FINA351-Managerial Finance, Study Guide for Test 1, Chapters 1-7
NOTE: Make sure to bring a pencil to the test because the answer sheets require a pencil. You may bring a 3”
by 5” index card (or piece of paper that size) with both sides crammed with as much information as possible
(such as formulas, definitions, etc.) Time-value-of-money tables will be supplied, as well as the ratio formulas
(i.e. Table 3.5 in your text).
Chapter 1
1. Review the four basic areas of finance.
2. Managerial or corporate finance deals with which three broad areas? How are these areas defined?
3. What is the goal of a corporation? Is it possible to achieve this goal over the long run and ignore
corporate responsibility to employees, communities, environment or customers? What was Johnson &
Johnson’s view on this? What is the triple bottom line? [answer: profits, people, planet]. Should a
Christian view the goal of a corporation differently from your textbook goal? Does the goal of
maximizing the current stock price reflect only short-term results or does it also reflect long-term
expectations?
4. Will corporations usually act in a totally responsible manner without any government intervention?
5. What is the agency problem? What are the five ways for stockholders to encourage their hired managers
to do a good job for them? What are ways for management to fight back against stockholders who want
to replace them? (See instructor notes.)
6. Review the info on financial markets. How do the primary and secondary markets differ? What do the
acronyms NASDAQ and NYSE stand for? How do these two markets differ? Which is the largest
market in terms on dollars? In terms of listings? Which market is also known as the Big Board? How
can you generally tell by the ticker if a stock is traded on the NASDAQ or the NYSE?
7. Review the notes on market indices, particularly the DJIA and the S&P500. What is the DJIA and how
is it calculated? What are its weaknesses? Is a bear or bull an optimist?
Chapter 2
1. What does a balance sheet tell us? What are its other names? In what order are assets listed? Liabilities?
What is liquidity?
2. Review the assignment on Microsoft. How is the total book value (or net worth) of a company
determined? How is the total market value determined? What are two reasons why they are not the
same? (Note that the total market value of a company is called its market capitalization or market cap.)
How do you calculate and interpret the market-to-book ratio? Is a ratio less than one good or bad?
3. What does an income statement tell us? What are its other names? Why should a person never look
only at the bottom-line? How does an income statement on the accrual basis differ from one on the cash
basis? What is earnings management and does it always result in higher earnings?
4. What are the three sections of a cash flow statement and what activities appear in each category? Be
able to read and interpret a statement of cash flows, as we did in class. For example, what is going on in
a company if operating and investing activities used cash (negative) but financing activities provided
cash (positive)? What would a normal and healthy cash flow pattern look like?
5. Be able to find the tax liability and the average & marginal tax rates for a corporation if given the tax
rates and the taxable income. Which rate (marginal or average) is more important for tax planning?
Why is a marginal and average tax rate of 35% assumed for large corporations?
6. Are individual federal tax rates in the U.S. progressive or regressive? (See instructor notes.) For the
latest year with data, what percent of federal individual income taxes are paid by those with the highest
10% of taxable income? Bottom 50% of taxable income? Have the rich been getting more or less rich
over the last few decades? (see instructor notes at the end for tax information)
7. Why might corporations prefer to finance with debt (bonds) rather than equity (stock)? [See instructor
notes for Ch. 2]
8. Why do corporations get a tax break on dividend income they receive from stocks invested in other
corporations? [Answer: Otherwise there would be triple taxation on the same money as it is passed
from one corporation to another and eventually to the ultimate stockholder.]
9. Why might corporate investors invest heavily in preferred stock? [Answer: Because preferred stock
usually pays lots of dividends and most inter-corporate dividend income is tax-exempt.]
10. Suppose you own shares of stock. Are dividends received by individuals (not corporations) fully
taxable? [Answer: Yes, they are reported right smack on the front of your Form 1040.] How does this
cause double taxation? [Answer: the corporation pays tax on its profits and then distributes the profits
in the form of dividends to shareholders who pay tax on the dividends.]
Chapter 3
1. Be able to prepare simple common-size and base-year financial statements. On a common-size income
statement, what figure equals 100%, total revenues/sales or net income? In base-year analysis, if the
base year is set to 100%, how are future year’s percentages calculated?
2. Be able to work/interpret the financial ratios that were on the Target/Wal-Mart assignment. You will
not be responsible for ratios that were not on the assignment. Note that a copy of Table 3.5 (ratio
formulas) will be included with the test.
3. What conclusions were drawn in your comparison of Target and Wal-Mart? Which company was the
biggest? Which company appears to have higher quality products/service and charges higher prices?
How can you tell? Which company appears to be more efficient through economies of scale (higher
sales volume, more sales per sq. foot, etc.)? Which company has a smaller percent of sales spent on
operating expenses and this is more efficient? Which company sells its inventory more quickly?
How can you tell?
Chapters 4 & 5
The best way to review these chapters is to rework the assignments -- the test will have a couple of problems
very similar to those on the assignments. Review subjects such as: simple vs. compound interest, present and
future values of single-sums, present and future values of ordinary annuities, present and future values of
multiple cash flows of different amounts, difference between ordinary annuities and annuity dues (you won’t
have to calculate annuity dues), effect of compounding frequency (quarterly, daily, perpetually, etc.), finding
EAR/APY, Rule of 72, and amortization tables. If you have a financial calculator or financial phone app, you
will be allowed to use it on the test. For those without calculators, tables will be provided.
