following EXCEPT:
a. life insurance companies
b. venture capital firms
c. pension funds
d. mutual funds10. A life insurance company purchases $1 billion of corporate bonds from premiums collected on
its life insurance policies. Therefore:
a. the corporate bonds are direct securities and the life insurance policies are direct
securities
b. the corporate bonds are indirect securities and the life insurance policies are indirect
securities
c. the corporate bonds are indirect securities and the life insurance policies are direct
securities.
d. the corporate bonds are direct securities and the life insurance policies are indirect
securities.
11. Which of the following represents an attempt to measure the net results of the firm’s
operations (revenues versus expenses) over a given time period?
a. statement of cash flows
b. sources and uses of funds statement
c. balance sheet
d. income statement
12. Gross profit is equal to:
a. revenues minus expenses
b. profits plus depreciation
c. sales minus cost of goods sold
d. earnings before taxes minus taxes payable
13. An income statement may be represented as follows:
a. Sales – Expenses = Retained Earnings
b. Sales – Expenses = Profits
c. Revenues – Liabilities = Net Income
d. Sales – Liabilities = Profits
14. Which of the following ratios would be the poorest indicator of how rapidly the firm’s credit
accounts are being collected?
a. average collection period
b. cash conversion cycle
c. times interest earned
d. accounts receivable turnover ratio15. An analyst is evaluating two companies, A and B. Company A has a debt ratio of 50% and
Company B has a debt ratio of 25%. In his report, the analyst is concerned about Company B’s
debt level, but not about Company A’s debt level. Which of the following would best explain
this position?
a. Company A has a lower times interest earned ratio and thus the analyst is not worried
about the amount of debt.
b. Company B has much higher operating income than Company A.
c. Company B has a higher operating return on assets than Company A, but Company A has a
higher return on equity than Company B.
d. Company B has more total assets than Company A.
16. Jeter Industries has an accounts receivable turnover ratio of 4.5. If Jeter has an accounts
receivable balance of $100,000, what is Jeter’s average daily credit sales?
a. $1,232.88
b. $22,222.22
c. $1,893.45
d. $745.23
17. As of today, the most severe economic crisis to afflict the United States’ economy is
considered to be:
a. the Great Depression of the 1930s
b. the Reagan Tax Law Changes of 1985
c. the Great Recession of 2007-2009
d. the Savings and Loan Crisis of 1978 -1982
18. A corporate treasurer is typically responsible for each of the following duties EXCEPT:
a. credit management
b. capital expenditures
c. cash management
d. cost accounting
19. A wealthy private investor providing a direct transfer of funds is called:
a. a financial intermediary
b. an angel investor
c. an investment banker
d. a venture capitalist
20. Rogue Industries reported the following items for the current year: Sales = $3,000,000;
Cost of Goods Sold = $1,500,000; Depreciation Expense = $170,000;
Administrative Expenses = $150,000; Interest Expense = $30,000;
Marketing Expenses = $80,000; and Taxes = $300,000. Rogue’s net profit margin is equal to:
a. 35.67%
b. 36.67%
c. 25.67%
d. 50.00%
21. Septon Inc. has an average collection period of 74 days. What is the accounts receivable
turnover ratio for Septon Inc.?
a. 2.66
b. 1.74
c. 4.93
d. 2.47
22. Which form of organization is free of initial legal requirements?
a. sole proprietorship
b. general partnership
c. corporation
d. both a and b
23. Which of the following is NOT a benefit provided by the existence of organized security
exchanges?
a. standardization of all debt agreements
b. helping businesses raise new capital
c. providing a continuous market
d. establishing and publicizing fair security prices
24. California Retailing Inc. has sales of $4,000,000; the firm’s cost of goods sold is $2,500,000;
and its total operating expenses are $600,000. The firm’s interest expense is $250,000, and
the corporate tax rate is 40%. What is California Retailing’s net income?
a. $288,000
b. $377,000
c. $350,000
d. $390,00025. Company A and Company B have the same gross profit margin and the same total asset
turnover, but company A has a higher return on equity. This may result from:
a. Company B has more common stock.
b. Company A has lower selling and administrative expenses, resulting in a higher net profit
margin.
c. Company A has lower cost of goods sold, resulting in a higher net profit margin.
d. Company A has a lower debt ratio.
