Ch.1
1. Which of the following represent investment decisions that were made by Tim Hortons
during its expansion phase? (Select all that apply.)
a. Forming joint ventures with other companies
b. Raising money by increasing its bank loans
(Reason: Borrowing funds from a bank or raising capital by issuing shares is a financing decision)
c. Constructing a new manufacturing plant
d. Expanding its menu to include Timbits
2. Capital budgeting decisions involve both tangible and intangible assets.
3. The decision a firm makes to raise the money required for its investments and operations is
known as the _____.
a. investment decision
b. capital budgeting decision
c. capital expenditure decision
d. financing decision
4. What type of financing does a firm use that raises money by selling shares of stock?
a. Both debt and equity
b. Debt
c. Equity
d. Neither debt nor equity
5. In the context of capital structure decisions, the term capital refers to a firm's sources of
_____.
a. long-term financing
b. trade receivables
c. short-term financing
d. trade payables
6. The decision by Tim Hortons to expand outside of Canada is an example of a/an ________.
a. shareholder decision
b. financing decision
c. investment decision
7. A securities market is used to trade shares of public corporations.
8. Which of the following are intangible assets? (Select all that apply.)
a. Trademarks
b. Equipment
c. Land
d. Patents
9. The purpose of a corporation and how it is to be managed, financed, and governed is set out
in _____.
a. corporation deeds
b. articles of sole proprietorship
c. partnership agreements
d. articles of incorporation
10. One of the main responsibilities of a financial manager is to raise the money the firm needs
for its investments and operations. This is the _____.
a. investment decision
b. capital expenditure decision
c. financing decision
d. capital budgeting decision
11. Which of the following are advantages of sole proprietorships? (Select all that apply.)
a. ease of setting up
b. no taxation on profits
c. limited liability
d. little regulations
12. What type of financing does a firm that raises money by promising to pay back the investors'
cash plus interest use?
a. Neither debt nor equity
b. Debt
c. Equity
d. Both debt and equity
13. In the context of a partnership, _____ set out how business decisions are to be made and
how profits will be distributed among partners.
a. articles of incorporation
b. articles of a sole proprietorship
c. partnership agreements
d. partnership incorporation statements
14. The capital structure decision is the choice between _____.
a. buying short-term and long-term assets
b. investing in tangible and intangible assets
c. debt and equity financing
d. investing and financing
15. A corporation whose shares are not publicly traded is privately owned.
16. In a limited partnership, the partners who manage the business and have unlimited liability
are known as _____.
a. business associates
b. general partners
c. limited partners
d. friends
17. Which of the following are rights of a corporation? (Select all that apply.)
a. To borrow money
b. To enter into contracts
c. To vote on public issues
d. To avoid income taxes
e. To sue or be sued
18. Which type of liability are sole proprietorships are subjected to?
a. Incomplete
b. Shared
c. Limited
d. Unlimited
19. Financial managers are responsible for organizing and supervising the _____.
a. articles of incorporation
b. production line
c. audit team
d. capital budgeting process
20. A major disadvantage of a partnership is _____.
a. taxation
b. limited liability
c. permanence
d. unlimited liability
21. An individual most directly responsible for raising new capital for a corporation is the _____.
a. controller
b. treasurer
c. MD
d. CEO
22. In a limited partnership, the partners who do not manage the business and are liable only
for the money they contribute to the business are known as _____.
a. limited partners
b. friends
c. business associates
d. general partners
23. An individual who manages a corporation's internal budgets is called the _____.
a. MD
b. CEO
c. controller
d. treasurer
24. A permanent entity, legally distinct from its owners, who are called shareholders or
stockholders is known as a _____.
a. corporation
b. sole proprietorship
c. partnership
d. limited partnership
25. Individuals responsible for the significant corporate investment or financing decisions are
known as the _____.
a. financial managers
b. marketing managers
c. production managers
d. service line managers
26. What kind of decisions does a smart and effective financial manager make? (Select all that
apply.)
a. Decisions that increase the wealth of the company's shareholders
b. Decisions that increase the cash outflows compared to the cash inflows of the company
c. Decisions that increase the systematic risk of the company's shareholders
d. Decisions that increase the current value of the company's shares
27. An individual most directly responsible for maintaining a corporation's banking relationships
is called the _____.
a. MD
b. CEO
c. treasurer
d. controller
28. Conflicts of interest that arise between managers and a firm's shareholders are
called agency problems.
29. An individual who looks after a corporation's tax affairs is called the _____.
a. controller
b. treasurer
c. CEO
d. MD
30. Employee year-end cash bonus plans ________________ create agency problems.
a. sometimes
b. never
c. always
31. Good corporate governance requires that CEOs and financial managers have a/an
_____________ duty to stockholders.
a. fiduciary
b. indirect
c. passive
d. paternal
32. Treating the customers and employees of a firm fairly can maximize the value of the firm.
a. True
b. False
(Customers are more satisfied and employees are more loyal when treated fairly.)
33. The financial objective on which almost all shareholders can agree is to _____.
a. minimize corporate costs for the next three years
b. maximize corporate profits for the current year
c. minimize the risk by investing only in safe projects
d. maximize the current market value of their investment
34. How do investors make profits on a short sale?
a. They sell half their shares at one price and then the remainder at a lower price.
(averaging down)
b. They sell shares they own and then buy them back later at a lower price.
(a normal sale of shares and repurchase)
c. They borrow shares to sell and then buy back the shares back at a lower price.
35. Which of the following are considered Agency problems? (Select all that apply.)
a. Managers engaging in empire building.
b. Managers submitting claims for business expenses.
c. Managers purchasing luxurious corporate jets for business travel.
d. Managers refusing to take on moderate risky projects.
36. The best way for firms to persuade managers to act in the best interests of shareholders is
to ____________________.
a. give large payouts based on quarterly profits
b. tie their compensation to the firm's share price.
c. give them access to corporate jets and big spending accounts
d. pay the managers large year-end cash bonuses
37. Individuals who seek to carve up established companies, leaving them with heavy debt
burdens, basically in order to get rich quick are known as _____.
a. underwriters
b. tax avoiders
c. creative accountants
d. corporate raiders
38. The set of securities laws, regulations and corporate practices that protect shareholders and
other investors is called corporate _____________.
a. performance
b. financing
c. governance
39. By acting ethically, the firm can protect its __________________, which is one of its most
important assets.
a. cash reserves
b. reputation
c. level of debt
d. head office
40. Which of the following activities maybe included in the job of financial analysts?(Select all
that apply.)
a. Managing the manufacturing facilities
b. Arranging leases
c. Analyzing new investments
d. Raising capital
e. Developing the marketing strategy
41. Investors sometimes bet that securities they do not own will fall in price. They borrow the
security and sell it in the hope that they will be able to buy it back cheaply. This is known as
_____.
a. liquidation
b. underpricing
c. short selling
d. risk analysis
42. _____ target companies whose assets can be profitably sold and redeployed.
a. Corporate raiders
b. Shareholders
c. Sole proprietors
d. Insiders
43. Financial analysts are not involved in monitoring and controlling risk.
True False
Ch.5
1. A dollar invested today at 8.0 percent interest compounded annually will be worth _____
three years from now.
a. $1.2597 (FV = $1.00(1 + 0.08)3)
b. $1.1664
c. $1.08
2. A dollar invested today at 8.0 percent simple annual interest will be worth _____ three years
from now.
a. $1.2597
b. $1.16
c. $1.24 (FV = $1 + ($1 x .08 x 3)
3. When dealing with future value, the higher the rate of interest, the ___________ your
savings will grow.
a. larger
b. slower
c. smaller
4. Which of the following is the formula for calculating the future value (FV) if you have invested
PV at r% interest per annum for t years?
a. FV = PV(1 + r)t
b. FV = PV(1 + rt)
c. FV = PV(1 + r)t
d. FV = PV(1 + r)/t
5. The current value of a future cash flow is referred to as the _____.
a. present value
b. real value
c. past value
d. inflated value
6. A dollar invested today at 7.5 percent interest compounded annually will be worth _____ one
year from now.
a. $1.075 (FV = $1.00(1 + 0.075)1)
b. $1.0075
c. $1.75
7. If the interest rate on an investment is 5%, then the present value of $300 received after
three years from today equals $ _____.
a. 155.15
b. 335.25
c. 259.15 (PV = $300 x 1/(1 + .05)3)
8. The rate of return used to calculate the present value is also known as the _____.
a. discount rate
b. inflation rate
c. growth rate
d. exchange rate
9. Assume that an investor has $100 to invest today. Investing it at 5% interest compounded
annually will yield _____ in 10 years, while investing it at 6% interest compounded annually will
yield _____ in 10 years.
a. $162.89; $175.00
b. $162.89; $179.08 (FV = $100 x (1 + .05)10, FV = $100 x (1 + .06)10)
c. $179.08; $179.08
d. $179.08; $162.89
10. For a given future value and discount rate, the present value will _____ as the number of
time periods _____.
a. decrease; increase
b. decrease; decrease
c. increase; increase
d. remain constant; increase
11. The formula I × (1 + r)t is used to calculate the _____.
a. intrinsic value
b. present value
c. future value
d. book value
12. You are offered an investment that will return $1000 to you 5 years from now on a payment
of $750 today. What is the annual interest rate implicitly promised on this investment?
a. 7.50 percent
b. 6.54 percent
c. 5.75 percent
d. 5.92 percent
$750 = $1000 x 1/(1+r)5
$.75 x (1+r)5 = $1000
(1+r)5 = 1.3333
(1+r) = (1.3333)1/5
R = .0592
13. True or false: The present value will help us determine the amount to be invested today in
order to produce certain amount in the future.
a. True
b. False
14. The easiest way to solve for the investment period (t) if given the interest rate (r), future
value (FV) and present value is to ______________.
a. use the present value interest factor table
b. use the future value interest factor tables
c. use a financial calculator
d. rearrange the present value formula and solve for number of periods
15. If the interest rate on an investment is 10%, then what is the present value of $100 received
after one year from today?
a. $86.78
b. $90.91(PV = $100 / 1.10)
c. $90.00
d. $110.00
16. Most real-world investments involve _____________ over time.
a. a single cash flow
b. many cash flows
c. negative cash flows
17. The discount rate is the _____.
a. interest rate charged by a country's federal bank on loans and advances
b. rate of interest used to compute the interest earned only on an investment
c. annual growth rate of an investment over a specified period of time
d. interest rate used to compute present values of future cash flows
18. Assume that an investor deposits $1000 in an account today and $100 every year for the
next three years. The account pays interest at 6%. How much money would the investor have at
the end of year 4?
a. $1,493.94
b. $1,399.44
c. $1,527.99
d. $1,599.94 ($1000(1.06)4 + $100(1.06)3 + $100(1.06)2 + $100(1.06)1 = $1,599.94)
19. For a given number of time periods and future value, the present value will _____ if the
interest rate _____.
a. stay the same; increases
b. decrease; increases
c. decrease; decreases
d. increase; increases
20. A traditional (non-growing) annuity consists of a(n) _____ stream of cash flows for a fixed
period of time.
 level
21. You are given the number of time periods (t), future value (FV), and present value (PV).
Which of the following is the correct equation to solve for the interest rate r?
a. r = (FV / PV)t – 1
b. r = (FV / PV)1/t – 1
c. r = (FV / PV) – 1
d. r = FV / PV + t
22. A perpetuity is a constant stream of cash flows for a(n) _____ period of time.
a. infinite
b. certain
c. finite
d. random
23. Sam invests $4,000 in a mutual fund with the aim of receiving $8,000 at the end of the
investment's life. Assuming the rate of interest on the investment to be 9%, identify the true
keystrokes for input values while finding the length of time of the investment.
a. 9 i, $4,000 FV, –$8,000 PV, 0 PMT
b. 9 i, $8,000 FV, –$4,000 PV, 0 PMT
c. 9 i, –$4,000 FV, $8,000 PV, 0 PMT
d. 9 i, –$8,000 FV, $4,000 PV, 0 PMT
24. Which of the following is the formula to calculate the present value of a perpetuity?
a. PV of perpetuity = 1 / r
b. PV of perpetuity = C × r
c. PV of perpetuity = C / r
d. PV of perpetuity = 1 / r(1+r)
25. Real-world investments often involve many payments received or paid over time. Managers
refer to this as a(n) _____.
a. stream of cash flows
b. cash flow bonus
c. payment sequence
d. amortized cash flow
26. The present value of a perpetuity whose payments of $500 per year start at the end of year
2 when interest rates are 7% is ____________.
 6675.57 (500 x (1/.07) x 1/1.07)
27. Assume that an investor deposits $100 at the end of year 1, $200 at the end of year 2, and
$300 at the end of year 3. If the investor can earn a 7.5% rate of interest, what will the future
value of this stream of cash flows be at the end of 3 years?
 $630.56 ($100(1.075)2 + $200(1.075)1 + $300)
28. How much is $200 of payment each year forever at 10% per year worth today?
a. $7,621.09
b. $3,294.12
c. $1,228.91
d. $2,000.00 ($200/.10)
29. An equally spaced, level stream of cash flows that ends after a specified time period is called
a(n) _____.
a. perpetuity
b. annuity
c. net present value
d. consol
30. Which of the following is the correct equation for calculating the present value (PV) of
an annuity that pays C dollars a year for each of t years at r% interest?
a. PV = C / (1 + r)t – C / r
b. PV = C / r
c. PV = C / rt
d. PV = C[1 / r – 1 / r(1 + r)t]
31. Which of the following is a perpetuity?
a. A growing stream of cash payments that never ends
b. A stream of level cash payments for a fixed period
c. A stream of level cash payments that never ends
d. A declining stream of cash flows for a fixed period
32. What is the present value of an ordinary annuity that pays $100 per year for three years at
an interest rate of 10% per year?
a. $288.88
b. $248.69 (100[(1 /.10) – (1 /(.10(1.10)3))] = 248.69)
c. $269.73
d. $300.00
33. The formula for the present value (PV) of a(n) _____ is PV = C / r, where C is the constant
and regularly timed cash flow to infinity, and r is the interest rate.
a. growing annuity
b. annuity
c. perpetuity
d. growing perpetuity
34. Calculate the future value of an annuity of $600 per year for 6 years at 12 percent per year.
a. $4869.11 ($600 × [1.126 – 1] / .12)
b. $4382.20
c. $1593.74
35. If a perpetuity's payments do not begin for several years, this is called a ____________
perpetuity.
a. value-added
b. deferred
c. weak
d. ordinary
36. Which of the following is the correct equation for calculating the future value (FV) of an
annuity that pays C dollars a year for each of t years at r% interest?
a. FV = C[1/r - 1/r(1+r)t]
b. FV = C[(1+r)t - 1]/r
c. FV = C/r - C/(1+r)
d. FV = C[1/r - 1/rt]
37. Identify the mathematical expression for the t-year annuity factor.
a. 1 / (1 + r)t
b. 1 / rt
c. 1 / r - 1 / r(1 + r)
d. 1 / r - 1 / r(1 + r)t
38. The present value of $100 paid annually for 20 years at 10% interest per year is _____.
a. $2,000.00
b. $1,422.53
c. $851.36 (100[(1/.10)-(1/(.10(1.10)20))])
d. $1,880.09
39. Find the future value of an annuity of $100 per year for 10 years at 10 percent per year.
a. $1,437.60
b. $1,682.09
c. $1,755.25
d. $1,593.74 ($100 × [1.1010 - 1]/.10)
40. The present value of a perpetuity whose payments of $500 per year start at the end of year
2 when interest rates are 7% is ____________.
a. 7642.86
b. 8345.57
c. 7142.86
d. 6675.57 (500 / .07 x 1.07)
41. The future value of a 5-year annuity paying $400 at the end of each year when interest rates
are 6% is equal to __________.
a. 2255 (400 x (1.06)5−1.06(1.06)5-1.06)
b. 2957
c. 2256
Ch.5 (Part II)
1. The formula for the present value (PV) of a(n) _____ is PV = C / r, where C is the constant and
regularly timed cash flow to infinity, and r is the interest rate.
a. growing annuity
b. growing perpetuity
c. annuity
d. perpetuity
2. If a perpetuity's payments do not begin for several years, this is called a ____________
perpetuity.