Chapter 6
1. Review the various features of a typical bond, including the terminology discussed in your text and in
the notes. For example, what is the difference between an indenture and a debenture? Are most
corporate bonds debentures? Are most bonds term or serial bonds, and which would more likely
require a sinking fund? Are coupon/bearer or registered bonds more common today? Would an
investment grade bond have a higher or lower interest rate than a junk bond? Why?
2. Be able to determine the price of a bond by calculating the present value of the ordinary annuity
(interest payments) and the single-sum ($1,000 maturity value). Be able to explain why premiums
and discounts arise when interest rates change. For example, if a $1,000 face value bond is paying
interest of $100 annually (10% coupon), but its YTM (or market rate) is 12%, would the bond be
priced at a premium or a discount? Why?
3. Review the five bond pricing theorems illustrated in the notes and the assignments. What relationship
(direct or inverse) does a bond price have with market interest rates movements? What happens to
the price of a premium bond as it approaches maturity? A discount bond? Which are more sensitive
to changes in interest rates: long-term or short-term bonds? Low-coupon or high-coupon bonds?
What is interest rate risk? If a short-term bond investor thought interest rates were headed up, how
could the investor minimize interest-rate risk: by lengthening or shortening the average maturity of
the portfolio? By raising or lowering the average coupon rate of the portfolio?
4. Referring to the national debt, does the U.S. borrow more through Treasury Bills, Notes, or Bonds?
How much does the U.S. Federal government currently owe (approximately, to the nearest trillion)?
5. Differentiate between a T-Bill, T-Note, and T-Bond. Do Treasury securities have default (or credit)
risk (at least theoretically)? Do Treasury securities have liquidity risk?
6. What are municipal bonds? Are interest payments on municipal bonds subject to federal tax?
7. What are zero-coupon bonds? Are T-Bills essentially zero-coupon bonds?
8. Be able to read and interpret corporate and government bond quotes. A quote on a corporate bond of
99.25 means a price of how many dollars? What do the bid price and asked price mean? Which
would usually be higher: the bid or asked price? Why?
9. Understand how inflation affects the required rate of return on fixed-income investments. In other
words, be able to calculate real returns according the Fisher Effect (exact method) and the more
simple approximate method. Why is focusing on the real return, rather than the nominal return, so
critical in investing? What does it mean to have a negative real return? How is inflation measured
(i.e. what is the name of the index we track on the market indicators we follow every week)? Is it
possible for the nominal return to be smaller than the real return? Has this ever happened in the US?
10. What is meant by the “term structure of interest rates?” What are two main reasons that long-term
rates are usually higher than short-term rates on fixed-rate investments? What is the normal shape of
a yield curve? What does an inverted yield curve usually signify? What is the current shape of the
yield curve? Be familiar with inflation risk and interest-rate risk. Which of these risks would cause a
T-Bond to usually have a higher rate than a T-Bill?
Chapter 7
1. Why is valuing stock more difficult than valuing bonds? In other words, why are the future cash
flows more uncertain for stocks than for bonds?
2. Be able to value a share of common stock using the Dividend Growth Model (assuming constant
growth) as was done on the assignments.
3. What are the two components of required return on stock? How are they determined? Which one is
more important in a bull market? In a bear market?
4. Why is it said that corporate democracy follows the golden rule? Which of the two voting procedures
(cumulative or straight) favors minority voters? What is a proxy? Why do some firms have more
than one class of stock? What rights does a common stock owner have?
5. What preference does preferred stock owners have? What do they give up to get this preference?
6. Review the discussion in your text on stock markets: dealers vs. brokers, NYSE members, NYSE
organization/operation, Nasdaq market, ECNs, etc. Be able to answer similar questions to those on
your assignment over this material.
7. Know how to read and interpret a stock quote.
COMPUTATIONAL PROBLEMS TO REVIEW:
In addition to the concepts and theory, several computational problems will appear on the exam for which
you’ll need a calculator. At a minimum, you should review and be able to do problems similar to the list
below:
Assignment
Problems
Assignment
Problems
2a
5, 7a, 8b
4-5d
2, 3a, 4
3ab
6, 8a-e
6b
1, 3, 5, 9
4-5a
6, 7, 12
6c
2c, 10
4-5b
7, 9, 10
7a
3, 4, 17
4-5c
1, 2, 3, 5
7b
3, 4, 5
LAST BIT OF ADVICE:
Make sure to read the test questions carefully and attack them methodically. For those students who work
more slowly (as I did when in college), you will be allowed some extra time if needed.
Bring a pencil, which is required to fill out the answer sheet.
Expect a mixture of true/false and multiple choice questions . . . probably about a dozen T/F and maybe two
dozen MC questions.
Good luck! But remember that Thomas Jefferson said “I'm a great believer in luck; and I find that the harder
I work, the more I have of it.” See you at the grand celebration.