FINA 3770 Final Exam: Terms

With regard to information, a central idea of fairness suggests that:

• decisions should be made on an even playing field.

• insiders should never be able to trade.

• insiders should be able to trade whenever they want.

• outsiders should not be allowed to trade since, by definition, they are at a disadvantage.

Decisions should be made on an even playing field.

If you have loaned capital to a firm, then you could be…

• A manager

• A stakeholder

• A partner

• All of the above

A stakeholder

Cash dividends are paid out of:

• Residual cash flows

• Liquidated assets

• Long-term debt

• All of the above

Residual cash flows

Agency costs refer to …

• the fact that managers know how to manage the firm better than stockholders.

• the costs that result from default and bankruptcy of a firm.

• stockholders having unreasonable expectations about managerial performance.

• the total dividends paid to stockholders over the lifetime of a firm.

• the costs of any conflicts of interest between stockholders and management

The costs of any conflicts of interest between stockholders and management

Which of the following is primarily responsible for managing all financial aspects of a firm?

• CFO

• Chairman of the board

• External Auditors

• CEO

• Board of Directors

CFO

Which of the following is the Use (Outflow) of CASH in the statement of cash flows?

I. Increase in accounts payable

II. Payment of dividends

III. Sale of fixed assets

IV. Increase in accounts receivables

II and IV only - Payment of dividends + Increase in accounts receivables

Which one of the following actions by a financial manager is MOST LIKELY to create an agency problem?

• refusing to borrow money when doing so will create losses for the firm

• a manager expensing a lavish dinner on the company expense report.

• a manager using too little debt within the firm's capital structure because of the additior associated with debt.

  refusing to lower selling prices if doing so will reduce the net profits

  • a manager turning down a value-contributing project because of its risks.

A manager expensing a lavish dinner on the company expense report.

The process of converting financial securities with one set of characteristics into securities with another set of characteristics is called:

• none of the above.

• financial disintermediation.

• financial bundling.

• financial intermediation.

financial intermediation.

Which of the following types of owners is protected by limited liability?

• A sole proprietor

• A general partner

• Owner of a corporation

• None of the above

Owner of a corporation

Which of the following would generally NOT increase shareholders' wealth?

• Maximizing profits.

• Increased government regulation.

• Receiving larger cash flows.

• Rapid growth in the overall economy.

Receiving larger cash flows.

An example of an agency cost is:

• a manager turning down a value-contributing project because of its risks

• a manager expensing a lavish dinner on the company expense report.

• a manager using too little debt within the firm's capital structure because of the additional risk associated with debt.

• all of the above.

A manager expensing a lavish dinner on the company expense report.

The main responsibility of a financial manager is to

• manage the wealth of stockholders.

• assist the marketing department in making sales projections.

• make decisions that are in the best interests of the firm's owners.

• keep the firm's debt-holders happy.

Make decisions that are in the best interests of the firm's owners.

Investment banking firms provide

• auditing services.

• insurance.

• overdraft facility.

• underwriting services.

Underwriting services.

One of the main services offered by investment banks to companies is:

• helping companies sell new debt or equity issues in the security markets.

• making loans to companies.

• taking deposits from companies.

• all of the above.

Helping companies sell new debt or equity issues in the security markets

The most common reason that corporate firms use the futures and options markets is:

• to hedge risk.

• to take risk.

• to make deposits.

• none of the above.

To hedge risk

If a firm needs to finance a new corporate headquarters building, then it would most likely seek the funds in the:

• money market.

• capital market.

• futures market.

• all of the above.

capital market

Which of the following does NOT belong to an income statement?

• Depreciation expense

• Goodwill

• Extraordinary items

• Amortization expense

Goodwill

Which of the following is true about the quick ratio?

• The quick ratio is calculated by dividing the least liquid of current assets by current liabilities.

• Service firms that tend not to carry too much inventory will see significantly higher quick ratios than current ratios.

• Inventory, being not very liquid, is subtracted from total current assets to determine the most liquid assets.

• Quick ratios will tend to be much larger than current ratio for manufacturing firms or other industries that have a lot of inventory.

Inventory, being not very liquid, is subtracted from total current assets to determine the most liquid assets.

Money has time value because:

• people prefer to sell things later rather than today.

• people can earn interest on money that is invested.

• people do not require compensation for deferring consumption.

• people prefer to receive money tomorrow than today because it is worth more.

People can earn interest on money that is invested.

