Financial Management 2 Midterm

You recently sold 200 shares of Apple stock to your brother. The transfer was made through a broker, and the trade occurred on the NYSE. This is an example of: a. An over-the-counter market transaction. b. A secondary market transaction. c. A futures market transaction. d. A money market transaction. e. A primary market transaction.

b. A secondary market transaction.

Which of the following statements is CORRECT? a. If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase. b. If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will decrease. c. A reduction in the inventory turnover ratio will generally lead to an increase in the ROE. d. A reduction in inventories held would have no effect on the current ratio. e. An increase in inventories would have no effect on the current ratio.

a. If a firm increases its sales and cost of goods sold while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase.

Which of the following statements is CORRECT? a. If expected inflation increases, interest rates are likely to increase. b. Interest rates on all debt securities tend to rise during recessions because recessions increase the possibility of bankruptcy, hence the riskiness of all debt securities. c. If individuals in general increase the percentage of their income that they save, interest rates are likely to increase. d. Interest rates on long-term bonds are more volatile than rates on short-term debt securities like T-bills. e. If companies have fewer good investment opportunities, interest rates are likely to increase.

a. If expected inflation increases, interest rates are likely to increase.

Which of the following is a primary market transaction? a. Johnson & Johnson issues 2,000,000 shares of new stock and sells them to the public through an investment banker. b. You sell 200 shares of Johnson & Johnson stock on the NYSE through your broker. c. You buy 200 shares of Johnson & Johnson stock from your younger brother. You just give him cash and he gives you the stock ¾ the trade is not made through a broker. d. You invest $10,000 in a mutual fund, which then uses the money to buy $10,000 of Johnson & Johnson shares on the NYSE. e. One financial institution buys 200,000 shares of Johnson & Johnson stock from another institution. An investment banker arranges the transaction.

a. Johnson & Johnson issues 2,000,000 shares of new stock and sells them to the public through an investment banker.

Bond A has a 9% annual coupon while Bond B has a 6% annual coupon. Both bonds have a 7% yield to maturity, and the YTM is expected to remain constant. Which of the following statements is CORRECT? a. The price of Bond A will decrease over time, but the price of Bond B will increase over time. b. The price of Bond B will decrease over time, but the price of Bond A will increase over time. c. The prices of both bonds will increase by 7% per year. d. The prices of both bonds will increase over time, but the price of Bond A will increase by more. e. The prices of both bonds will remain unchanged.

a. The price of Bond A will decrease over time, but the price of Bond B will increase over time.

Which of the following statements is CORRECT? a. If Firms X and Y have the same P/E ratios, then their market-to-book ratios must also be the same. b. If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their P/E ratios must also be the same. c. If Firms X and Y have the same earnings per share and market-to-book ratio, they must have the same price earnings ratio. d. If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their market-to-book ratios must also be the same. e. If Firm X's P/E ratio exceeds that of Firm Y, then Y is likely to be less risky and also to be expected to grow at a faster rate.

b. If Firms X and Y have the same net income, number of shares outstanding, and price per share, then their P/E ratios must also be the same.

A firm's new president wants to strengthen the company's financial position. Which of the following actions would make it financially stronger? a. Increase inventories while holding sales and cost of goods sold constant. b. Increase EBIT while holding sales constant. c. Increase accounts receivable while holding sales constant. d. Increase notes payable while holding sales constant. e. Increase accounts payable while holding sales constant.

b. Increase EBIT while holding sales constant.

Which of the following factors could explain why Regal Industrial Fixtures had a negative net cash provided (used) by operations year, even though the cash on its balance sheet increased? a. The company paid a large dividend. b. The company sold a new issue of bonds. c. The company issued preferred stock. d. The company made a large investment in new plant and equipment. e. The company repurchased 20% of its common stock.

b. The company sold a new issue of bonds.

Which of the following statements is CORRECT? Assume a company's target capital structure is 50% debt and 50% common equity. a. The WACC exceeds the cost of equity. b. The cost of equity is always equal to or greater than the cost of debt. c. The WACC is calculated on a before-tax basis. d. The cost of reinvested earnings typically exceeds the cost of new common stock. e. The interest rate used to calculate the WACC is the average after-tax cost of all the company's outstanding debt as shown on its balance sheet.

b. The cost of equity is always equal to or greater than the cost of debt.

