FINC EXAM (CH 1-5)

(T or F) If we are given a periodic interest rate, say a monthly rate, we can find the nominal annual rate by dividing the periodic rate by the number of periods per year.

False

(T or F) One advantage of the corporate form of organization is that it avoids double taxation.

False

(T or F) If the tax laws were changed so that $0.50 out of every $1.00 of interest paid by a corporation was allowed as a tax-deductible expense, this would probably encourage companies to use more debt financing than they presently do, other things held constant.

False

Which of the following statements is CORRECT? a. One drawback of forming a corporation is that it generally subjects the firm to additional regulations. b. One drawback of forming a corporation is that it subjects the firm's investors to increased personal liabilities. c. One drawback of forming a corporation is that it makes it more difficult for the firm to raise capital. d. One advantage of forming a corporation is that it subjects the firm's investors to fewer taxes. e. One disadvantage of forming a corporation is that it is more difficult for the firm's investors to transfer their ownership interests.

A. One drawback of forming a corporation is that it generally subjects the firm to additional regulations.

you have the following data on three stocks shown below. You decide to use the data on these stocks to form an index, and you want to find the average earned rate of return for 2011 on your index. If you follow the averaging procedure used to calculate the S&P 500 Index return, what would your index's rate of return be? Hints: Rates of return are based on beginning-of-year prices, and the S&P Index is weighted by market values of the companies in the index. Stock Dividend Beginning Price Ending Price Shares Outstanding (millions) A $ 1.50 $ 30.00 $ 32.00 5.00 B $ 2.00 $ 28.50 $ 27.00 4.50 C $ 0.75 $ 20.00 $ 24.00 19.50

A.

Suppose you borrowed $75,000 at a rate of 8.5% and must repay it in 5 equal installments at the end of each of the next 5 years. By how much would you reduce the amount you owe in the first year? a. $12,657.43 b. $15,695.21 c. $12,404.28 d. $13,037.15 e. $15,062.34

A. $12,657.43

You are negotiating to make a 7-year loan of $27,500 to Breck Inc. To repay you, Breck will pay $2,500 at the end of Year 1, $5,000 at the end of Year 2, and $7,500 at the end of Year 3, plus a fixed but currently unspecified cash flow, X, at the end of each year from Year 4 through Year 7. Breck is essentially riskless, so you are confident the payments will be made. You regard 8% as an appropriate rate of return on a low risk but illiquid 7-year loan. What cash flow must the investment provide at the end of each of the final 4 years, that is, what is X? a. $5,683.99 b. $5,172.43 c. $5,513.47 d. $5,740.83 e. $5,058.75

A. $5,683.99

Five years ago, Weed Go Inc. earned $1.20 per share. Its earnings this year were $3.20. What was the growth rate in earnings per share (EPS) over the 5-year period? a. 21.67% b. 26.66% c. 22.76% d. 20.59% e. 20.81%

A. 21.67%

A firm wants to strengthen its financial position. Which of the following actions would INCREASE its quick ratio? a. Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2) lead to an increase in accounts receivable. b. Issue new common stock and use the proceeds to increase inventories. c. Speed up the collection of receivables and use the cash generated to increase inventories. d. Use some of its cash to purchase additional inventories. e. Issue new common stock and use the proceeds to acquire additional fixed assets.

A. Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2) lead to an increase in accounts receivable.

Which of the following statements is CORRECT? a. The present value of a 3-year, $150 annuity due will exceed the present value of a 3-year,$150 ordinary annuity. b. If a loan has a nominal annual rate of 8%, then the effective rate can never be greater than 8%. c. If a loan or investment has annual payments, then the effective, periodic, and nominal rates of interest will all be different. d. The proportion of the payment that goes toward interest on a fully amortized loan increases over time. e. An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is smaller than 6%.

