Fundamentals of Finance Quizzes

"What is the NPV of a project that costs $100,000 and returns $45,000 annually for three years if the opportunity cost of capital is 14%?"

"$4,473.44 "

Which of the following is a statement of a correct capital budgeting decision rule?

"If a project has a payback that is faster that what the company requires, the project should be accepted."

"In addition to the number of stocks represented, a difference between the S&P 500 and the Dow is that the S&P 500:"

"Is value-weighted, while the Dow is an equally weighted index."

Evaluate the following project using an IRR criterion, based on an opportunity cost of 10%: CF0 = -6000, CF1 = 3300, CF2= 3300."

"Reject, since opportunity cost exceeds IRR."

The estimated benefits from a project are expressed as cash flows instead of income flows because:

"it is cash, not accounting income, that is central to the firm s capital budgeting decision"

" If a project has a cost of $50,000 and a profitability index of 0.4, then:"

"its NPV is $20,000"

Calculate the EBIT for a firm with $4 million total revenues, $3.5 million cost of goods sold, $500,000 depreciation expense, and $120,000 interest expense.

$0

A decision tree shows a 30% probability of $2 million in returns and a 70% chance of $1 million in returns. What is the maximum you would invest today in this project if the cash inflow occurs one year in the future and the discount rate is 10%?

$1,181,818.18

What is the market price of a share of stock for a firm with 100,000 shares outstanding, a book value of equity of $3,000,000, and a market/book ratio of 3.5?

$105.00

Market demand allowed Acme Corp to raise its price by 20% to $60. What is the new level of break-even revenues if fixed charges including depreciation are $ 1 million and variable costs were 70% of the old price? Assume variable costs per unit do not change.

$2,400,000

"Assume your firm has an unused machine that originally cost $75,000, has a book value of $20,000, and is currently worth $25,000. Ignoring taxes, the correct opportunity cost for this machine in capital budgeting decisions is:"

$25,000

What is the present value of your trust fund if it promises to pay you $50,000 on your 30th birthday (7 years from today) and earns 10% compounded annually?

$25,657.91

What is the economic break-even level of sales for a project costing $4,000,000 and generating annual cash flows equal to 0.30 × sales - $450,000? Assume the project will last 10 years and require a discount rate of 12%.

$3,859,789

"For a profitable firm in the 35% marginal tax bracket with $100,000 of annual depreciation expense, the depreciation tax shield would be:"

$35,000

What is the current price of stock for a firm with $5 million in balance sheet equity, 500,000 shares outstanding, and a price/book value ratio of 4?

$40.00

If a stock's P/E ratio is 13.5, and if earnings are $3 per share, what is the stock's current price?

$40.50

If the interest rate is positive, which of the following cash flows should you prefer? Year 1 Year 2 Year 3 Year 4

$400 $300 $200 $100

"What is the amount of the operating cash flow for a firm with $500,000 profit (earnings) before tax, $100,000 depreciation expense, and a 35% marginal tax rate?"

$425,000

How much should you pay for a share of stock that offers a constant growth rate of 10%, requires a 16% rate of return, and is expected to sell for $50 one year from now?

$45.45

"Adam Smith can automate his pin factory with the purchase of a $475,000 machine. Shipping and installation would cost $5000. The automation would save $45,000 a year due to reduced scrap and $65,000 a year due to reduced labor costs. The machine has a useful life of 4 years and falls in the 3-year property class for MACRS depreciation purposes. The estimated final salvage value of the machine is $120,000. The firm s marginal tax rate is 34%. The cost of this asset that may be written off over time for tax purposes is closest to"

$480,000

"Adam Smith can automate his pin factory with the purchase of a $475,000 machine. Shipping and installation would cost $5000. The automation would save $45,000 a year due to reduced scrap and $65,000 a year due to reduced labor costs. The machine has a useful life of 4 years and falls in the 3-year property class for MACRS depreciation purposes. The estimated final salvage value of the machine is $120,000. The firm s marginal tax rate is 34%. The incremental cash outflow at time period 0 is closest to"

$480,000

"Your forecast shows $500,000 annually in sales for each of the next three years. If your second an third year predictions have failed to incorporate 5% expected annual inflation, how far off in total dollars is your three-year forecast?"

