Chapter 1 The Goals and Functions of Financial Management

Multiple Choice Questions

1. What is the primary goal of financial management?

A) Increased earnings

B) Maximizing cash flow

C) Maximizing shareholder wealth

D) Minimizing risk of the firm

2. The partnership form of organization

A) avoids the double taxation of earnings and dividends found in the corporate form of organization.

B) usually provides limited liability to the partners.

C) has unlimited life.

D) simplifies decision making.

3. Increased productivity due to technology has

A) increased corporations’ reliance on debt for capital expansion needs.

B) created larger asset values on the firm’s historical balance sheet.

C) made it cheaper (in terms of interest costs) for firms to borrow money.

D) helped to keep corporate costs in check.

4. Insider trading occurs when

A) someone has information not available to the public which they use to profit from trading in stocks.

B) corporate officers buy stock in their company.

C) lawyers, investment bankers, and others buy common stock in companies represented by their firms.

D) any stock transactions occur in violation of the Federal Trade Commissions restrictions on monopolies.

Chapter 2 Review of Accounting

5. When a firm’s earnings are falling more rapidly than its stock price, its P/E ratio will:

A) remain the same

B) go up

C) go down

D) could go either up or down

6. The net worth of a firm

A) is usually the same as the firm’s market value.

B) is based on current asset costs.

C) is based on current liabilities.

D) none of the above.

7. A statement of cash flows allows a financial analyst to determine

A) whether a cash dividend is affordable.

B) how increases in asset accounts have been financed.

C) whether long-term assets are being financed with long-term or short-term financing.

D) all of the above

8. A firm has $200,000 in current assets, $400,000 in long-term assets, $80,000 in current liabilities, and $200,000 in long-term liabilities. What is its net working capital?

A) $120,000

B) $320,000

C) $520,000

D) none of the above

Chapter 3 Financial Analysis

Multiple Choice Questions

9. The ______________ method of inventory costing is least likely to lead to inflation-induced profits.



C) Weighted average

D) Lower of cost or market

10. The Bubba Corp. had net income before taxes of $200,000 and sales of $2,000,000. If it is in the 50% tax bracket its after-tax profit margin is:

A) 5%

B) 12%

C) 20%

D) 25%

11. XYZ’s receivables turnover is 10x. The accounts receivable at year-end are $600,000. The average collection period is 90 days (3 months). What was the sales figure for the year?

A) $60,000

B) $6,000,000

C) $24,000,000

D) none of the above

12. A firm has total assets of $2,000,000. It has $900,000 in long-term debt. The stockholders equity is $900,000. What is the total debt to asset ratio?

A) 45%

B) 40%

C) 55%

D) none of the above

Chapter 4 Financial Forecasting

13. Required production during a planning period will depend on the

A) beginning inventory of products.

B) sales during the period.

C) desired level of ending inventory.

D) all of the above

14. XYZ Co. has forecasted June sales of 600 units and July sales of 1000 units. The company maintains ending inventory equal to 125% of next month’s sales. June beginning inventory reflects this policy. What is June’s required production?

A) 1100 units

B) -0- units

C) 500 units

D) 400 units

15. The difference between total receipts and total payments referred to as

A) cumulative cash flow.

B) beginning cash flow.

C) net cash flow.

D) cash balance.

16. In developing the pro forma income statement we follow four important steps:

1) compute other expenses,

2) determine a production schedule,

3) establish a sales projection,

4) determine profit by completing the actual pro forma statement.

What is the correct order for these four steps?

A) 1,2,3,4

B) 4,3,2,1

C) 2,1,3,4

D) 3,2,1,4

Chapter 5 Operating and Financial Leverage

17. In break-even analysis the contribution margin is defined as

A) sales minus variable costs.

B) sales minus fixed costs.

C) variable costs minus fixed costs.

D) fixed costs minus variable costs.

18. Firm A employs a high degree of operating leverage; Firm B takes a more conservative approach. Which of the following comparative statements about firms A and B is true?

A) A has a lower break-even point than B, but A’s profit grows faster after the break-even.

B) A has a higher break-even point than B, but A’s profit grows slower after the break-even.

C) B has a lower break-even point than A, but A’s profit grows faster after break-even.

D) B has a lower break-even point than A, and profit grows the same rate for both companies after the breakeven point.

19. Heavy use of long-term debt may be beneficial in an inflationary economy because

A) the debt may be repaid in more “expensive” dollars.

B) nominal interest rates exceed real interest rates.

C) inflation is associated with the peak of a business cycle.

D) the debt may be repaid in “cheaper” dollars.

20. Under which of the following conditions could the overuse of financial leverage be detrimental to the firm?

A) Stable industry

B) Cyclical demand for the firm’s products.

C) Upswing of business cycle.

D) Low interest cost compared to return on assets

Chapter 6 Working Capital and the Financial Decision

21. Risk exposure due to heavy short-term borrowing can be compensated for by

A) carrying highly liquid assets.

B) carrying illiquid assets.