A. The present value of a 3-year, $150 annuity due will exceed the present value of a 3-year,$150 ordinary annuity.

Last year Dania Corporation's sales were $525 million. If sales grow at 11.5% per year, how large (in millions) will they be 8 years later? a. $1,417.22 b. $1,254.18 c. $1,116.22 d. $1,567.72 e. $1,166.38

B. $1,254.18

Brown Office Supplies recently reported $13,500 of sales, $8,250 of operating costs other than depreciation, and $1,750 of depreciation. It had $9,000 of bonds outstanding that carry a 7.0% interest rate, and its federal-plus-state income tax rate was 40%. How much was the firm's earnings before taxes (EBT)? a. $3,272 b. $2,870 c. $2,784 d. $2,755 e. $2,841

B. $2,870

How much would $1, growing at 12.0% per year, be worth after 75 years? a. $3,881.31 b. $4,913.06 c. $4,028.71 d. $5,797.41 e. $3,733.92

B. $4,913.06

Quigley Inc. is considering two financial plans for the coming year. Management expects sales to be $300,000, operating costs to be $265,000, assets (capital) to be $200,000, and its tax rate to be 35%. Under Plan A it would use 25% debt and 75% common equity. The interest rate on the debt would be 8.8%, but under a contract with existing bondholders the TIE ratio would have to be maintained at or above 3.2. Under Plan B, the maximum debt that met the TIE constraint would be employed. Assuming that sales, operating costs, assets, the interest rate, and the tax rate would all remain constant, by how much would the ROE change in response to the change in the capital structure? a. 7.10% b. 7.40% c. 8.21% d. 8.73% e. 7.25%

B. 7.40%

Lovell Co. purchased preferred stock in another company. The preferred stock's before-tax yield was 9.6%. The corporate tax rate is 40%. What is the after-tax return on the preferred stock, assuming a 70% dividend exclusion? a. 7.69% b. 8.45% c. 8.62% d. 8.19% e. 6.50%

B. 8.45%

Which of the following statements is CORRECT? a. Since depreciation increases the firm's net cash provided by operating activities, the more depreciation a company has, the larger its retained earnings will be, other things held constant. b. A firm can show a large amount of retained earnings on its balance sheet yet need to borrow cash to make required payments. c. Common equity includes common stock and retained earnings, less accumulated depreciation. d. The retained earnings account as reported on the balance sheet shows the amount of cash that is available for paying dividends. e. If a firm reports a loss on its income statement, then the retained earnings account as shown on the balance sheet will be negative.

B. A firm can show a large amount of retained earnings on its balance sheet yet need to borrow cash to make required payments.

Which of the following statements is CORRECT? a. The use of debt financing will tend to lower the basic earning power ratio, other things held constant. b. A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure. c. If two firms have identical sales, interest rates paid, operating costs, and assets, but differ in the way they are financed, the firm with less debt will generally have the higher expected ROE. d. The numerator used in the TIE ratio is earnings before taxes (EBT). EBT is used because interest is paid with post-tax dollars, so the firm's ability to pay current interest is affected by taxes. e. All else equal, increasing the debt ratio will increase the ROA.

B. A firm that employs financial leverage will have a higher equity multiplier than an otherwise identical firm that has no debt in its capital structure.

Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and managers? a. Pay managers large cash salaries and give them no stock options. b. Change the corporation's formal documents to make it easier for outside investors to acquire a controlling interest in the firm through a hostile takeover. c. Beef up the restrictive covenants in the firm's debt agreements. d. Eliminate a requirement that members of the board of directors must hold a high percentage of their personal wealth in the firm's stock. e. For a firm that compensates managers with stock options, reduce the time before options are vested, i.e., the time before options can be exercised and the shares that are received can be sold.

B. Change the corporation's formal documents to make it easier for outside investors to acquire a controlling interest in the firm through a hostile takeover.