a. ordinary
b. weak
c. deferred
d. value-added
3. How much is $100 at the end of each year forever at 10% interest worth today?
a. $7,621.09
b. $9,255.75
c. $8,830.14
d. $1,000
4. Identify the mathematical expression for the t-year annuity factor.
a. 1 / rt
b. 1 / (1 + r)t
c. 1 / r - 1 / r(1 + r)t
d. 1 / r - 1 / r(1 + r)
5. What is the present value of an ordinary annuity that pays $100 per year for three years at an
interest rate of 10% per year?
a. $248.69 (100[(1 /.10) – (1 /(.10(1.10) 3))] = 248.69)
b. $300.00
c. $288.88
d. $269.73
6. A series of level stream of cash flows starting immediately for a specified period of time is
called a(n) _____.
a. corporate bond
b. annuity due
c. perpetuity due
d. delayed annuity
7. The present value of a perpetuity whose payments of $500 per year start at the end of year 2
when interest rates are 7% is ____________.
a. 7142.86
b. 7642.86
c. 6675.57 (500 / (.07) x (1.07)1 = 6675.57)  C / 1r x 1(1+r)t-1
d. 8345.57
8. The relationship between the present value of an ordinary annuity (PV ord) and the present
value of an annuity due (PVdue) is given by the equation _____.
a. PVdue = PVord(1 + r)t
b. PVord = PVdue(1 + r)
c. PVdue = PVord(1 + r)
d. PVdue = PVord(1 + r)t
9. Find the future value of an annuity of $100 per year for 10 years at 10 percent per year.
a. $1,593.74 ($100 × [1.1010 - 1]/.10 = $1,593.74)
b. $1,682.09
c. $1,437.60
d. $1,755.25
10. Which of the following is the correct equation for calculating the present value (PV) of
an annuity that pays C dollars a year for each of t years at r% interest?
a. PV = C / (1 + r)t – C / r
b. PV = C / r
c. PV = C / rt
d. PV = C[1 / r – 1 / r(1 + r)t]
11. Which of the following is the correct equation for calculating the future value (FV) of an
annuity that pays C dollars a year for each of t years at r% interest?
a. FV = C[1/r - 1/r(1+r)t]
b. FV = C/r - C/(1+r)
c. FV = C[1/r - 1/rt]
d. FV = C[(1+r)t - 1]/r
12. The present value of $100 paid annually for 20 years at 10% interest per year is _____.
 $851.36 (100[(1/.10)-(1/(.10(1.10) 20))])
13. The present value of a perpetual stream of payments growing at a constant rate is given by
the expression _____, where C1 is the payment to occur at the end of the first period, r is the
discount rate, and g is the growth rate of the payments.
a. r - g / C1
b. C1 / r + g
c. r + g / C1
d. C1 / r - g
14. True or false: An ordinary annuity is a series of level payments that will begin immediately.
a. True
b. False
15. If the growth rate of a growing annuity is zero, then the present value of that growing
annuity becomes the same as a present value of a/an ______________.
a. delayed annuity
b. annuity due
c. ordinary annuity
d. ordinary perpetuity
16. The present value of an annuity due will always be ___________ the present value of an
ordinary annuity, if interest rates are greater than 0%.
a. the same as
b. greater than
c. less than
17. Inflation can be defined as _____.
a. an increase in the price of imports caused by government tariffs
b. an increase in the purchasing power of an individual
c. an overall general rise in prices
d. a rise in interest rates during an economic boom
18. Calculate the future value of an annuity of $600 per year for 6 years at 12 percent per year.
a. $5356.02
b. $4382.20
c. $1593.74
d. $4869.11 ($600 × [1.126 – 1] / .12 = $4869.11)
19. In 2018, the consumer price index (CPI) was about 2.5 times its level in 1981. If the cost of
one semester of college was $5000 in 1981, what should the nominal cost of a semester of
college be in 2018, assuming that the real price is constant?
a. $10,000
b. $12,000
c. $2,000
d. $12,500 (2.5 x $5000= $12,500)
20. The future value of a 5-year annuity paying $400 at the end of each year when interest rates
are 6% is equal to __________.
a. 2256
b. 2957
c. 2255 (400 x (1.06)5−1.06(1.06)5-1/.06 =2255)
d. 2482
21. Which of the following is true of the nominal interest rate?
a. The rate at which money invested grows
b. The purchasing power-adjusted rate of a dollar
c. The rate used to compute present values of future cash flows
d. The rate at which the purchasing power of an investment increases
22. An infinite stream of cash flows growing at a constant rate is called a(n)
Growing perpetuity.
23. A finite stream of cash flows growing at a constant rate is sometimes referred to as a(n)
Growing annuity.
24. The rate at which the purchasing power of an investment increases is known as the
Real interest rate.
25. The overall increase in the level of prices means that purchasing power of money has
_____________.
a. decreased
b. increased
26. In 2018, the consumer price index (CPI) was about 2.5 times its level in 1981. If the price of a
pack of cigarettes was $1.00 in 1981 and $5.00 in 2018, then the real price has _____ by
________ since 1981.
a. not changed, $0.00
b. decreased, $5.00
c. increased; $2.50
d. increased; $5.00
27. If the nominal interest rate is 6% and the real interest rate is 3%, then inflation must be
_______.
a. 2.9% (Inflation rate = 1.06/1.03 - 1 = 2.9%)
b. 4.1%
c. 1.3%
d. 9%
28. The rate quoted by Big Bank on a car loan is 8 percent. The annual rate of inflation is
currently 1.5 percent. What is the approximate real interest rate paid by the consumer on this
loan?
a. 8 percent
b. 12 percent
c. 9.5 percent
d. 6.5 percent (8 - 1.5 = 6.5 percent)
29. True or false: The nominal interest rate is defined as the interest rate quoted today by a
financial institution on a loan or investment.
a. True
b. False
30. The real interest rate is defined as _____.
a. the final rate of interest applied to an investment or loan after the deduction of fees
b. the interest rate set by the Federal Reserve Bank through open market operations
c. the rate of interest at which the money invested grows
d. the rate at which the purchasing power of an investment increases
31. When solving for present value of a future cash flow, if you discount the nominal future cash
flow by the nominal rate; or the real future cash flow by the real interest rate, your answers will
be ____________.
a. incorrect
b. different
c. identical
32. The equation (1 + effective annual rate) = _____.
a. (1 + monthly rate) × 12
b. (1 + monthly rate)12
c. (1 + monthly rate) / 12
d. (1 – monthly rate)
33. The equation to calculate the real interest rate uses both the inflation rate and the
___________ interest rate.
a. nominal
b. Bank of Canada
c. CPI adjusted
34. A mortgage company is advertising a 30 year fixed rate mortgage with monthly payments
and an annual percentage rate (APR) of 3.0 percent. What is the effective annual rate of this
loan?
a. 3.10 percent
b. 3.04 percent (EAR= (1 + 0.03/12)12 - 1 = 3.04 percent)
c. 2.75 percent
d. 3.00 percent
35. What is the annual percentage rate (APR) that a bank will quote for a bank account that pays
a monthly interest rate of 0.50% on deposits?
a. 3%
b. 0.50%
c. 12%
d. 6% (12 × 0.5 = 6%)
36. Your neighborhood bank is offering investors a money market account that pays 3.5 percent
interest on deposits. If the current annual rate of inflation is 1.2 percent, how much is the exact
real rate for this account?
a. 3.05 percent
b. 2.80 percent
c. 2.30 percent
d. 2.27 percent ([1.035/1.012] - 1 = 2.27 percent)
37. When monthly rates are multiplied by 12, the resulting rate is a/an ___________.
a. annual percentage rate
b. effective annual rate
c. real annual rate
38. Which of the following statements are true of the present value of a stream of cash
payments? (Check all that apply.)
a. Real cash payments should be discounted using a real interest rate.
b. Nominal cash payments should be discounted using a nominal interest rate.
c. Real cash payments may be discounted using a nominal rate.
d. Nominal cash payments may be discounted using a real rate.
39. If you financed your car with a loan requiring monthly payments. If the effective annual rate
(EAR) is 12%, then the per-period rate is _____.
a. 0.95% (Since it is an EAR, the monthly rate = (1.12) 1/12 - 1 = 0.95%)
b. 1%
c. 1.05%
40. Which of the following is the definition of an effective annual rate (EAR)?
a. It is the interest rate that is annualized using real interest.
b. It is the interest rate that is annualized using compound interest.
c. It is the interest rate that is annualized using simple interest.
41. What is the effective annual rate of an investment if a bank offers a savings account with an
annual percentage rate (APR) of 9 percent and the interest is calculated monthly?
a. 9.38 percent (EAR=(1 + 0.09/12)12 - 1 = 9.38 percent)
b. 9.30 percent
c. 9.25 percent
d. 9.00 percent
42. What is the monthly interest rate on a loan on which a bank quotes an annual percentage
rate (APR) of 12 percent?
a. 1 percent (.12 / 12 = 1 percent)
b. 1.25 percent
c. 15 percent
d. 1.5 percent
43. The annual percentage rate (APR) on a loan or investment is defined as _____.
a. the annually compounded rate of interest
b. a rate that is changed every year by the Federal Reserve Bank
c. the rate applied to the loan or investment balance per year
d. the interest rate that is annualized using simple interest
44. A bank charges you an annual percentage rate of 8% compounded monthly, then the perperiod rate is _____.
a. 0.54%
b. 0.67% (per-period rate = 8%/12 = 0.67%)
c. 5.41%
d. 6.67%
Ch.6
1. Bond valuation involves discounting both the fixed interest payments and principal amount
using a ____________ calculation.
a. time-value-of money
b. multiplication
c. simple addition
2. What is the payment at the maturity of the bond called? (Check all that apply.)
a. Face value
b. Maturity value (also called principal)
c. Coupon value
d. Personal value
3. The coupon rate is calculated as a fixed annual percentage of the bond's _________.
a. face value
b. call value
c. market value
4. The bond price excluding the accrued interest is referred to as the _____.
a. face value
b. present value
c. dirty price
d. clean price
5. The discount rate that is used in the calculation of the present value of a bond's cash flows is
also known as the _________.
a. overnight lending rate
b. coupon rate
c. market interest rate
6. Which of the following cash flows are received by a bond investor? (Select all that apply.)
a. regular dividends
b. fixed interest payments
c. principal at maturity
d. stock splits
7. Using a financial calculator, find the price of a 6% annual-paying coupon bond that matures in
5 years and the market interest rate is 7%. The par value is $1000.
a. 1017.25
b. 1000
c. 959.00
* 5 for n; 7 for I or I/Y; 1000 for FV; and 60 for PMT, then CMP PV
8. The interest payment to a bondholder is called the bond's _____.
a. par value
b. face value
c. coupon
d. dividend
9. A company issues a $1,000 bond that matures in 5 years. The bond's coupon rate is 6%, and
the market interest rate is 6%. The bond's current selling price is _____.
a. $1,020
b. $1,000
c. $980
d. $998
* When the bond coupon rate and the market interest rate are the same, the bond will sell for
face value. No calculations are necessary.
10. Annual interest payment on a bond, as a percentage of its face value is known as the bond's
coupon rate.
11. When the market interest rate is below the coupon rate of a bond, the bond sells _____.
a. for more than face value
b. at a discount
c. at face value
d. for less than face value
12. he bond price including the accrued interest is known as the _____.
a. face value
b. dirty price
c. present value
d. clean price
13. The market interest rate that is used to value a bond is also called the ____________.
(Select all that apply.)
a. bond's yield to maturity
b. coupon rate
c. discount rate
d. opportunity cost of funds
e. overnight lending rate
14. Using a financial calculator, find the price of a 5% annual-paying coupon bond that matures
in 3 years and the market interest rate is 4%. The par value is $1000.
a. 1027.75
b. 1000
c. 997.53
* 3 for n; 4 for I or I/Y; 1000 for FV; and 50 for PMT, then CMP PV
15. A change in market interest rates has a _________ impact on the value of shorter-term
bonds.
a. smaller
b. greater (for long-term)
c. neutral
16. When the market interest rate is the same as the coupon rate of a bond, the bond will sell
_____.
a. for more than face value
b. for less than face value
c. at face value
d. at a discount
17. Annual coupon payment divided by a bond's price is called ______________.
a. current yield
b. dividend yield
c. yield to maturity
18. When the market interest rate exceeds the coupon rate of a bond, the bond sells _____.
a. for more than face value
b. for less than face value
c. at face value
d. at a premium
19. A measure of return that takes account of both coupon yield and the change in a bond's
value over its life is a standard measure known as the _____.
a. coupon rate
b. current rate of interest
c. yield to maturity
d. current yield
20. The discount rate that is used in the calculation of the present value of a bond's cash flows is
also known as the _________.
a. market interest rate
b. overnight lending rate
c. coupon rate
21. Dixie Inc. sells 10-year bonds for $973.55. The bonds have a face value of $1,000 and a
coupon rate of 8%. Interest is paid semi-annually. The bond's yield to maturity is _____. (Use
your financial calculator.)
a. 8.00%
b. 4.20%
c. 7.52%
d. 8.40% (4.2% x 2)
22. A change in the market interest rate has a larger impact on ____________.
a. short-term bonds
b. long-term bonds
23. At the start of the year, an individual invested $1,000 in a bond with an annual coupon
payment of $12. The price of the bond increased to $1,400 by the year-end. What is the rate of
return on this bond?
a. 39%
b. 12%
c. 40%
d. 41.2%
24. A 7% annual coupon paying bond with a face value of $1000 and market price of $950 has a
current yield of _______.
a. 7.37% (70/950)
b. 8.25%
c. 7.0%
d. 13.57%
25. For an individual who buys bonds in Canada, any capital gains incurred when the bond is
sold will be taxed at _____________.
a. 50% of the personal tax rate
b. 25% of the personal tax rate
c. 100% of the personal tax rate
26. When calculating a multi-period rate of return for a bond, the yield-to maturity approach is
the same as calculating the bond's ___________________,
a. total coupon income
b. internal rate of return
c. capital gains
d. current yield
27. The interest rate for which the present value of a bond's payments equals the price is known
as the _____.
a. yield to maturity
b. current yield
c. coupon rate
d. current rate of interest
28. The graph of the relationship between time to maturity and yield to maturity, for bonds that
differ only in their maturity dates is known as the _____.
a. total credit cost curve
b. total revenue curve
c. yield curve
29. Marley Corporation's bonds have four years left to maturity. Interest is paid annually, and
the bonds have a $1,000 par value and a coupon rate of 5%. If the current price of the bond is
$1000, its yield to maturity (YTM) will be _____.
a. 10%
b. 5%
c. 12%
d. 8%
* If a bond's market price = par value, then the bond's YTM will be equal to the coupon rate
30. The total income per period per dollar invested is known as the _____.
a. coupon rate
b. maturity rate
c. yield to maturity
d. rate of return
31. On which of the following does the real interest rate on Canada bonds depend? (Check all
that apply.)
a. Nominal interest rate
b. Bond prices
c. Common stock prices
d. Rate of inflation
32. An investor bought a 4.5% annual coupon bond for $1,000 and sold it 1 year later for
$1,050. If her personal tax rate is 35% what is the after-tax coupon income on her 1-year
investment?
a. $29.25 ($45 x (1-.35) = $29.25)
b. $45
c. $25
d. $15.75
33. On which of the following do real interest rates depend? (Check all that apply.)
a. Supply of savings
b. Demand for new investment
c. Supply of new investment
d. Demand for savings
34. If an investor bought a 6% annual coupon bond for $1,020 and sold it 2 years later for
$1,080, the annual rate of return on her 2-year investment will be _____. (Use your calculator
and the yield to maturity approach which assumes coupons are reinvested.)
a. 11.76%
b. 17.65%
c. 10.65%
d. 8.70%
* FV=1080 PV=-1000 PMT=60 n=2 COMP I/Y = 8.70%
35. The relationship between bond yields and maturity is called the yield curve or the
____________________.
a. after-tax return of bonds
b. term structure of interest rates
c. international bond swap
36. The additional yield on a bond that investors require for bearing credit risk is known as the
_____.
a. interest rate premium
b. nominal yield
c. default premium
d. market yield
37. Mortor Corporation sells 6-year bonds for $1,073.55. The bonds have a face value of $1,000
and a coupon rate of 8%. Interest is paid semi-annually. The bond's yield to maturity is _____.
