# Financial management concepts

1. Time value of money is based on the belief that a dollar that will be received at some future date has the exact same purchasing power as a dollar has today.

___ True

___ False

2. The future value of $100 received today and deposited in an account for four years paying semiannual interest of 6 percent is:

___ $450

___ $126

___ $899

___ $134

3. The present value of $200 to be received 10 years from today, assuming an opportunity cost of 10 percent, is:

___ $50

___ $200

___ $518

___ $77

4. A local bank is offering zero coupon certificates of deposit for $25,000. At maturity, three years from now, the investor will receive $32,000. What is the rate of return on this investment?

___ 3 percent

___ 6 percent

___ 9 percent

___12 percent

5. The _______ value of a bond is also called its face value. Bonds which sell at less than face value are priced at a _________, while bonds which sell at greater than face value sell at a _______.

___ discount; par; premium

___ premium; discount; par

___ par; discount; premium

___ coupon, premium; discount

6. The more frequent the compounding, the higher the future value, other things equal.

___True

___False

7. How much can be accumulated for retirement if $2,000 is deposited annually, beginning one year from today, and the account earns 9% interest compounded annually for 40 years?

___ $ 87,200.00

___ $675,764.89

___ $736,583.73

___ $802,876.27

8. Under which of the following conditions will a future value calculated with simple interest exceed a future value calculated with compound interest at the same rate?

___ The interest rate is very high.

___ The investment period is very long.

___ The compounding is annually.

___ This is not possible with positive interest rates.

9. How long must one wait (to the nearest year) for an initial investment of $1,000 to triple in value if the investment earns 8% compounded annually?

___ 9

___ 14

___ 22

___ 25

10. What is the APR on a loan that charges interest at the rate of 1.4% per

month?

___ 10.20%

___ 14.00%

___ 16.80%

___ 18.16%

11. In capital budgeting, the NPV will be zero when the discount rate used to evaluate the project is identical to the IRR.

___ True

___ False

12. Capital budgeting is the process of evaluating:

___ Short -term investment alternatives for the currents assets.

___ The long term capital rationing process

___ The costs associated with an IPO

___ The CAPM formula

___ The cost of capital for the firm

13. The following are all methods of evaluating capital projects except for:

___ IRR (internal rate of return)

___ NPV (net present value)

___ PI (profitability index)

___ The CAPM model

___ Payback

14. In performing a capital budgeting comparison of two or more mutually exclusive projects, all of the following are relevant except for:

___ The firm's marginal tax rate

___ The applicable depreciation schedule

___ The cost of capital (the discount rate)

___ The projected cash flows or savings

___ The firm's operating leverage

15. In performing a financial "lease vs. buy" comparison, all of the following are relevant except for:

___ The cost of capital

___ The depreciation schedule to be used

___ The initial outlay of funds

___ The anticipated life of the project

___ The past (sunk) costs of the equipment being replaced by the lease

16. In leasing equipment, which of the following is true?

___ Leasing always involves more risk than buying

___ Leasing always costs more than buying

___ Leasing allows the deduction of depreciation expense by the lessee

___ Leasing allows the deduction of depreciation expense by the lessor

17. A Treasury bond's bid price will be lower than the ask price.

___ True

___ False

18. Which of the following presents the correct relationship? As the coupon rate of a bond increases, the bonds:

___ Face value increases

___ Current price decreases

___ Interest payments increase

___ Maturity date is extended

19. What happens when a bond's expected cash flows are discounted at a rate lower than the bond's coupon rate?

___ The price of the bond increases

___ The coupon rate of the bond increases

___ The par value of the bond decreases

___ The coupon payments will be adjusted to the new discount rate

20. When an investor purchases a $1,000 par value U.S. Treasury bond that was quoted at 97.16, the investor:

___ Receives 97.5% of the stated coupon payments

___ Receives $975 upon the maturity date of the bond

___ Pays 97.5% of face value for the bond

___ Pays $1,025 for the bond

21. The _________ is utilized to value preferred stock.

___ Capital Asset Pricing Model (CAPM)

___ Constant growth model

___ Variable growth model

___ Zero-growth model

___ Gordon model

22. The current price of DEF Corporation stock is $26.50 per share. Earnings next year should be $2.00 per share and it should pay a $1.00 dividend. The P/E multiple is 15 times on average. What price would you expect for DEF's stock in the future?

___ $13.50

___ $15.00

___ $22.50

___ $26.50

___ $30.00

23. The factors involved in setting a dividend policy include all of the following except:

___ Operating constraints

___ Legal constraints

___ Contractual constraints

___ Internal constraints

___ Regulatory constraints

24. The optimal capital structure is the one that balances:

___ Return and risk factors in order to maximize profits

___ Return and risk factors in order to maximize earnings per share

___ Return and risk factors in order to maximize market value

___ Return and risk factors in order to maximize revenues

___ Return and risk factors in order to maximize dividends

25. As the volume of financing increases, the costs of the various types of financing will ______, _______ the firm's weighted average cost of capital.