C) carrying longer term, more profitable current assets.

D) carrying more receivables to increase cash flow.

22. When actual sales are greater than forecasted sales

A) inventory will decline.

B) production schedules might have to be revised upward.

C) accounts receivable will rise.

D) all of the above

23. Yield curves change daily to reflect

A) changing conditions in the money and capital markets.

B) new inflation expectations.

C) changing conditions in the overall economy.

D) all of the above.

24. Retail companies like Target and Limited Brands are more likely to have

A) stable sales and earnings per share.

B) cyclical sales but less volatile earnings per share.

C) cyclical sales and more volatile earnings per share.

D) cyclical sales but stable accounts receivable and inventory.

Chapter 7 Current Asset Management

25. When using the economic order quantity model

A) ordering costs increase as the level of inventory increases.

B) carrying costs decrease as the level of inventory increases.

C) costs are minimized when total carrying costs and total ordering costs are equal.

D) none of the above

26. Hedging

A) is a way to protect your accounts receivable position.

B) increases risk.

C) is a legal agreement to buy or sell a financial futures contract.

D) can be carried out with a futures contract.

27. Which of the following is not a true statement about commercial paper?

A) Finance paper is sold directly to the lender by the finance company.

B) Finance paper is also referred to as direct paper.

C) Dealer paper is sold directly to the lender by a finance company.

D) Industrial companies, utility firms or finance companies too small to sell direct paper sell dealer paper.

28. Which of the following best describes the benefits to the borrower of selling asset backed securities?

A) Due to the portfolio effect, the borrower can package up low quality accounts receivable and sell them for a premium price.

B) The borrower trades future cash flows for current cash flows.

C) The asset-backed security is likely to carry a high credit rating of AA or better.

D) b and c are correct.

29. Price Corp. is considering selling to a group of new customers and creating new annual sales of $70,000. 5% will be uncollectible. The collection cost on these accounts is 3.5% of new sales, the cost of producing and selling is 80% of sales and the firm is in the 31% tax bracket. What is the profit on new sales?

A) $5,554.50

B) $9,660.00

C) $7,245.00

D) none of the above.

Chapter 8 Sources of Short-Term Financing

30. Mr. Jones borrows $2,000 for 90 days and pays $35 interest. What is his effective rate of interest?

A) 9.3%

B) 7.0%

C) 11.7%

D) None of the above

31. The prime rate

A) is the effective rate of interest for banks’ best customers.

B) has been quite volatile during the past two decades, moving as much as 8 percentage points in a 12-month period.

C) is usually lower than treasury bill rates.

D) none of the above

32. Accounts receivable may be used as a source of financing by

A) pledging the receivables as loan collateral.

B) factoring the receivables to a finance company.

C) selling securities backed by the receivables.

D) all of the above

33. The required compensating balance is usually computed as a

A) percentage of customer loans outstanding.

B) factor of accounts receivable.

C) percentage of the bank’s commitments toward future loans.

D) a and c are correct


Chapter 9 The Time Value of Money

34. The concept of time value of money is important to financial decision making because

A) it emphasizes earning a return on invested capital.

B) it recognizes that earning a return makes $1 worth more today than $1 received in the future.

C) it can be applied to future cash flows in order to compare different streams of income.

D) all of the above

35. Mr. Nailor invests $5,000 in a certificate of deposit at his local bank. He receives annual interest of 8% for 7 years. How much interest will his investment earn during this time period?

A) $2,915

B) $3,570

C) $6,254

D) $8,570

36. Mr. Fish wants to build a house in 10 years. He estimates that the total cost will be $170,000. If he can put aside $10,000 at the end of each year, what rate of return must he earn in order to have the amount needed?

A) Between 11% and 12%

B) Between 8% and 9%

C) 17%

D) None of the above

Chapter 10 Valuation and Rates of Return

37. A 20-year bond pays 12% on a face value of $1,000. If similar bonds are currently yielding 9%, What is the market value of the bond? Use annual analysis.

A) over $1,000

B) under $1,000

C) over $1,200

D) not enough information given to tell

38. An issue of preferred stock is paying an annual dividend of $5. The growth rate for the firm’s common stock is 14%. What is the preferred stock price if the required rate of return is 11%?

A) $45.45

B) $41.67

C) $35.71

D) none of the above

39. Which of the following does not influence the yield to maturity for a security?

A) required real rate of return

B) risk free rate

C) business risk

D) yields of similar securities

40. The cost of common stock is usually greater than the simple dividend yield because

A) investors perceive risk in common stock.

B) investors expect both a current dividend and future growth.

C) dividends are not tax-deductible.

D) the company must make profits before it can pay dividends.

41. The dividend valuation model stresses the

A) importance of earnings per share.

B) importance of dividends and legal rules for maximum payment.

C) relationship of dividends to market prices.

D) relationship of dividends to earnings per share.

Chapter 11 Cost of Capital

42. Although debt financing is usually the cheapest component of capital, it cannot be used to excess because

A) interest rates may change.