(Use your financial calculator.)
a. 6.50% (3.25 x 2)
b. 8.00%
c. 8.26%
d. 7.52%
38. Zero coupon bonds are usually sold at prices considerably __________ than the face value
of the bond.
a. higher
b. lower
39. If the nominal rate of interest is 10% and the rate of inflation is 3%, the real interest rate is
will be _____. (Round your answer to one decimal place.)
a. 6.8% (1.1/1.03-1)
b. 7.3%
c. 13.0%
40. Coupons on a strip bond are separated from the bond and the remaining principal amount
is called a _____________.
a. strip coupon bond
b. strip bond residual
c. discount coupon bond
41. According to the Fisher effect, which of the following determine the nominal interest rate?
(Check all that apply.)
a. Real interest rate
b. Current rate of inflation
c. Expected rate of inflation
c. Coupon rate
42. Bonds whose coupon payments are not fixed, but are tied to some measure of current
market interest rates are called ____________________.
a. strip bonds
b. convertible bonds
c. zero-coupon bonds
d. floating-rate bonds
43. A convertible bond provides the bondholder the option of converting the bond into a fixed
number of ________.
a. preferred shares
b. strip bonds
c. common shares
d. higher coupon bonds
44. The risk that a bond issuer will not pay the coupons or repay the face value of its bonds is
known as _____.
a. the default risk
b. the default premium risk
c. risk aversion
d. risk deflection
45. Bonds which can be redeemed by the issuer before maturity are called ____________.
a. zero coupon bonds
b. strip bonds
c. callable bonds
d. convertible bonds
46. Bonds that do not pay a coupon and whose return is based on only the difference between
the purchase price and the payment of face value at maturity are called zero coupon bonds.
47. If bonds are at a high risk of being redeemed early by the issuer, investors will calculate
the yield to call with the __________ replacing face value.
a. call price
b. strip price
c. conversion price
48. For strip bonds, the coupons are split from the bond and are sold separately as zero-coupon
bonds called __________________.
a. strip bond residuals
b. discount coupon bonds
c. strip coupon bonds
49. Sukuk securities are securities most similar to ___________ and exceed $44 billion in market
capitalization.
a. preferred shares
b. bonds
c. common shares
50. Coupons on floating-rate bonds are usually reset every ________.
a. six months
b. day
c. month
d. year
51. Investors of convertible bonds are will accept a _______ coupon rate due to the inclusion of
the conversion feature.
a. higher
b. floating
c. zero
d. lower
52. The specific price at which a bond can be redeemed early by the issuer during certain time
periods called the __________ price.
a. conversion
b. discount
c. strip
d. call
53. If bonds are at a high risk of being redeemed early by the issuer, investors will calculate the
_________________.
a. yield to maturity
b. yield to conversion
c. yield to call
54. Fixed-income paying bonds are not permitted in Islam because Islamic laws prohibit the the
charging of and/or paying of ______________.
a. tangible assets
b. rent
c. interest
Ch.14 (Part I)
1. Since interest payments on debt are paid out of before-tax income, debt reduces the _____
of the firm.
a. tax liability
b. asset base
c. operating expenses
d. operating income
2. If the annual coupon on a fixed-interest loan is 12% and the amount borrowed is $1000, how
much will the annual interest payment be?
a. $12
b. $120
c. $100
d. $1200
3. Which of the following best describes the prime rate?
a. It is the interest rate charged by banks to large customers with very good credit.
b. It is the same as the Treasury bill rate.
c. It is the interest rate paid by creditworthy homeowners for a mortgage.
d. It is the interest rate paid by banks on savings accounts that hold a large minimum balance.
4. Debt that is repayable in more than one year from the date of issue is called _____ debt, or
_____ debt.
a. funded; short-term
b. funded; long-term
c. unfunded; short-term
d. unfunded; long-term
5. When a sinking fund is present, investors are prepared to lend at a _____ rate of interest for
that bond.
a. higher
b. prime
c. lower
d. normal
6. As interest payments on debt are paid out of _____ income and dividends are paid out of
_____ income, debt has a tax advantage over equity.
a. gross; net
b. after-tax; before-tax
c. before-tax; after-tax
d. operating; taxable
7. For zero coupon bonds, the issuing firm makes _____ at _____.
a. twelve interest payments; monthly intervals
b. one interest payment; the start
c. one interest payment; annual intervals
d. one interest payment; maturity
8. Loans with floating rate interest payments are usually tied to benchmark rates such as the
_____ or _____.
a. corporate bond rate; LIBOR (London Interbank Offered Rate)
b. subprime rate; LIBOR (London Interbank Offered Rate)
c. prime rate; subprime rate
d. prime rate; LIBOR (London Interbank Offered Rate)
9. A bond that can be repurchased from investors before the maturity date is referred to as a
_____ bond.
a. desirable
b. callable
c. refundable
d. repurchasable
10. Debt that is due in less than one year from the date of issue is called _____ debt, or _____
debt.
a. funded; long-term
b. unfunded; short-term
c. unfunded; long-term
d. funded; short-term
11. In order to be prepared to repay a bond's principal at maturity, a firm may annually put
aside a sum of cash into a _____ fund.
a. savings
b. contingency
c. slush
d. sinking
12. A bond refunding decision is usually made when market interest rates _________.
a. increase
b. decline
13. Subordinated debt is debt that has a junior claim to assets and, in the event of default, is
only paid after _______ are paid.
a. senior debtholders
b. common shareholders
c. preferred shareholders
14. The fixed interest payment on most long-term loans is called the _____.
a. risk
b. debt
c. coupon
d. security
15. A _____ is a debt that has first claim on specified collateral in the event of default.
a. subordinated debt
b. weighted debt
c. nominal debt
d. secured debt
16. The price that the issuing firm will pay investors for a callable bond that is being recalled is
known as the _____.
a. call price
b. par value
c. face value
d. market price
17. In a _____, a bond is sold directly to a small number of qualified institutional investors and
may only be resold to other qualified institutional investors.
a. special placement
b. limited investment
c. direct investment
d. private placement
18. Debt that is repayable in more than one year from the date of issue is called _____ debt, or
_____ debt.
a. unfunded; short-term
b. unfunded; long-term
c. funded; short-term
d. funded; long-term
19. Every year, billions of dollars of mortgages, credit card loans and receivable are
packaged every year, or ________, and resold as asset-back bonds.
a. redeemed
b. converted
c. securitized
20. _____ is replacing an old bond issue with a new one by the firm.
a. Conversion
b. Refunding
c. Substitution
21. A convertible bond is a _____.
a. new bond issued by the firm to replace an old bond
b. bond that may be repurchased by the firm before maturity at a specified call price
c. bond that the holder may exchange for a specified amount of another security
d. bond issued in the currency of one country for which the borrower is from another country
22. Debt that may be repaid in bankruptcy only after senior debt is paid is
called subordinated debt.
23. The assets set aside by a company as security for a loan are collateral termed .
24. ___________ bonds are sold to anyone who wishes to buy and can be freely traded
afterward in the securities markets.
a. Private placement
b. Lease agreement
c. Publicly issued
25. In case of asset-backed securities, the borrower sets aside a group of assets and the income
from these assets is then used to service the debt.
26. A bond that may be converted entirely into shares of stock at the discretion of the
bondholder is called a(n) _____ bond.
a. convertible
b. eurobond
c. optional
d. callable
Ch.7
1. Which type of investor is entitled to the residual cash flows of a company?
a. bondholders
b. employees
c. preferred shareholders
d. common shareholders
2. When a company offers shares for sale to the public for the first time, the sale is called a/an
_________________.
a. secondary public offering
b. seasoned equity offering
c. initial public offering
3. Which of the following is true of a secondary market?
a. A secondary market is a market for new securities.
b. In a secondary market, the financial securities are issued by a company directly to investors.
c. In a secondary market, small investors have a lower chance of buying or selling securities
because they are excluded from the IPOs.
d. A secondary market is a market in which already issued securities are traded among
investors.
4. True or false: The price-earnings multiple or the P/E ratio can be viewed as the price that a
buyer of a share is willing to pay per dollar of the firm's earnings.
a. True
b. False
5. The book value of a firm's equity refers to _____.
a. the net proceeds that would be realized by selling the firm’s assets and paying off its creditors
b. the net worth of the firm according to the balance sheet
c. the current market price at which a share of the common stock is being traded by investors.
d. the total dollar value of all of the firm's outstanding shares and liabilities.
6. When an investor purchases a share of a firm's common stock, what does he or she receive in
return? (Select all that apply.)
a. A share in the company's future successes and setbacks
b. A guarantee of future dividends
c. A guaranteed constant increase in the market value of the share
d. An ownership share in the firm
7. The liquidation value of a firm equals _____.
a. the net proceeds that would be realized by selling the firm's assets and paying off its
creditors.
b. the net worth of the firm according to the balance sheet.
c. the difference between the firm's market value and book value.
d. the total dollar market value of all of the firm's outstanding shares.
8. A transaction in which a firm sells its shares directly to investors and receives the proceeds
from the sale is called a _____ transaction.
a. treasury market
b. money market
c. primary market
d. secondary market
9. Valuation by comparables involves comparing ratios of ________ firms to see what investors
are willing to pay per dollar of assets or earnings.
a. similar
b. unique
c. contrasting
10. A transaction in which investors sell shares of a firm's stock to each other on an exchange or
through an electronic network is called a _____ transaction.
a. primary market
b. money market
c. call money market
d. secondary market
11. Which of the following expressions is used to calculate the P/E ratio?
a. Price per share / Total expenses
b. Price per share / Earnings per share
c. Price per share / Variable expenses
d. Price per share / Total equity
12. Identify the true statements about the intrinsic value of a stock. (Select all that apply.)
a. It is the fair price of the stock.
b. It is the present value of the cash payoffs anticipated by the investor who buys the stock.
c. It is based on the recent historical returns of the stock.
d. It is the future value of the cash payoffs anticipated by the investor who buys the stock.
13. The market value of a successful company should be worth _________ its liquidation value.
a. more than
b. less than
c. the same as
14. Which of the following statements are true about the book value of a firm's equity? (Select
all that apply.)
a. It is calculated by multiplying the firm's outstanding shares by the current market price per
share.
b. It includes the book value of common stock and retained earnings.
c. It is always less than the market value of the firm's equity.
d. It is calculated as assets minus liabilities using the firm's balance sheet.
e. It is what an investor would pay to buy the firm today.
15. The expected rate of return on a stock can be calculated as the sum of its _____.
a. dividend yield and capital gains yield
b. market / book ratio and P/E ratio
c. dividend yield and expected stock price
d. dividend yield and current stock price
16. The present value of the dividends that a company will pay over the next five years is $12.
The present value of the expected stock price at the end of the five years is $28. Calculate the
current value of the stock.
a. $58
b. $40
c. $336
d. $16
* The value of a stock is the present value of the dividends it will pay over the investor’s horizon
plus the present value of the expected stock price at the end of that horizon. Therefore, the
current value of the stock is = $12 + $28 = $40.
17. True or false: As Canadian companies’ financial statements are based on IFRS rules and
American companies’ on U.S. GAAP rules, the differences in the rules will contribute to
variations in comparable ratios.
a. True
b. False
18. Find the price of stock that pays a $2.00 per share in annual dividends forever and whose
discount rate is 7%.
a. $1.40
b. $14.00
c. $28.57 (P0 = D1/r = $2.00/0.07)
d. $32.45
19. _____________ is the present value of the expected future cash flows from a stock or other
security.
a. Intrinsic value
b. Liquidation value
c. Book value
20. If a stock has a required return of "r," its next dividend is expected to be "D 1," and its
dividends are expected to grow at a constant rate "g" thereafter, then its current stock price "P0"
can be determined using the expression _____.
a. D1/(r − g)
b. P1/r
c. D1/g
d. D1/(r + g)
21. If D0 is the dividend just paid by a stock that you own, D1 is the next expected dividend, P0 is
the price you paid for the stock, and P1 is the price you expect to receive when you sell the
stock, then the expected dividend yield can be calculated as _____.
a. D0 / P0
b. (D1 + P1) / P0
c. D1 / P1
d. D1 / P0
22. According to the dividend discount model, the price of a stock today equals _____.
a. the present value of next year's dividend
b. the present value of the firm's forecasted P/E ratio
c. the sum of the present value of next year's dividend and the current book value per share of
common stock
d. the present value of all expected future dividends.
23. Helena Handbaskets expects to pay a dividend of $0.50 at year-end and expects the
dividend to grow at a rate of 6% per year thereafter. Solve for the current stock price if investors
require a 15% return on Helena's stock. (Round your answer to two decimal places.)
a. $3.33
b. $6.00
c. $5.56 ($0.50 / (0.15 – 0.06))
d. $4.89
24. Valuation by comparables involves comparing ratios of ________ firms to see what investors
are willing to pay per dollar of assets or earnings.
a. unique
b. contrasting
c. similar
25. A stock's next dividend is "D1," it has a required rate of return "r" and the future dividends
are expected to grow at a rate of "g". The expected rate of return for the stock is _____.
a. (D1/P0) + g
b. (D1+ P0)/g
c. g
d. D1/P0
26. The zero-growth version of the dividend discount model is really a ______________
calculation.
a. future value
b. annuity
c. perpetuity
27. Which factor(s) affect a firm's sustainable growth rate? (Select all that apply.)
a. profits generated by new business
b. relationship with employees
c. portion of earnings reinvested
d. interest coverage ratio
28. The constant growth model for calculating share price works because the present value of
very distant dividends will get close to __________.
a. one
b. the growth value
c. zero
29. The fraction of earnings that is reinvested in the company is referred to as the
______________ ratio. (Select all that apply.)
a. payout
b. dividend
c. plowback
d. retention
30. Which of the following correctly describes the horizon year of a company?
a. The future year by which the present value of all of the company’s cash inflows will be more
than the present value of all the outflows
b. The future year by which the company will start paying dividends
c. The future year by which the company’s growth is expected to settle down
d. The future year after which the company will wind up its business
31. Smithfield Hams just paid a dividend of $1.50 and expects the dividend to grow at a rate of
3% in the future. If investors require an 11% rate of return on Smithfield's stock, what should
Smithfield's current stock price be? (Round your answer to two decimal places.)
a. $18.75
b. $22.22
c. $50.00
d. $19.31 ($1.50(1.03) / (0.11 – 0.03))
32. While interpreting price-earnings ratios, you can think of a stock’s value as the sum of two
parts—the value of the assets in place and the present value of growth opportunities.
33. Brown Corporation's expected year-end dividend is $10, and the growth rate is 6%. If its
current stock price is $120, the expected rate of return is _____. (Round your answer to two
decimal places.)
a. 14.33% (r = ($10/$120) + 6%)
b. 15.68%
c. 11.25%
d. 12.54%
34. A firm's _______________ is the rate at which the firm can grow by reinvesting earnings,
keeping its long-term debt ration constant.
a. payout ratio
b. reinvestment rate
c. sustainable growth rate
35. Investors buy __________ stocks primarily for the expectation of cash dividends.
a. income
b. growth
c. mature
36. The portion of a firm's earnings that is paid out as dividends is called the __________ ratio.
a. retention
b. reinvestment
c. payout
d. plowback
37. Companies that grow at a rapid or irregular rate for several years before settling down at a
stable growth rate should use the _____ for stock valuation.
a. constant-growth model
b. non-constant growth model
c. no-growth model
d. present value of growth model
38.True or false: Discounted cash flow (DCF) analysis can work for valuing shares of a company
as well as for entire businesses,
a. false
b. true
39. For rapidly growing firms, free cash flow (FCF) is often __________.
a. negative
b. positive
c. increasing
d. irrelevant
40. Growth firms may not pay dividends for many years. How can these firm's stock be valued?
(Select all that apply.)
a. These firms' stock can be valued as the sum of average future earnings if the firm does not
grow and present value of terminal value.
b. These firms' stock can be valued as the sum of EPS/r and PVGO.
c. These firms' stock can be valued as the sum of EPS/r and g.
d. These firms' stock can be valued as the sum of average future earnings if the firm does not
grow and present value of growth opportunities.
