Calculate Financial Ratios
Which feature is generally not associated with preferred stock? Voting rights Convertibility to common stock Callability at the option of the corporation Preference in dividends
Voting rights
During a fiscal year, a company had $25,000,000 in total sales. It had a cost of goods sold (COGS) of $18,000,000, and $4,000,000 in additional expenses. What is the company's gross profit margin? 33.33% 28% 12% 16%
Gross Profit Margin = Gross Profit / Sales. Gross Profit = Sales - COGS = $25,000,000 - $18,000,000 = $7,000,000. Hence, GP Margin = $7,000,000/$25,000,000 = 0.28 or 28%.
Which answer is generally not a right granted to owners of preferred shares? Convertibility to common shares Callability Preference with regards to receiving dividends Variable dividend amounts
Variable dividend amounts
A company had $5,000,000 in total revenues for its fiscal year. Its expenses for the year were $3,500,000. Its total assets were $12,500,000. What is the company's return on assets for the fiscal year? 0.4 0.28 0.12 0.7
0.12 ROA = NI/TA. NI = $5,000,000 - $3,500,000 = $1,500,000. Hence, ROA = $1,500,000/$12,500,000 = 0.12.
A company has $450,000 in cash, $300,000 in marketable securities, and $500,000 worth of inventory. Its current assets are worth $1,750,000 and its current liabilities are $1,250,000. What is the company's acid test ratio? 1 1.04 1.16 0.8
1 Acid test ratio = (CA - Inv)/CL = ($1,750,000-$500,000)/$1,250,000 = 1
A company has $750,000 in cash, $200,000 in marketable securities and $300,000 worth of accounts receivable. Its current assets are worth $1,500,000 and its current liabilities are $1,000,000. What is the company's quick ratio? 1.5 1.3 1.05 1.25
1.25 Quick ratio = (CA - Inv)/CL Since we are given all the current assets except for the Inventory, then (CA - Inv) = $750,000 + $200,000 + $300,000 = $1,250,000 and Quick Ratio = $1,250,000/$1,000,000 = 1.25.
A US Treasury security matures in 4 years. What type of treasury is it? A note A money market instrument A bond A bill
A bill Correct! U.S. Treasury bills are short term instruments with maturities between 1-5 years.
Which statement regarding bonds and par values is true? Corporate bonds usually have par values equal to $10,000. The par value of a bond changes. Corporate bonds usually have a par value of less than $100,000. A bond selling at par has a coupon rate so the bond is worth its redemption value at maturity.
A bond selling at par has a coupon rate so the bond is worth its redemption value at maturity.
A bond pays a coupon rate equal to the LIBOR rate plus 0.30%. The coupon rate is recalculated every three months. What type of bond is this? An inflation-linked bond A zero-coupon bond A floating rate note A stepped-coupon bond
A floating rate note
Of the following car financing options, which one would you prefer while assuming that you prefer paying the least amount of dollars and that you face a 10% annual compound interest rate on all your financial decisions? A payment $10,000 today and another of $10,000 in one year from today. A lump-sum payment of $20,000 in two years from today. A lump-sum payment of $19,000 today only. A lump-sum payment of $20,000 today only. Incorrect. A lump sum payment of $19,000 today is greater than the value today of a payment of $20,000 in two years, which gives PV = $20,000/(1.102) = $16,529.
A lump-sum payment of $20,000 in two years from today. Using Calculator: N = 2, I/Y = 10, FV = 20,000. [CPT] PV = $16,529.
Which prediction based on a description of the yield curve is not correct? An inverted yield curve suggests that interest rates will be dramatically cut. A normal yield curve suggests that interest rates will be raised in the future. A flat yield curve suggest that interest rates will be cut. A normal yield curve suggests that interest rates will remain the same in the future.
A normal yield curve suggests that interest rates will remain the same in the future.
A US Treasury security matures in 7 years. What type of security is it? A bond A money market instrument A note A bill
A note Correct! U.S. Treasury notes are medium-term instruments with maturities between 6-12 years.
Which statement accurately describes systematic risk? Systematic risk is what provides a stock's "risk premium." By diversifying your stock portfolio, you can minimize systematic risk. Systematic risk is uncertainty associated with a company or industry in which you invest. An example of a systematic risk is if you own stock in a company that has liquidity problems. Incorrect. Systematic risk is associated with changes in the entire market.
By diversifying your stock portfolio, you can minimize systematic risk.
External sources of financing include
Commercial paper is an external source of financing.