Below is the common equity section (in millions) of Timeless Technology's last two year-end balance sheets: The firm has never paid a dividend to its common stockholders. Which of the following statements is CORRECT? 2011 2010 Common stock: 2,000 1,000 Retained earnings: 2,000 2,340 Total common equity: $4,000 $3,340 a. The company's net income in 2011 was higher than in 2010. b. The firm issued common stock in 2011. c. The market price of the firm's stock doubled in 2011. d. The firm had positive net income in both 2010 and 2011, but its net income in 2011 was lower than it was in 2010. e. The company has more equity than debt on its balance sheet.

B. The firm issued common stock in 2011.

Scranton Shipyards has $7 million in total investor-supplied operating capital, and its WACC is 10%. Scranton has the following income statement: Sales $10.0 million Operating costs 6.0 million Operating income (EBIT) $ 4.0 million Interest expense 2.0 million Earnings before taxes (EBT) $ 2.0 million Taxes (40%) 0.8 million Net income $ 1.2 million What is Scranton's EVA? a. $1,785,000 b. $1,360,000 c. $1,700,000 d. $1,445,000 e. $1,615,000

C. $1,700,000

On January 1, 2009, your brother's business obtained a 30-year amortized mortgage loan for $425,000 at a nominal annual rate of 7.0%, with 360 end-of-month payments. The firm can deduct the interest paid for tax purposes. What will the total interest expense for 2009? a. $33,759.09 b. $34,055.22 c. $29,613.24 d. $29,317.10 e. $31,390.03

C. $29,613.24

Which of the following statements is CORRECT? a. The NYSE does not exist as a physical location. Rather it represents a loose collection of dealers who trade stock electronically. b. An example of a primary market transaction would be your uncle transferring 100 shares of Walmart stock to you as a birthday gift. c. Capital market instruments include both long-term debt and common stocks. d. If your uncle in New York sold 100 shares of Microsoft through his broker to an investor in Los Angeles, this would be a primary market transaction. e. While the two frequently perform similar functions, investment banks generally specialize in lending money, whereas c

C. Capital market instruments include both long-term debt and common stocks.

Which of the following statements is CORRECT? a. A good goal for a firm's management is the maximization of expected EPS. b. Most business in the U.S. is conducted by corporations, and corporations' popularity results primarily from their favorable tax treatment. c. Conflicts can exist between stockholders and managers, but potential conflicts are reduced by the possibility of hostile takeovers. d. Corporations and partnerships have an advantage over proprietorships because a sole proprietor is exposed to unlimited liability, but the liability of all investors in the other types of businesses is more limited. e. For a stock to be in equilibrium, its intrinsic value must be greater than the actual market price.

C. Conflicts can exist between stockholders and managers, but potential conflicts are reduced by the possibility of hostile takeovers.

Which of the following statements is CORRECT? a. In general, if investors regard a company as being relatively risky and/or having relatively poor growth prospects, then it will have relatively high P/E and M/B ratios. b. The basic earning power ratio (BEP) reflects the earning power of a firm's assets after giving consideration to financial leverage and tax effects. c. The "apparent," but not necessarily the "true," financial position of a company whose sales are seasonal can change dramatically during a given year, depending on the time of year when the financial statements are constructed d. The market/book (M/B) ratio tells us how much investors are willing to pay for a dollar of accounting book value. In general, investors regard companies with higher M/B ratios as being more risky and/or less likely to enjoy higher future growth. e. It is appropriate to use the fixed assets turnover ratio to appraise firms' effectiveness in managing their fixed assets if and only if all the firms being compared have the same proportion of fixed assets to total assets.

C. The "apparent," but not necessarily the "true," financial position of a company whose sales are seasonal can change dramatically during a given year, depending on the time of year when the financial statements are constructed

Which of the following statements is CORRECT? a. In most corporations, the CFO ranks above the CEO. b. By law in most states, the chairman of the board must also be the CEO. c. The board of directors is the highest ranking body in a corporation, and the chairman of the board is the highest ranking individual. The CEO generally works under the board and its chairman, and the board generally has the authority to remove the CEO under certain conditions. The CEO, however, cannot remove the board, but he or she can endeavor to have the board voted out and a new board voted in should a conflict arise. It is possible for a person to simultaneously serve as CEO and chairman of the board, though many corporate control experts believe it is bad to vest both offices in the same person. d. The CFO generally reports to the firm's chief accounting officer, who is normally the controller. e. The CFO is responsible for raising capital and for making sure that capital expenditures are desirable, but he or she is not responsible for the validity of the financial statements, as the controller and the auditors have that responsibility.