41. If a firm repurchases 1% of all shares outstanding, that is similar to the firm paying a
__________.
a. 1% coupon
b. 10% coupon
c. 10% dividend
d. 1% dividend
42. Investors buy __________ stocks primarily for the expectation of capital gains.
a. income
b. growth
c. mature
43. Because few professional money managers consistently outperform the market, many
investors buy and hold __________, an alternative to index funds.
a. exchange-traded funds
b. 30-day treasury bills
c. foreign currency funds
44. An attempt to identify undervalued stocks by searching for patterns in past stock prices is
known as _____.
a. historical analysis
b. technical analysis
c. growth analysis
d. fundamental analysis
45. Which of the following can be used in the numerator of a discounted cash flow analysis of a
firm? (Select all that apply.)
a. book values
b. free cash flow
c. legal expenses
d. dividends
46. An attempt to find mispriced securities by analyzing information, such as accounting data
and business prospects, is known as _____.
a. technical analysis
b. market value determination
c. fundamental analysis
d. insider trading
47. Cash that a firm can pay out to investors after paying all expenses and investments is called
________.
a. net income
b. free cash flow
c. discounted cash flow
d. opportunity cash flow
48. Identify the type of market efficiency in which share price changes are random and technical
analysis that searches for patterns in past returns is valueless.
a. Hulk-form efficiency
b. Weak-form efficiency
c. Semi-strong-form efficiency
d. Strong-form efficiency
49. Stock repurchases complicate the dividend discount model because the number of _______
changes with each buyback.
a. shares
b. coupons
c. bonds
50. The earnings announcement puzzle ______________ the efficient market theory.
a. is not related to
b. does not support
c. provides support for
51. Because few professional money managers consistently outperform the market, many
investors buy and hold __________.
a. treasury bills
b. index funds
c. cash
52. Technical analysts attempt to achieve superior returns by identifying and exploiting patterns
in ___________.
a. consumer behaviour
b. debt levels
c. stock prices
53. Researchers in the field of behavioural finance have identified two broad areas of
psychology that may explain investors' irrational behaviour. Identify these areas. (Select all that
apply.)
a. Attitudes toward risk
b. Beliefs about probabilities
c. Depression
d. Obsessive-compulsive behaviour
e. Sentiment
54. True or false: An attempt to find mispriced securities by analyzing information, such as
accounting data and business prospects, is known as fundamental analysis.
a. True
b. False
55. The type of market efficiency that asserts that no investor, including firm insiders, can earn
superior returns is _____.
a. strong-form efficiency
b. semi-strong-form efficiency
c. weak-form efficiency
d. hulk-form efficiency
56. Identify the investor behaviour reflected in the earnings announcement puzzle.
a. Investors react to the earnings announcement of other firms.
b. Investors underreact to the earnings announcement of a firm.
c. Investors overreact to the earnings announcement of a firm.
d. Investors do not react to the earnings announcement of a firm.
57. The field of psychology that tries to explain investors' irrational behaviour is called
_______________.
a. efficient market theory
b. capital asset pricing model
c. behavioural finance
Ch.14 (Part II)
1. Identify the statement that best describes the owners of a corporation.
a. The owners of a corporation provide long term debt to the corporation.
b. The owners of a corporation hold a number of shares of common stock.
c. The owners of a corporation hold a number of debentures.
d. The owners of a corporation provide unsecured debt to the corporation.
2. The number of issued and outstanding shares may be ________ the number of authorized
shares.
a. more than
b. less than
3. The authorized share capital is the maximum number of shares that the company is
permitted to issue as specified in the firm's articles of incorporation.
4. Retained earnings belong to the firm's _____.
a. employees
b. management
c. creditors
d. shareholders
5. Market values of shares are usually _________ book values.
a. greater than
b. the same as
c. less than
6. The owners of most major corporations are called _____ or _____.
a. debtors; creditors
b. shareholders; creditors
c. employees; creditors
d. stockholders; shareholders
7. Identify the statements that are true about dividends. (Check all that apply.)
a. The decision whether to declare dividends is up to the board of directors.
b. A company is obliged to pay a certain amount of dividends to its shareholders.
c. Companies are not allowed to deduct dividend payments when they calculate their taxable
income.
d. Dividends are considered to be a business expense.
8. The takeover attempt in which outsiders compete with management for shareholders' votes
is known as proxy contest.
9. Shares that have been issued and are in the hands of shareholders are referred to as _____.
a. retained shares
b. treasury stock
c. outstanding shares
d. inactive stock
10. Who enjoys the right to elect the board of directors of a corporation?
a. Bondholders
b. Common stockholders
c. Preferred stockholders
d. Top management
11. The maximum number of shares that a firm can issue as specified in the firm's articles of
incorporation is called the _____.
a. allowed number of shares
b. authorized share capital
c. maximum share issue
d. maximum shares allowed
12. A staggered election occurs when _____.
a. all the members of the board of directors are elected at the same time
b. only a fraction of the members of the board of directors are elected at a time
c. the members of the board of directors are elected by the majority shareholders
d. the members of the board of directors are elected by the minority shareholders
13. An indirect form of shareholder investment in a company that occurs when the company
keeps some portion of its profits for reinvestment is called _____.
a. extra investment
b. retained earnings
c. additional paid-in capital
d. extra capital provided
14. If restricted shares have no votes, they are called _____.
a. no-vote shares
b. subordinate voting shares
c. non-voting shares
d. limited voting shares
15. Dividend payments are paid out from _________ as they are not considered a business
expense.
a. pretax profits
b. after-tax profits
16. Who is entitled to any profits that are left after lenders have been paid?
a. The CRA
b. The CEO
c. The shareholders
d. The management
17. Among other things, the Sarbanes-Oxley Act in the U.S. requires that the board's audit
committee consist of ____________ directors.
a. female
b. independent
c. bank executive
18. What are the basic effects of staggered elections? (Check all that apply.)
a. They appear to protect management.
b. They make takeover attempts easier.
c. They appear to encourage proxy contests.
d. They make board takeover attempts more difficult.
19. When is a corporation legally obligated to pay dividends to preferred stockholders?
a. Never
b. When the firm generates profits
c. Once a year
d. When the firm pays interest to bondholders
20. Which two groups usually compete to obtain votes from shareholders during a proxy
contest?
a. The current board of directors and minority shareholders
b. Current management and a group of outsiders
c. Current management and the current board of directors
d. Employees and institutional investors
21. Common shares without full voting rights are called restricted shares.
22. Non-cumulative preferred shareholders are entitled to dividends ______________.
a. only when common dividends are paid
b. every four months
c. only if declared by the board of directors
23. The Sarbanes-Oxley Act was passed by the U.S. Congress to _____.
a. ensure that companies are making enough profit to pay their lenders and shareholders
b. ensure that companies' going concern is not affected
c. ensure that companies and their accountants provide directors, lenders, and shareholders
with the information that they need to monitor progress
d. ensure that the independence of the accounting firms that offer other services to companies
whose accounts they audit is not affected
24. If preferred dividends cannot be paid, then __________ cannot be paid either.
a. common dividends
b. coupon payments
c. common dividends and coupon payments
25. The main goal of a proxy contest is _____.
a. to encourage voting by employees
b. to replace the existing group of shareholders
c. to replace the current management team
d. to negotiate voting rights for bondholders
26. Arrears dividends accrue on _________ preferred shares.
a. all types
b. non-cumulative
c. cumulative
Ch.8
1. Capital expenditures can be made for ___________ assets, such as research and testing costs
for the development of a new drug.
a. tangible
b. short-term
c. fixed
d. intangible
2. The opportunity cost of capital is best described as _____.
a. the balance remaining in an asset class that has not yet been depreciated in that year
b. the expected rate of return given up by investing in a project
c. the return that investors would achieve by investing in a competitor's share of stock
d. the discount rate at which the net present value of a project is zero
3. The discount rate used for calculating the NPV of an investment is determined by the _____
of the investment.
a. risk
b. value
c. size
d. time period
4. What is the net present value (NPV) of a project with an initial investment of $95, a cash flow
of $107 at the end of Year 1, and a discount rate of 6%? (Round your answer to two decimal
places.)
a. $5.94 (NPV = −$95 + ($107 / 1.06))
b. $12.46
c. $6.17
d. $11.32
5. If two projects (investments), A and B, are said to be mutually exclusive, then we know that a
firm _____.
a. can choose to invest in both A and B, but only if the more risky project is executed first
b. must choose to invest in either A or B, but not both
c. can choose to invest in both A and B together, but then cannot invest in any other projects
d. can choose to invest in both A and B, but must execute the project with the higher NPV first
6. When companies spend large amounts of money in the hope of generating more cash at a
later date, that outlay is called a ______________ expenditure.
a. income
b. financing
c. capital
7. In addition to net present value, which of the following criteria can be used when making
investment decisions? (Select all that apply.)
a. payback
b. discounted payback
c. treasury bill rate of return
d. internal rate of return
8. The expected future payoff from a project is discounted by the rate of return offered by
comparable investment alternatives. This discount rate is also called _____.
a. a sunk cost
b. the opportunity cost of capital
c. the internal rate of return
9. Since a risky dollar is worth less than a safe one, cash flows generated by more
risky investments should be discounted at ____________ cash flows generated by less risky
investments.
a. the same rate as
b. a rate comparable with
c. a lower rate than
d. a higher rate than
10. True or false: The payback rule states that a project should be accepted if its payback period
is greater than a specified cutoff period.
a. True
b. False
11. When calculating the net present value (NPV), the present value of the nth cash flow is
calculated by dividing the nth cash flow by 1 plus the _____ rate raised to the nth power.
a. average accounting rate
b. discount
c. prime
d. coupon
12. The capital budgeting method that involves calculating the length of time before a project
starts giving a positive net present value is called the _____.
a. payback period
b. discounted payback period
c. accounting rate of return
d. internal rate of return
13. True or false: When choosing among mutually exclusive projects, choose the one that offers
the highest net present value (NPV).
a. True
b. False
14. The internal rate of return rule specifies that a firm should select any project whose rate of
return is _____ the firm's _____.
a. equal to; opportunity cost of capital
b. higher than; opportunity cost of capital
c. higher than; average project NPV
d. lower than; opportunity cost of capital
15. Which of the following investment criteria tends to lead to the same decisions as net
present value?
a. discounted payback
b. book rate of return
c. internal rate of return
d. payback
16. Which of the following statements about the relationship between NPV and rate of return
are true? (Check all that apply.)
a. When the project rate of return is greater than the firm's opportunity cost of capital, the
project's net present value (NPV) is less than zero.
b. When the project rate of return is less than the firm's opportunity cost of capital, the
project's net present value (NPV) is greater than zero.
c. When the project rate of return is less than the firm's opportunity cost of capital, the
project's net present value (NPV) is less than zero.
d. When the project rate of return is greater than the firm's opportunity cost of capital, the
project's net present value (NPV) is greater than zero.
17. The payback period for a project can best be defined as _____.
a. the amount of time until you recover the losses on this project from a future project
b. the length of time until you start earning the average accounting rate from the project
c. the length of time until you recover your initial investment
d. the total duration of the project
18. Internal rate of return (IRR) is also known as _____.
a. accelerated rate of return
b. average accounting rate of return
c. discounted cash flow rate of return
d. compounded cash flow rate of return
19. The _____ is the number of periods before the present value of prospective cash flows
equals or exceeds the initial investment.
a. net present value
b. discounted payback
c. internal rate of return
20. The ______________ rule states that a firm should invest in any project whose rate of
return is greater that the opportunity cost of capital.
a. net present value
b. book rate of return
c. discounted payback
d. internal rate of return
21. A firm plans to invest $400,000 in a new high-efficiency furnace that will reduce its energy
bill by $100,000 in years 1 and 2, $75,000 in years 3, 4, and 5, and $50,000 in years 6 through
10. Calculate the project's internal rate of return. (Use your financial calculator.)
a. 12.7%
b. 13.07%
c. 10.08%
d. 11.19%
22. The rate of return that is equal to the return offered by equivalent-risk investments is called
the ______________.
a. internal rate of return
b. opportunity cost of capital
c. coupon rate
23. True or false: The rate of return is the discount rate at which a project's net present value
equals zero.
a. True
b. False
24. Projects that often have a higher net present value can have _______ internal rates of
return, in contrast to projects who have high cash inflows early but which do not last a long
time.
a. higher
b. lower
c. more volatile
25. The internal rate of return (IRR) is best defined as _____.
a. the interest rate at which funds are borrowed to invest in a project
b. the discount rate at which the net present value (NPV) equals zero
c. the discount rate at which the net present value (NPV) equals the opportunity cost of capital
26. A project whose cash flow signs change twice can have _____ different internal rates of
return.
a. two
b. six
c. four
27. Identify the decision rule for investment timing.
a. Always make the choice to invest today so that the firm can start earning its cash flows as
soon as possible.
b. Choose the investment date that minimizes your initial investment.
c. Choose the investment date that produces the highest net present value (NPV) today.
d. Choose the investment date that produces the highest internal rate of return (IRR) today.
28. Find the internal rate of return for project with an initial outlay of 350,000 in year 0; cash
inflows of $16,000 for years 1 and 2; and cash inflow of $466,000 in year 3. (Use your financial
calculator.)
a. 13.05%
b. 9.95%
c. 4.35%
d. 12.96%
29. When faced with mutually-exclusive projects with different lives, it is best to calculate the
________________ instead of net present value.
a. equivalent annual cost
b. internal rate of return
c. discounted payback period
30. _______________ is the rate that depends only on a project's own cash flows.
a. Opportunity cost of capital
b. Market interest rate
c. Internal rate of return
31. One limitation of __________ is that it favours projects with large early cash inflows.
a. internal rate of return
b. net present value
32. A machine costs $20,000 today, and has annual operating costs of $4,000 in each of the next
four years. The cost of capital is 10%. The present value of the machine's costs is _____ and its
equivalent annual cost is _____.
a. $33,102.61; $11,947.52
b. $32,679.46; $10,309.42
c. $25,192.61; $7,023.53
d. $23,102.61; $8,083.53
 PV=-$20,000, I/Y=10%, N=4, FV=0, CPT PMT=$6,309.42
EAC = $6,309.42 + $4,000 = $10,309.42
PMT=$10,309.42, I/Y=10%, N=4, FV=0, CPT PV=$32,678.78
33. With soft capital rationing, a firm's top management, not investors, imposes limits on capital
spending.
34. For project whose cash flows change from positive to negative, there can be as many
different internal rates of returns as there are changes in the ______ of the cash-flow stream.
a. sign
b. years
c. numbers
35. Investment timing decisions always involves a choice among ________ investments.
a. implicitly codependent
b. independent
c. mutually exclusive
36. Managers should avoid replacing old machines unless the ________ of a new machine is
lower.
a. equivalent annual cost
b. net present value
c. internal rate of return
37. Which of the following is the correct definition of equivalent annual cost?
a. It is the cost per period with the same present value as the cost of buying and operating a
machine.
b. It is an annuity that is equivalent to the initial project investment.
c. It is the cost of maintaining current assets plus the opportunity cost of capital.
d. It is an annuity whose future value is the same as the future value of the initial project
investment, compounded at the opportunity cost of capital.
38. A machine costs $10,000 today, and has annual operating costs of $3,000 in each of the next
four years. The cost of capital is 10%. The present value of the machine's costs is _____ and its
equivalent annual cost is _____.
a. $13,102.61; $4,947.52
b. $15,102.61; $5,083.53
c. $9,192.61; $3,023.53
d. $19,509.60; $6,154.71
 PMT=-3,000,N=4,I/Y=10,FV=0,CPT PV=9,509.60
PV=9,509.60+10,000=19,509.60,N=4,I/Y=10,FV=0,CPT PMT=6,154.71
39. When a company's new projects are limited by the amount of funds it can raise, then it is
said to be experiencing _______ capital rationing.
a. zero
b. soft
c. hard
40. When a firm's capital is rationed, management should pick the projects that give the highest
net present value per dollar of investment. This ratio is called the profitability index.
41. The best approach to solving replacement decisions is to calculate the ___________ of the
new machine and the old machine.
a. total nominal costs
b. equivalent annual cost
c. internal rate of return
42. When funds are not rationed, a firm should use which criteria to chose projects?
a. net present value
b. profitability index
c. discounted payback
43. Capital rationing occurs when there is a limit set on the amount of funds available for
investment.