Which answer is not a true statement regarding voting rights? Shareholders generally get to vote on who is part of the corporate Board of Directors. Preferred stock generally does not carry voting rights. Corporate shareholders are prohibited from casting their vote online. Generally each share of common stock equals one vote.
Corporate shareholders are prohibited from casting their vote online.
What type of risk can an investor reduce through the process of diversification? Uncertainty Unsystematic risk All risk can be reduced Systematic risk only
Correct! Unsystematic risk can be reduced through diversification.
Which statement is false regarding debt vs. equity? Debt carries high risk to investors as compared to Equity. Debt can be secured or unsecured, whereas equity is always unsecured. Debt holders are the creditors whereas equity holders are the owners of the company. Debt can be kept for a limited period and should be repaid back after the expiry of that term. On the other hand, Equity can be kept for a long period. Incorrect. This statement is true.
Debt carries high risk to investors as compared to Equity.
A firm is evaluating the merits of investing in one of two non-repeatable projects with different lifespans. Start-up costs for each project are equal. If project A has an expected lifetime of five years, and project B has an expected lifetime of eight years, which capital budgeting method provides the best way to compare future cash flows from these projects? Accounting rate of return Internal rate of return Payback Period Equivalent annuity
Equivalent annuity
An investment portfolio has a 30% chance of earning $125,000 in a year, a 40% chance of earning $50,000, a 15% chance of earning nothing and 15% chance of losing $20,000. What is its expected return? $38,750 $50,000 $62,000 $54,500
Expected return = (30% × $125,000) + (40% × $50,000) + (15% × 0) + (15% × -$20,000) = $54,500
A portfolio is composed of 30% stock, 20% bonds, and 50% mutual funds. The stock is expected to have a 10% return, the bonds a 5% return and the mutual funds a 7% return. What is the expected return of the portfolio? 8.1% 7% 7.5% 7.3%
Expected return = (30% × 10%) + (20% × 5%) + (50% × 7%) = 7.5%.
A portfolio has $70,000 of bonds and $30,000 of stock. The bonds are 80% likely to have a 10% return and 20% likely to have a 0% return. The stock is 50% likely to have a 20% return and 50% likely to have a 10% loss. What is the expected return? 5.9% 7.1% 13% 2.9% Incorrect.
Expected return on bonds = (80% × 10%) + (20% × 0) = 8% Expected return on stock= (50% × 20%) + (50% × -10%) = 5% Overall expected return = ( 70/100 × 8%) + (30/100 × 5%) = 7.1%
You plan to invest $100,000 in a 3 year Certificate of Deposit that has a simple interest rate of 5%. What is its future value? $105,000 $115,927 $115,763 $115,000
FV = $100,000 + (3 × 5% × $100,000) = $115,000.
What is the future value in 30 years of $100,000 invested today in a savings account earning a 1% simple interest rate every year (rounded up to the nearest dollar)? $130,000 More than $134,785 $134,785 $30,000
FV = $100,000 + (30 × 1% × $100,000) = $130,000.
What is the future value in 30 years of $100,000 invested today in a savings account earning a 1% compound interest rate every year (rounded up to the nearest dollar)? $130,000 More than $134785 $134,785 $30,000
FV = $100,000 × 1.0130 = $134,785 Using Calculator: N = 30, I/Y = 1, PV = 100,000. [CPT] FV = $134,785.
You plan to invest $100,000 in a 3 year Certificate of Deposit that has a 5% compound interest rate. What is its future value? $115,927 $105,000 $115,763 $115,000
FV = $100,000 × 1.053 = $115,763 Using Calculator: N = 3, I/Y = 5, PV = 100,000. [CPT] FV = $115,763.
You have $300,000 that you want to invest in a one year Certificate of Deposit (CD) with a 4% annual interest rate. What will be the value of that CD in a year? $315,000 $301,200 $420,000 $312,000
FV = $300,000 × 1.04 = $312,000 Using Calculator: N = 1, I/Y = 4, PV = 300,000. [CPT] FV = $312,000.
Which answer correctly describes an advantage the internal rate of return has over net present value for capital budgeting purposes? The IRR method recognizes the time value of money. Internal rate of return is an indicator of the efficiency, quality or yield of an investment. The IRR shows the actual annual profitability of an investment. The IRR method is clear and easy to understand. Incorrect. IRR and NPV each recognize TVM, so no advantage here.
Internal rate of return is an indicator of the efficiency, quality or yield of an investment.
Which option is an adequate method to reduce an investor's risk through diversification? Invest in the common stocks of the two companies that have performed the best in the last 5 years. Invest in a start-up business that has a broad ownership among a large number of investors. Invest in a broad pool of US and international stocks and bonds. Invest in a small pool of stocks from companies in the same industry. Correct! Risk can be diversified away by investing in a broad pool of assets.