$76,250

"A firm with 60% of sales going to variable costs, $1.5 million fixed costs, and $500,000 depreciation would show what accounting profit (ignore taxes) with sales of $3 million?"

$800,000 loss

How much should you pay for a $1000 bond with a 10% coupon, annual payments, and five years to maturity if the interest rate is 12%?

$927.90

"What is the change in the NPV of a one-year project if fixed costs are increased from $400 to $600, the firm is profitable, has a 35% tax rate, and employs a 12% cost of capital? "

($116.07)

Krispy Kreme's debt-to-total assets ratio (D/TA) is 0.4. What is its debt-to-equity (D/E) ratio?

0.667

"What is the beta of a three-stock portfolio that includes 25% of stock A with a beta of 0.90, 40% stock B with a beta of 1.05, and 35% stock C with a beta of 1.73?"

1.25

What is the dividend yield of a stock that pays $1.00 dividend per quarter and trades at $40.00 per share?

10.0%

How much will accumulate in an account with an initial deposit of $100, and which earns 10% interest compounded quarterly for three years?

134.49

What is the APR on a loan that charges interest at the rate of 1.4% per month?

16.80%

A payout ratio of 35% for a company indicates that:

35% of earnings are paid out as dividends

What is the rate of return for an investor who pays $1054.47 for a three-year bond with a 7% coupon and sells the bond one year later for $1037.19?

5.00%

"Under MACRS, assets in the 5-year property class would be depreciated over ___ years."

6

Your parents borrow $22,000 to buy a van. They will pay $450 a month for 5 years. What is the annual interest rate (compounded monthly) on the loan?

8.37%

Vertigo Airlines will pay a $4.00 dividend next year on its common stock that currently sells for $100 per share. What is the company's required return if the dividend is expected to grow at 5% forever?

9%

Which of the following bonds would be likely to exhibit a greater degree of interest rate risk?

A zero-coupon bond with 20 years until maturity

What is the decision rule for IRR?

Accept a project when IRR > firm s required rate of return

What is the decision rule for NPV?

Accept a project when NPV > 0

Which of the following is true about annuities?

An annuity due is an equal amount paid or received at the beginning of each period.

The benefits of portfolio diversification are highest when the individual securities have returns that:

Are uncorrelated with the rest of the portfolio.

Which of the following bank accounts would provide you with the highest effective interest rate?

Bank 2: 8.0% compounded quarterly

Which of the following banks provides the highest effective rate of interest?

Bank D; 8.0% compounded daily.

The stability of a firm's operating income is the focus of

Business risk

How does a bond dealer generate profits when trading bonds?

By maintaining bid prices lower than ask prices

In proper capital budgeting analysis we evaluate incremental

Cash flow

What happens when moving from net income to cash flows from operations as the results of an increase in inventory balances?

Cash flows decrease.

According to the pecking order theory, managers will often choose to finance with:

Debt rather than new equity, to avoid reduced share price

"You have a portfolio that consists of equal amounts of IBM stock and Treasury bills. If you replace one-third of the IBM stock with more Treasury bills, the expected portfolio return will ______, ceteris paribus."

Decrease

"You have a portfolio that consists of equal amounts of IBM stock and Treasury bills. If you replace one-third of the IBM stock with more Treasury bills, the variance of the expected portfolio returns will ______."

Decrease

"You plan to sell some of your General Motors common stock (which tends to move up and down with the economy as a whole) and replace it with the common stock of Hercules Gold Mining, Inc. (whose shares tend to rise when the economy falls and vice versa). Your portfolio s beta should:"

Decrease

Which of the following methods will provide a correct analysis for capital budgeting purposes?