44. Which of the following is the one of the few situations when NPV fails as a decision rule?
a. When the firm faces capital rationing
b. When the firm has to choose between mutually exclusive projects
c. When the opportunity cost of the firm is zero
d. When the firm has a variety of independent projects to choose from
45. When a company is experiencing hard capital rationing, it needs to select the package of
projects that will maximize overall ___________ within the budget.
a. bondholder return
b. net present value
c. profit per book value
46. Profitability index is calculated as the ratio of _____.
a. present value of cash inflows to present value of cash outflows
b. present value of cash inflows to initial investment
c. net present value to present value of cash outflows
d. net present value to initial investment
47. The profitability index should only be used to select projects when funds are __________.
a. limited
b. unlimited
48. Which of the following capital investment criteria is consistent with maximizing the value of
the firm?
a. Discounted payback period
b. Internal rate of return (IRR)
c. Profitability index
d. Payback period
e. Net present value (NPV)
Ch.9 Discounted Cash Flow (DCF)
1. Which of the following is discounted when calculating the net present value of a project?
a. Project incremental free cash flows
b. Project net income
c. Project earnings before interest, depreciation, and amortization
d. Project total cash flows plus sunk costs
2. Which of the following best describes the term incremental cash flow?
a. Additional cash flows due to inflation less cash flows due to accounting errors
b. Total cash flows of a project
c. Total cash flows with a project minus total cash flows without the project
3. Which of the following are examples of indirect effects that are included in the calculation of
incremental cash flows? (Check all that apply.)
a. Reduction of existing product sales because of introduction of a new product
b. Loss of the firm's product sales due to the introduction of a new product by competitors
c. Increased sales of an existing product due to the release of a new complimentary product
d. Loss of product sales of competitors due to the introduction of a new product by the firm
e. Loss of existing store sales by opening a new store too close by
4. Which of the following costs should never be included in project analysis?
a. indirect costs
b. opportunity costs
c. sunk costs
5. An opportunity cost arises whenever _____.
a. a project uses an existing asset that could have been sold or put to use elsewhere
b. a project does not use an existing asset until its book value has been depreciated to zero
c. a project uses an asset that would have been scrapped otherwise
d. a project uses an asset that cannot be used for any other purpose
6. Why do we not discount project accounting profits when performing discounted cash flow
analysis?
a. Accounting profits do not recognize the timing of cash flows.
b. Accounting profits are always more than the cash flows.
c. Accounting profits ignore the incremental tax effects of the project.
d. Accounting profits do not take depreciation into account.
7. Incremental cash flow is equal to _____.
a. cash flow with project + cash flow without project
b. revenues − costs − taxes
c. cash flow from investment in working capital + cash flow from operations
d. cash flow with project − cash flow without project
8. Which of the following are considered short-term assets? (Select all that apply).
a. accounts payable
b. cash
c. accounts receivable
d. inventories
e. taxes payable
9. True or False: The indirect effects of accepting a project, whether positive or negative, should
be included in the incremental cash flows.
a. True
b. False
10. Which of the following are characteristics of sunk costs? (Check all that apply.)
a. They decrease the project net present value.
b. Sunk cost should not be a consideration in project evaluation decision.
c. They increase the project net present value.
d. They are past and irreversible cash outflows.
11. Which of the following is true of a project's shutdown cash flows? (Check all that apply.)
a. They may include the recovery of the working capital investment.
b. They may be positive or negative.
c. They always have an insignificant effect on the net present value of the project.
d. Their value is known with certainty at the start of the project.
e. They may be due to the sale of a project's asset.
12. True or false: When a resource can be freely traded, its opportunity cost is the market price.
a. True
b. False
13. Overhead costs, such a existing electricity expenses, should only be included in project
analysis if those costs are __________.
a. incremental
b. fixed
c. significant
14. Net working capital is the difference between a company's short-term assets and
___________.
a. short-term liabilities
b. long-term assets
c. shareholder's equity
15. The difference between the nominal discount rate and the real discount rate is _____.
a. zero
b. the expected inflation
c. the market risk
d. the risk-free rate
16. Which of the following statements about the calculation of the cash flows from a project is
true?
a. Regardless of the actual financing, the cash flows from a project should be calculated as if it
were half-debt and half-equity financed.
b. Regardless of the actual financing, the cash flows from a project should be calculated as if the
project were all-debt-financed.
c. Regardless of the actual financing, the cash flows from a project should be calculated as if
the project were all-equity-financed.
d. The cash flows from a project should be calculated on the basis of actual equity and debt
financing used.
17. Total cash flow from a project is calculated as _____.
a. cash flow from investment in plant and equipment + cash flow from investment in working
capital – cash flow from operations
b. cash flow from investment in plant and equipment – cash flow from investment in working
capital + cash flow from operations
c. cash flow from investment in plant and equipment – cash flow from investment in working
capital – cash flow from operations
d. cash flow from investment in plant and equipment + cash flow from investment in working
capital + cash flow from operations
18. Completion of a project will almost always involve _______ costs which may be positive or
negative.
a. only minor
b. deferred
c. shutdown
19. The initial capital investment by a firm in a project represents a _____ cash flow. The salvage
value of the project represents a _____ cash flow to the firm.
a. negative; negative
b. positive; positive
c. negative; positive
d. positive; negative
20. True or false: Working capital components like accounts receivable and inventory tend to
increase with projects that are growing.
a. True
b. False
21. Expenses such as rent or heat that will occur regardless of whether a project is accepted or
rejected should be _____________.
a. discounted as part of the initial investment
b. allocated appropriately
c. ignored
22. Which of the following statements about nominal and real cash flows are true? (Check all
that apply.)
a. Nominal cash flows must be discounted using nominal discount rate.
b. Nominal cash flows must be discounted using real discount rate.
c. Real cash flows must be discounted using nominal discount rate.
d. Real cash flows must be discounted using real discount rate.
23. Which of the following equations can be used to calculate a project's operating cash flow?
a. Revenues – taxes
b. Revenues – costs
c. Revenues – costs – taxes
24. True or false: Financing costs like interest and principal payments on the funds borrowed for
a project must be included in the incremental cash flows for the project.
a. True
b. False
25. A project's revenues are $5,000, cash expenses are $3,000, and depreciation is $500. The
firm's tax bracket is 35%. What is the firm's depreciation tax shield?
a. $250
b. $500
c. $150
d. $175 ($500 x 0.35)
26. The three categories of a project's cash flow are cash flow from investment in plant and
equipment, cash flow from operations, and cash flow from investment in _________.
a. sunk costs
b. working capital
c. allocated overhead costs
27. Which of the following are included in the initial capital investment at the start of the
project? (Check all that apply.)
a. Any sale of equity or borrowing made to fund the project
b. Any investment in a manufacturing facility
c. Any investment in equipment
28. In Canada, the depreciation amount that firms are allowed to deduct from taxable income is
called the capital cost allowance.
29. Investment in working capital tends to be a _______ cash flow at the beginning of a project
and a _______ cash flow when the project winds down.
a. negative; negative
b. positive; positive
c. positive; negative
d. negative; positive
30. A project generates revenues of $5,000. The cash expenses are $3,000, and depreciation is
$525. The firm's tax bracket is 35%. What is the firm's operating cash flow?
a. $1,483.75
b. $2,008.75
c. $1,475.00
d. $2,000.00
31. The reduction in taxes that is attributable to the depreciation allowance is called the
depreciation tax shield.
32. Which of the following asset classes follow the straight-line depreciation method, instead of
the declining balance method? (Select all that apply.)
a. leasehold improvements
b. patents
c. buildings
d. manufacturing equipment
e. computers
33. The amount of write-off on depreciable assets allowed by the Canada Revenue Agency
against taxable income is referred to as the _____.
a. capital cost allowance
b. undepreciated capital cost
c. depreciation tax shield
34. When a depreciable asset is sold, the undepreciated capital cost of its asset class _____.
a. is increased by either the asset's sale price or its initial cost, whichever is less
b. is increased by either the asset's sale price or its initial cost, whichever is more
c. is reduced by either the asset's sale price or its initial cost, whichever is more
d. is reduced by either the asset's sale price or its initial cost, whichever is less
35. A terminal loss occurs when there is a positive UCC balance in asset class and there are
______ assets remaining in that class.
a. many
b. no other
c. taxable
36. The new Accelerated Investment Incentive that applies to eligible property acquired after
November 20, 2018 will apply the prescribed CCA rate to _______ times the net addition to the
class for the year.
a. 2.0
b. 1.5
c. 0.5
37. Identify the mathematical expression for calculating the present value of a perpetual tax
shield. (C = Capital cost of an asset acquired at the beginning of year 1, d = CCA rate for the
asset class to which the asset belongs, Tc = The firm's tax rate, r = Discount rate)
 [(CdTc/r+d) x [1+.5r/1+r]
38. Under which of the following methods is depreciation calculated as a constant amount for
each year of an asset’s accounting life?
a. The units of activity method
b. The sum of the year' digits method
c. The declining balance depreciation method
d. The straight-line depreciation method
39. When performing a discounted cash flow analysis for a project, the first cash flows (in terms
of timing) are often the capital investment and the _______.
a. allocated overhead costs
b. large sunk costs
c. changes in net working capital
40. When a depreciable asset is sold, the UCC of its asset class is reduced by the lower of its
asset price or initial cost. The result is called the _________ of disposal.
a. adjusted cost
b. capital loss
c. CCA tax shield
41. When calculating cash flow from operations for a project that lasts many years, the CCA tax
shield has to be calculated separately as it is usually a ________.
a. perpetuity
b. annuity
c. large number
42. The positive balance following the disposal of all assets in an asset class is called a(n)
terminal loss.
43. Since the CCA tax shield reduces taxable income, it is considered a cash ______ when
calculating a project's NPV.
a. inflow
b. outflow
44. The new Accelerated Investment Incentive which increases the CCA deduction in the first
year will also result in removing the ________.
a. terminal loss benefit
b. straight-lie depreciation classes
c. half-year rule
45. The CCA tax shield from an investment can continue ________ if dealing with a declining
balance depreciation class (provided assets remain in the class and the UCC balance is positive).
a. for a maximum of 10 years
b. in perpetuity
c. for a minimum of 2 years
46. When calculating the present value of the CCA tax shields over a project's life, they need to
be _______ the other operating cash flows.
a. separated from
b. included with
47. Working capital usually increases during the initial years of a project and then _______ as
the project winds down.
a. has no impact
b. is recovered
48. When dealing with projects lasting many years and whose assets are subject to declining
balance CCA, the cash flow from operations has to be split into operating cash flows excluding
CCA and the _________.
a. profit before tax
b. CCA tax shield
c. non-cash items
49. The CCA tax shield for a single year is the product of the CCA rate for that asset and the
firm's __________.
a. cost of capital
b. borrowing rate
c. tax rate
50. When equipment is sold for salvage value at the end of a project, the present value of the
proceeds are a cash _________ for the firm.
a. inflow
b. outflow
51. The Canada Revenue Agency (CRA) only lets firms deduct CCA based on the ___________
cost of assets.
a. inflation-adjusted
b. nominal
52. The present value of the CCA tax shields over a project's life will be ____________ if there is
a salvage value, compared to no salvage value.
a. higher
b. lower
53. When equipment is sold for salvage value at the end of a project, the present value of CCA
tax shields are ____________.
a. reduced
b. increased
54. If there is inflation over a depreciable asset's life, then the real value of the CCA that firms
can claim is __________.
a. higher
b. unchanged
c. lower
Ch.10 Project Analysis
1. The list of a firm's planned investment projects is called the firm's _____.
a. capital structure
b. scenario analysis
c. capital budget
d. sensitivity analysis
2. To have a large project approved often a detailed proposal identifying ______________ will
have to be submitted.
a. cash-flow forecasts
b. accounting profits
c. non-cash items
3. Which of the following is a solution to the problem of inconsistency in project forecasts?
a. Ensuring that all managers are using the same statistical forecasting technique
b. Ensuring that all managers are using the same type of computer for their analyze
c. Providing managers with a common set of economic and firm-specific indicators upon
which forecasts are based
d. Scheduling an off-site meeting where all managers can discuss their forecasts
4. When interests of managers conflict with those of shareholders, the result is likely to be
investments in projects that have ________________.
a. quick paybacks
b. positive IRR
c. positive NPV
5. Identify some of the reasons for cash flow forecast bias. (Check all that apply.)
a. Forecasts are subject to financial calculator or spreadsheet errors.
b. Managers want to gain approval of their division's projects at the expense of other
divisions' projects.
c. Managers try to adjust random errors in the cash flow estimation process.
d. Managers are too optimistic about their project's chances of success.
e. Managers try to gain approval for projects that will increase their responsibilities and
power.
6. Which of the following is the best definition of a firm's capital budget?
a. It is the firm's annual budget for salaries and benefits.
b. It is the amount of capital that the firm plans to raise by selling stock and bonds.
c. It is the list of the firm's planned investment projects.
d. It is the amount set aside by the firm to repurchase stock and pay dividends.
7. Managers ask "what if" questions related to the factors that can increase or reduce project
cash flows because _____.
a. they are paid to do that
b. project working capital usually requires additional funds
c. they want to know how sensitive their payback is to changes in cash flow
d. changes in cash flows change project net present value
8. Which of the following must be included in the detailed proposal submitted to obtain the
final authorization for a budgeted project? (Check all that apply.)
a. Present value calculations
b. Engineering analyses
c. Market research reports
d. Government approval
e. Cash-flow forecasts
f. Customer testimonials
9. When managers change one variable at a time in their cash flow forecasts and then calculate
the resulting change in the project's NPV, this is called ___________ analysis.
a. sensitivity
b. scenario
c. break-even
10. To ensure consistency in the capital budgeting forecasts, many firms start by establishing
forecasts of ______________.
a. economic indicators
b. employee salaries
c. plant utilization rates
11. Costs that do not depend on the level of output are called _____ costs.
a. deferred
b. fixed
c. variable
12. Conflicts of interest between shareholders and managers may cause managers to propose
quick-payback projects instead of _____ projects.
a. short-term
b. positive NPV
c. long-term
d. large budget
13. If lower-level managers are not rewarded on the basis of net present value then _________
will occur when resources are limited.
a. forecast accuracy
b. forecast bias
14. Sensitivity analysis is performed on variables separately to determine which ones affect the
project's __________ the most.
a. suppliers
b. NPV
c. total costs
d. payback period
15. _______________ analysis for projects involves managers looking at different combinations
of interrelated variables.
a. Scenario
b. Break-even
c. Sensitivity
16. True or false: Once the initial discounted cash flow analysis has been completed and a
project has been budgeted and initiated, managers are no longer concerned about the project's
cash flow forecasts.
a. True
b. False
17. Which of the following activities is a part of sensitivity analysis?
a. Changing the forecasts for all cash flow variables and recalculating net present value
b. Changing the forecast of one cash flow variable at a time to observe the effect on net
present value.
c. Establishing cash flow forecasts for different scenarios involving several variables
d. Randomly generating values for all variables and then calculating the net present value
distribution
18. The analysis of the level of sales at which a company breaks even is called break-even
analysis.
19. Costs that vary with the level of sales are called variable costs.
20. The level of sales at which total revenues equals total costs is called the ________ breakeven.
a. declining
b. accounting
c. net present value
21. When performing sensitivity analysis on a variable such as sales level, often optimistic,
pessimistic and ____________ forecasts are made.
a. negative
b. expected
c. doomsday
22. Jones Corp. has annual fixed costs of $250,000, depreciation of $50,000, and variable costs
that are 88.25% of sales. What is Jones's accounting break-even level of sales?
a. $2,127,660
b. $2,553,191 ($250,000 + 50,000) / (1 – 0.8825)
c. $339,943
d. $340,001
23. Simulation analysis involves the estimation of the probabilities of different possible
outcomes of a project.
24. An investment that breaks even on an accounting basis is generally not considered an
acceptable investment from the finance perspective. Which of the following describe why this is
true? (Check all that apply.)
a. Such an investment returns initial investment but does not cover the opportunity cost of
capital tied up in the project.
b. Such an investment does not take into account the time value of cash flows over the life of
the project.
c. Such an investment has a negative net present value.
d. Such an investment does not consider non-cash transactions in its analysis.
e. Such an investment recovers variable costs but does not recover fixed costs.