Invest in a broad pool of US and international stocks and bonds.
In the bond market, firms raise debt financing directly from
Investors Correct. Issuers sell bonds or other debt instruments to investors in the bond market to fund the operations of their organizations. Firms like bonds because typically they help defray costs by going straight to investors.
An annuity has an interest rate of 7% and makes a quarterly payment of $2,000. The annuity is to last for 5 years. What is the present value of the annuity? $33,505 $8,200.40 $32,801.58 $2,118.80
N=5x4=20, I/Y=7/4=1.75, PMT=2000, FV=0 and [CPT] [PV] = 33,505.76.
You expect to receive a payment of $1 million in a year. The annual interest rate is 5%. What is the present value of the future payment? $666,667 $952,381 $995,025 $105,000 Correct! PV = $1 million/(1.05) = $952,381 Using Calculator: N = 1, I/Y = 5, FV = $1 million. [CPT] PV = $952,381
PV = $1 million/(1.05) = $952,381 Using Calculator: N = 1, I/Y = 5, FV = $1 million. [CPT] PV = $952,381
What is the present value of $100,000 that will be received 5 years from today if you face a 10% compound interest rate every year (rounded up to the nearest dollar)? $82,092 $72,092 $52,092 $62,092
PV = $100,000/(1.105) = $62,092 Using Calculator: N = 5, I/Y = 10, FV = 100,000. [CPT] PV = $62,092.
You own a perpetuity that pays $1000 in the first year. It has a 5% annual interest rate and a 2% annual growth rate. What is the present value of the perpetuity? $14,286 $33,333 $50,000 $20,000
PVGP = A1/(i - g) = $1000/(0.05 - 0.02) = $33,333.
Which investment proposal ranking method is widely used due to its simplicity, despite having several limitations? Internal Rate of Return (IRR) Payback period Profitability Index Net Present Value (NPV)
Payback period
Internal sources of financing include which of the following? Trade credit Factoring Debenture Sale of stock
Sale of stock
Which is the correct reason as to why businesses issue preferred stock? Preferred stock provides a simpler means of raising substantial capital than the sale of common stock does. The par value at which companies offer preferred stock is often significantly lower than the common stock price. Preferred stock also offers companies some financial rigidity. Preferred stock carries a lower privilege by almost every measure in relation to common stock.
Preferred stock provides a simpler means of raising substantial capital than the sale of common stock does.
Which statement is not true regarding preferred stock owners? Preferred stockholders typically have voting rights. Preferred stockholders must be paid their due dividends before the company can distribute dividends to common stockholders. Preferred stockholders enjoy a fixed dividend. Preferred stock owners are paid before common stock shareholders in the event of the company's liquidation.
Preferred stockholders typically have voting rights.
A company issues a bond with the provision that it may pay off the debt early. Which type of risk is this bond subject to? Model risk. Asset-backed risk Prepayment risk. Foreign investment risk
Prepayment risk. The buyer of the bond will lose the right to future interest payments if the company pays off the debt early.
Which statement correctly explains the difference between price risk and reinvestment risk? When market interest rates rise, both price risk and reinvestment risk rise also. Price risk is positively correlated to maturity, reinvestment risk is inversely correlated. Price risk is positively correlated to interest rates, reinvestment risk is inversely correlated. For corporate planning, a bond's price risk is a bigger concern than its reinvestment risk.
Price risk is positively correlated to interest rates, reinvestment risk is inversely correlated.
Which answer is not a cost to the investor that is included in the calculation of an investment's interest rate? Brokerage commissions and fees Opportunity Cost Risk of a bad investment Inflation Incorrect. Opportunity cost is included in calculation of investments' interest rate.
Risk of a bad investment
You are considering investing in the common stock of a major US Corporation. Which answer is an example of systematic risk? Risk related to an impending lawsuit against the company Risk resulting from general unrest in the company's labor force Risk resulting from a general decline in the US stock markets Risk related to the possibility of foreign expropriation of the company's property Correct! This illustrates a risk exposure that affects all companies in the market and is thus an example of systematic risk.
Risk resulting from a general decline in the US stock markets
The most common measure of risk in finance is the
Standard deviation
Factors that influences market interest rates? Alternative investments Deferred consumption Stock market activity Inflationary expectations
Stock market activity
The risk that remains after an investor has extensively diversified his portfolio is primarily
Systematic risk is the portion of risk in a portfolio that cannot be diversified away.