___ increase; lowering

___ increase; raising

___ remain the same, maintaining

___ decrease; lowering

___ decrease; raising

26. Financial leverage is:

___ The amount of equity used in the capital structure of the firm

___ The extent to which fixed assets and associated fixed costs are used in business

___ The amount of debt used in the capital structure of a firm

___ The impact of change in sales or volume on the bottom-line earnings per share

27. Which item below is NOT part of the Initial Public Offering process?

___ Meet throughout the process with the media

___ Select the underwriters

___ Register the stock with the Securities and Exchange Commission

___ Distribute a preliminary prospectus

___ Meet with potential investors in a "road show"

28. The IPO process is prescribed and regulated by

___ An "underwriting "firm

___ An investment Banker

___ The Securities and Exchange Commission

___ All of the above

___ None of the above

29. The IPO process, the "spread" refers to:

___ The underwriting firm's payment for services

___ Internally generated funds

___ The "prospectus"

___ None of the above

30. Which of the following investment criteria does not take the time value of money into consideration?

___ Book rate of return

___ Net present value

___ Profitability index

___ Internal rate of return for borrowing projects

31. Financial planning considers the overall effects of future investments and financing decisions.

___ True

___ False

32. Which of the following is not a component of a financial plan?

___ Capital expenditures

___ Working capital requirements

___ Price/earnings on the stock

___ Sales and expenses projections

___ Funding strategies

33. The financial planning model includes all but which of the following:

___ Inputs as listed in the above question

___ Alternative investment options

___ Model to project inputs into financial outputs

___ Outputs of results

___ Assumptions that drive inputs

34. Cash flow to fund future growth is not a concern of the profitable company

___ True

___ False

35. A financial plan should provide a projected income statement, balance sheet and cash flow that tie together.

___ True

___ False

36. A financial plan can be used to project all but the following:

___ Profitability

___ Cash flow

___ Market competitiveness

___ Cost of capital

___ Asset utilization

37. Projects that have a zero NPV when calculated at the WACC will provide sufficient returns to all stakeholders.

True

False

38. Which component is more likely to be biased if book values are used in the calculation of WACC rather than market values?

Debt

Preferred stock

Common stock

All categories should be equally based

39. What would you estimate to be the required rate of return for equity investors if a stock sells for $40 and will pay a $4.40 dividend that is expected to grow at a constant rate of 5%?

___ 7.6%

___ 12.0%

___ 12.6%

___ 16.0%

40. What dividend is paid on preferred stock if investors require a 9% rate of return and the stock has a market value of $54.00 per share and a book value of $50.00 per share?

___ $2.92

___ $4.50

___ $4.68

___ $4.86

41. A merger tactic which buys shares directly from stockholders is a:

___ Poison pill

___ Tender offer

___ Shark repellent

___ Proxy contest

42. Which of the following motives for mergers and acquisitions is least compelling, form a financial perspective?

___ Horizontal integration

___ Vertical integration

___ Use surplus funds

___ Successfully replace inefficient management

___ Diversification

43. Fluctuations in foreign exchange markets can affect foreign revenues and profits of a multinational company, but they have no impact on its overall value.

___ True

___ False

44. FASB No. 52 is a statement issued by the Financial Accountings Standards Board requiring American MNCs to first convert the financial statement accounts of foreign subsidiaries into the country's _______currency and then translate the accounts into the parent firm's currency using the ______ method.

___ spot; historical rate

___ spot; weighted average

___ functional; all-current-rate

___ principal; average rate

___ forward rate; weighted average

45. Between two major currencies, the spot exchange rate is the rate _______ and the forward exchange rate is the rate ________.

___ on that date; today

___ at some specified future date; today

___ today; on that date

___ on that date; at some specified future date

___ none of the above

46. History has shown a positive relationship between higher interest rates and higher subsequent rates of inflation.

___ True

___ False

47. The three basic types of risks associated with international cash flows are business and financial risks, inflation and foreign exchange risks, and political risks.

___ True

___ False

48. The main purpose in contracting to purchase foreign currency in the forward market is to:

___Earn a premium (interest) on the exchange

___Lock into a price now

___Take advantage of the future price reductions

___Avoid the more expensive spot rates

49. If prices in the U.S. rise less rapidly than in Canada, which of the following would be expected according to purchasing power parity?

