Foundations of Finance Exam 1
Chapter 1 – 4
1.
Shareholder wealth maximization means maximizing the price of the existing common
stock.
A. T
B. F
2.
It is important to evaluate a corporate manager's financial decision by measuring the effect
the decision should have on the corporation's stock price if everything else were held constant.
A. T
B. F
3.
When making financial decisions, managers should always look at marginal, or incremental
cash flows.
A. T
B. F
4.
Cash flows and profits are synonymous; in other words, higher cash flows equal higher
profits.
A. T
B. F
5.
An efficient market is one where the prices of the assets traded in that market fully reflect all
available information at any instant in time.
A. T
B.
6.
F
While many factors contributed to the financial crisis of 2007 and beyond, it is safe to say
that real estate loans were NOT much of a contributing factor.
A. T
B. F
7. The five basic principles of finance include all of the following EXCEPT
A) Cash flow is what matters.
B) Money has a time value.
C) Risk requires a reward.
D) Incremental profits determine value
8.
To measure value, the concept of time value of money is used
A) to determine the interest rate paid on corporate debt.
B) to bring the future benefits and costs of a project, measured by its expected profits, back
to the present.
C) to bring the future benefits and costs of a project, measured by its cash flows, back to
the present.
D) to ensure that expected future profits exceed current profits today.
Foundations of Finance Exam 1
Chapter 1 – 4
9. Investors want a return that satisfies the following expectation(s):
A) A return for delaying consumption
B) An additional return for taking on risk
C) An additional return for accepting dividends rather than capital gains
D) Both A and B
10. The principle of risk-return trade-off means that
A) higher risk investments must earn higher returns.
B) an investor who takes more risk will earn a higher return.
C) a rational investor will only take on higher risk if he expects a higher return.
D) an investor who bought stock in a small corporation five years ago has more money than
an investor who bought U.S. Treasury bonds five years ago.
11. All of the following statements about agency problems are true EXCEPT
A) Agency problems interfere with the goal of maximizing shareholder value.
B) Agency costs are paid by the managers who do not act in the shareholders' best
interest.
C) Agency problems result from the separation of management and the ownership of a firm.
D) The root cause of agency problems is conflicts of interest.
12. In order to reduce agency problems, managers may be provided compensation that includes
A) a fixed salary so managers' pay is not at risk, allowing managers to focus on the
company's business.
B) a bonus based on the level of profit achieved during the year.
C) an option to buy the company's stock.
D) incentive pay for achieving higher sales than last year.
13. Investors generally don't like risk. Therefore, a typical investor
A) will not be induced to take on any risk.
B) will only take on the least risk possible.
C) will only take on additional risk if he expects to be compensated in the form of
additional return.
D) will only accept a zero return if the risk is zero.
14. Determining how a firm should raise money to fund its long-term investments is referred to
as capital structure decisions.
A. T
B. F
15. Determining the best way to raise money to fund a firm's long-term investments is called
A) the capital budgeting decision.
B) the portfolio decision.
C) the money flow processing decision.
D) the capital structure decision.
Foundations of Finance Exam 1
Chapter 1 – 4
16. S-type corporations and limited liability companies are taxed like partnerships, but have the
advantage of limited liability for their owners.
A. T
B. F
17. Joe is deciding whether or not to invest $10,000 in a business that has pending lawsuits
against it. If Joe invests and the business loses the lawsuits, the most Joe can lose is
A) $10,000 if Joe is a general partner.
B) $10,000 if Joe is a sole proprietor.
C) $10,000 if Joe is a limited partner.
D) $10,000 plus his share of the lawsuits if Joe is a limited partner.
18. The true owners of the corporation are the
A) holders of debt issues of the firm.
B) preferred stockholders.
C) board of directors of the firm.
D) common stockholders.
19. All of the following forms of business organizations provide limited liability to all owners
EXCEPT
A) limited liability company.
B) S-type corporation.
C) corporation.
D) limited partnership.
20. A corporation needing money will sell securities to investors in the secondary market.
A. T
B. F
21. Venture capita1ists typically provide funds to high –risk startup companies but take
no active role in their management .
A. T
B. F
22. Common stock is considered a short-term security because it has no maturity date and a
long-term security is one with a maturity date of more than one year.
A. T
B. F
23. Three ways that savings can be transferred through the financial markets to those in need
of funds include direct transfers, indirect transfers using the investment banker, and indirect transfers
using the financial intermediary.
A. T
B. F
Foundations of Finance Exam 1
Chapter 1 – 4
24. A seasoned equity offering is the sale of additional shares by a company whose shares are
already publicly traded.
A. T
B. F
25. An example of a primary market transaction is
A) a new issue of common stock by AT&T.
B) a sale of some outstanding common stock of AT&T by an investor.
C) AT&T repurchasing its own stock from a stockholder.
D) all of the above
26. The investment banker performs three basic functions: (1) underwriting, (2) distributing,
and (3) advising.