B) the firm’s stock price will increase and raise the cost of equity financing.

C) the financial risk of the firm may increase and thus drive up the cost of all sources of financing.

D) underwriting costs may change.

43. Each project should be judged against

A) the specific means of financing used to support its implementation.

B) the going interest rate at that point in time.

C) the cost of new common stock equity.

D) none of the above.

44. The cost of debt is determined by taking the

A) present value of the interest payments and principal times one minus the tax rate.

B) historical yield on bonds times one minus the tax rate

C) estimated yield on new bond issues of the same risk times one minus the shareholder marginal tax rate.

D) none of the above

45. The pre-tax cost of debt for a new issue of debt is determined by

A) the investor’s required rate of return on issued stock.

B) the coupon rate of existing debt.

C) the yield to maturity of outstanding bonds.

D) all of the above.

Chapter 14 Capital Markets

46. During the next ten years, the major threat to the dominance of the U.S. money and capital markets will come from

A) Russia’s difficulty in transforming its economy into a capitalistic one.

B) Japan’s prolonged recession and banking crisis.

C) The Euro-zone countries comprising the European Monetary Union and a single currency.

D) The huge Chinese economy and its billion plus people.

47. With respect to the United States and its relationship with the rest of the world, it can be said that

A) the U.S. has invested more dollars in the rest of the world than foreign countries have invested in the U.S.

B) the U.S. has actively helped foreign countries finance the government deficits.

C) foreign investors hold large positions in U.S. government securities.

D) All of the above.

48. Financial instruments in the capital markets generally fall under what category in the Balance Sheet?

A) Short-term liabilities and equities.

B) Long-term liabilities and equities.

C) Near cash assets.

D) None of the above.

Chapter 16 Long-Term Debt and Lease Financing

49. With regard to interest rates and bond prices it can be said that

A) a 1% change in interest rates will cause a greater change in long-term bond prices than short-term prices.

B) a 1% change in interest rates will cause a greater change in short-term bond prices than long-term prices.

C) long-term rates are more volatile than short-term rates.

D) a decrease in interest rates will cause bond prices to fall.

50. Which one of these conditions must be met for a lease to qualify as a capital lease?

A) The lease contains a bargain purchase price at the end of the lease.

B) The lease must have a value of at least $10 million.

C) The lease must have a life of 10 years.

D) All of the above.

Chapter 17 Common and Preferred Stock Financing

51. Which of the following is not a true statement?

A) Common stockholders have a residual claim to income.

B) Bondholders may force a corporation into bankruptcy for failure to make interest payments.

C) Common stockholders are legally entitled to some dividend.

D) A minority interest can still elect members to the Board of Directors under cumulative voting even though someone else owns 51% of the stock.

52. Kuhns Corp. has 200,000 shares of preferred stock outstanding that is cumulative. The dividend is $6.50 per share and has not been paid for 3 years. If Kuhns earned $3 million this year, what could be the maximum payment to the preferred stockholders on a per share basis?

A) $19.50 per share

B) $15.00 per share

C) $13.00 per share

D) $6.50 per share

53. When comparing common stock of the same company it is fair to say that

A) all shares, no matter how many classes, are all created with the same equal rights.

B) companies sometimes have two different classes of shares with unequal rights to dividends and votes.

C) the Securities and Exchange Commission allows only one class of common stock.

D) investors are indifferent between class A and class B shares.

54. Dr. J. wants to buy an IBM personal computer which will cost $2,788 four years from today. He would like to set aside an equal amount at the end of each year in order to accumulate the amount needed. He can earn 7% annual return. How much should he set aside?

A) $697.00

B) $627.93

C) $823.15

D) $531.81

Problems to be solved-Chapter 2

55. The following is the December 31, 2003 balance sheet for the Epics Corporation.

Assets Liabilities

Cash $ 70,000 Accounts Payable $ 100,000

Accounts Receivable 150,000 Notes Payable 120,000

Inventory 280,000 Bonds Payable 300,000

Total Current Assets $ 500,000 Total Liabilities $ 520,000

Plant and Equipment $1,250,000 Equity

Less: Accum. Deprec. 250,000 Common Stock 300,000

Net plant and Equipment $1,000,000 Paid In Capital 200,000

Retained Earnings 480,000

Total Assets $1,500,000 Total Equity $ 980,000

Total Liab. & Equity $1,500,000

Sales for 2003 were $2,000,000, with the cost of goods sold being 55% of sales. Depreciation expense was 10% of the gross plant and equipment at the beginning of the year. Interest expense was 9% on the notes payable and 11% on the bonds payable. Selling and administrative expenses were $200,000 and the firm’s tax rate is 40%.

Prepare an income statement.

56. Given the financial information for the A.E. Neuman Corporation,

(a) Prepare a statement of cash flows for the year ended December 31, 2010.

(b) What is the dividend payout ratio for 2010?

(c) If we increased the dividend payout ratio to 100%, what would happen to retained earnings at year end 2010?