C. The board of directors is the highest ranking body in a corporation, and the chairman of the board is the highest ranking individual. The CEO generally works under the board and its chairman, and the board generally has the authority to remove the CEO under certain conditions. The CEO, however, cannot remove the board, but he or she can endeavor to have the board voted out and a new board voted in should a conflict arise. It is possible for a person to simultaneously serve as CEO and chairman of the board, though many corporate control experts believe it is bad to vest both offices in the same person.

Last year, Martyn Company had $400,000 in taxable income from its operations, $50,000 in interest income, and $100,000 in dividend income. Using the corporate tax rate table given below, what was the company's tax liability for the year? TI Tax on Base of Bracket Percentage on Excess above Base $0-$50,000 $0 15% $50,000-$75,000 7,500 25 $75,000-$100,000 13,750 34 $100,000-$335,000 22,250 39 $335,000-$10,000,000 113,900 34 $10,000,000-$15,000,000 3,400,000 35 $15,000,000-$18,333,333 5,150,000 38 Over $18,333,333 6,416,667 35 a. $150,144 b. $176,256 c. $163,200 d. $200,736 e. $168,096

C.$ 153,200

Your bank account pays a 6% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT? a. The periodic rate of interest is 1.5% and the effective rate of interest is 3%. b. The periodic rate of interest is 6% and the effective rate of interest is greater than 6%. c. The periodic rate of interest is 1.5% and the effective rate of interest is greater than 6%. d. The periodic rate of interest is 3% and the effective rate of interest is 6%. e. The periodic rate of interest is 6% and the effective rate of interest is also 6%.

C.The periodic rate of interest is 1.5% and the effective rate of interest is greater than 6%.

You want to quit your job and go back to school for a law degree 4 years from now, and you plan to save $6,400 per year, beginning immediately. You will make 4 deposits in an account that pays 5.7% interest. Under these assumptions, how much will you have 4 years from today? a. $22,980.31 b. $22,685.69 c. $26,221.12 d. $29,461.93 e. $31,524.26

D. $29,461.93

Your sister is thinking about starting a new business. The company would require $380,000 of assets, and it would be financed entirely with common stock. She will go forward only if she thinks the firm can provide a 13.5% return on the invested capital, which means that the firm must have an ROE of 13.5%. How much net income must be expected to warrant starting the business? a. $58,482 b. $45,144 c. $52,326 d. $51,300 e. $39,501

D. $51,300

Farmers Bank offers to lend you $50,000 at a nominal rate of 5.0%, simple interest, with interest paid quarterly. Merchants Bank offers to lend you the $50,000, but it will charge 5.5%, simple interest, with interest paid at the end of the year. What's the difference in the effective annual rates charged by the two banks? a. 0.35% b. 0.32% c. 0.49% d. 0.41% e. 0.46%

D. 0.41%

A corporation recently purchased some preferred stock that has a before-tax yield of 6.75%. The company has a tax rate of 38%. What is the after-tax return on the preferred stock? Assume a 70% dividend exclusion for Tax on Dividends. a. 6.34% b. 6.16% c. 4.55% d. 5.98% e. 7.06%