1. What is the present value of an annuity of $120 received at the end of each year for 11 years?
Assume a discount rate of 7%. The first payment will be received one year from today (round
to nearest $1).
a. $570
b. $250
c. $400
d. $900
2. You bought a racehorse that has had a winning streak for six years, bringing in $250,000 at
the end of each year before dying of a heart attack. If you paid $1,155,720 for the horse 4
years ago, what was your annual return over this 4-year period?
a. 12%
b. 8%
c. 18%
d. 33%
3. How much money do I need to place into a bank account that pays a 1.08% rate in order to
have $500 at the end of 7 years?
a. $751.81
b. $463.78
c. $629.51
d. $332.54
4. Your daughter is born today and you want her to be a millionaire by the time she is 40 years
old. You open an investment account that promises to pay 11.5% per year. How much money
must you deposit today so your daughter will have $1,000,000 by her 35th birthday?
a. $20,100
b. $18,940
c. $28,575
d. $22,150
5. If you want to have $3,575 in 29 months, how much money must you put in a savings account
today? Assume that the savings account pays 12% and it is compounded monthly (round to
nearest $1).
a. $2,438
b. $2,679
c. $3,147
d. $3,008
Unit 2 Examination
6. U.S. Savings Bonds are sold at a discount. The face value of the bond represents its value on
its future maturity date. Therefore:
a. The current price of a $50 face value bond that matures in 10 years will be greater than
the current price of a $50 face value bond that matures in 5 years.
b. The current prices of all $50 face value bonds will be the same, regardless of their
maturity dates because they will all be worth $50 in the future.
c. The current price of a $50 face value bond will be higher if interest rates increase.
d. The current price of a $50 face value bond that matures in 10 years will be less than the
current price of a $50 face value bond that matures on 5 years.
7. You are considering a sales job that pays you on a commission basis or a salaried position that
pays you $50,000 per year. Historical data suggests the following probability distribution for
your commission income. Which job has the higher expected income?
Probability of…
Commission Occurrence
$15,000 .15
$35,000 .20
$48,000 .35
$67,000 .22
$80,000 .18
a. The salary of $50,000 is less than the expected commission of $50,050.
b. The salary of $50,000 is less than the expected commission of $52,720.
c. The salary of $50,000 is greater than the expected commission of $49,630.
d. The salary of $50,000 is greater than the expected commission of $48,400.
8. Beginning with an investment in one company’s securities, as we add securities of other
companies to our portfolio, which type of risk declines?
a. unsystematic risk
b. market risk
c. systematic risk
d. non-diversifiable risk
9. Assume the risk-free rate of return is 2% and the market risk premium is 8%. If you are a risk
averse investor, which project should you choose?
a. Project 3
b. Project 2
c. Project 1
d. Either Project 2 or Project 3 because the higher expected return on project 3 offsets its
higher risk.
10. Stock A has a beta of 1.2 and a standard deviation of returns of 14%. Stock B has a beta of
1.8 and a standard deviation of returns of 18%. If the risk-free rate of return increases and the
market risk premium remains constant, then:
a. the required returns on stocks A and B will not change
b. the required returns on stocks A and B will both increase by the same amount
c. the required return on stock A will increase more than the required return on stock B
d. the required return on stock B will increase more than the required return on stock A
Unit 2 Ex
11. Suppose interest rates have been at historically low levels the past two years. A reasonable
strategy for bond investors during this time period would be to:
a. buy only junk bonds which have higher interest rates
b. invest in long-term bonds to reduce interest rate risk
c. invest in short-term bonds to reduce interest rate risk
d. invest in long-term bonds to lock in a bond position for when interest rates increase in the
future
12. Fred and Ethel are both considering buying a corporate bond with a coupon rate of 8%, a face
value of $1,000, and a maturity date of January 1, 2025. Which of the following statements is
MOST correct?
a. Fred and Ethel will only buy the bonds if the bonds are rated BBB or above.
b. Because both Fred and Ethel will receive the same cash flows if they each buy a bond,
they both must assign the same value to the bond.
c. If Fred decides to buy the bond, then Ethel will also decide to buy the bond if markets are
efficient.
d. Fred may determine a different value for a bond than Ethel because each investor may
have a different level of risk aversion, and hence a different required return.