Discounting real cash flows with real rates.

The present value of a perpetuity can be determined by:

Dividing the payment by the interest rate.

The average of beta values for all individual stocks is:

Exactly 1.0; these stocks represent the market.

News that has been discounted by the market is reflected in the ________ portion of the total return.

Expected

In three years you will receive $5000. If the interest rate suddenly increases, the present value of that future amount would:

Fall

Converting an annuity to an annuity due decreases the present value.

False

For a given amount, the lower the discount rate, the less the present value.

False

The "trade-off theory"of capital structure suggests that:

Firms with higher operating risk should use less debt

When shareholder A sells her Ford stock to shareholder B in the secondary market, such as on the New York Stock Exchange, how much money is received by Ford?

Ford will receive nothing.

Perhaps the best way to reduce macro risk in a stock portfolio is to invest in stocks that:

Have low exposure to business cycles

The standard deviations of individual stocks are generally higher than the standard deviation of the market portfolio because individual stocks:

Have no diversification of risk.

"If you were willing to bet that the overall stock market was heading up on a sustained basis, it would be logical to invest in:"

High beta stocks.

The purpose of sensitivity analysis is to show:

How variables in a project affect profitability.

Which of the following statements is correct for a project with a positive NPV?

IRR exceeds the cost of capital

Consider a project with an initial investment and positive future cash flows. As the discount rate is decreased the

IRR remains constant while NPV increases

A manufacturer contemplates a change in technology that would reduce fixed costs from $800,000 to $600,000, and reduce depreciation expense from $125,000 to $100,000. However, the ratio of variable costs to sales would increase from 68% to 80%. What would be the change in the break-even level of revenues?

Increase of $609,375

"If a project is expected to increase inventory by $15,000, increase accounts payable by $10,000, and decrease accounts receivable by $1000, what effect does working capital have during the life of the project?"

Increases investment by $4000.

An implicit cost of adding debt to the capital structure is that it

Increases the required return on equity

Which of the following is an argument for relevance of dividends?

Informational content Reduction of uncertainty Some investors' preference for current income

Which of the following is more likely to be correct if market value of equity is less than book value of equity?

Investors anticipate low earning potential.

What effect will a reduction in the cost of capital have on the accounting break-even level of revenues?

It has no effect on the break-even level.

Which of the following statements is correct about a stock currently selling for $50 per share that has 16% expected return and a 10% expected capital appreciation?

It is expected to pay $3 in annual dividends

In what manner does depreciation expense affect investment projects?

It reduces taxable income by the amount of the depreciation expense

When Tri-C Corp compares its ratios to industry averages, it has a higher current ratio, an average quick ratio, and a low inventory turnover. What might you assume about Tri-C?

Its average inventory is too high.

________ are issued by state and local government governments.

Municipal bonds

When is it appropriate to include sunk costs in the evaluation of a project?

NEVER

Which of the following would be most detrimental to a firm's current ratio if that ratio is currently 2.0?

Pay off a portion of long-term debt with cash.

"When the overall market is up by 10%, an investor with a portfolio of defensive stocks will probably have:"

Positive portfolio returns less than 10%.

A modified Du Pont chart shows how return on equity (ROE) is affected by:

Profit margin on sales. Total assets turnover. Leverage (equity multiplier).

Which of the following consider the time value of money in their computation?

Profitability index IRR

Which of the following is an advantage of the sole proprietorship form of organization?

Profits taxed at only one level.

One of the easiest methods of diversifying away firm specific risks is to:

Purchase the shares of a mutual fund.

The major benefit of diversification is to:

Reduce the expected risk.

Which of the following is most likely to result in a higher P/E ratio for a firm, ceteris paribus?

Reduction in the stock's required rate of return.

Depreciation:

Represents allocations of the costs of assets over their useful lives. Is referred to as a non-cash charge. Applies to tangible assets.