D. 5.98%

Which of the following statements is CORRECT? a. If a lower level person in a firm does something illegal, like "cooking the books" to understate costs and thereby artificially increase profits because he or she was ordered to do so by a superior, the lower level person cannot be prosecuted but the superior can be prosecuted. b. There are many types of unethical business behavior. One example is where executive provide information that they know is incorrect to outsiders. It is illegal to provide such information to federally regulated banks, but it is not illegal to provide it to stockholders because they are the owners of the firm. c. The bankruptcy of Enron Corporation, and the fraud committed by some of its officers, was the focus of news stories, but it did not lead to any important changes in business practices. d. If someone deliberately understates costs and thereby causes reported profits to increase, this can cause the price of the stock to rise above its intrinsic value. The stock will probably fall in the future. Both those who participated in the fraud and the firm itself can be prosecuted. e. Ethical behavior is not influenced by training and auditing procedures. People are either ethical or they are not, and this is what determines ethical behavior in business.

D. If someone deliberately understates costs and thereby causes reported profits to increase, this can cause the price of the stock to rise above its intrinsic value. The stock will probably fall in the future. Both those who participated in the fraud and the firm itself can be prosecuted.

A 7-year municipal bond yields 4.8%. Your marginal tax rate (including state and federal taxes) is 25%. What interest rate on a 7-year corporate bond of equal risk would provide you with the same after-tax return? a. 6.34% b. 7.49% c. 7.23% d. 6.46% e. 6.40%

E. 6.40%

You agree to make 24 deposits of $500 at the beginning of each month into a bank account. At the end of the 24th month, you will have $13,200 in your account. If the bank compounds interest monthly, what nominal annual interest rate will you be earning? a. 10.14% b. 10.77% c. 7.79% d. 11.14% e. 9.05%

E. 9.05%

Which of the following mechanisms would be most likely to help motivate managers to act in the best interests of shareholders? a. Decrease the use of restrictive covenants in bond agreements. b. Take actions that reduce the possibility of a hostile takeover. c. Elect a board of directors that allows managers greater freedom of action. d. Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries. e. Eliminate a requirement that members of the board of directors have a substantial investment in the firm's stock.

D. Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries.

. Which of the following statements is CORRECT? a. One disadvantage of organizing a business as a corporation rather than a partnership is that the equity investors in a corporation are exposed to unlimited liability. b. Using restrictive covenants in debt agreements is an effective way to reduce conflicts between stockholders and managers. c. Managers generally welcome hostile takeovers since the "raider" generally offers a price for the stock that is higher than the price before the takeover action started. d. The managers of established, stable companies sometimes attempt to get their state legislatures to impose rules that make it more difficult for raiders to succeed with hostile takeovers. e. The managers of established, stable companies sometimes attempt to get their state legislatures to remove rules that make it more difficult for raiders to succeed with hostile takeovers.

D. The managers of established, stable companies sometimes attempt to get their state legislatures to impose rules that make it more difficult for raiders to succeed with hostile takeovers.

A $150,000 loan is to be amortized over 7 years, with annual end-of-year payments. Which of these statements is CORRECT? a. The annual payments would be larger if the interest rate were lower. b. If the loan were amortized over 10 years rather than 7 years, and if the interest rate were the same in either case, the first payment would include more dollars of interest under the 7-year amortization plan. c. The proportion of each payment that represents interest as opposed to repayment of principal would be higher if the interest rate were lower. d. The proportion of each payment that represents interest versus repayment of principal would be higher if the interest rate were higher. e. The proportion of interest versus principal repayment would be the same for each of the 7 payments

D. The proportion of each payment that represents interest versus repayment of principal would be higher if the interest rate were higher.

