# Finance Problems (MC)

1. The primary objective of business financial management is to

a. maximize total corporate profit.

b. maximize net income.

c. minimize the chance of losses.

d. maximize shareholder wealth (i.e. stock price).

2. Theoretically, stock price is not directly determined by

a. the risk associated with expected cash flows.

b. the net income or loss reported on the income statement.

c. the size of expected cash flows.

d. the timing of expected cash flows.

3. Consider a bond that has a $1000 face value, a 6.875% coupon rate, and pays interest semiannually. The bond has ten years remaining until maturity. The current price reflects an 8.125% annual return to investors. Which of the following statements concerning this bond is true?

a. The bond will sell at a discount.

b. The bond will sell for exactly par value.

c. The bond will sell at a premium.

d. None of the above are true.

4. Which of the following statements is NOT true?

a. If a firm is experiencing severe capital rationing, one may not be able to choose all positive NPV projects.

b. If a firm has plenty of capital for investment, the preferred decision criterion for ranking capital budgeting projects would be the NPV.

c. NPV and IRR will always give you the same accept or reject decision.

d. All of the above are true.

5 . Which of the following statements is true?

a. If interest is compounded more than once a year, the nominal (stated) annual rate is greater than the effective annual rate.

b. If interest is compounded once a year, the nominal (stated) annual rate and the effective annual rate are equal.

c. If interest is compounded more than once a year, the effective annual rate is greater than the nominal (stated) annual rate.

d. (b) and (c) are both correct.

6. In using the percent-of-sales method of forecasting the Additional Funds Needed (AFN):

a. As the dividend payout ratio increases, the amount of required new funds rises.

b. As the dividend payout ratio increases, the amount of required new funds declines.

c. The dividend payout ratio does not affect the amount of required new funds.

d. None of the above is correct.

7. You are looking at two different stocks. Climber, Inc. has a beta of 1.25 and Steady As She Goes Co. has a beta of .95. Which statement is true about these investments?

a. The stock in Steady As She Goes Co. has a lower risk premium than Climber Inc.

b. The required return on Steady will be the higher of the two.

c. The required return on Climber will be the lower of the two.

d. (b) and (c) are both correct.

8. The NPV of a project

a. Is positive if IRR=cost of capital.

b. Measures the percentage increase in shareholder wealth if a project is accepted.

c. Equals the net investment cash outflow when the discount rate is 0%.

d. Measures the dollar change in shareholder wealth if a project is accepted.

9. Which of the following statements is NOT true concerning diversification?

a. The risk of the portfolio is will be reduced as securities are added.

b. The risk being reduced is security-specific risk.

c. If you hold more than 100 securities, then the portfolio is risk-free.

d. As more and more securities are added to the portfolio, the level of risk approaches the level of systematic risk in the market.

10. Capital market theory and history tell us:

I. Financial investors tend to be risk averse.

II. Ceteris paribus, the greater the risk associated with a financial asset, the greater is the return.

III. The NYSE stock exchange is an inefficient market because information about changes in the risk associated with stocks does not translate into changes in required rates of return.

a. I only

b. II only

c. I and II only

d. I and III only

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#### Solution Preview

1. The primary objective of business financial management is to

a. maximize total corporate profit.

b. maximize net income.

c. minimize the chance of losses.

d. maximize shareholder wealth (i.e. stock price).

Answer: d

The primary goal of management should be to maximize stockholders' wealth, and this means maximizing the firm's stock price. Actions which maximize stock prices also increase social welfare.

2. Theoretically, stock price is not directly determined by

a. the risk associated with expected cash flows.

b. the net income or loss reported on the income statement.

c. the size of expected cash flows.

d. the timing of expected cash flows.

Answer: a

The value of a share of stock is calculated as the present value of the stream of dividends the stock is expected to provide in the future.

3. Consider a bond that has a $1000 face value, a 6.875% coupon rate, and pays interest semiannually. The bond has ten years remaining until maturity. The current price reflects an 8.125% annual return to investors. Which of the following statements concerning this bond is true?

a. The bond will sell at a discount.

b. The bond will sell for exactly par value.

c. The bond will sell at a premium.

d. None of the above are true.

Answer: a.

The bond's yield to maturity (YTM) is the interest rate generally discussed by investors. It is the total rate of return if they bought the bond and held it to maturity. The yield to maturity for a bond that sells at par will have the yield to maturity equal to the coupon rate of the bond. ...

#### Solution Summary

This solution is comprised of a detailed explanation to answer multiple choice finance problems.

Financial or Public Economic Questions

1. Consider an economy with two people, Henry and Catherine, who consume two commodities, bread and water. Suppose that, due to a drought, the authorities decide to allocate exactly half the available water to each person. In order to prevent one person from "exploiting" the other, neither person may trade away any water to the other for exchange for more bread. Set up an Edgeworth Box to depict this situation and explain why it is unlikely to be Pareto efficient.

2. Tarzan and Jane live alone in the jungle and have trained Cheetah both to patrol the perimeter of their clearing and to harvest tropical fruits. Cheetah can collect 3 pounds of fruit an hour and currently spends 6 hours patrolling, 8 hours picking, and 10 hours sleeping.

A). What are the public and private goods in this example?

B). If Tarzan and Jane are each currently willing to give up on hour of patrol for 2 pounds of fruit, is the current allocation of Cheetah's time Pareto efficient? Should he patrol more or less?

3. Rodolfo and Mimi share an apartment. The table below shows, for each temperature in the apartment, the marginal benefit (MB) to Rodolfo, the MB to Mimi, and the marginal cost (MC) of attaining that temperature:

Temp (degrees) MB to Rodolfo MB to Mimi MC

66 8 12 14

67 7 10 17

68 5 8 21

69 2 6 26

70 1 3 32

Explain why the apartment's temperature in this problem is a public good, and find the efficient temperature.

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