13. Which of the following statements is true?
a. Short-term bonds have greater interest rate risk than do long-term bonds.
b. Long-term bonds have greater interest rate risk than do short-term bonds.
c. Interest rate risk is highest during periods of high interest rates.
d. All bonds have equal interest rate risk.
14. Crandle’s common stock is currently selling for $79.00. It just paid a dividend of $4.60 and
dividends are expected to grow at a rate of 5% indefinitely. What is the required rate of return
on Crandle’s stock?
a. 11.76%
b. 11.11%
c. 12.2%
d. 14.21%
15. An example of the growth factor in common stock is:
a. retaining profits in order to reinvest into the firm
b. two strong companies merging together to increase their economies of scale
c. acquiring a loan to fund an investment in Asia
d. issuing new stock to provide capital for future growth
Unit 2 Ex
16. Waterfront Solutions, Inc. paid a dividend of $5.00 per share on its common stock yesterday.
Dividends are expected to grow at a constant rate of 4% for the next two years, at which point
the stock is expected to sell for $56.00. If investors require a rate of return on Waterfront’s
common stock of 18%, what should the stock sell for today?
a. $40.22
b. $50.22
c. $44.76
d. $48.51
17. Andre’s parents established a college savings plan for him when he was born. They deposited
$50 into the account on the last day of each month. The account has earned 10.9%
compounded monthly, tax-free. How much can they withdraw on his 18th birthday to spend on
his education?
a. $33,307
b. $30,028
c. $43,730
d. $27,560
18. Charlie wants to retire in 15 years, and he wants to have an annuity of $50,000 a year for
20 years after retirement. Charlie wants to receive the first annuity payment the day he
retires. Using an interest rate of 8%, how much must Charlie invest today in order to have his
retirement annuity (round to nearest $10).
a. $167,130
b. $315,240
c. $256,890
d. $200,450
An investor currently holds the following portfolio:
Amount
Invested
4,000 shares of Stock H $8,000 Beta = 1.3
7,500 shares of Stock I $24,000 Beta = 1.8
12,500 shares of Stock J $48,000 Beta = 2.2
19. The beta for the portfolio is:
a. 1.45
b. 1.27
c. 1.99
d. 1.77
20. Which of the following will cause the value of a bond to increase, if other things held the
same?
a. interest rates decrease
b. the company’s debt rating drops from AAA to BBB
c. investors’ required rate of return increases
d. the bond is callable
21. A small biotechnology research corporation has been experiencing losses for the first three
years of its existence, and thus has a negative balance in retained earnings. The corporation’s
stock price, however, is $1 per share. Which of the following statements is MOST correct?
a. The required return on the stock will be small because the company has very few assets.
b. Investors believe the stock is worth $1 per share because future earnings (and cash flows)
are expected to be positive.
c. The corporation’s accountants must have made a mistake because retained earnings may
not be negative.
d. Investors are irrational to pay $1 per share when earnings per share have been negative for
three years.
22. How much money must be put into a bank account yielding 6.42% (compounded annually) in
order to have $1,671 at the end of 11 years? (round to nearest $1)
a. $798
b. $886
c. $921
d. $843
23. Wendy purchased 800 shares of Robotics Stock at $3 per share on 1/1/09. Wendy sold the
shares on 12/31/09 for $3.45. Genetics stock has a beta of 1.3, the risk-free rate of return is
3%, and the market risk premium is 8%. The required return on Genetics Stock is:
a. 21.1%
b. 13.4%
c. 16.5%
d. 17.6%
24. Bart’s Moving Company bonds have a 11% coupon rate. Interest is paid semiannually. The
bonds have a par value of $1,000 and will mature 8 years from now. Compute the value of
Bart’s Moving Company bonds if investors’ required rate of return is 9.5%.
a. $1,133.05
b. $1,098.99
c. $1,082.75
d. $1,197.27
25. Jackson Corp. common stock paid $2.50 in dividends last year (D0). Dividends are expected to
grow at a 12-percent annual rate forever. If Jackson’s current market price is $40.00, what is
the stock’s expected rate of return? (nearest .01 percent)
a. 18.25%
b. 5.50%
c. 11.00%
d. 19.00%
1. The DEF Company is planning a $64 million expansion. The expansion is to be financed by
selling $25.6 million in new debt and $38.4 million in new common stock. The before-tax
required rate of return on debt is 9 percent and the required rate of return on equity is 14
percent. If the company is in the 35 percent tax bracket, what is the firm’s cost of capital?