Suppose you are buying your first condo for $220,000, and you will make a $15,000 down payment. You have arranged to finance the remainder with a 30-year, monthly payment, amortized mortgage at a 6.5% nominal interest rate, with the first payment due in one month. What will your monthly payments be? a. $1,023.63 b. $1,580.80 c. $1,373.48 d. $1,049.55 e. $1,295.74

E. $1,295.74

Houston Pumps recently reported $185,000 of sales, $140,500 of operating costs other than depreciation, and $9,250 of depreciation. The company had $35,250 of outstanding bonds that carry a 6.75% interest rate, and its federal-plus-state income tax rate was 35%. In order to sustain its operations and thus generate future sales and cash flows, the firm was required to spend $15,250 to buy new fixed assets and to invest $6,850 in net operating working capital. What was the firm's free cash flow? a. $9,861 b. $10,868 c. $10,465 d. $7,547 e. $10,063

E. $10,063

Sam was injured in an accident, and the insurance company has offered him the choice of $49,000 per year for 15 years, with the first payment being made today, or a lump sum. If a fair return is 7.5%, how large must the lump sum be to leave him as well off financially as with the annuity? a. $437,070.42 b. $576,560.98 c. $506,815.70 d. $427,771.05 e. $464,968.53

E. $464,968.53

Jordan Inc has the following balance sheet and income statement data: Cash $14,000 Receivables 70,000 Inventories 280,000 Total CA $364,000 Net fixed assets 126,000 Total assets $490,000 Sales $280,000 Net income 21,000 Accounts payable $42,000 Other current liabilities 28,000 Total CL $70,000 Long-term debt 140,000 Common equity 280,000 Total liab. and equity $490,000 The new CFO thinks that inventories are excessive and could be lowered sufficiently to cause the current ratio to equal the industry average, 2.10, without affecting either sales or net income. Assuming that inventories are sold off and not replaced to get the current ratio to the target level, and that the funds generated are used to buy back common stock at book value, by how much would the ROE change? a. 28.16% b. 20.93% c. 24.28% d. 32.29% e. 25.83%

E. 25.83%

Last year Rennie Industries had sales of $240,000, assets of $175,000, a profit margin of 5.3%, and an equity multiplier of 1.2. The CFO believes that the company could reduce its assets by $51,000 without affecting either sales or costs. Had it reduced its assets by this amount, and had the debt/assets ratio, sales, and costs remained constant, how much would the ROE have changed? a. 3.55% b. 3.19% c. 3.66% d. 3.01% e. 3.59%

E. 3.49%

(T or F) If a stock's market price is above its intrinsic value, then the stock can be thought of as being undervalued, and it would be a good buy

False

With which of the following statements would most people in business agree? a. A corporation's short-run profits will almost always increase if the firm takes actions that the government has determined are in the best interests of the nation. b. Firms and government agencies almost always agree with one another regarding the restrictions that should be placed on hiring and firing employees. c. "Whistle blowers," because of the courage it takes to blow the whistle, are generally promoted more rapidly than other employees. d. It is not useful for large corporations to develop a formal set of rules defining ethical and unethical behavior. e. Although people's moral characters are probably developed before they are admitted to a business school, it is still useful for business schools to cover ethics, if only to give students an idea about the adverse consequences of unethical behavior to themselves, their firms, and the nation.

E. Although people's moral characters are probably developed before they are admitted to a business school, it is still useful for business schools to cover ethics, if only to give students an idea about the adverse consequences of unethical behavior to themselves, their firms, and the nation.

Assume that Congress recently passed a provision that will enable Bev's Beverages Inc. (BBI) to double its depreciation expense for the upcoming year but will have no effect on its sales revenue or the tax rate. Prior to the new provision, BBI's net income was forecasted to be $4 million. Which of the following best describes the impact of the new provision on BBI's financial statements versus the statements without the provision? Assume that the company uses the same depreciation method for tax and stockholder reporting purposes. a. The provision will reduce the company's cash flow. b. The provision will increase the company's tax payments. c. The provision will increase the firm's operating income (EBIT). d. The provision will increase the company's net income. e. Net fixed assets on the balance sheet will decrease.

E. Net fixed assets on the balance sheet will decrease.

Which of the following would indicate an IMPROVEMENT in a company's financial position, holding other things constant? a. The inventory and total assets turnover ratios both decline. b. The debt ratio increases. c. The profit margin declines. d. The times-interest-earned ratio declines. e. The current and quick ratios both increase.