Which of the following is a use of cash?

Repurchasing stock.

Financial risk refers to the

Risk faced by equity holders when debt is issued

Which method of project analysis consists of computing NPV values in best-case, worst-case, and base-case situations?"

Scenario analysis

Which of the following is a characteristic of common stock secondary markets?

Secondary-market trades do not provide funds for corporations whose stock is traded

A company can improve (lower) its debt-to-total assets ratio by doing which of the following?

Sell common stock.

Which of the following best represents the hierarchy of creditor and stockholder claims?

Senior secured debt, subordinated debentures, common stock

A financial manager reviewing a project that has a positive NPV is concerned that there may be a high degree of variability in the forecasted cash flows. Identification of the variable that presents the highest degree of forecasting risk can be accomplished by the use of

Sensitivity analysis

Which method of project analysis consists of computing NPV values while letting a single variable vary?

Sensitivity analysis

Which of the following factors tend to encourage management to pursue stock price maximization as a goal?

Shareholders link management's compensation to company performance. Managers' reactions to the threat of firing and hostile takeovers.

"If the line measuring a stocks historic returns against the markets historic returns has a slope greater than 1.0, then the:"

Stock has a beta exceeding 1.0.

Which of the following statements is correct when Treasury bills yield 7.5% and the market risk premium is 9.5%?

The S&P 500 would be expected to return about 17.00%.

In general, what is changing as you read down the left hand side of a balance sheet?

The assets are becoming less liquid.

The difference between an NPV break-even level of sales and an accounting break-even level of sales is:

The consideration of opportunity cost.

Which of the following is a true statement regarding publicly traded stocks and bonds?

The constant dividend growth model can be used to value stocks only if the dividend growth rate remains constant.

The book value of a firms equity is determined by:

The difference between book values of assets and liabilities

How are funds allocated efficiently in a market economy?

The economic unit that is willing to pay the highest expected return receives the funds.

Which of the following factors will change when interest rates change?

The present value of a bonds payments

Killnum Corporation announces that the dividend for next period will be $5.00 per share rather than the originally expected $2.50 per share. From then on, it is expected that dividends will resume the historical growth of 5% per year. What would you expect to happen to the price of their stock. Ignore tax effects.

The price will double

The appropriate opportunity cost of capital is the return that investors give up on alternative investments with:

The same risk

The more frequent the compounding, the higher the future value, ceteris paribus.

True

Macro events only are reflected in the performance of the market portfolio because:

Unique risks have been diversified away.

"If sensitivity analysis concludes that the largest impact on profits would come from changes in the sales level, then:"

Variable costs should be traded for fixed costs.

The variance of an investment s returns is a measure of the:

Volatility of the rates of return.

Which if the following will increase the NPV of a project?

a decrease in the discount rate

In examining the liquidity ratios, the primary emphasis is the firm's

ability to pay short-term obligations on time

The decision rule for net present value is to:

accept all projects with positive NPV

The gathering of related revenues and expenses incurred the same period, regardless of when they were collected or paid, is:

accrual accounting

A project that gives us the opportunity to abandon the project if things go poorly is said to include an option to expand. This option __________ the project NPV computed using static DCF analysis.

adds to

A project that gives us the opportunity to invest additional funds if things go well is said to include an option to expand. This option __________ the project NPV computed using static DCF analysis.

adds to

The cost of monitoring management is considered to be a(n):

agency cost

The purpose of financial markets is to

allocate savings efficiently

A table showing precisely how a loan will be repaid that gives the required payment each due date and a breakdown of interest versus principal is:

an amortization schedule

The document that outlines the covenants and duties existing between bondholders and the issuing corporation is called

an indenture

" If sales volume exceeds the break-even point, the firm will experience"

an operating profit

Modigliani and Miller argue that investors:

are indifferent between dividends and capital gains

In future value or present value problems, unless stated otherwise, cash flows are assumed to be

at the end of the time period

The yield curve depicts the current relationship between:

bond yields and maturity

Which of the following investment criteria does not take the time value of money into consideration?