a. 8.92%
b. 10.74%
c. 11.50%
d. 9.89%
Valley Flights, Inc. has a capital structure made up of 40% debt and 60% equity and a tax
rate of 30%. A new issue of $1,000 par bonds maturing in 20 years can be issued with a
coupon of 9% at a price of $1,098.18 with no flotation costs. The firm has no internal equity
available for investment at this time, but can issue new common stock at a price of $45. The
next expected dividend on the stock is $2.70. The dividend for the firm is expected to grow at
constant annual rate of 5% per year indefinitely. Flotation costs on new equity will be $7.00
per share. The company has the following independent investment projects available:
Project Initial Outlay IRR
1 $100,000 10%
2 $10,000 8.5%
3 $50,000 12.5%
2. Which of the above projects should the company take on?
a. Project 3 only
b. Projects 1, 2 and 3
c. Projects 1 and 3
d. Projects 1 and 2
3. PrimaCare has a capital structure that consists of $7 million of debt, $2 million of preferred
stock, and $11 million of common equity, based upon current market values. The firm’s yield
to maturity on its bonds is 7.4%, and investors require an 8% return on the firm’s preferred
stock and a 14% return on PrimaCare’s common stock. If the tax rate is 35%, what is
PrimaCare’s WACC?
a. 7.21%
b. 10.18%
c. 12.25%
d. 8.12%
Unit 3 Examination
136
BAM 313 Introduction to Financial Management
4. JPR Company is financed 75 percent by equity and 25 percent by debt. If the firm expects
to earn $30 million in net income next year and retain 40% of it, how large can the capital
budget be before common stock must be sold?
a. $15.5 million
b. $7.5 million
c. $16.0 million
d. $12.0 million
5. All else equal, an increase in beta results in:
a. an increase in the cost of retained earnings
b. an increase in the cost of common equity, whether or not the funds come from retained
earnings or newly issued common stock
c. an increase in the cost of newly issued common stock
d. an increase in the after-tax cost of debt
6. Haroldson Inc. common stock is selling for $22 per share. The last dividend was $1.20, and
dividends are expected to grow at a 6% annual rate. Flotation costs on new stock sales are 5%
of the selling price. What is the cost of Haroldson’s retained earnings?
a. 12.09%
b. 11.78%
c. 11.45%
d. 5.73%
7. A company has preferred stock that can be sold for $21 per share. The preferred stock pays
an annual dividend of 3.5% based on a par value of $100. Flotation costs associated with
the sale of preferred stock equal $1.25 per share. The company’s marginal tax rate is 35%.
Therefore, the cost of preferred stock is:
a. 14.26%
b. 12.94%
c. 18.87%
d. 17.72%
8. Which of the following should NOT be considered when calculating a firm’s WACC?
a. after-tax YTM on a firm’s bonds
b. cost of newly issued preferred stock
c. after-tax cost of accounts payable
d. cost of newly issued common stock
Unit 3 Examination
137
BAM 313 Introduction to Financial Management
9. Your firm is considering an investment that will cost $920,000 today. The investment will
produce cash flows of $450,000 in year 1, $270,000 in years 2 through 4, and $200,000 in
year 5. The discount rate that your firm uses for projects of this type is 11.25%. What is the
investment’s profitability index?
a. 1.26
b. 1.69
c. 1.21
d. 1.43
10. Your firm is considering investing in one of two mutually exclusive projects. Project A requires
an initial outlay of $3,500 with expected future cash flows of $2,000 per year for the next
three years. Project B requires an initial outlay of $2,500 with expected future cash flows of
$1,500 per year for the next two years. The appropriate discount rate for your firm is 12% and
it is not subject to capital rationing. Assuming both projects can be replaced with a similar
investment at the end of their respective lives, compute the NPV of the two chain cycle for
Project A and three chain cycle for Project B.
