Finance 300 Exam 1

Which of the following transactions occurred in the primary market?

South Wind Co. sold 20,000 shares of newly issued stock to Vanguard Investment Company.

The primary goal of financial management is to maximize________ for a corporation?

Stock price

Which of the following factors could explain why JuJu Smith-Schuster Energy had a negative net cash flow from operations last year, even though the cash on its balance sheet increased?

The company sold a new issue of bonds

You are analyzing the value of an investment by calculating the present value of its expected cash flows. Which of the following would cause the investment to look better?

The discount rate decreases

In recent years, Smith Inc. has greatly increased its current ratio. At the same time, the quick ratio has fallen. What has happened? Has the liquidity of the company improved?

The firm has increased inventory relative to other current assets; therefore, assuming current liability levels remain mostly unchanged, liquidity has potentially decreased.

Explain why the marginal tax rate, rather than the average tax rate, is used when computing the cash flows from a proposed new project

The marginal tax rate is used because that is the tax rate that will apply to the incremental taxable income generated by the new project.

A lump sum payment of $1,000 is due at the end of 5 years. The nominal interest rate is 10%, semiannual compounding. Which of the following statements is/are INCORRECT? Why?

The periodic interest rate is 5%.

What are the differences between primary market and secondary market?

The primary market - where a firm sells NEWLY issued securities (bonds or stocks) to raise capital. The secondary market - where transactions traded (buy or sell) among investors. A firm will NOT receive any capital from secondary market.

Copyright is defined as an intangible fixed asset

True

Other things being equal, the present value of a 3-year, $150 annuity due will exceed the present value of a 3-year, $150 ordinary annuity.

True

The more frequently the interest payments are compounded, the larger the future value of $1 for a given time period.

True

If a firm has an agency problem that is reflected in a poor performing stock for a long period of time, then the firm may become a target of _________________.

a takeover

Cash flow to creditors is equal to

beginning long-term debt minus ending long-term debt plus interest paid

Over the past year, a firm decreased its current assets and increased its current liabilities. As a result, the firm's net working capital:

had to decrease

The Sarbanes-Oxley Act of 2002 has___________.

made officers of publicly traded firms personally responsible for the firm's financial statements.

Last year, ABC Inc. had $150,000 in current assets and $80,000 in current liabilities. These values are referred to as the firm's__________.

working capital

What are the three most basic decisions managers must make?

-capital budgeting decision -financing decision -working capital management decision

What are some advantages and disadvantages of operating as public corporation?

Advantages: 1) Limited liability/ not exceeding the investment amount 2) Easier to raise capital/ more channels of finding capital 3) Easier to transfer the ownership 4) Unlimited life Disadvantages: 1) Double taxation - corporate tax and personal tax (dividend income) 2) Agency problem - conflicts of interest - separation between manager and stockholders

Which of the following statements is/are correct?

All stock trades between existing shareholders are secondary market transactions

What are agency conflicts? What are different mechanisms to align managers' interest with shareholders' interests?

An agency conflict occurs when the goals of the principals (stockholders) are not aligned with the goals of the agents (managers). Management is often more concerned with pursuing its own self-interest, and so the maximization of shareholder value is pushed to the side. Mechanisms - employee stock option, Performance based cash bonus, proxy fight and a takeover threat. Proxy fight - can be initiated by active shareholders to solicit voting rights from other shareholders in an attempt to remove an incompetent incumbent manager or to demand higher dividends, share buyback, etc. Takeover threat - an external corporate "raider" identifies a firm which has solid business fundamentals but is currently poorly managed. The corporate raider begins acquiring a firm's outstanding shares to gain the majority of control ownership. Stock option - gives employees an option to buy specific number of shares at a specific price. The higher stock price is, the more valuable the stock option will be.

Which of the following statements is/are correct?

As compared to a sole proprietorship, a corporation faces double taxation.

Snoop Dogg's Pharmacy generates $2 in sales for every $1 the firm has invested in total assets. Which one of the following ratios would reflect this relationship?

Asset turnover

Capital budgeting includes the evaluation of which of the following?

Size, timing and risk of future cash flows.

What is capital structure? What are different sources of capital?

Capital structure, i.e., financing mix, refers to proportion of financial capital funded by various sources, like cash, long debt or/and equity. The proportion of capital components add up to 100%.

What types of information do common-size financials statements reveal about the firm? What is the best use for these common-size statements?

Common size financial statements express all balance sheet accounts as a percentage of total assets and all income statement accounts as a percentage of total sales. Using these percentage values rather than nominal dollar values facilitates comparisons between firms of different size or business type.

Which one of the following is a measure of long-term solvency?

Equity multiplier

Highly liquid assets generally produce a high rate of return

False

The present value of a future sum decreases as either the discount rate or the number of periods per year decreases.

False

The proportion of the payment of a fully amortized loan that goes toward interest increases over time.

False

The marginal tax rate is used because that is the tax rate that will apply to the incremental taxable income generated by the new project.

From a finance perspective, operating cash flow is more important because it reveals the actual net amount of cash generated or used by a firm's daily operations. Expenses associated with a firm's financing cost are not included in operating cash flows. The difference between net income and operating cash flow - an adjustment of depreciation and other noncash expenses plus the interest paid.

Which of the following is/are an effective means of aligning management goals with shareholder interests? I. Employee stock options II. Threat of a takeover III. Management bonuses tied to performance goals IV. Threat of union strike

I, II and III only

Which of the following are advantages of forming a corporation? I. Ability to raise large sums of equity capital II. Ease of ownership transfer III. Profits taxed at the corporate level IV. Limited liability for all owners

I, II and IV

Which of the following are determinants of a firm's sustainable rate of growth? I. Amount of sales generated from each dollar invested in assets II. Amount of debt per dollar of equity III. Amount of current assets per dollar of current liabilities IV. Percentage of net income distributed as dividends

I, II and IV only

Which of the following will increase the future value of a lump sum investment? I. Decreasing the interest rate II. Increasing the interest rate III. Increasing the time period IV. Decreasing the amount of the lump sum investment

II and III only

Which of the following statements is/are correct regarding an annual rate of 6%?

Its EFF (or EAR) is bigger than 6%, if the rate is semi-annually compounding Its EFF (or EAR ) is same as 6%, if the rate is annually compounding.

Why is profit maximization an unsatisfactory goal for managing a firm? What is the primary goal for managing a firm?

Profit maximization is not a satisfactory goal when managing a firm because it is rather difficult to define profits since accountants can apply and interpret the same accounting principles differently. Also, profit maximization does not define the size, the uncertainty, and the timing of cash flows; it ignores the time value of money concept.

What are pros and cons of enacting SOX in 2002?

Pros: 1) Assurance of accuracy and transparency of a firm's accounting/financial statements to strengthen the protection against corporate fraud. 2) Hold CEO/CFO accountable for the content of financial statements to fairly represent a firm's financial results without false statements or material omission. Cons: 1) Cost of complying with SOX is proportionally more for smaller firms. 2) Firms are inclined to delist from U.S exchange and re-list to foreign exchanges.

Which of the following statements is/are correct?

Ratio analysis involves analyzing financial statements in order to appraise a firm's financial position and strength. Although a full liquidity analysis requires the use of a cash budget, the current and quick ratios provide fast and easy-to-use measures of a firm's liquidity position.