Which of the following statements is CORRECT? a. Higher sales usually require higher asset levels, and this leads to what we call AFN. However, the AFN will be zero if the firm chooses to retain all of its profits, i.e., to have a zero dividend payout ratio. b. The sustainable growth rate is the maximum achievable growth rate without the firm having to raise external funds. In other words, it is the growth rate at which the firm's AFN equals zero. c. Dividend policy does not affect the requirement for external funds based on the AFN equation. d. If a firm increases its dividend payout ratio in anticipation of higher earnings, but sales and earnings actually decrease, then the firm's actual AFN must, mathematically, exceed the previously calculated AFN. e. If a firm's assets are growing at a positive rate, but its retained earnings are not increasing, then it would be impossible for the firm's AFN to be negative.

b. The sustainable growth rate is the maximum achievable growth rate without the firm having to raise external funds. In other words, it is the growth rate at which the firm's AFN equals zero.

Which one of the following statements is TRUE? a. An example of asset switching is an option to exchange one piece of real estate for another. b. When lenders protect themselves from the risk of asset switching, the firm's WACC can increase. c. An example of an agency cost is when the board of directors pays a dividend to shareholders. d. An example of an agency cost is when an attorney hires an expert witness for a trial. e. Lenders can't legally prevent a firm from engaging in asset switching.

b. When lenders protect themselves from the risk of asset switching, the firm's WACC can increase.

Which one of the following statements is TRUE? a. A supplier substituting a lower-quality raw material without approval is an example of asset switching. b. When lenders protect themselves from the risk of asset switching by raising the interest rate, the firm's WACC can decrease. c. A corporate golf club membership is an example of a nonpecuniary benefit. d. Firms borrowing money have greater flexibility to use that money when there are debt covenants. e. A lender calling in a corporate loan and then lending the funds out to a safer borrower is an example of asset switching.

c. A corporate golf club membership is an example of a nonpecuniary benefit.

Which one of the following statements is TRUE? a. Anti-takeover charter provisions are good for shareholders because they prevent a raider from stealing the company for a below-market price. b. Shareholders want to prevent takeovers because they don't want the company purchased out from under them. c. A targeted share repurchase can be used to prevent a hostile takeover. d. One tool of corporate governance is choosing a good investment banker. e. A targeted share repurchase can be used to increase the stock price if the company is undervalued.

c. A targeted share repurchase can be used to prevent a hostile takeover.

Which of the following is NOT a capital component when calculating the weighted average cost of capital (WACC) for use in capital budgeting? a. Common stock raised by new issues. b. Long-term debt. c. Accounts payable. d. Preferred stock. e. Common stock "raised" by reinvesting earnings.

c. Accounts payable.

Which one of the following statements is TRUE? a. An example of an agency relationship is when the CEO nominates a slate of candidates to be on the board of directors. b. An agency relationship is when a principal works for an agent. c. An agency relationship is when someone hires someone else to perform a service and gives them decision-making authority. d. An agency relationship is when an agent hires a principal to perform a service. e. In an agency relationship, the agent delegates authority to the principal.

c. An agency relationship is when someone hires someone else to perform a service and gives them decision-making authority.

Which one of the following corporate board characteristics usually improves corporate governance? a. The board has a majority of insiders from company management on it who bring first-hand knowledge of how the company operates. b. The board has many outsiders who have lots of other important commitments. c. CEO is not the chairman of the board. d. The board is as large as is possible. e. Board members are paid at a rate higher than their peers and their payment is mostly cash.

c. CEO is not the chairman of the board.

The term "additional funds needed (AFN)" is generally defined as follows: a. The amount of internally generated cash in a given year minus the amount of cash needed to acquire the new assets needed to support growth. b. The amount of assets required per dollar of sales. c. Funds that a firm must raise externally from non-spontaneous sources, i.e., by borrowing or by selling new stock to support operations. d. Funds that are obtained automatically from routine business transactions. e. A forecasting approach in which the forecasted percentage of sales for each balance sheet account is held constant.

c. Funds that a firm must raise externally from non-spontaneous sources, i.e., by borrowing or by selling new stock to support operations.

Which of the following statements is CORRECT? a. All else equal, an increase in a company's stock price will increase its marginal cost of new common equity, re. b. All else equal, an increase in a company's stock price will increase its marginal cost of reinvested earnings (not newly issued stock), rs. c. If a company's tax rate increases but the YTM on its noncallable bonds remains the same, the after-tax cost of its debt will fall. d. When calculating the cost of preferred stock, a company needs to adjust for taxes, because preferred stock dividends are deductible by the paying corporation. e. Since the money is readily available, the after-tax cost of reinvested earnings (not newly issued stock) is usually much lower than the after-tax cost of debt.

c. If a company's tax rate increases but the YTM on its noncallable bonds remains the same, the after-tax cost of its debt will fall.