a. $2,865 and $94
b. $3,528 and $136
c. $5,000 and $1,500
d. $2,232 and $85
11. The capital budgeting manager for XYZ Corporation, a very profitable high technology company,
completed her analysis of Project A assuming 5-year depreciation. Her accountant reviews the
analysis and changes the depreciation method to 3-year depreciation. This change will:
a. increase the present value of the NCFs
b. have no effect on the NCFs because depreciation is a non-cash expense
c. only change the NCFs if the useful life of the depreciable asset is greater than 5 years
d. decrease the present value of the NCFs
12. Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000
and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs
$120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in
year three, and $45,000 in year four. Lithium, Inc.’s required rate of return for these projects
is 10%. The modified internal rate of return for Project B is:
a. 18.52%
b. 22.80%
c. 19.75%
d. 17.84%
Unit 3 Examination
138
BAM 313 Introduction to Financial Management
13. A capital budgeting project has a net present value of $30,000 and a modified internal rate of
return of 15%. The project’s required rate of return is 13%. The internal rate of return is:
a. greater than $30,000
b. greater than 15%
c. between 13% and 15%
d. less than 13%
14. A new project is expected to generate $800,000 in revenues, $250,000 in cash operating
expenses, and depreciation expense of $150,000 in each year of its 10-year life. The
corporation’s tax rate is 35%. The project will require an increase in net working capital of
$85,000 in year one and a decrease in net working capital of $75,000 in year ten. What is the
free cash flow from the project in year one?
a. $410,000
b. $375,000
c. $380,000
d. $298,000
15. A local restaurant owner is considering expanding into another rural area. The expansion
project will be financed through a line of credit with City Bank. The administrative costs of
obtaining the line of credit are $500, and the interest payments are expected to be $1,000
per month. The new restaurant will occupy an existing building that can be rented for $2,500
per month. The incremental cash flows for the new restaurant include:
a. $2,500 per month rent
b. $500 administrative costs, $1,000 per month interest payments, $2,500 per month rent
c. $1,000 per month interest payments, $2,500 per month rent
d. $500 administrative costs, $2,500 per month rent
16. Which of the following should be included in the initial outlay?
a. increased investment in inventory and accounts receivable
b. preexisting firm overhead reallocated to the new project
c. first year depreciation expense on any new equipment purchased
d. taxable gain on the sale of old equipment being replaced
Unit 3 Examination
139
BAM 313 Introduction to Financial Management
17. QRW Corp. needs to replace an old lathe with a new, more efficient model. The old lathe was
purchased for $50,000 nine years ago and has a current book value of $5,000. (The old
machine is being depreciated on a straight-line basis over a ten-year useful life.) The new
machine costs $100,000. It will cost the company $10,000 to get the new lathe to the factory
and get it installed. The old machine will be sold as scrap metal for $2,000. The new machine
is also being depreciated on a straight-line basis over ten years. Sales are expected to increase
by $8,000 per year while operating expenses are expected to decrease by $12,000 per year.
QRW’s marginal tax rate is 40%. Additional working capital of $3,000 is required to maintain
the new machine and higher sales level. The new lathe is expected to be sold for $5,000 at
the end of the project’s ten-year life. What is the incremental free cash flow during year 1 of
the project?
a. $11,400
b. $15,200
c. $12,800
d. $14,400
18. The cost of retained earnings is less than the cost of new common stock because:
a. dividends are not tax deductible
b. flotation costs are incurred when new stock is issued
c. accounting rules allow a deduction when using retained earnings
d. marginal tax brackets increase
19. Beauty Inc. plans to maintain its optimal capital structure of 40 percent debt, 10 percent
preferred stock, and 50 percent common equity indefinitely. The required return on each
component source of capital is as follows: debt–8 percent; preferred stock–12 percent;
common equity–16 percent. Assuming a 40 percent marginal tax rate, what after-tax rate of
return must the firm earn on its investments if the value of the firm is to remain unchanged?
a. 12.00 percent
b. 11.12 percent
c. 12.40 percent
d. 10.64 percent
20. Your firm is considering an investment that will cost $920,000 today. The investment will
produce cash flows of $450,000 in year 1, $270,000 in years 2 through 4, and $200,000 in
year 5. The discount rate that your firm uses for projects of this type is 11.25%. What is the
investment’s internal rate of return?