When the discount rate:

• increases, the present value of a future cash flow decreases.

• increases, the present value of a future cash flow increases.

• decreases, the present value of a future cash flow will remain the same.

• decreases, the present value of a future cash flow decreases.

Increases, the present value of a future cash flow decreases.

Which of the following statements about the time value of money is true?

• The value of a dollar invested at a positive interest rate decreases over time.

• The further in the future you receive a dollar, the less it is worth today.

• A dollar in hand today is worth less than a dollar to be received in the future.

• The higher the rate of interest, the more likely an investor will elect to consume at present and forgo invest his funds.

The further in the future you receive a dollar, the less it is worth today.

The price of a bond is calculated by:

A. Discounting the sum of coupon payments and principal

B. Adding the present value of principal payment and the present value of coupon payments

C. Subtracting the present value of principal payment from the present value of coupon payments

D. Discounting the difference between the principal payment and the coupon payments

Adding the present value of the principal payment and the present value of coupon payments.

Which one of the following statements about bonds is NOT true?

• To compute a bond's price, one needs to calculate the present value of the bond's expected cash flows.

• The value, or price, of any asset is the future value of its cash flows.

• The required rate of return, or discount rate, for a bond is the market interest rate called the bond's yield to maturity.

• The expected future cash flows are estimated using the coupons that the bond will pay and the maturity value to be received.

The value, or price, of any asset is the future value of its cash flows.

The constant growth dividend model would be useful to determine the value of all, but which of the following firms?

• A firm whose earnings and dividends are declining at a fairly steady rate.

• A firm whose sales, profits, and dividends are growing at an annual average compound rate of 5 percent.

• A firm whose earnings and dividends are growing at a fairly steady rate.

• A firm whose expected sales, profits, and dividends are fluctuating.

A firm whose expected sales, profits, and dividends are fluctuating.

Which of the following is a major role of secondary markets?

• To assist firms in finding underwriters.

• To provide good marketability for securities.

• To issue the initial public offering of a security.

• To provide good arbitrage opportunities.

To provide good marketability for securities.

When two projects are independent, accepting one project implicitly eliminates the other. True/False

False

Projects are classified as independent when their cash flows are unrelated. True/False

True

When computing the NPV of a capital budgeting project, one should NOT

• estimate the cost of the project.

• discount the future cash flows over the project's expected life.

• ignore the salvage value.

• make a decision based on the project's NPV.

Ignore the salvage value.

Which of the following statements is NOT true about common stock?

• Common-stock holders have the right to vote on the election of the board of directors of their company.

• Common stock is considered to have no fixed maturity.

• Owners of common stock are guaranteed dividend payments by the firm.

• Common-stock holders have limited liability toward the obligations of

  the corporation.

Owners of common stock are guaranteed dividend payments by the firm.

The reason we cannot apply the constant growth dividend model in the case where the growth rate, g, is greater than or equal to the required rate, R, is because it would result in the value of the stock becoming:

• zero

• negative

• infinite

• negative or infinite above

Negative or infinite above

Utilizing the CAPM to estimate the cost of capital for a project is difficult in practice because analysts do not have the stock returns from individual proiects that are necessary to use in a regression analysis for estimating a project's beta.

True/False

False

The investments with the highest expected return have the lowest risk.

True/False

False

A stakeholder is:

• someone geographically close to the firm's headquarters.

• someone who has a claim on the cash flows of the firm.

• some government agency.

• all of the above.

Someone who has a claim on the cash flows of the firm.

Which one of the following characteristics does NOT pertain to corporations?

• Can enter into contracts.

• Can borrow money.

• Are the easiest type of business to form.

• Can be sued.

• Can own stock in other companies.

Are the easiest type of business to form.

The capital budgeting decision process can be described as

• How a firm's day-to-day financial matters should be managed.

• How a firm should finance its assets.

• Which productive assets a firm should purchase.

• All of the above.

Which productive assets a firm should purchase.

Which of the following is responsible for rolling back many of the rules against commercial banks offering investment banking activities?

• The Securities Act of 1933.

• The Securities Exchange Act of 1934.

• The Glass-Steagall Act of 1933.

• The Financial Services Modernization Act of 1999.

The Financial Services Modernization Act of 1999.

Which of the following statements is incorrect?