The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to a. Maximize the stock price on a specific target date. b. Minimize the chances of losses. c. Maximize the stock price per share over the long run, which is the stock's intrinsic value. d. Maximize the firm's expected total income. e. Maximize the firm's expected EPS.

c. Maximize the stock price per share over the long run, which is the stock's intrinsic value.

A firm wants to strengthen its financial position. Which of the following actions would increase its quick ratio? a. Issue new common stock and use the proceeds to acquire additional fixed assets. b. Speed up the collection of receivables and use the cash generated to increase inventories. c. 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. d. Issue new common stock and use the proceeds to increase inventories. e. Use some of its cash to purchase additional inventories.

c. 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.

If a bank loan officer were considering a company's request for a loan, which of the following statements would you consider to be CORRECT? a. Other things held constant, the lower the current ratio, the lower the interest rate the bank would charge the firm. b. The lower the company's TIE ratio, other things held constant, the lower the interest rate the bank would charge the firm. c. Other things held constant, the lower the debt ratio, the lower the interest rate the bank would charge the firm. d. Other things held constant, the higher the debt ratio, the lower the interest rate the bank would charge the firm. e. The lower the company's EBITDA coverage ratio, other things held constant, the lower the interest rate the bank would charge the firm.

c. Other things held constant, the lower the debt ratio, the lower the interest rate the bank would charge the firm.

Below is the common equity section (in millions) of Fethe Industries' last two year-end balance sheets: 20222021Common stock$2,000$1,000Retained earnings 2,000 2,340Total common equity$4,000$3,340 The company has never paid a dividend to its common stockholders. Which of the following statements is CORRECT?

c. The company issued common stock in 2022.

Aubey Aircraft recently announced that its net income increased sharply from the previous year, yet its cash flow from operations declined. Which of the following could explain this performance? a. The company's interest expense increased. b. The company's operating income declined. c. The company's depreciation and amortization expenses declined. d. The company's cost of goods sold increased. e. The company's expenditures on fixed assets declined.

c. The company's depreciation and amortization expenses declined.

Which of the following statements is NOT CORRECT? a. Free cash flows are assumed to grow at a constant rate beyond a specified date in order to find the horizon, or terminal, value. b. The free cash flow valuation model can be used both for companies that pay dividends and those that do not pay dividends. c. The free cash flow valuation model discounts free cash flows by the required return on equity. d. An important step in applying the free cash flow valuation model is forecasting the firm's pro forma financial statements. e. The free cash flow valuation model can be used to find the value of a division.

c. The free cash flow valuation model discounts free cash flows by the required return on equity.

Considered alone, which of the following would increase a company's current ratio? a. An increase in accounts payable. b. An increase in net fixed assets. c. An increase in notes payable. d. An increase in accounts receivable. e. An increase in accrued liabilities.

d. An increase in accounts receivable.

Which of the following items is NOT included in current assets? a. Inventory. b. Short-term, highly liquid, marketable securities. c. Cash. d. Bonds. e. Accounts receivable.

d. Bonds.

Which of the following could explain why a business might choose to operate as a corporation rather than as a sole proprietorship or a partnership? a. Less of a corporation's income is generally subjected to taxes than would be true if the firm were a partnership. b. Corporate investors are exposed to unlimited liability. c. Corporations generally face relatively few regulations. d. Corporate shareholders escape liability for the firm's debts, but this factor may be offset by the tax disadvantages of the corporate form of organization. e. Corporations generally find it relatively difficult to raise large amounts of capital.

d. Corporate shareholders escape liability for the firm's debts, but this factor may be offset by the tax disadvantages of the corporate form of organization

Which of the following would be most likely to lead to higher interest rates on all debt securities in the economy? a. The economy moves from a boom to a recession. b. The level of inflation begins to decline. c. Households start saving a larger percentage of their income. d. Corporations step up their expansion plans and thus increase their demand for capital. e. The Federal Reserve uses monetary policy in an attempt to stimulate the economy.

d. Corporations step up their expansion plans and thus increase their demand for capital.