Question 1 of 15 A company issues a bond with a coupon rate of 5%. Since the bond was issued, market interest rates have decreased. What effect will this decrease have on the bond's market price and its current yield?
The bond will trade above par and its current yield will decrease.
A firm is trying to choose the most profitable project to invest in. Which feature should be used as the company's discount rate? The company's weighted average cost of capital The company's profitability index The company's reinvestment rate The company's internal rate of return
The company's reinvestment rate
A company has $100,000 in cash, $300,000 in accounts receivable, $50,000 in inventory and a $300,000 office building. Its current liabilities are $250,000. What is the company's current ratio, and does that ratio show good short-term financial strength? The current ratio is 3, and the ratio indicates good short-term financial strength. The current ratio is 1.8, and the ratio indicates poor short-term financial strength. The current ratio is 1.8, and the ratio indicates good short-term financial strength. The current ratio is 3, and the ratio indicates poor short-term financial strength.
The current ratio is 1.8, and the ratio indicates good short-term financial strength. Current ratio = CA/CL. CA = $100,000 + $300,000 + $50,000 = $450,000. (Note: office building is a Fixed Asset). Current ratio = $450,000/$250,000 = 1.8. The firm has $1.80 in current assets for every $1 it owes in current liability so this reflects good short-term financial strength.
Under the internal rate of return rule in capital budgeting, which statement does not apply? The internal rate of return can be equal to the cost of capital. The initial investment for all projects under consideration can require the same amount of capital. The cash inflows can be estimates. The internal rate of return can vary throughout the life of a project. Incorrect. Since IRR is a forecasting tool, all cash flows are estimates of future cash flows from the project.
The internal rate of return can vary throughout the life of a project.
Which definition is a correct description of a capital budgeting method? Real option analysis is the ratio of payoff to investment of a proposed project. Equivalent annuity method essentially value projects as if they were risk bonds. The profitability index is the time required for an investment to "repay" the original investment. The internal rate of return is the discount rate that gives a net present value of zero.
The internal rate of return is the discount rate that gives a net present value of zero.
Which statement reflects the best reason to use the payback method to evaluate investments? The payback method helps gauge a project's risk. If you use the payback method, you do not need to perform additional analyses. The payback method covers all cash inflows and outflows for the duration of the investment. The payback method is easy to use and understandable for most people, regardless of training.
The payback method is easy to use and understandable for most people, regardless of training.
Which statement accurately describes a shareholder's preemptive rights? The right to purchase new shares issued by the company The right to claim a company's remaining assets after a liquidation The right to vote on directors The right to retain their proportional ownership in a company should it issue another stock offering
The right to retain their proportional ownership in a company should it issue another stock offering
Which answer is a benefit associated with common stock? The right to vote on corporate objectives and policy Preemptive rights Guaranteed dividends The right to vote on who gets to sit on the company's Board of Directors
The right to vote on corporate objectives and policy Preemptive rights The right to vote on who gets to sit on the company's Board of Directors
In which situation would it be appropriate to use the IRR method to make an investment decision? To assess a project in which cash flows fluctuate To compare two investments that have different lifespans To rate the desirability of mutually exclusive projects To compare two projects that have an equal initial investment
To compare two projects that have an equal initial investment
Which answer correctly describes a way the internal rate of return (IRR) is used in capital budgeting? To determine which discount rate results in a net present value (NPV) of zero As the effective interest rate for savings and loans As a means to compare the profitability of different investments To determine the actual annual profitability of an investment
To determine which discount rate results in a net present value (NPV) of zero
Which of the following is a function of corporate capital budgeting? To encourage managers to operate independently of other business operations and departments To provide a history of past revenues and expenditures To assist managers with reacting to problems after they arise To rank projects by profitability
To rank projects by profitability
Which of the following describes the relationship between present value and future value? When one increases, the other increases, assuming all variables are constant. The higher the interest rate, the higher the present value and the lower the future value. When present value increases, the future value decreases, assuming all variables are constant. The more time that passes, the higher the present value and the lower the future value.
When one increases, the other increases, assuming all variables are constant.
Which type of bond will not be affected by reinvestment risk? Floating rate Inflation linked Stepped-coupon Zero-Coupon
Zero-Coupon Correct. There are no coupon payments made to the investor over the life of the bond.
Question 2 of 5 A bond makes only one payment—the payment of the face value on the maturity date. The bond is sold at a discount. What type of bond is this? Floating rate note Inflation-linked bond Stepped-coupon bond Zero-coupon bond
Zero-coupon bond