• Hedge funds are major buyers and sellers of securities in the direct financial markets

• The retail individual investor is a common direct participant in the direct financial markets

• Life insurance companies are major buyers of securities in the direct financial markets

• Direct transactions in wholesale markets have a typical minimum transaction size of $1 million

The retail individual investor is a common direct participant in the direct financial markets

Stocks that are traded in the ____ are typically those of smaller and less known firms.

• National Stock Exchange

• New York Stock Exchange

• American Stock Exchange

• over-the-counter market

over-the-counter market

The conventional way of preparing a balance sheet is to list all assets in the order of their:

• market value.

• risk.

• liquidity.

• historical cost.

liquidity

Which of the following statements is correct?

• A time line is not meaningful unless all cash flows occur annually.

• Time lines are useful for visualizing complex problems prior to doing

  actual calculations.

• Time lines cannot be constructed in situations when the cash flows occur at yearly and quarterly frequencies.

• Time lines cannot be constructed for annuities where the payments

  occur at the beginning of the periods.

Time lines are useful for visualizing complex problems prior to doing actual calculations.

The cost of a new car to the dealership is calculated as

• the wholesale price from the manufacturer less the carrying cost.

• the trade-in price from the customer less the carrying cost.

• the wholesale price from the manufacturer plus the carrying cost.

• the trade-in price from the customer plus the carrying cost.

the wholesale price from the manufacturer plus the carrying cost

The process of converting future cash flows into their present value is called:

• annualizing.

• discounting.

• compounding.

• capital budgeting.

discounting.

Which of the following investments will have the highest future value at the end of three years? Assume that the effective annual rate for all investments is the same.

• You earn $3,000 at the end of three years (a total of one payment).

• You earn $1,000 at the end of every year for the next three years (a total of three payments).

• You earn $1,000 at the beginning of every year for the next three years (a total of three payments).

You earn $1,000 at the beginning of every year for the next three years (a total of three payments).

A preferred stock would be an example of:

• a perpetuity.

• an ordinary annuity.

• an annuity due.

• a growing annuity.

Perpetuity

• Reminder: Perpetuity is a series of equally spaced and level cash flows that continues forever

The yield to maturity of a bond is the discount rate that makes the present value of the coupon and principal payments:

• exceed the price of the bond.

• equal to zero.

• equal to the price of the bond.

• less than the price of the bond.

equal to the price of the bond.

Which of the following is a simplifying assumption that is made when applying the dividend discount model to common stock valuation?

• Dividends vary each year.

• Dividends are constant till the tenure of the firm.

• Dividend growth rate is not equal to the required rate of return.

• Dividends rate grow lesser than 0.

Dividend growth rate is not equal to the required rate of return.

Which of the following capital budgeting technique ignores the time value of money?

• Payback period

• Net present value

• Modified internal rate of return

• Discounted payback period

Payback period

Depreciation and amortization expenses are:

• Part of current assets on the balance sheet.

• After-tax expenses that reduce a firm's cash flows.

• Long-term liabilities that reduce a firm's net worth.

• Noncash expenses that cause a firm's after-tax cash flows to exceed its net income.

Noncash expenses that cause a firm’s after-tax cash flows exceed its net income

_____ a series of equally spaced and level cash flows extending over a finite number of periods

Annuity

___an annuity in which payments are made at the beginning of each period

Annuity Due

____ a series of equally spaced and level cash flows that continues forever

Perpetuity

____ an annuity in which payments are made at the end of each period

Ordinary Annuity

What is a zero coupon bond?

Bonds have no coupon payments but promise a single payment at maturity.

___ represents the basic ownership claim in a corporation.

• One of the basic rights of the owners is to vote on all important matters that affect the company, such as the election of the board of directors.

Common Stock

“stockholders take precedence over common stockholders in the payment of dividends and in the distribution of corporate assets in the event of liquidation”

…Is what type of stock?

Preferred Stock

Projects that are classified as contingent could be mandatory or optional projects. True/False

True, the acceptance of one project is contingent on the acceptance of another.

• There are two types of contingency situations: optional and mandatory

What’s a primary and secondary market?

A primary market is any market where companies sell new security issues (debt or equity)

A secondary market is any market where owners of outstanding securities can sell them to other investors. Secondary markets are like used-car markets in that they allow investors to buy or sell previously owned securities for cash.

What’s Yield to Maturity?

For a bond, the discount rate that makes the present value of the coupon and principal payments equal to the price of the bond

Financial markets where equity and debt instruments with maturities greater than one year are traded are called:

• Money markets.

• Capital markets.