A. T
B. F
27. Which of the following statements concerning private placements is MOST correct?
A) Private placements do not involve investment bankers.
B) Although not selling the securities to the public, investment bankers may provide
advice on the evaluation of prospective buyers and the terms of sale for private placements.
C) Private placements are limited to stocks, not bonds.
D) More than half of all private placements are sold to federal, state, or local governments
or government agencies.
28. The real rate of return is the return earned above the
A) default risk premium.
B) risk-adjusted return.
C) inflation risk premium.
D) variability of returns measured by standard deviation.
29. You are considering an investment in a AAA-rated U.S. corporate bond but you are not
sure what rate of interest it should pay. Assume that the real risk-free rate of interest is 1.0%; inflation is
expected to be 1.5%; the maturity risk premium is 2.5%; and, the default risk premium for AAA rated
corporate bonds is 3.5%. What rate of interest should the U.S. corporate bond pay?
A) 8.5%
B) 6.0%
C) 5.0%
D) 2.5%
30. Common-sized income statements restate the numbers in the income statement as a
percentage of sales to assist in the comparison of a firm's financial performance across time and with
competitors.
A. T
B. F
31. The basic format of an income statement is
Foundations of Finance Exam 1
Chapter 1 – 4
A) Sales - Expenses = Profits.
B) Income - Expenses = EBIT.
C) Sales - Liabilities = Profits.
D)Assets-Liabilities= Profits
32. The increase in owners' equity for a given period is equal to
A) positive net cash flow minus dividends.
B) net income minus dividends.
C) sales minus dividends.
D) gross profit minus distributions to shareholders.
33. The accounting book value of an asset represents the historical cost of the asset rather
than its current market value or replacement cost.
A. T
B. F
34. A balance sheet is a statement of the financial position of the firm on a given date,
including its asset holdings, liabilities, and equity.
A. T
B. F
35. Liquidity refers to the ability to quickly convert an asset into cash without lowering the
selling price.
A. T
B. F
36. The two principal sources of financing for corporations are
A) debt and accounts payable.
B) debt and equity.
C) common equity and preferred equity.
D) cash and common equity.
37. Siskiyou, Inc. has total current assets of $1,200,000; total current liabilities of $500,000;
long-term assets of $800,000; and long-term debt of $600,000. How much is the firm's total equity?
A) $1,200,000
B) $800,000
C) $900,000
D) $2,000,000
38. What financial statement explains the changes that took place in the firm's cash
balance over a period?
A) statement of cash flow
B) balance sheet
C) income statement
D) reconciliation of free cash flow
Foundations of Finance Exam 1
Chapter 1 – 4
39. Examples of uses of cash include
A) paying cash dividends to stockholders.
B) borrowing an additional amount using a secured loan.
C) selling machinery.
D) all of the above
40. International Financial Reporting Standards (IFRS) is a set of principle-based
accounting standards that were established by the International Accounting Standards Board (IASB).
A. T
B. F
41. Theoretically, market values of assets are better for evaluating the creation of
shareholder wealth than accounting numbers, but accounting numbers are used because they are more
readily available.
A. T
B. F
42. Financial ratios are often reported by industry or line of business because differences
in the type of business can make ratio comparisons uninformative or even misleading.
A. T
B. F
43. Financial analysis
A) uses historical financial statements and is thus useful only to assess past
performance.
B) relies on generally accepted accounting principles to make comparisons between
companies valid.
C) uses historical financial statements to measure a company's performance and in
making financial projections of future performance.
D) is accounting record
44. If company A has a lower average collection period than company B, then company
A will have a higher accounts receivable turnover.
A. T
B. F
45. The current ratio of a firm would be increased by which of the following?
A) Land held for investment is sold for cash.
B) Equipment is purchased, financed by a long-term debt issue.
C) Inventories are sold for cash.
D) Inventories are sold on a credit basis
46. XYZ Corporation has a P/E ratio of 20 and EFG Corporation has a P/E ratio of 10. It is
likely that
A) XYZ's earnings per share are twice the earnings per share of EFG.
B) investors expect XYZ's earnings to grow faster than EFG's earnings.
Foundations of Finance Exam 1
Chapter 1 – 4
C) investors believe that for the same level of earnings growth, XYZ is a higher risk
company.
D) investors believe XYZ stock is overvalued.
47. Which of the following financial ratios is the best measure of the operating
effectiveness of a firm's management?
A) times interest earned
B) net profit margin
C) operating return on assets
D) operating efficiency quotient
48. Which of the following does NOT provide an indication of liquidity?
A) quick ratio
B) debt ratio
C) inventory turnover
D) average collection period
49. A firm that wants to know if it has enough cash to meet its bills would be most
likely to use which kind of ratio?
A) liquidity
B) leverage
C) efficiency
D) profitability
50. Which of the following has the most significant influence on return on equity?
A) common dividends
B) principal payments
C) accruals
D) operating income