E. The current and quick ratios both increase.

Which of the following statements regarding a 15-year (180-month) $125,000, fixed-rate mortgage is CORRECT? (Ignore taxes and transactions costs.) a. The remaining balance after three years will be $125,000 less one third of the interest paid during the first three years. b. Because the outstanding balance declines over time, the monthly payments will also decline over time. c. Interest payments on the mortgage will increase steadily over time, but the total amount of each payment will remain constant. d. The proportion of the monthly payment that goes towards repayment of principal will be lower 10 years from now than it will be the first year. e. The outstanding balance declines at a faster rate in the later years of the loan

E. The outstanding balance declines at a faster rate in the later years of the loan

(T or F) . A disadvantage of the corporate form of organization is that corporate stockholders are more exposed to personal liabilities in the event of bankruptcy than are investors in a typical partnership.

False

(T or F) As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or less than the nominal rate on the deposit (or loan).

False

(T or F) Companies typically provide four basic financial statements: the fixed income statement, the current income statement, the balance sheet, and the cash flow statement.

False

(T or F) Disregarding risk, if money has time value, it is impossible for the future value of a given sum to exceed its present value.

False

(T or F) High current and quick ratios always indicate that the firm is managing its liquidity position well.

False

(T or F) Private markets are those like the NYSE, where transactions are handled by members of the organization, while public markets are those like the Nasdaq, where anyone can make transactions

False

(T or F) Some of the cash flows shown on a time line can be in the form of annuity payments but none can be uneven amounts.

False

(T or F) Suppose you are analyzing two firms in the same industry. Firm A has a profit margin of 10% versus a margin of 8% for Firm B. Firm A's debt ratio is 70% versus one of 20% for Firm B. Based only on these two facts, you cannot reach a conclusion as to which firm is better managed, because the difference in debt, not better management, could be the cause of Firm A's higher profit margin.

False

(T or F) The NYSE is defined as a "primary" market because it is one of the largest and most important stock markets in the world.

False

(T or F) The next-to-last line on the income statement shows the firm's earnings, while the last line shows the dividends the company paid. Therefore, the dividends are frequently called "the bottom line."

False

(T or F) The operating margin measures operating income per dollar of assets.

False

(T or F) The term IPO stands for "individual purchase order," as when an individual (as opposed to an institution) places an order to buy a stock.

False

(T or F) There are many types of unethical business behavior. One example is where executives provide information that they know is incorrect to banks and to stockholders. It is illegal to provide such information to banks, but it is not illegal to provide it to stockholders because they are the owners of the firm, not outsiders.

False

( T or F) If a firm's fixed assets turnover ratio is significantly higher than its industry average, this could indicate that it uses its fixed assets very efficiently or is operating at over capacity and should probably add fixed assets.

True

( T or F) The times-interest-earned ratio is one, but not the only, indication of a firm's ability to meet its long-term and short-term debt obligations.

True

(T or F) A hostile takeover is said to occur when another corporation or group of investors gains voting control over a firm and replaces the old managers. If the old managers were managing the firm inefficiently, then hostile takeovers can improve the economy. However, hostile takeovers are controversial, and legislative actions have been taken to make them more difficult to undertake.

True

(T or F) Although a full liquidity analysis requires the use of a cash budget, the current and quick ratios provide fast and easy-to-use estimates of a firm's liquidity position.

True

(T or F) An increase in accounts payable represents an increase in net cash provided by operating activities just like borrowing money from a bank. An increase in accounts payable has an effect similar to taking out a new bank loan. However, these two items show up in different sections of the statement of cash flows.

True

(T or F) As a result of compounding, the effective annual rate on a bank deposit (or a loan) is always equal to or greater than the nominal rate on the deposit (or loan).

True

(T or F) Financial institutions are more diversified today than they were in the past, when federal laws kept investment banking houses, commercial banks, insurance companies, and similar organizations quite separate. Today the larger financial corporations offer a variety of services, ranging from checking accounts, to insurance, to underwriting securities, to stock brokerage.