25. When using break-even analysis, most managers focus on the break-even level of _______.
a. depreciation
b. fixed costs
c. variable costs
d. sales
26. Which of the following best describes the NPV break-even point?
a. The net present value obtained when depreciation is excluded from the project cash flow
calculation
b. The level of project sales at which the net present value is maximized
c. The level of project sales at which the net present value switches from negative to positive
d. The level of initial expenditure at which the project starts to lose money
27. Which of the following accurately describe the accounting break-even point? (Check all that
apply.)
a. The level of sales at which profits are zero
b. The level of sales at which total revenues equal total costs
c. The level of sales at which fixed costs equal variable costs
d. The level of sales at which the operating cash flow is exactly zero
28. The Jones Lumber Co project is a 10-year project with annual cash flows given by (0.7803 ×
Sales – $130,000). If the discount rate is 9% and the initial investment is $1,000,000, at what
level of sales does this project achieve the NPV break-even?
a. $366,295 6.417658 × (0.7803 × Sales – 130,000) = $1,000,000
b. $400,101
c. $1,000,000
d. $357,389
29. Accounting break-even level of sales equals fixed costs plus depreciation divided by
_____________.
a. additional profit from each additional dollar of tax
b. additional sales from each additional dollar of net profit
c. additional profit from each additional dollar of sales
30. _______________ analysis for projects involves managers looking at different combinations
of interrelated variables.
a. Scenario
b. Sensitivity
c. Break-even
31. In order to lower a project's NPV break-even level of sales, it should try to lower its
________ costs wherever possible.
a. variable
b. fixed
32. A project that just breaks even on an accounting basis will have a ______ net present value.
a. positive
b. zero
c. negative
33. The level of _______ at which NPV switches from negative to positive is called the NPV
break-even point.
a. variable costs
b. sales
c. fixed costs
34. _____ leverage refers to the degree to which a firm's costs are fixed.
a. Operating
b. Financial
35. In a booming economy, a firm with a _______ portion of fixed costs relative to variable costs
will perform very well.
a. higher
b. lower
35. The NPV break-even equation is described as the sales level for which the present value (PV)
of all the project's cash flows equals the __________.
a. future value of expenses
b. nominal salvage value
c. initial investment
36. _____ measures the percentage change in profits given a 1% change in sales.
a. Profitability index
b. The degree of financial leverage
c. The degree of operating leverage
d. Break-even analysis
37. A firm's degree of operating leverage is 4.5%. Based on this information, which of the
following interpretations are true? (Check all that apply.)
a. Every 1% increase in sales will decrease profits by 4.5%.
b. Every 1% drop in sales will decrease profits by 4.5%.
c. Every 1% increase in sales will increase profits by 4.5%.
d. Every 1% drop in sales will increase profits by 4.5%.
38. Projects that can be modified as the future unfolds are considered more __________ than
projects that do not provide flexibility.
a. risky
b. valuable
c. expensive
39. A firm is said to have high operating leverage if its _____.
a. fixed costs are high relative to its variable costs
b. fixed costs are equal to its variable costs
c. fixed costs are zero
d. variable costs are high relative to its fixed costs
40. A decision tree is a diagram of sequential decisions and possible outcomes.
41. Which of the following indicate the correct equation for calculating the degree of operating
leverage (DOL)? (Check all that apply.)
a. DOL = variable costs / fixed costs
b. DOL = percentage change in profits / percentage change in variable costs
c. DOL = 1 + (fixed costs / profits)
d. DOL = fixed costs / variable costs
e. DOL = percentage change in profits / percentage change in sales
42. If a firm decides to purchase more land than is needed for a new production facility, in case
of future expansion requirements, the extra land can be considered a/an _________.
a. sunk cost
b. real option
c. deferred loss
d. intangible asset
43. The lower the degree of operating leverage, the _____ the sensitivity of profits to variation
in sales and the _____ the risk of the project.
a. higher; higher
b. lower; higher
c. higher; lower
d. lower; lower
44. In order to lower a project's NPV break-even level of sales, it should try to lower its
________ costs wherever possible.
a. fixed
b. variable
45. When a decision is made to abandon a project, it is usually because ________.
a. there is high resale value of the assets
b. the project is no longer profitable
c. assets expire due to old age
46. Projects that can be expanded if things go well, or cut back if things do not go well, are said
to have additional value due to their __________.
a. passivity
b. longevity
c. flexibility
47. The real option of timing is really an option to _____.
a. wait until a critical company asset becomes available for the project
b. wait until the firm has additional information about the project before investing
c. invest only when the firm is ready to undertake additional projects
48. What should managers do if they want to maintain flexible production facilities? (Check all
that apply.)
a. They should design production facilities to easily be retooled to produce other products.
b. They should identify multiple sources for key raw materials and supplies.
c. They should wait until a critical company asset becomes available for the project.
d. They should seek debt and equity capital in markets where the best price can be obtained.
49. A decision tree diagram is helpful for managers who have projects that involve ___________
decisions.
a. one time
b. future
c. historical
50. Options to invest in, modify, or dispose of a capital investment project are called _____.
a. project options
b. actual options
c. real options
d. investment options
51. Which of the following projects would most likely have negative abandonment value?
a. sale of a manufacturing facility
b. decommissioning a nuclear power plant.
c. sale of research and development knowledge
52. If a new project is marginal for a positive NPV, or has the potential for large losses, it often
makes sense to __________.
a. walk away from the project
b. go ahead with the investment quickly
c. delay the investment
53. If manufacturing facilities can be converted easily to accommodate changes in product mix,
then this option is called the _________.
a. option to expand
b. timing option
c. flexible production option
d. abandonment option
Ch.11 Risk, Return and the Cost of Capital
1. An investor purchases a stock when the purchase price is $12.30 per share and sells it at a
later date for $14.10 per share. Her capital gain per share is equal to 1.80.
2. True or false: The percentage return on a stock investment is the sum of the dividend yield
and the percentage capital gain on the stock.
a. True
b. False
3. _____ are measures of the investment performance of the overall market.
a. Correlation coefficients
b. Dividend yields
c. Market values
d. Market indexes
4. ____________ securities are the safest investment you can make.
a. Common stocks of banks
b. Treasury bills
c. Long-term Canada bonds
5. The maturity premium reflects that fact that investors will demand a higher return if their
investment has a ____________.
a. lower coupon rate
b. longer time horizon
c. shorter time horizon
d. higher coupon rate
6. An investor purchases a stock today at $9.00 per share and sells it after one week at $7.50 per
share. The capital loss per share is $1.50.
7. The extra return that investors expect from investing in common stocks compared to
investing in Treasury bills is called the ________________.
a. dividend premium
b. market risk premium
c. maturity premium
8. Which of the following mathematical expressions computes percentage return on an
investment?
a. Percentage return = capital gain / initial share price
b. Percentage return = dividend / initial share price
c. Percentage return = final share price / initial share price
d. Percentage return = (capital gain + dividend) / initial share price
9. The expected return on the stock market is the sum of the _____ and the _____.
a. interest rate on Treasury bills; normal risk premium
b. interest rate on Treasury bonds; normal risk premium
c. interest rate on Treasury bills; interest rate on Treasury bonds
d. federal funds rate; normal risk premium
10. The primary stock market index in Canada is the _____.
a. S&P/TSX Composite Index
b. Nikkei Index
c. Dow Jones Industrial Average
d. Dow Jones Wilshire 5000 Index
11. The appropriate cost of capital to be used to discount average risk projects is the _____.
a. market risk premium
b. Treasury bill rate of return
c. Treasury bond rate of return
d. expected return on the market portfolio
12. Treasury bills are considered one of the safest investments because they are issued by the
_________.
a. insurance companies
b. federal government
c. big tech companies
d. provincial government
13. Variance and standard deviation measure the volatility of the returns from investment.
14. Extra average return from investing in long-term bonds versus short-term Treasury securities
is called the maturity premium.
15. Expected return is the weighted average of possible outcomes.
16. The market risk premium can be calculated by subtracting the Treasury bill return from the
rate of return on _____________.
a. government bonds
b. corporate bonds
c. common stocks
17. Standard deviation is equal to _____.
a. the difference in the maximum return and the variance
b. the sum of of squared deviations
c. the square root of variance
d. the product of average return and variance
18. If Treasury bills are yielding 1.5% and the normal risk premium is estimated to be 4.4%, then
the expected market return should be approximately _______.
a. 5.9%
b. 4.4%
c. 10.3%
d. 2.9%
19. When calculating variance from a subset of historical observations, we should use the
_________ formula.
a. sample variance
b. square root variance
c. population variance
20. The appropriate cost of capital to be used to discount risk-free projects is the _____.
a. expected return on the market portfolio
b. Treasury bill rate of return
c. market risk premium
d. Treasury bond rate of return
21. Rank the following investments from the lowest risk to the highest risk.
* .05 x .08
22. The expected return of an investment can be calculated by multiplying the expected return
of each possible outcome by the ________ of that outcome occurring.
a. probability
b. reciprocal
c. square root
23. Diversification works best when portfolio stock returns are negatively correlated.
24. Variance can be defined as the probability-weighted average of the ___________ around
the expected return.
a. Treasury bill return
b. squared deviations
c. squared market return
25. Identify the true statements about the portfolio return.
a. The portfolio return is maximum when all the stocks invested in belong to the same industry.
b. The portfolio return is the weighted average of returns on the individual assets.
c. The portfolio return is the simple average of returns on the individual assets.
d. The portfolio return is the sum of returns on the individual assets.
26. When calculating the variance of an observed sample of historical returns, the denominator
in the sample variance is the ______________.
a. number of observations plus 1
b. number of observations minus 1
c. number of observations
27. The appropriate cost of capital to be used to discount average risk projects is the _____.
a. Treasury bond rate of return
b. expected return on the market portfolio
c. market risk premium
d. Treasury bill rate of return
28. Covariance of returns is a statistical measure of how the returns of two securities move
__________.
a. with the market
b. with inflation
c. together
29. Identify the true statements about the portfolio diversification? (Check all that apply.)
a. Portfolio diversification works because prices of different stocks do not move exactly
together.
b. Portfolio diversification works best when the returns are positively correlated.
c. Portfolio diversification works when prices of different stocks move exactly together.
d. Portfolio diversification works best when the returns are negatively correlated.
30. Sarah has a portfolio formed from only two assets. The fraction of the first asset is 0.4 and
the fraction of the second asset is 0.6. The rate of return on the first asset is 4% and that on the
second asset is 8%. What is the portfolio rate of return?
a. 4.80%
b. 6.40%
c. 1.60%
d. 3.20%
31. When calculating variance from a subset of historical observations, we should use the
_________ formula.
a. sample variance
b. population variance
c. square root variance
32. The standard deviation of the returns of an individual security measures _____.
a. how risky that security would be if held in a portfolio of stocks selected from the same
industry
b. the risk of a stock held in a diversified portfolio
c. the average risk of the industry to which that firm belongs
d. the risk of the security if it is held in isolation
33. The type of risk that can be eliminated by diversification of a security portfolio is called
_____.
a. market risk
b. firm-specific risk
c. systematic risk
d. common risk
34. True or false: An investor can reduce the risk involved in investing in a stock by combining it
in a diversified portfolio with other assets and securities.
a. True
b. False
35. Identify factors that affect an investor's return on a diversified portfolio. (Check all that
apply.)
a. Expansion plans of the companies whose stocks are in the portfolio.
b. Historical return from stocks in the portfolio.
c. Interest rates prevalent in the economy.
d. Rate of inflation in the economy.
36. To measure the risk of a single stock, if we are holding it in a portfolio, we can use
_________.
a. the individual stock's correlation with other stocks in the portfolio
b. the individual stock's average return for the past five years
c. the individual stock's deviation in the market price from the forecasted market value
d. the individual stock’s sensitivity to the fluctuations of the overall stock market
37. The total risk of a diversified portfolio of assets can be measured by _____.
a. the standard deviation of the returns of the highest risk stock in the portfolio
b. the standard deviation of the returns of the lowest risk asset in the portfolio
c. the standard deviation of the portfolio returns
d. adding the past returns of each stock in the portfolio
38. Identify the types of risk that cannot be diversified away. (Check all that apply.)
a. Specific risk
b. Systematic risk
c. Market risk
d. Unique risk
39. The risk of an individual asset can be reduced by combining it with a ____________
portfolio.
a. risk-free
b. diversified
c. highly correlated
40. Uncertain events that affect entire securities markets and economy are called __________
factors.
a. microeconomic
b. negative correlation
c. unsystematic
d. macroeconomic
41. If holding stocks in a portfolio, we should be concerned with the stock's sensitivity to
fluctuations in the overall ________.
a. bond market
b. currency market
c. stock market
Ch.12 Risk, Return and Capital Budgeting
1. A market portfolio contains all assets in the world economy—not just stocks, but bonds,
foreign securities, real estate, and so on—to achieve the greatest diversification.
2. The average beta for all stocks (the beta of the market portfolio) is _____.
a. +1.0
b. 0.0
c. -1.0
d. +0.5
3. The beta of a stock can be calculated by multiplying the stock's correlation coefficient by the
stock's standard deviation and then dividing by the ___________________.
a. market's expected return
b. market's standard deviation
c. stock's variance
d. stock's expected return
4. If Blackberry's beta is 1.40, then Blackberry would be classified as a/an ___________ stock.
a. defensive
b. aggressive
c. undervalued
d. overvalued
5. Total risk consists of firm-specific risk plus _____________.
a. diversifiable risk
b. technical risk
c. market risk
6. In principle, the market portfolio should contain all assets in the world economy. However, in
practice, financial analysts use _____ as a proxy for the market portfolio.
a. an index that tracks returns on Treasury bonds
b. an index that tracks returns on Treasury bills
c. stock market indexes like the S&P500
d. a portfolio that contains all stocks in the world economy but nothing else
7. If an investor invests 50% of their funds in a stock with beta 1.5, 30% in a stock with beta 0.9
and 20% in a stock with beta 0.3, their portfolio beta will be _____.
a. 1.08
b. 0.95
c. 0.99
d. 1.10
8. Rank the following stocks from lowest risk to highest risk.
9. Find the beta of ABC Corp. if it's correlation coefficient with the market is 0.33, its standard
deviation of returns is 6.4% and the market's standard deviation of returns is 3.5%.
a. 0.18
b. 1.39
c. 0.60 (0.33 x 6.4)/3.5 = 0.60
d. 3.52
10. A diversified investor will not judge the risk of a stock based on its standalone volatility, but
by its contribution to ____________.
a. market risk
b. industry risk
c. portfolio risk
11. If Blackberry's beta (as determined by the line of best fit) is 1.40, that means for every 1%
decline in the market, Blackberry's stock price would _________ by 1.40%.
a. increase
b. decrease
12. The least risky security which has a beta of zero is ____________.
a. Treasury bills
b. the market portfolio
c. long-term government bonds
13. The portion of total risk that can be diversified away is called ___________ risk.
a. firm-specific
b. market
c. macro event
14. If an investor invests 40% of their funds in a stock with beta 2.5, 35% in a stock with beta
1.05 and 25% in a stock with beta 0.5, their portfolio beta will be _____.
a. 2.50
b. 1.49
c. 1.01
d. 1.23
15. The annual market risk premium in Canada over the past 45 years was approximately _____.
a. 4.6%
b. 3.5%
c. 2.5%
d. 8%
16. If a stock's beta is 1.10, the risk-free rate is 3% and the return on the market portfolio is 7%,
then the market risk premium is ______ and the stock's risk premium is _______.
a. 3.3%; 4.4%
b. 4%; 4.4% MRP= 7% - 3% = 4% SRP = MRP x beta = 4% x 1.10 = 4.4%
c. 7.7%; 3.3%
17. To achieve diversification benefits similar to the market portfolio, an investor can invest in
mutual funds with a portfolio beta of close to _____.
a. 0.0
b. 2.0
c. 1.0
d. 0.5
18. Treasury securities are considered to be a risk-free investment that is fixed and not affected
by movements in the market. Such a security would naturally have a beta of _____.
a. 2
b. -1
c. 0
d. 1
19. The capital asset pricing model (CAPM) assumes that for well-diversified investors, the only
relevant measure of investment risk is the _____.
a. risk-free rate
b. portfolio beta
c. average security variance
d. average standard deviation
20. The security market line shows graphically the relationship between expected return of a
security or portfolio and its _________.
a. beta
b. variance
c. standard deviation
21. Empirical testing of the CAPM shows that the actual security market line (SML) has been
_________ than what the model predicts.
a. steeper
b. flatter
22. The market risk premium is the additional return that investors expect when they invest in
_____ rather than in _____.
a. the market portfolio; individual stocks
b. individual stocks; the market portfolio
c. treasury bills; the market portfolio
d. the market portfolio; treasury bills
23. The expected risk premium for any security is equal to its beta times the __________.
a. treasury bill yield
b. market risk premium
c. market's standard deviation
24. The risk-free rate is 5%, the market rate of return is 10%, and beta is 2. Find the expected
rate of return using the capital asset pricing model (CAPM). Note you are given the market
return here, not the market risk premium.
a. 5%
b. 15%
c. 20%
d. 10%
25. The return that shareholders give up by keeping their money in the company is called the
opportunity cost of capital.