On its 2021 balance sheet, Barngrover Books showed $510 million of retained earnings, and exactly that same amount was shown the following year in 2022. Assuming that no earnings restatements were issued, which of the following statements is CORRECT? a. If the company lost money in 2022, they must have paid dividends. b. The company must have had zero net income in 2022. c. The company must have paid out half of its earnings as dividends. d. Dividends could have been paid in 2022, but they would have had to equal the earnings for the year. e. The company must have paid no dividends in 2022.

d. Dividends could have been paid in 2022, but they would have had to equal the earnings for the year.

Which of the following events would make it more likely that a company would choose to call its outstanding callable bonds? a. Inflation increases significantly. b. The company's bonds are downgraded. c. Market interest rates rise sharply. d. Market interest rates decline sharply. e. The company's financial situation deteriorates significantly.

d. Market interest rates decline sharply.

Which one of the following statements is TRUE? a. One tool of corporate governance is choosing a good investment banker. b. One tool of corporate governance is a company's tax avoidance strategy. c. Creditors have a claim on a firm's earning stream through the dividend payments they receive. d. One tool of corporate governance is how the company's charter affects the likelihood of a takeover. e. One tool of corporate governance is stock repurchases.

d. One tool of corporate governance is how the company's charter affects the likelihood of a takeover.

Money markets are markets for a. Foreign stocks. b. U.S. stocks. c. Long-term bonds. d. Short-term debt securities. e. Consumer automobile loans.

d. Short-term debt securities.

A company expects sales to increase during the coming year, and it is using the AFN equation to forecast the additional capital that it must raise. Which of the following conditions would cause the AFN to increase? a. The company's profit margin increases. b. The company previously thought its fixed assets were being operated at full capacity, but now it learns that it actually has excess capacity. c. The company decides to stop taking discounts on purchased materials. d. The company increases its dividend payout ratio. e. The company begins to pay employees monthly rather than weekly.

d. The company increases its dividend payout ratio.

Which of the following statements is CORRECT? a. When calculating the cost of preferred stock, companies must adjust for taxes, because dividends paid on preferred stock are deductible by the paying corporation. b. Because of tax effects, an increase in the risk-free rate will have a greater effect on the after-tax cost of debt than on the cost of common stock as measured by the CAPM. c. Higher flotation costs reduce investors' expected returns, and that leads to a reduction in a company's WACC. d. When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are deductible by the paying corporation. e. If a company's beta increases, this will increase the cost of equity used to calculate the WACC, but only if the company does not have enough reinvested earnings to take care of its equity financing and hence must issue new stock.

d. When calculating the cost of debt, a company needs to adjust for taxes, because interest payments are deductible by the paying corporation.

F. Marston, Inc. has developed a forecasting model to estimate its AFN for the upcoming year. All else being equal, which of the following factors is most likely to lead to an increase of the additional funds needed (AFN)? a. The company reduces its dividend payout ratio. b. The company discovers that it has excess capacity in its fixed assets. c. A switch to a just-in-time inventory system and outsourcing production. d. The company switches its materials purchases to a supplier that offers a longer credit period (with all other terms held equal). e. A sharp increase in its forecasted sales.

e. A sharp increase in its forecasted sales.

Which of the following is NOT normally regarded as being a barrier to hostile takeovers? a. Poison pills. b. Targeted share repurchases. c. Shareholder rights provisions. d. Restricted voting rights. e. Abnormally high executive compensation.

e. Abnormally high executive compensation.

Which of the following is NOT one of the steps taken in the financial planning process? a. Determine the amount of capital that will be needed to support the plan. b. Develop a set of forecasted financial statements under alternative versions of the operating plan in order to analyze the effects of different operating procedures on projected profits and financial ratios. c. Monitor operations after implementing the plan to spot any deviations and then take corrective actions. d. Forecast the funds that will be generated internally. If internal funds are insufficient to cover the required new investment, then identify sources from which the required external capital can be raised. e. Consult with key competitors about the optimal set of prices to charge, i.e., the prices that will maximize profits for our firm and its competitors.

e. Consult with key competitors about the optimal set of prices to charge, i.e., the prices that will maximize profits for our firm and its competitors.