a. 15.98%
b. 27.28%
c. 20.53%
d. 21.26%
Unit 3 Examination
140
BAM 313 Introduction to Financial Management
21. The advantages of NPV are all of the following EXCEPT:
a. it provides the amount by which positive NPV projects will increase the value of the firm
b. it allows the comparison of benefits and costs in a logical manner through the use of time
value of money principles
c. it recognizes the timing of the benefits resulting from the project
d. it can be used as a rough screening device to eliminate those projects whose returns do
not materialize until later years
22. Which of the following are included in the terminal cash flow?
a. recapture of any working capital increase included in the initial outlay
b. the expected salvage value of the asset
c. any tax payments or receipts associated with the salvage value of the asset
d. all of the above
23. Which of the following differentiates the cost of retained earnings from the cost of newly
issued common stock?
a. the larger dividends paid to the new common stockholders
b. the flotation costs incurred when issuing new securities
c. the cost of the pre-emptive rights held by existing shareholders
d. the greater marginal tax rate faced by the now-larger firm
24. Lithium, Inc. is considering two mutually exclusive projects, A and B. Project A costs $95,000
and is expected to generate $65,000 in year one and $75,000 in year two. Project B costs
$120,000 and is expected to generate $64,000 in year one, $67,000 in year two, $56,000 in
year three, and $45,000 in year four. Lithium, Inc.’s required rate of return for these projects
is 10%. The profitability index for Project B is:
a. 1.55
b. 1.39
c. 1.33
d. 1.48
25. When terminating a project for capital budgeting purposes, the working capital outlay required
at the initiation of the project will:
a. increase the cash flow because it is recaptured
b. decrease the cash flow because it is an outlay
c. not affect the cash flow
d. decrease the cash flow because it is a historical cost
 
1. A high degree of variability in a firm’s earnings before interest and taxes refers to:
a. business risk
b. financial leverage
c. operating leverage
d. financial risk
2. If a firm has no operating leverage and no financial leverage, then a 10% increase in sales will
have what effect on EPS?
a. EPS will increase by 10%
b. EPS will remain the same
c. EPS will increase by less than 10%
d. EPS will decrease by 10%
3. According to the moderate view of capital costs and financial leverage, as the use of debt
financing increases:
a. the cost of capital continuously increases
b. there is an optimal level of debt financing
c. the cost of capital remains constant
d. the cost of capital continuously decreases
4. The primary weakness of EBIT-EPS analysis is that:
a. it double counts the cost of debt financing
b. it applies only to firms with large amounts of debt in their capital structure
c. it may only be used by firms that are profitable this year
d. it ignores the implicit cost of debt financing
5. Potential applications of the break-even model include:
a. optimizing the cash-marketable securities position of a firm
b. replacement for time-adjusted capital budgeting techniques
c. pricing policy
d. All of the above.
Unit 4 Examination
191
BAM 313 Introduction to Financial Management
6. The Modigliani and Miller hypothesis does NOT work in the “real world” because:
a. interest expense is tax deductible, providing an advantage to debt financing
b. higher levels of debt increase the likelihood of bankruptcy, and bankruptcy has real costs
for any corporation
c. both a and b
d. dividend payments are fixed and tax deductible for the corporation
7. A corporation with very high growth prospects and many positive NPV projects to fund may
want to increase its dividend based on the:
a. very low agency costs of the corporation
b. information effect
c. tax bias against capital gains
d. residual dividend theory
8. Which of the following strategies may be used to alter a firm’s capital structure toward a higher
percentage of debt compared to equity?
a. stock split
b. stock repurchase
c. stock dividend
d. maintain a low dividend payout ratio
9. AFB, Inc.’s dividend policy is to maintain a constant payout ratio. This year AFB, Inc. paid
out a total of $2 million in dividends. Next year, AFB, Inc.’s sales and earnings per share are
expected to increase. Dividend payments are expected to:
a. increase above $2 million only if the company issues additional shares of common stock
b. decrease below $2 million
c. increase above $2 million
d. remain at $2 million
10. Which of the following is true?
a. In industries with volatile earnings, the residual dividend policy results in the most
consistent dividend stream.
b. If the clientele effect is correct, firms should follow a constant dividend payout ratio policy.
c. In general, the higher the number of positive NPV investment opportunities for a firm, the
lower the dividend payout ratio.
d. According to the informational content of dividends, an increase in dividends is always a
positive signal.
Unit 4 Examination
192
BAM 313 Introduction to Financial Management
11. Which of the following is always a non-cash expense?
a. salaries
b. depreciation
c. income taxes
d. None of the above.
