Chapter 1 [section 1 (5 q's)]

7. My ABC Company sells personalized ABC books and has a current ratio of 4:1. If the company has $40,000 in current assets, how much working capital does it have? A. $40,000 B. $30,000 C. $10,000 D. $160,000

7. Answer: B. If the current ratio is 4:1 (4 to 1), My ABC Company would have four times as many current assets as current liabilities, or $10,000 in current liabilities (working capital = current assets - current liabilities ($40,000 - $10,000 = $30,000)).

1. Which of the following is not a current asset? A. Inventory B. Accounts receivable C. Cash D. Trademarks

1. Answer: D. Current assets are anything that could be converted into cash within a year. Current assets include cash and cash equivalents, inventory, accounts receivable, and prepaid expenses. Property, plants, equipment, and intangible assets, such as trademarks, are not considered current assets.

10. What is the appropriate formula to use if you want to calculate an investment's annualized return, including compound interest? A. (Appreciation or loss on investment / original investment) / number of years B. Geometric mean C. Arithmetic mean D. Ending value of investment / original value of investment - 1

10. Answer: B. If one wants to calculate an investment's annualized return, including compounded interest, the appropriate formula is the geometric mean.

11. Wayne purchased 500 shares of ABC Corporation at $20 per share. Three months later, he sold the shares at $30 per share. What was Wayne's holding period return? A. 50% B. 200% C. 12.5% D. 33.3%

11. Answer: A. A holding period return is calculated in the following way: holding period return = (investment's value at sale - original investment) / original investment original investment = 500 × $20 = $10,000 investment's value at sale = 500 shares × $30 = $15,000 Wayne's holding period return = ($15,000 - $10,000) / $10,000 = 50%

12. Based on historical information, an analyst has calculated that an investment in ABC Corporation's common stock has a 20% chance of returning 20% and an 80% chance of returning 10%. What is the expected return on an investment in shares of XYZ Corporation? A. 12.8% B. 15.0% C. 12.0% D. 11.6%

12. Answer: C. The expected return is calculated in the following manner: expected return = probability × return + probability × return expected return = (0.20 × 0.20) + (0.80 × 0.10) = 0.040 + 0.08 = 0.12 = 12%

13. Stock A has a return of 11% and a historical SD of 4, whereas Stock B has a return of 12% and a historical SD of 3. Three-month Treasury bills are currently returning 3%, and the S&P returned 7% last year. Using the Sharpe ratio, which stock has the best performance, adjusting for risk? A. Stock A B. Stock B C. They have equivalent Sharpe ratios. D. Impossible to determine, because not all of the variables are available.

13. Answer: B. Stock B has the highest Sharpe ratio, and therefore is the best investment after adjusting for risk. Sharpe ratio of Stock A = (11% - 3%) / 4 = 2 Sharpe ratio of Stock B = (12% - 3%) / 3 = 3

14. Pick two statements that best represent time-weighted and dollar-weighted returns: I. Conceptually, the time-weighted return is the compounded growth rate of the initial investment over a given period of time, and is calculated using the geometric mean rather than the arithmetic mean. II. Conceptually, the dollar-weighted return is the compounded growth rate of the initial investment over a given period of time and is calculated using the geometric mean rather than the arithmetic mean. III. Conceptually, a time-weighted return is the internal rate of return on an investment. IV. Conceptually, a dollar-weighted return is the internal rate of return on an investment. A. I and III B. I and IV C. II and III D. II and IV

14. Answer: B. A time-weighted return is used to measure the compounded rate of growth in a portfolio. Conceptually, the time-weighted return is the compounded growth rate of the initial investment over a given period of time. This return is calculated using the geometric mean rather than the arithmetic mean. The time-weighted return gives a return that does not incorporate deposits to or withdrawals from the account. For this reason, it does not weight the return toward periods when the account contains more money. The time-weighted return is the standard measure used by mutual fund portfolio managers to report performance in their fund prospectuses. It is also used by most investment advisers when reporting the returns of a client's portfolio. A dollar-weighted return provides a return between two points in time, incorporating all the cash inflows, such as dividends, interest, and contributions, and all cash outflows, such as withdrawals, from the portfolio. The dollar-weighted return differs from the simple arithmetic return and the time-weighted return, because it gives more weight to periods where more funds are in the account or portfolio. Conceptually, a dollar-weighted return is the internal rate of return on an investment. It is calculated in the same manner as the internal rate of return on any investment by figuring the return that is necessary to achieve a net present value of 0 given the increase in the investment, and all cash inflows and outflows.

2. The best place to look for a current list of the long-term debts which a company that first issued its securities five years ago must repay is its: A. Prospectus B. Form 144 C. Balance sheet D. Income statement

2. Answer: C. A company's balance sheet contains a breakdown of its assets (what it owns) and its liabilities and debts (what it owes). The prospectus is the document issued when the security is first offered to the investing public. Five years later, the financial information that appears in the prospectus is most likely outdated. Form 144 is used by company management and insiders to disclose transactions in securities owned by them personally. The income statement shows the cash inflows and outflows of a company, but does not contain a comprehensive listing of its assets and debts.

3. All of the following are components of a company's quick ratio except: A. Inventory B. Accounts receivable C. Cash D. Current liabilities

3. Answer: A. When calculating the quick ratio, add the cash and accounts receivable together, then divide by the amount of the company's current liabilities. This gives a picture of a company's ability to meet its current obligations without having to liquidate its inventory. The current ratio includes inventory as part of this calculation.

4. An investor calculating the investing merits of a payment or payments not yet received might potentially use all of the following except: A. Present value B. Net present value C. Future value D. Internal rate of return

4. Answer: C. Future value can be used to determine the value of an asset already held by a company or investor, not one that will be received in the future. An investor that is interested in determining the investment merit of a future payment or stream of payments might use a present value, net present value, or internal rate of return calculation.

5. Jim wishes to calculate the future value of $1,000 three years from now if it earns 8%. Which of the following could be used to calculate this amount? A. $1,000 / (1 + 0.08)3 B. $1,000 × (1 + 0.08)3 C. 3 × $1,000 × (1 + 0.08) D. 3 × $1,000 / (1 + 0.08)

5. Answer: B. The correct formula for future value of this bond is $1,000 × (1 + 0.08)3.

6. Which balance sheet item is deducted from current assets when calculating the acid test or quick ratio? A. Accounts receivable B. Inventory C. Taxes D. Equipment

6. Answer: B. Current assets less inventory, divided by current liabilities equals a company's quick ratio. The quick ratio measures how much of the company's debt can be paid off immediately without selling inventory. The quick ratio is also known as the acid-test ratio.

8. You have received the following facts about various companies. One of the pieces of information has an error. Which company is most likely to have the error? A. Company A has a quick ratio of 0.2 B. Company B has a working capital of -$30 million C. Company C has a P/E of 15 D. Company D has a current ratio of -2

8. Answer: D. A company cannot have a negative current ratio because the current ratio is simply assets divided by liabilities, and you can't have negative assets or negative liabilities.

9. Steve bought 100 shares of XYZ Company at $50. Two years later, he sold the shares for $60. Over the two years, Steve received a total of $2/share in dividends. What was Steve's annualized total return, not taking into account compound interest? A. 24% B. 12% C. 20% D. 10%

9. Answer: B. Total return is calculated according to the following formula: total return = (appreciation or loss in value + dividends and interest) / original investment annualized total return = (($1,000 + $200) / $5,000) / 2 = 12%