book rate of return

The expected return on a common stock is composed of:

both dividend yield and capital appreciation

Which of the following best illustrates the problem imposed by capital rationing?

bypassing projects with positive NPVs

The essence of _______ is determining whether a proposed investment or project will generate positive wealth for the owners of the firm once it is in place.

capital budgeting

You are planning to save your annual bonus and are comparing savings accounts: account A compounds semi-annually while account B compounds monthly. If both accounts have the same effective annual interest rate and you place only the bonuses in the account, you should

choose either because you are indifferent between the two

You are faced with the choice of a three-year investment yielding 10% in simple interest versus the same investment yielding 10% compound interest. You should

choose the compound interest option because it provides a higher return than the simple interest option.

The argument that stocks attract particular groups based on dividend yield is called:

clientele effect

A firm's degree of operating leverage (DOL) depends primarily upon its:

closeness to its operating break-even point

Economic value added differs from accounting profit in that it:

considers the cost of equity capital while accounting profit does not.

Financial markets evaluate the performance of publicly traded corporations

constantly

A stock's ______ is found by dividing the stock's annual dividend by its closing price.

current yield

As the interest rate increases, the present value of an amount to be received at the end of a fixed period

decreases

Taxing authorities allow the fully installed cost of an asset to be written off for tax purposes. This amount is the asset's

depreciable basis

If we solve the dividend growth model presented in the text for total return, we find that total return is comprised of

dividend yield and capital gains yield

Common stock can be valued using the perpetuity formula if the:

dividends are not expected to grow

While corporations provide shareholders returns from ____, capital markets provide returns to shareholders from ____.

dividends; capital gains

The current yield of a bond can be calculated by:

dividing the annual coupon payments by the price

Free cash flow is:

equal to cash available for distribution to investors after the company has made all investments in fixed assets, new products, and working capital

"If a stock consistently goes down (up) by 1.6% when the market goes down (up) by 1.2%, then its beta:"

equals 1.33

A common-size balance sheet portrays the firm's accounts as a percent of the:

firm's total assets

A financial manager who consistently overestimates the _______ will tend to choose projects that actually decrease shareholder wealth

future cash inflows associated with projects

A NPV of zero implies that an investment

has a present value equal to its cost

A capital investment is one that

has the prospect of long-term benefits

Modified Accelerated Cost Recovery System (MACRS) allows an increase:

in annual depreciation during the earlier years

Which of the following work to reduce agency conflicts between stockholders and bondholders?

including restrictive covenants in the company's bond contract.

For a firm with a DOL of 3.5, an increase in sales of 6% will:

increase pretax profits by 21.0%.

The long-run goal of financial management should be to:

increase shareholder wealth.

The value of a proposed capital budgeting project depends upon the:

incremental cash flows produced

Bond refunding occurs when

interest rates in the market are sufficiently less than the coupon rate on the old bond

"When managers cannot determine whether to invest now or wait until costs decrease later, the rule should be to:"

invest at the date that gives the highest NPV today

The decision function of financial management can be broken down into the ____ decisions.

investment, financing, and dividend policy

The minimum, acceptable rate of return on corporate investments is determined by:

investors in financial markets

A large liquidity premium:

is required for assets that cannot be converted into cash on short notice at a reasonable price.

Ceteris paribus, if a bond's yield to maturity increases:

its price will fall.

A major advantage of the corporate form of organization is:

limited liability.