26. The capital asset pricing model (CAPM) assumes that the stock market is dominated by
_____ investors.
a. irrational
b. well-diversified
c. uninformed
d. very wealthy
27. The _____ _____ _____ describes the expected returns and risks from investing different
fractions of the investor's funds in the market.
a. asset mix chart
b. security market line
c. portfolio beta line
28. Risky companies, such as tech start-ups, will have a higher ________ rate for their projects,
than safer companies, such as banks.
a. dividend rate
b. risk-free
c. discount rate
29. The capital asset pricing model (CAPM) predicts that the difference in return between stock
A and stock B should be due only to the difference in the _____ of the two stocks.
a. standard deviation
b. diversifiable risk
c. beta
d. total risk
30. According to the capital asset pricing model (CAPM), what is the expected return on a stock
if its beta is equal to zero?
a. Zero
b. The risk-free rate
c. The market-risk premium
d. The return on the market minus the risk-free rate
31. Projects that have high operating leverage tend to have __________ betas.
a. lower
b. zero
c. higher
32. A company needs to earn at least the _________ in order for shareholders to keep their
money in the firm.
a. long-term government yield
b. Treasury bill return
c. opportunity cost of capital
33. The capital asset pricing model (CAPM) assumes that for well-diversified investors, the only
relevant measure of investment risk is the _____.
a. average standard deviation
b. portfolio beta
c. average security variance
d. risk-free rate
34. In the _____ approach, the project's cost of capital is estimated using the cost of capital of
another company involved exclusively in the same type business as the new project.
a. same-discount
b. dividend discount
c. security market line
d. pure-play
35. Firms may use the _____ to discount the cash flows of their average risk projects.
a. company cost of debt
b. risk-free rate
c. company cost of equity
d. company cost of capital
36. Using a pure-play approach for a new project is complicated because a comparable firm may
have a different ________________.
a. tax rate
b. capital structure
c. management style
37. True or false: Projects that involve high fixed costs tend to have lower betas.
a. True
b. False
38. True or false: A sensible way for a manager to account for over-optimistic cash flow forecasts
is to adjust the discount rate.
a. True
b. False
39. The key to a pure-play approach is to find the _______ and market rate of return of a
company in the same line of business as the new project.
a. beta
b. standard deviation
c. variance
40. Identify one problem of the pure-play approach.
a. It is difficult to find companies exclusively involved in a single line of business for
comparison.
b. It is based on the revenue of a firm instead of cash flows of a firm.
c. It does not consider time value of money.
d. It does not consider the opportunity cost of capital.
41. Which of the following is a sensible way for a manager to account for over-optimistic cash
flow forecasts?
a. To abandon such kind of projects
b. To adjust the discount rate
c. To adjust the expected cash flows
d. To wait till the forecast becomes correct
Ch.13 The Weighted-average cost of capital and company valuation
1. If a firm is all-equity financed and has no debt outstanding, the value of the firm is equal to
____________.
a. total book value of the shares
b. total liquidation value of the shares
c. total market value of the shares
2. Spock Enterprises has a market value of $100 million in debt outstanding. They also have a
market value of equity of $400 million. Spock's capital structure is _____ percent debt and
_____ percent equity.
a. 10; 90
b. 15; 85
c. 80; 20
d. 20; 80
3. Which of the following statements regarding the company cost of capital are true? (Check all
that apply.)
a. It is used to value the riskiest new projects undertaken by a firm.
b. It is based only on a firm's cost of new debt.
c. It is an opportunity cost.
d. It is used to value new assets that have the same risk as the existing ones.
e. It is the minimum rate of return that a firm must earn on its average-risk investments.
4. Which of the following are correct equations to calculate return on asset? (Select all that
apply.)
a. rassets = D×rdebt+E×requity / V
b. rassets = Value of investment – Total income
c. rassets = Total income / Value of Investment
d. rassets =V – (D × rdebt + E × requity)
5. The company cost of capital is a weighted average of returns required by a firm's _____
holders and _____ holders.
a. debt; equity
b. debt; net working capital
c. net income; short-term debt
d. assets; liabilities
6. If a firm has only equity outstanding and no debt, its cost of capital will be equal to the
_______________.
a. return demanded by shareholders
b. nominal risk-free rate
c. after-tax Treasury bill yield
7. Which of the following best describes a firm's capital structure?
a. The firm's mix of debt and equity financing
b. The total market value of the firm's debt
c. The difference of current assets minus the current liabilities for the firm
d. The total market value of the firm's equity
8. True or false: It is acceptable to use book values of debt and equity to calculate the weights of
debt and equity for the company cost of capital calculation.
a. True
b. False
9. Another name for the weighted-average cost of capital is the _____.
a. systematic cost of capital
b. company cost of capital
c. project specific cost of capital
d. global cost of capital
10. To satisfy both debtholders and shareholders, a firm needs to earn a return called the
_____________.
a. return on securities
b. return on assets
c. return on book value
11. The combined total investment of debtholders and equity holders in a firm is called the total
_________ of the firm
a. income
b. value
c. return
12. If a firm is all-equity financed and has no debt outstanding, the value of the firm is equal to
____________.
a. total market value of the shares
b. total book value of the shares
c. total liquidation value of the shares
13. If the Jones Corporation has a market cost of debt capital of 8% and a corporate tax rate of
35%, what is Jones' after-tax cost of debt capital? (Round your answer to one decimal place.)
a. 2.8%
b. 5.0%
c. 5.2%
d. 8.0%
14. Unlike book values, market values depend on the _____.
a. future source of financing
b. future profits and cash flows
c. accounting history
d. net cumulative historical outlays
15. The weighted-average cost of capital is the expected return on a portfolio of all the firm's
securities, adjusted for tax savings due to _________ payments.
a. dividends
b. income
c. interest
16. Lacey Corp has $30 million of debt, $10 million of preferred stock and $60 million of
common stock outstanding. The market cost of debt is 7%, the cost of preferred stock is 9% and
the cost of common equity is 11%. They have a 35% corporate tax rate. What is Lacey's
weighted-average cost of capital?
a. 10.68%
b. 11.10%
c. 8.87%
d. 9.77%
17. The company cost of capital is a weighted average of returns required by a firm's _____
holders and _____ holders.
a. assets; liabilities
b. net income; short-term debt
c. debt; net working capital
d. debt; equity
18. A project's NPV can be calculated by discounting the cash flows by the firm's _________.
a. after-tax cost of debt
b. risk-free rate of interest
c. weighted average cost of capital
19. If a firm's relevant corporate tax rate is T and its before-tax cost of debt capital is R, which of
the following is the correct equation to use in the weighted-average cost of capital calculation?
a. R × T
b. T × (1 – R)
c. R
d. R × (1 – T)
20. Identify the true statement about the project that has zero NPV when the expected cash
flows are discounted at the weighted-average cost of capital.
a. The project's cash flows are not sufficient to give debtholders and shareholders the returns
they require.
b. The project's cash flows are just sufficient to give debtholders and shareholders the returns
they require.
c. The project's cash flows are just sufficient to pay the firm's debtholders.
d. The project's cash flows are not only sufficient to give debtholders and shareholders the
returns they require but also can be retained by the firm.
21. The market value of the common stock of a firm can be calculated by multiplying the _____.
a. book value of equity and the equity multiplier
b. book value of equity and the market value of equity
c. common share price and the number of common shares
d. book value per share and the number of shares outstanding
22. Vandalay Industries has $30 million of debt and $70 million of equity outstanding. The
market cost of debt is 8% and the cost of equity is 14%. They have a 35% corporate tax rate.
What is Vandalay's weighted-average cost of capital?
a. 11.00%
b. 11.63%
c. 12.36%
d. 11.36%
23. For most large and healthy firms, the probability of bankruptcy is sufficiently low that
financial managers are content to take the _____ on the bonds as a measure of the expected
return.
a. historical yield on maturity
b. risk-free rate
c. promised yield to maturity
d. coupon rate
24. Potter National Bank has a beta of 1.8. The risk-free rate is currently quoted at 1.5% and the
market risk premium is 7.5%. What is Potter's cost of common equity? (Round your answer to
one decimal place.)
a. 14.5%
b. 15.5%
c. 15.7%
d. 15.0%
25. Find the NPV of a project if it has perpetual annual after-tax cash inflows of $5.0 million, a
weighted average cost of capital of 8.5% and the initial capital outlay is $32 million.
a. $58.82 million
b. $26.82 million (-32 + 5/.085)
c. $37.53 million
d. $35.59 million
26. When a project's cash flows are discounted at the weighted-average cost of capital and the
net present value is exactly zero, then those cash flows are _____ to give debtholders and
shareholders the returns they require.
a. not likely
b. too little
c. just enough
d. too much
27. The _____ value of equity should always be used when calculating a firm's capital structure
weight of equity.
a. canonical
b. market
c. book
d. historical
28. Which of the following should one check when an estimation of the expected return on a
common stock is given?
a. The cost of equity must be greater than the cost of debt.
b. The cost of equity must be adjusted by the tax rate
c. The cost of debt must be greater than the cost of equity.
29. The _____ is usually accepted as a firm's cost of debt capital for weighted-average cost of
capital calculations.
a. risk-free rate
b. promised yield to maturity on the firm's existing bonds
c. coupon rate on the firm's existing bonds
d. rate on Treasury bonds of similar maturity
30. Evans Inc. has a current stock price of $30, constant growth rate of 5% and the expected
dividend this year is $1.20 per share. What is Evan's Inc.'s cost of equity using the constant
growth formula?
a. 10%
b. 12%
c. 4%
d. 9%
31. A firm's cost of equity is usually calculated using the _____ equation.
a. free cash flow
b. net working capital
c. weighted-average cost of capital
d. capital asset pricing model
32. The accuracy of cost of equity can be improved by estimating the cost of equity for a
_________________.
a. an industry unrelated to your firm
b. group of comparable companies
c. large diversified equity index
33. What is the correct equation for the required return of a preferred stock, r, given an annual
dividend, D, and the price of the preferred stock, P0?
a. r = D + P0
b. r = P0/D
c. r = D × P0
d. r = D/P0
34. In addition to checking that the cost of equity is greater than the cost of debt, a second
check on the cost of equity can be obtained from using the _______________ model.
a. yield to maturity
b. dividend discount
c. expectations
35. Calculating the cost of equity using the constant-growth dividend formula will be incorrect
when applying it to ____________.
a. utility companies
b. financial firms
c. high growth firms
36. Arrange the steps to calculate the weighted average cost of capital.
37. True or false: The accuracy of the cost of equity and the weighted average cost of capital of a
firm can be improved by estimating the same for an industry or a group of comparable
companies.
a. True
b. False
38. The long-term government bond yield, instead of Treasury bill yield, is often used by
managers when using CAPM to calculate the cost of equity for a __________ project.
a. risk-free
b. long-term
c. short-term
39. Martin Co. has issued preferred stock with an annual dividend of $6.00. The current market
price per share of this preferred stock is $47.00. What is the expected return on the Martin
preferred stock?
a. 13.5%
b. 12.6%
c. 19.9%
d. 12.8%
40. A company's weighted-average cost of capital should only be used to assess projects that
have the __________ as the firm's existing operations.
a. same risk or higher risk
b. same risk
c. same risk or lower risk
41. There are two costs of debt finance, the _____ cost and the _____ cost.
a. explicit; implicit
b. known; unknown
c. high; low
d. external; internal
42. The constant growth dividend model formula can be rearranged to solve for the cost of
equity The expected return on equity is equal to the dividend yield (D1/P0) plus the __________.
a. long-term government bond yield
b. perpetual growth rate in dividends
c. current risk-free rate
43. Which is the first step in determining the appropriate cost of capital for a project?
a. Assess the risk of the project's cash flows.
b. Select the best financing mix for the project.
44. When completing your weighted average cost of capital calculation, you should make sure
that your market value weights; D/V, E/V and P/V, add up to _______.
a. the cost of equity
b. 100% minus the tax rate
c. 100%
45. You can treat a company as one big project by discounting its ________ by WACC and then
subtracting the value of debt, as long as the debt ratio is expected to remain fairly constant.
a. cash flows
b. coupon payments
c. net income
46. When calculating the return on equity to be used in WACC to evaluate a long-term project,
often managers will use ________ as the risk-free security.
a. 5-year corporate bond
b. long-term government bond
c. Treasury bills
47. The weighted-average cost of capital is the appropriate discount rate for _____ projects but
should be adjusted _____ for higher risk ones or _____ for lower risk ones.
a. average-risk; upward; downward
b. risk-free; upward; downward
c. average-risk; downward; upward
d. risk-free; downward; upward
48. The increase in the rate that bondholders demand as the amount of debt borrowed
increases is called the _____ cost of debt.
a. implicit
b. internal
c. external
d. explicit
49. What does the project's weighted-average cost of capital reflect? (Check all that apply.)
a. It reflects the overall risk of the project.
b. It reflects the best financing mix for the project.
c. It reflects the overall requirement of working capital for the project.
d. It reflects the amount of capital to be raised for the project.
50. A firm's operating cash flow that is left over after all expenditures are made for working
capital and investment in fixed assets is called ________.
a. free cash flow
b. depreciation
c. net income
51. To determine the equity value of an entire business, discount the firm's _____ using the
_____ as the discount rate, then subtract the value of the firm's _____.
a. equity; cost of equity; debt
b. cash flows; cost of equity; debt
c. cash flows; weighted-average cost of capital; debt
d. equity; weighted-average cost of capital; debt
52. The value of firm's equity is equal to the value of the company minus the ____________.
a. dividends paid
b. net working capital
c. value of debt
53. If WACC is used to discount many years of cash flows for the purpose of business valuation,
then it usually makes sense to use the __________ as the cost of debt.
a. firm's short-term interest rate
b. firm's long-term interest rate
c. Treasury bill risk free rate
54. A firm's free cash flow is the amount of cash that is left over after all necessary expenditures
and can be paid out to _________.
a. government agencies
b. investors
c. employees
55. If the value of Blue Sky inc. is $1.2 million and the company is financed with 30% debt, then
the equity in the business is equal to ______________.
a. $840,000
b. $360,000
c. $1,200,000
d. $4,000,000
56. Which of the following can be included in the calculation of the weighted average cost of
capital? (Check all that apply.)
a. Cost of the project
b. Cost of equity
c. Cost of inventories
d. Cost of long-term debt
e. Cost of short-term debt
Ch.20 Working Capital Management (WCM)
1. Which of the following strategies implies a permanent need for short-term borrowing?
a. Restrictive strategy
b. Relaxed strategy
c. Middle-of-the-road strategy
d. Intensive strategy
2. Firms that match the maturities of their assets and liabilities finance their current assets with
_____.
a. short-term sources of financing
b. retained earnings
c. long-term sources of financing
d. the purchase of treasury stock
3. When permanent working capital requirements are funded with long-term sources of
financing, this is an extension of the _________ principle.
a. cumulative capital
b. maturity-matching
c. capital asset pricing
4. True or false: Short-term financial planning mostly focuses on variation in working capital.
a. True
b. False
5. Accounts receivable from the sale of goods to other companies is known as _____.
a. consumer credit
b. bank credit
c. financial credit
d. trade credit
6. Identify the strategy that involves a firm lending out spare cash during the part of the year
when total capital requirements are relatively low.
a. Intensive strategy
b. Relaxed strategy
c. Restrictive strategy
d. Middle-of-the-road strategy
7. Net working capital is equal to _____.
a. current liabilities divided by current assets
b. current liabilities minus current assets
c. current assets minus current liabilities
d. current assets divided by current liabilities
8. Firms that match the maturities of their assets and liabilities finance their long-lived assets
with _____.
a. retained earnings
b. short-term sources of financing
c. long-term sources of financing and equity
d. the purchase of treasury stock
9. Match the periods with their definitions.
10. Permanent working capital requirements are funded with _____.
a. long-term sources of financing
b. short-term sources of financing
c. the purchase of treasury stock
d. retained earnings
11. If a firm's inventory period is 60 days and accounts receivable period is 40 days, then the
operating cycle of the firm is _____ days.
a. 240
b. 100
c. 15
d. 20
12. Both current assets and current liabilities vary _________ through the manufacturing and
sales cycle.
a. considerably
b. randomly
c. minimally
13. The period of time between the firm's payment for raw materials and the collection on its
sales is called the _________.
a. inventory period
b. operating cycle
c. cash conversion cycle
14. Assets that will be used up, sold, or converted to cash within one year or sooner are called
Current Assets.