Companies Heidee and Leaudy are virtually identical in that they are both profitable, and they have the same total assets (TA), Sales (S), return on assets (ROA), and profit margin (PM). However, Company Heidee has the higher debt ratio. Which of the following statements is CORRECT? a. Heidee has a lower equity multiplier than Leaudy. b. Heidee has lower operating income (EBIT) than Leaudy. c. Heidee has a lower total assets turnover ratio than Leaudy. d. Heidee has a higher fixed assets turnover ratio than Leaudy. e. Heidee has a higher ROE than Leaudy

e. Heidee has a higher ROE than Leaudy

Which of the following statements is CORRECT? a. Since debt capital can cause a company to go bankrupt but equity capital cannot, debt is riskier than equity, and thus the after-tax cost of debt is always greater than the cost of equity. b. The tax-adjusted cost of debt is always greater than the interest rate on debt, provided the company does in fact pay taxes. c. Higher flotation costs tend to reduce the cost of equity capital. d. Because no flotation costs are required to obtain capital as reinvested earnings, the cost of reinvested earnings is generally lower than the after-tax cost of debt. e. If a company assigns the same cost of capital to all of its projects regardless of each project's risk, then the company is likely to reject some safe projects that it actually should accept and to accept some risky projects that it should reject.

e. If a company assigns the same cost of capital to all of its projects regardless of each project's risk, then the company is likely to reject some safe projects that it actually should accept and to accept some risky projects that it should reject.

A 15-year bond has an annual coupon rate of 8%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 6%. Which of the following statements is CORRECT? a. The bond should currently be selling at its par value. b. The bond is currently selling at a price below its par value. c. If market interest rates remain unchanged, the bond's price one year from now will be higher than it is today. d. If market interest rates decline, the price of the bond will also decline. e. If market interest rates remain unchanged, the bond's price one year from now will be lower than it is today.

e. If market interest rates remain unchanged, the bond's price one year from now will be lower than it is today.

Which of the following statements is CORRECT? a. The riskiness inherent in a firm's earnings per share (EPS) depends on the characteristics of the projects the firm selects, and thus on the firm's assets. However, EPS is not affected by the manner in which those assets are financed. either force or motivate managers to act in the stockholders' best interests. e. Potential agency problems can arise between managers and stockholders, because managers hired as agents to act on behalf of the owners may instead make decisions favorable to themselves rather than the stockholders.

e. Potential agency problems can arise between managers and stockholders, because managers hired as agents to act on behalf of the owners may instead make decisions favorable to themselves rather than the stockholders.

Companies can issue different classes of common stock. Which of the following statements concerning stock classes is CORRECT? a. All common stocks fall into one of three classes: A, B, and C. b. All common stocks, regardless of class, must have the same voting rights. c. All common stock, regardless of class, must pay the same dividend. d. All firms have several classes of common stock. e. Some class or classes of common stock are entitled to more votes per share than other classes.

e. Some class or classes of common stock are entitled to more votes per share than other classes.

Which of the following would, generally, indicate an improvement in a company's financial position, holding other things constant? a. The total assets turnover decreases. b. The TIE declines. c. The current and quick ratios both decline. d. The DSO increases. e. The EBITDA coverage ratio increases.

e. The EBITDA coverage ratio increases.

Other things held constant, which of the following actions would increase the amount of cash on a company's balance sheet? a. The company repurchases common stock. b. The company purchases a new piece of equipment. c. The company pays a dividend. d. The company gives customers more time to pay their bills. e. The company issues new common stock.

e. The company issues new common stock.

Which of the following statements is CORRECT? a. It is appropriate to use the constant growth model to estimate a stock's value even if its growth rate is never expected to become constant. b. Two firms with the same expected free cash flows and growth rates must also have the same value of operations. c. If a company has a weighted average cost of capital WACC = 12%, and if its free cash flows are expected to grow at a constant rate of 5%, this implies that the stock's dividend yield is also 5%. d. The value of operations is the present value of all expected future free cash flows, discounted at the free cash flow growth rate. e. The constant growth model takes into consideration the capital gains investors expect to earn on a stock.

e. The constant growth model takes into consideration the capital gains investors expect to earn on a stock.

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 EBITDA coverage ratio declines. c. The debt ratio increases. d. The profit margin declines. e. The current and quick ratios both increase.

e. The current and quick ratios both increase.

You, in analyzing a stock, find that its expected return exceedsits required return. This suggests that you think a. management is probably not trying to maximize the price per share. b. the stock is experiencing supernormal growth. c. the stock should be sold. d. dividends are not likely to be declared. e. the stock is a good buy.

e. the stock is a good buy.