The money market is a (an) _____ market, while the capital market is a (an) _____ market.

liquidity; investment

The term "capital structure" refers to:

long term debt, preferred stock, and common equity

If the balance sheet indicates that total assets exceed current liabilities plus shareholder equity, then the firm has:

long-term debt

A debenture is:

long-term unsecured debt

When the level of fixed costs is decreased, the break-even level of revenues:

may or may not change, depending on variable costs

A bond with a call provision would generally be sold to yield

more than a non-callable bond of similar character

"If the IRR for a project is 15%, then the project s NPV would be:"

negative at a discount rate of 20%

The extent to which fixed costs are used in a firm's operations is called its:

operating leverage

The dividend policy that strikes a balance between current dividends and future growth and maximizes the firm's stock price is the

optimal dividend policy

Most bonds are traded in the:

over-the-counter market

You estimate that the required return on Citicorp stock is 12% and that the expected dividend growth rate is 10% and will remain constant for the foreseeable future. The stock is:

overvalued

When a investor purchases a $1000 par value US Treasury bond that was quoted at 97:16, the investor:

pays 97.5% of face value for the bond

An annuity with an infinite life is called a

perpetuity

The present value of the costs of financial distress increases with increases in the debt ratio because the:

probability of default and/or bankruptcy is greater

The __________ relates the present value of future cash flows to each dollar of investment.

profitability index

A firm's liquidation value is the amount:

realized from selling all assets and repaying debts

" In general, if a depreciable assets used in business is sold for more than its depreciated (tax) book value, any amount realized in excess of book value, but less than the asset s depreciable basis is considered a"

recapture of depreciation and is taxed at the corporate ordinary income rate

As new information is available, financial markets

reflect this new information immediately in the prices of securities traded

A decision tree indicates a 30% chance of making a $250,000 profit and a 70% chance of sustaining a $140,000 loss. Given this, the project should be:

rejected because the expected value is negative before discounting

Projects that are calculated as having negative NPVs should be:

rejected or abandoned

The ability to borrow money at a reasonable cost when good investment opportunities arise is called:

reserve borrowing capacity

Financial markets are used for trading:

securities, such as shares of IBM

An offer by a firm to repurchase some of its own shares is known as a:

self-tender offer

Which of the following bonds offers the most security to the bondholder?

senior mortgage bonds

A board of directors is elected as representatives of the corporation's:

shareholders.

Owners of mutual funds own _____ and are called _________.

shares; shareholders

A manager's compensation plan that offers financial incentives for increases in quarterly profitability may create agency problems in that:

short-term, not long-term profits become the focus

Which form of dividend/distribution is used when a firm is short of cash, but wishes to distribute something to its shareholders?

stock dividend

The mix of debt, preferred stock, and common equity with which the firm pans to raise capital is called the:

target capital structure

"When a depreciable asset is ultimately sold, the sales price is:"

taxable if the sales price exceeds book value

An indenture is

the contract between a corporation and a trustee acting for bondholders

The call provision on some bonds allows

the corporation to redeem the bonds earlier than maturity, but usually for a premium over the par value

In the formula ke = (D1 / P0 ) + g, what does g represent?

the expected price appreciation yield from a common stock

In determining the compound sum of a single amount, one measures

the future value of an amount allowed to grow at a given interest rate

If the intrinsic value of a stock is greater than its market value, one should conclude that:

the market is undervaluing the stock

"Some electric utility companies build small, relatively inexpensive oil fired electricity generating facilities that are used only during period of peak electricity demand. When the utilities shut these facilities down during non-peak times they are exercising ____________."

the option to abandon

The market price of a share of common stock is determined by

the stock exchange

The traditional approach towards the valuation of a company assumes that:

there is an optimal capital structure

" If two projects offer the same, positive NPV, then:"

they add the same value to the firm

When using ratio analysis you are most likely to compare your company's ratios with:

those of companies in similar industries.

When taxes are considered, the value of a levered firm equals the value of the:

unlevered firm plus the present value of the tax shield

You are considering investing in a firm The dividend on the company's stock has not changed in the past ten years and most likely will not change in the foreseeable future. In this case, the most appropriate stock valuation model would be the _________ model.

zero growth