True

(T or F) Free cash flow (FCF) is, essentially, the cash flow that is available for interest and dividends after the company has made the investments in current and fixed assets that are necessary to sustain ongoing operations.

True

(T or F) If a firm finances with only debt and common equity, and if its equity multiplier is 3.0, then its debt ratio must be 0.667.

True

(T or F) If someone deliberately understates costs and thereby increases profits, this can cause the price of the stock to rise above its intrinsic value. The stock price will probably fall in the future. Also, those who participated in the fraud can be prosecuted, and the firm itself can be penalized.

True

(T or F) If the discount (or interest) rate is positive, the future value of an expected series of payments will always exceed the present value of the same series.

True

(T or F) In a "Dutch auction" for new stock individual investors place bids for shares directly. Each potential bidder indicates the price he or she is willing to pay and how many shares he or she will purchase at that price. The highest price that permits the company to sell all the shares it wants to sell is determined, and this is the "market clearing price." All bidders who specified this price or higher are allowed to purchase their shares at the market clearing price.

True

(T or F) Interest paid by a corporation is a tax deduction for the paying corporation, but dividends paid are not deductible. This treatment, other things held constant, tends to encourage the use of debt financing by corporations.

True

(T or F) Klein Cosmetics has a profit margin of 5.0%, a total assets turnover ratio of 1.5 times, a zero debt ratio and therefore an equity multiplier of 1.0, and an ROE of 7.5%. The CFO recommends that the firm borrow money, use it to buy back stock, and raise the debt ratio to 50% and the equity multiplier to 2.0. She thinks that operations would not be affected, but interest on the new debt would lower the profit margin to 4.5%. This would probably be a good move, as it would increase the ROE from 7.5% to 13.5%.

True

(T or F) One danger of starting a proprietorship is that you may be exposed to personal liability if the business goes bankrupt. This problem would be avoided if you formed a corporation to operate the business

True

(T or F) Some of the cash flows shown on a time line can be in the form of annuity payments while others can be uneven amounts.

True

(T or F) Suppose Sally Smith plans to invest $1,000. She can earn an effective annual rate of 5% on Security A, while Security B has an effective annual rate of 12%. After 11 years, the compounded value of Security B should be more than twice the compounded value of Security A. (Ignore risk, and assume that compounding occurs annually.)

True

(T or F) The "over-the-counter" market received its name years ago because brokerage firms would hold inventories of stocks and then sell them by literally passing them over the counter to the buyer.

True

(T or F) The advantage of the basic earning power ratio (BEP) over the return on total assets for judging a company's operating efficiency is that the BEP does not reflect the effects of debt and taxes

True

(T or F) The alternative minimum tax (AMT) was created by Congress to make it more difficult for wealthy individuals to avoid paying taxes through the use of various deductions.

True

(T or F) The annual rate of return on any given stock can be found as the stock's dividend for the year plus the change in the stock's price during the year, divided by its beginning-of-year price.

True

(T or F) The annual report contains four basic financial statements: the income statement, the balance sheet, the cash flow statement, and statement of stockholders' equity.

True

(T or F) The greater the number of compounding periods within a year, then (1) the greater the future value of a lump sum investment at Time 0 and (2) the smaller the present value of a given lump sum to be received at some future date.

True

(T or F) The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firm's future earnings and dividends, and the riskiness of those cash flows.

True

(T or F) The profit margin measures net income per dollar of sales.

True

(T or F) The value of any asset is the present value of the cash flows the asset is expected to provide. The cash flows a business is able to provide to its investors is its free cash flow. This is the reason that FCF is so important in finance.

True

(T or F) Time lines can be constructed for annuities where the payments occur at either the beginning or the end of the periods.

True

(T or F) When a corporation's shares are owned by a few individuals who are associated with the firm's management, we say that the stock is closely held.

True