___The value of the Canadian dollar will decline, relative to the U.S. dollar

___The value of the U.S. dollar will decline, relative to the Canadian dollar

___Inflation will increase in Canada

___The price of gold will decline

50. Which of the following would you expect to be nearly equal across countries?

___Nominal interest rates

___Real interest rates

___Inflation rates

___Forward premium

51. The shares of the Dyer Drilling Co. sell for $60. The firm has a P/E ratio of 15. Forty percent of earnings are paid out in dividends. What is the firm's dividend yield?

52. Compute the present value of a $100 cash flow for the following combinations of discount rates and times:

a. r = 8 percent, t = 10 years.

b. r = 8 percent, t = 20 years.

c. r = 4 percent, t = 10 years.

d. r = 4 percent, t = 20 years.

53. Compute the future value of a $100 cash flow for the same combinations of rates and times as in problem 1.

a. r = 8 percent, t = 10 years.

b. r = 8 percent, t = 20 years.

c. r = 4 percent, t = 10 years.

d. r = 4 percent, t = 20 years.

54. A 6-year Circular File bond pays interest of $80 annually and sells for $950. What are its coupon rate, current yield, and yield to maturity?

55.

Project Co C1 C2 C3

A -$36 +$20 +$20 +$20

B -50 +25 +25 +25

A. Which project has the higher NPV if the discount rate is 10 percent?

B. Which has the higher profitability index?

C. Which project is most attractive to a firm that can raise unlimited amount of funds to pay for its investment projects?

D. Which project is most attractive to a firm that is limited in the funds it can raise?

56. Nucore Company is thinking of purchasing a new candy-wrapping machine at a cost of $370,000. The machine should save the company approximately $70,000 in operating costs per year over its estimated useful life of 10 years. The salvage value at the end of the 10 years is expected to be $15,000. (Ignore income tax effects.)

1. What is the machine's payback period?

2. Compute the net present value of the machine if the cost of capital is 12%.

3. What is the expected internal rate of return for this machine?

#### Solution Preview

1. Time value of money is based on the belief that a dollar that will be received at some future date has the exact same purchasing power as a dollar has today.

___ True

___ False

2. The future value of $100 received today and deposited in an account for four years paying semiannual interest of 6 percent is:

___ $450

___ $126

___ $899

___ $134

3. The present value of $200 to be received 10 years from today, assuming an opportunity cost of 10 percent, is:

___ $50

___ $200

___ $518

___ $77

4. A local bank is offering zero coupon certificates of deposit for $25,000. At maturity, three years from now, the investor will receive $32,000. What is the rate of return on this investment?

___ 3 percent

___ 6 percent

___ 9 percent

___12 percent

5. The _______ value of a bond is also called its face value. Bonds which sell at less than face value are priced at a _________, while bonds which sell at greater than face value sell at a _______.

___ discount; par; premium

___ premium; discount; par

___ par; discount; premium

___ coupon, premium; discount

6. The more frequent the compounding, the higher the future value, other things equal.

___True

___False

7. How much can be accumulated for retirement if $2,000 is deposited annually, beginning one year from today, and the account earns 9% interest compounded annually for 40 years?

___ $ 87,200.00

___ $675,764.89

___ $736,583.73

___ $802,876.27

8. Under which of the following conditions will a future value calculated with simple interest exceed a future value calculated with compound interest at the same rate?

___ The interest rate is very high.

___ The investment period is very long.

___ The compounding is annually.

___ This is not possible with positive interest rates.

9. How long must one wait (to the nearest year) for an initial investment of $1,000 to triple in value if the investment earns 8% compounded annually?

___ 9

___ 14

___ 22

___ 25

10. What is the APR on a loan that charges interest at the rate of 1.4% per

month?

___ 10.20%

___ 14.00%

___ 16.80%

___ 18.16%

11. In capital budgeting, the NPV will be zero when the discount rate used to evaluate the project is identical to the IRR.

___ True

___ False

12. Capital budgeting is the process of evaluating:

___ Short -term investment alternatives for the currents assets.

___ The long term capital rationing process

___ The costs associated with an IPO

___ The CAPM formula

___ The cost of capital for the firm

13. The following are all methods of evaluating capital projects except for:

___ IRR (internal rate of return)

___ NPV (net present value)

___ PI (profitability index)

___ The CAPM model

___ Payback

14. In performing a capital budgeting comparison of two or more mutually exclusive projects, all of the following are relevant except for:

___ The firm's marginal tax rate

___ The applicable depreciation schedule

___ The cost of capital (the discount rate)

___ The projected cash flows or savings

___ The firm's operating leverage

15. In performing a financial "lease vs. buy" comparison, all of the following are relevant except for:

___ The cost of capital

___ The depreciation schedule to be used

___ The initial outlay of funds

___ The anticipated life of the project

___ The past (sunk) costs of the equipment being replaced by the lease

16. In ...

#### Solution Summary

This explans the key financial management concepts such as time value of money, future value, opportunity cost