• over-the-counter exchange.

• None of the above.

Capital markets

Which of the following is a stakeholder?

• An employee

• A lender

• The IRS

• All of the above

All of the above

Which of the following securities is sold in the money market?

• Commercial papers

• Foreign currency derivatives

• Mortgage backed securities

• U.S. Treasury bonds

Commercial papers

The ease with which a security can be sold and converted into cash is called:

• convertibility.

• liquidity.

• marketability.

• none of the above.

marketability.

In the United States, the real rate of interest has historically been around:

• 1 percent.

• 3 percent.

• 5 percent.

• 7 percent.

3 percent.

Which of the following would appear as a liability on a company's balance sheet?

• Cost of goods sold

• Depreciation expense

• Notes payable

• Preferred stock

Notes payable

The matching principle calls for the accountant of a firm to:

• identify an asset with each liability of the firm.

•associate the revenue generated from a sale to the costs or expenses incurred to generate the revenue.

• match each item of inventory with the historical cost at which it was acquired.

• none of these.

Associate the revenue generated from a sale to the costs or expenses incurred to generate the revenue.

When prices are rising, the value of ending inventory using the FIFO method rather than LIFO gives:

• inventory a higher value but lowers net income.

• inventory a lower value and also lowers net income.

• both inventory and net income a higher value.

• inventory a lower value and net income a higher value.

Both inventory and net income a higher value.

Which of the following statements is NOT true of the asset turnover ratio?

• Asset turnover ratio measures the dollar amount of sales per dollar of assets that the firm has.

• The fixed assets turnover ratio is less significant for equipment-intensive manufacturing industry firms than the total assets turnover ratio.

• The higher the total asset turnover, the more efficiently management is using total assets.

• The ratio is quite useful in identifying the inefficient use of current and long-term assets.

The fixed assets turnover ratio is less significant for equipment-intensive manufacturing industry firms than the total assets turnover ratio.

Time value of money refers to the concept of:

• what the value of the stream of future cash flows is today.

• why a dollar received tomorrow is worth more than a dollar received

today.

• what the time required to double an amount of money.

• why people prefer to consume things at some time in the future rather than today.

what the value of the stream of future cash flows is today.

The process of converting future cash flows into their present value is called:

• annualizing.

• discounting.

• compounding.

• capital budgeting.

Discounting.

Which of the following interest rates will result in the highest amount of interest being charged?

• 7% per year, compounded daily

• 8% per year, compounded annually

• 7.5% per year, compounded quarterly

• 7.8% per year, compounded daily

7.8% per year, compounded daily

The present value of multiple cash flows is:

• greater than the sum of the cash flows.

• equal to the sum of all the cash flows.

• less than the sum of the cash flows.

• higher or lower than the cash flows depending on the interest rate.

Less than the sum of the cash flows.

Which of the following is a characteristic of common stock?

• Fixed dividends

• Fixed interest

• Limited liability for owners

• Credit ratings

Limited liability for owners

The payback method is a discounted cash flow technique.

True/False

False

When estimating the cost of debt capital for a firm, we are primarily interested in

• the weighted average cost of capital.

• the cost of long-term debt.

• the coupon rate of the debt.

• none of the above.

the cost of long-term debt.

The appropriate risk-free rate to use when calculating the cost of equity for a firm is

• a long-term Treasury rate.

• a short-term Treasury rate.

• an equal mix of short-term and long-term Treasury rates.

• none of the above.

A long-term Treasury rate.

Which of the following statements is true of amortization?

• With an amortized loan, a larger proportion of each month's payment goes toward interest in the early periods.

• With an amortized loan, a larger proportion of each month's payment goes toward interest in the later periods.

• With an amortized loan, a smaller proportion of each month's payment goes toward interest in the early periods.

• With an amortized loan, the interest portion of each month's payment remains unchanged.

With an amortized loan, a larger proportion of each month's payment goes toward interest in the early periods.

The Oriole Company has an after-tax cost of debt capital of 3 percent, a cost of preferred stock of 8 percent, a cost of equity capital of 10 percent, and a weighted average cost of capital of 7 percent. Oriole intends to maintain its current capital structure as it raises additional capital. In making its capital-budgeting decisions for the average-risk project, the relevant cost of capital is:

• 3%

• 7%

• 8%

• 10%

7 percent is correct. The weighted average cost of capital, using weights derived from the current capital structure, is the best estimate of the cost of capital for the average-risk project of a company.