12. Which of the following is a limitation of the “percent of sales method” of preparing pro forma
financial statements?
a. Inventory levels are seldom affected by changes in sales volume.
b. A firm’s investment in accounts receivable is seldom related to sales volume.
c. Not all assets and liabilities increase or decrease as a constant percent of sales.
d. The dividend payout ratio may change from one year to the next.
13. Spontaneous sources of funds refer to all of the below EXCEPT:
a. accounts payable
b. accruals
c. common stock
d. a bank loan
14. Selection of a source of short-term financing should include all of the following EXCEPT:
a. the effect of the use of credit from a particular source on the cost and availability of other
sources of credit
b. the floatation costs for debentures
c. the effective cost of credit
d. the availability of financing in the amount and for the time needed
15. The terminal warehouse agreement differs from the field warehouse agreement in that:
a. the cost of the terminal warehouse agreement is lower due to the lower degree of risk
b. the warehouse procedure differs for both agreements
c. the terminal agreement transports the collateral to a public warehouse
d. the borrower of the field warehouse agreement can sell the collateral without the consent
of the lender
Unit 4 Examination
193
BAM 313 Introduction to Financial Management
16. Your company buys supplies on credit terms of 2/10 net 45. Suppose the company makes a
purchase of $20,000 today. Which of the following payment options makes the most sense as
a general rule?
a. pay the bill as soon as possible to keep the supplier happy
b. pay the bill on day 10 to get the discount
c. either pay the bill on day 10 to get the discount, or wait until day 45
d. pay the bill on day 45 due to the time value of money
17. Which of the following statements about financial leverage is true?
a. Financial leverage is the responsiveness of the firm’s EBIT to fluctuations in sales.
b. Financial leverage is the responsiveness of the firm’s EPS to fluctuations in EBIT.
c. Financial leverage involves the incurrence of fixed operating costs in the firm’s income
stream.
d. Financial leverage reduces a firm’s risk.
18. Which of the following statements about combined (operating & financial) leverage is true?
a. Usage of both operating and financial leverage reduces a firm’s risk.
b. If a firm employs both operating and financial leverage, any percent change in sales will
produce a larger percent change in earnings per share.
c. High operating leverage and high financial leverage offset one another, meaning that if
sales increase by 10%, then EPS will also increase by 10%.
d. A firm that is in a capital-intensive industry should use a higher level of financial leverage
than a firm that employs low levels of operating leverage.
19. The “bird-in-the-hand dividend theory” supports which view of the effect of dividend policy on
company value?
a. constant dividends increase stock values
b. high dividends increase stock values
c. a firm’s dividend policy is irrelevant
d. low dividends increase stock values
20. All of the following will increase the discretionary financing needed EXCEPT:
a. decrease the dividend payout ratio
b. decrease the spontaneous financing
c. decrease the sales growth rate
d. decrease the net profit margin
Unit 4 Examination
194
BAM 313 Introduction to Financial Management
21. If a firm relies on short-term debt or current liabilities in financing its asset investments, and
all other things remain the same, what can be said about the firm’s liquidity?
a. The liquidity of the firm will be unchanged.
b. The firm will be relatively more liquid.
c. The firm will be relatively less liquid.
d. The firm will be more liquid only if interest rates are below the company’s weighted
average cost of capital.
22. Dakota Oil, Inc. reported that its sales and EBIT increased by 10%, but its EPS increased by
30%. The much larger change in earnings per share could be the result of:
a. high operating leverage
b. high financial leverage
c. high fixed costs of production
d. a high percentage of credit sale collections from prior years
23. Which of the following statements would be consistent with the bird-in-the-hand dividend
theory?
a. Dividends are less certain than capital gains.
b. Investors are indifferent whether stock returns come from dividend income or capital gains
income.
c. Wealthy investors prefer corporations to defer dividend payments because capital gains
produce greater after-tax income.
d. Dividends are more certain than capital gains income.
24. The term “lumpy asset” means:
a. assets that have economies of scale but not economies of scope
b. assets that must be purchased in discrete quantities
c. the same thing as assets that exhibit scale economies
d. assets that can be purchased in incremental units
25. All of the following are potential advantages of commercial paper EXCEPT:
a. ability to borrow very large amounts
b. flexible repayment terms
c. no compensating balance requirements
d. lower interest rates than comparable sources of short-term financing

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