15. True or false: Generally, companies have a negative net working capital.
a. True
b. False
16. Mahan Corporation has inventory of $75,000 and annual cost of goods sold of $400,000.
The corporation's inventory period is _____. (Round your answer to the nearest whole number.)
a. 54 days
b. 68 days
c. 46 days
d. 72 days
17. The production cycle influences a firm's investment in working capital. Arrange the steps in
the order in which they take place in the production cycle.
18. A firm's operating cycle is the period of time from the _________ of raw materials to the
collection of cash from the sale of finished goods.
a. cash payment
b. order or purchase
19. The financial manager of a firm must find the level of current assets that minimizes the sum
of carrying costs and shortage costs.
20. How can a company reduce the amount of cash it needs? (Check all that apply.)
a. By speeding up the production process
b. By speeding up collection of accounts receivable
c. By delaying payment for materials
d. By delaying the production process
e. By speeding up payment for materials
21. Which of the following are current assets? (Check all that apply.)
a. Equipment
b. Cash and cash equivalents
c. Accounts payable
d. Inventory
e. Accounts receivable
22. Bank loans for one or more years are called term loans.
23. Identify the correct formula to calculate the inventory period of a firm.
a. Inventory period = Inventory / Annual cost of sales – 365
b. Inventory period = Annual cost of sales / Inventory
c. Inventory period = Inventory / Annual cost of sales / 365
d. Inventory period = Inventory + Accounts receivable / Accounts payable
24. A secured loan is a type of loan for which a borrower needs to provide security or collateral
for the loan.
25. Accounts receivable that are collateral, the security, for a loan are referred to as _____.
a. commercial paper
b. the pledged accounts receivable
c. the collateral accounts receivable
d. a factor
26. Which of the following are considered to be carrying costs? (Check all that apply.)
a. Running out of inventory
b. Obsolescence
c. Spoilage
d. Opportunity cost of capital
e. Running out of cash
27. A financing procedure that involves a firm selling its accounts receivable at a discount for
the purpose of obtaining short-term financing is known as factoring.
28. Mahan Corporation has an inventory period of 20 days, a receivables period of 30 days, and
an accounts payable period of 35 days. The cash conversion cycle is _____ days.
a. 45
b. 30
c. 15
d. 20
29. The fee charged by the lender on the unused portion of a line of credit is called the _____.
a. commitment fee
b. arrangement fee
c. impact fee
d. service fee
30. A short-term security issued by financial companies who use the funds to purchase accounts
receivable and mortgages of other companies is called asset-backed commercial paper.
31. Which of the following can be the collateral when a bank is lending on a short-term basis?
(Check all that apply.)
a. Common stock
b. Securities
c. Prepaid expenses
d. Accounts receivable
e. Inventories
32. A banker’s acceptance is a firm's time draft that has been accepted by a bank and may be
sold to investors as a short-term unsecured note issued by the firm and guaranteed by the bank.
33. If a firm pledges its accounts receivables to a lender and the if the receivables cannot be
collected, then the ______ is responsible for the bad debt.
a. firm (borrower)
b. lender of funds
c. government
34. A firm takes a loan of $100,000 for a month at simple interest from a bank. If the bank
quotes an annual rate of 12% on a simple interest loan, then at the end of the month the firm
needs to repay _____.
a. $1,000
b. $101,000
c. $120,000
d. $12,000
35. In contrast to pledging accounts receivables, when factoring is used, the accounts
receivables are ______ to the non-bank company providing the financing.
a. forgiven by
b. loaned to
c. sold to
36. XYZ Corporation borrows $100,000 from United Bank at a discount of 4%. The actual return
on the loan is _____. (Round your answer to two decimal places.)
a. 96%
b. 4.17% ($4,000 / $96,000)
c. 4%
37. Compensating balance loans ________ the size of the loan required by the borrower.
a. decrease
b. increase
38. Short-term unsecured notes issued by large corporations are known as _____.
a. secured loans
b. commercial paper
c. accounts receivable
39. Banker's acceptance is a short-term unsecured note that has been guaranteed by a _______.
a. bank
b. pension
c. non-financial institution
40. To calculate a monthly interest rate using simple interest, you just divide the quoted annual
rate (r) by ______.
a. 1/12
b. (1+r)^12
c. 12
41. XYZ Corporation borrows $100,000 from United Bank at a discount of 4%. XYZ will receive
_____.
a. $95,833
b. $100,000
c. $104,000
d. $96,000
42. The effective interest rate charged on compensating balance loans is ____ than a regular
loan, because the amount of borrowed funds available is ______ than the face value of the
loan.
a. higher; less
b. lower; more
c. higher; more
d. lower; less
Ch.21 Working Capital Management (WCM)
1. To minimize carrying costs, inventory levels should be kept _______, but to minimize order
costs, inventory levels should be kept __________.
a. high; random
b. low; high
c. high; low
d. random; low
2. Mahan Corporation has sales of 300,000 units, carrying costs of $30 per unit, and ordering
costs of $200 per order. Using the economic order quantity, the optimal order size is _____
units.
a. 4,666,667
b. 1,414
c. 2,000
d. 324
3. The just-in-time approach to inventory management was established by _____.
a. Toyota in Japan
b. Mercedes in Germany
c. Honda in Japan
d. Ford in the United States
4. Ben can invest spare cash in Canadian Treasury bills at an interest rate of 8%, but every sale of
bills costs him $20. His firm pays out cash at a rate of $105,000 per per month, or $1,260,000
per year. Thus, his firm would sell _____ of Treasury bills. (Round your answer to the nearest
dollar.)
a. $5,040
b. $63,000
c. $25,100
d. $5,250
5. Which of the following are order costs of inventory? (Check all that apply.)
a. Handling expense
b. Costs of space
c. Insurance cost
d. Delivery charge
6. Under which of the following circumstances can a firm set its upper and lower limit of cash
balance far apart? (Check all that apply.)
a. When the firm's day-to-day variability in cash flows is large
b. When the cost of buying and selling securities is high
c. When the incentives to manage cash are correspondingly more important
d. When the rate of interest is high in the market
7. To minimize total inventory costs, managers must find the balance between ______ costs and
________ costs.
a. obsolescence; order
b. storage; insurance
c. transportation; delivery
d. order; carrying
8. True or false: Good cash management nevertheless implies some degree of centralization
a. True
b. False
9. The economic order quantity is used to calculate the _____.
a. average amount of inventory to carry
b. cost of inventory
c. optimal order size
d. inventory levels at the end of each month
10. Which of the following are characteristics of money market funds? (Check all that apply.)
a. Not highly marketable
b. High risk
c. Maturities of more than 1 year
d. Low risk
e. Liquid
f. Maturities of less than 1 year
11. A system of inventory management that requires minimal inventories of materials and very
frequent deliveries by suppliers is known as _____ inventory management.
a. aging schedule
b. z-score
c. economic order
d. just-in-time
12. Money market securities are _________, meaning that it is easy and cheap to convert them
to cash.
a. usually long-term
b. always government-guaranteed
c. very liquid
13. The Baumol model for optimal cash balances is almost identical to the ____________
model.
a. economic order quantity
b. market efficiency
c. capital asset pricing
14. Treasury bills in Canada are sold in weekly auctions by the __________ a with original
maturities of either 1, 3, 6 or 12 months.
a. provincial governments
b. big 5 Canadian banks
c. Bank of Canada
15. A more realistic approach to the Baumol model of optimal cash balances is to let the cash
holdings wander freely until they hit ____________.
a. slightly negative balances
b. twice the monthly outflow estimate
c. upper and lower limits
16. A short-term security with cash flows coming from a pool of assets such as mortgage or
credit card receivables is called asset-backed commercial paper.
17. Cash management from __________ is especially effective for multinational corporations.
a. individual branches
b. a centralized location
18. A market for short-term financial assets is known as the money market.
19. Guaranteed Investment Certificates (GIC) are ________ at Canadian banks with maturities of
6 months to 10 years.
a. term deposits
b. mutual funds
c. variable rate bonds
20. Which of the following are important money market instruments? (Check all that apply.)
a. Banker's acceptance
b. Treasury bills
c. Term loans
d. Commercial paper
e. Common stock
21. The safest and most liquid of money market securities are ________.
a. Commercial paper
b. Treasury bills
c. Banker's acceptance
22. Money market instruments that are more liquid and safer offer ________ yields.
a. lower
b. higher
23. When asset-backed commercial paper was first established, the underlying assets were
primarily __________ and various types of consumer loans and receivables.
a. automobiles
b. mortgages
c. derivatives
24. Identify the characteristics of guaranteed investment certificates (GIC). (Check all that
apply.)
a. They provide rates of return over fixed periods, between 6 months and 10 years.
b. They are term deposits at Canadian banks.
c. They do not have a maximum deposit limit.
d. They are term deposits at U.S. banks.
e. They have a minimum deposit of $500
25. Money market securities are _________, meaning that it is easy and cheap to convert them
to cash.
a. very liquid
b. always government-guaranteed
c. usually long-term
26. Despite the high quality of money market investments, there are often significant
differences in yield between corporate and government securities. Which of the following
statements are differences between corporate and government securities in terms of yield?
(Check all that apply.)
a. Government securities are more liquid when compared with corporate securities.
b. Government securities provide higher returns when compared with corporate securities.
c. The risk of default can be high in the case of corporate securities but low in the case of
government securities.
d. Corporate securities are more liquid when compared with government securities.
27. Guaranteed Investment Certificates (GIC) are ________ at Canadian banks with maturities of
6 months to 10 years.
a. mutual funds
b. term deposits
c. variable rate bonds
Ch.22 Working Capital Management (WCM)
1. Credit, discount, and payment terms offered on a sale are known as _____.
a. credit analysis
b. terms of sale
c. trade credit
d. credit procedures
2. If a firm sells goods on terms of 2/10, net 30, then its customers must pay within _____ days
in order to receive a discount.
a. 2
b. 10
c. 30
d. 20
3. The procedure to determine whether the customer is likely to pay his or her bills is known as
_____.
a. credit analysis
b. a credit agreement
c. a customer's cash flow analysis
d. an open account
4. True or false: Credit analysts concentrate on a company's financial statements, using financial
ratios to judge whether the firm is a good credit risk or not.
a. True
b. False
5. One of the 5 C's of credit is ________, meaning assets pledged by the customer that can be
seized in the event of nonpayment.
a. capital
b. condition
c. capacity
d. collateral
6. A company supplying goods to a wide variety of irregular customers may require the payment
for the goods _____.
a. partially on delivery and partially after delivery
b. before delivery
c. partially before delivery and partially after delivery
d. on delivery
7. True or false: Credit analysis is worthwhile only if the expected savings exceed the cost.
a. True
b. False
8. Which of the following ratios can be used to determine the possible bankruptcy of a
company? (Check all that apply.)
a. Total liabilities as a percentage of equity
b. Average days in inventory
c. EBITDA as a percentage of total liabilities
d. Return on assets
9. Terms of 2/10, net 30 require a company to give its customers a discount of _____% if
payment is received within the discount period.
a. 8
b. 10
c. 5
d. 2
10. The Z score, used in credit analysis to predict solvency, uses a mathematical approach called
_______________.
a. small business lending analysis
b. efficient market analysis
c. multiple discriminant analysis
11. The simplest and most obvious credit check for a customer is whether they ____________.
a. are a large or small customer
b. have paid promptly in the past
c. have international operations
12. When using financial statements to judge whether a customer is a good credit risk, most of
the analysis is based on ___________.
a. financial ratios
b. income statement items
c. balance sheet items
13. _____ refers to the standards set to determine the amount and nature of credit to extend to
customers.
a. Consumer credit
b. Credit policy
c. Credit analysis
d. Terms of sale
14. Which of the following are among the five Cs of credit? (Check all that apply.)
a. Character
b. Credit application
c. Capacity to sell
d. Collateral provided
e. Capacity to pay
15. When comparing firms that went bankrupt with firms that survived, which of the following
is related to failing firms?
a. Higher EBITDA relative to total liabilities
b. Lower return on assets (ROA)
c. Lower ratio of liabilities to assets
d. Higher return on assets (ROA)
16. Mahan Corporation receives revenues with a present value of $1,500 and incurs costs with a
present value of $1,200 on each non-delinquent sale. The probability of collection is 4/5. Mahan
Corporation's policy should be to grant credit whenever the chances of collection are _____.
a. less than 4 out of 5
b. better than 4 out of 5
c. equal to 4 out of 5
17. Mahan Corporation had the following ratios: Net profit after tax/Total debt = 0.38;
Sales/Total assets = 4.5, Total debt/Total assets = 0.4, Current Assets/Current liabilities = 1.2,
Rate of growth of equity − Rate of growth of assets = 0.15. The corporation's Z score is equal to
_____. (Round your answer to two decimal places.)
a. 1.89
b. 3.25
c. 2.22
d. 2.50 (0.972 × 0.38) + (0.234 × 4.5) – (0.531 × 0.4) + (1.002 × 1.2) + (0.612 × 0.15)
18. When making credit decisions involving repeat orders, instead on one-time orders, the
probability of collection to earn a break-even profit will most likely _______.
a. increase
c. decrease
19. Which of the following credit analysis is worthwhile. (Check all that apply.)
a. Do not undertake a full credit analysis for any order.
b. Undertake a full credit analysis for all the orders.
c. Do not undertake a full credit analysis for small orders.
d. Undertake a full credit analysis for the doubtful orders.
20. A firm's present value cash flow increases by $250,000 due to excess sales on switching from
a cash-only policy to a new credit policy. The cost of switching to the new credit policy is
$117,500. Calculate the net present value of the credit policy switch.
a. $367,500
b. $132,500
c. $183,750
d. $117,500
21. Which of the following decisions depends on the probability of payment?
a. To offer trade versus consumer credit
b. To offer discounts
c. To offer credit or not
22. Which of the following are to be considered while making credit decisions and credit terms?
(Check all that apply.)
a. A credit manager should focus on the dangerous accounts.
b. A credit manager should provide credit to customers irrespective of their creditworthiness.
c. By introducing a credit policy, a firm should be able to maximize its profits.
d. By introducing a credit policy, a firm should be able to maximize its tax shield.
23. Mahan Corporation receives revenues with a present value of $1,500 and incurs costs with a
present value of $1,200 on each non-delinquent sale. The probability of collection is 4/5. If the
corporation extends credit under these conditions, which of the following will be true?
a. The expected profit will be positive.
b. The expected profit will be negative.
c. The expected profit will be zero. (4 / 5 × $300) – (1 – 4 / 5) ($1,200) = 0
24. If there is a chance that a dubious customer will become a repeat customer,
_____________.
a. it may be worthwhile to grant some credit
b. it is not worth the expense to grant any credit
25. Credit terms for raw materials should be _______ than credit terms for finished goods.
a. longer
b. shorter
26. A firm's present value cash inflow increases by $250,000 due to excess sales on switching
from a cash-only policy to a new credit policy. The cost of switching to the new credit policy is
$75,000 at the end of each year for the next 3 years. If the firm's discount rate is 10%, calculate
the net present value of the credit policy switch.
a. $63,486 $250,000 – PV(Cash outflows = 186,514)
b. $175,000
c. $17,524
d. $186,514
27. As a credit manager, your primary job is to ________.
a. minimize the number of bad accounts
b. maximize sales
c. maximize profits
28. Which of the following statements are true about the credit terms relating to various types
of products? (Check all that apply.)
a. Short credit terms are given to the products whose demand is seasonal during the off-season.
b. More-rapidly-selling products are given short credit terms.
c. Inexpensive items are given shorter credit terms than expensive items.
d. Raw material is sold to manufacturers on longer credit terms than intermediate or finished
goods.