FINA 300: Exam #1

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A successful investment is one that increases the value of the firm.
T or F

True

Corporations that do not issue financial securities such as stock or debt obligations:
-will not be able to increase sales.
-cannot be profitable.
-may not be able to generate sufficient funds to fulfill their needs.
-do not face double taxation of their profits.

may not be able to generate sufficient funds to fulfill their needs

Which of the following would be considered a capital budgeting decision?
-Planning to issue common stock rather than issuing preferred stock
-Deciding to expand into a new line of products, at a cost of $5 million
-Repurchasing shares of common stock
-Issuing debt in the form of long-term bonds

Deciding to expand into a new line of products, at a cost of $5 million

The overall goal of capital budgeting projects should be to:
-decrease the firm's reliance on debt.
-increase the firm's sales.
-increase the firm's outstanding shares of stock.
-increase the wealth of the firm's shareholders.

increase the wealth of the firm's shareholders

The term "capital structure" refers to:
-the manner in which a firm obtains its long-term sources of funding.
-the length of time needed to repay debt.
-whether the firm invests in capital budgeting projects.
-which specific assets the firm should invest in.

the manner in which a firm obtains its long-term sources of funding

Which of the following would not be considered a real asset?
-A corporate bond
-A machine
-A patent
-A factory

A corporate bond

Which of the following statements best distinguishes the difference between real and financial assets?
-Real assets have less value than financial assets.
-Real assets are tangible; financial assets are not.
-Financial assets represent claims to income that is generated by real assets.
-Financial assets appreciate in value; real assets depreciate in value.

Financial assets represent claims to income that is generated by real assets

Which of the following would not be considered a financial asset?
-A patent
-A personal IOU
-A checking account balance
-A share of stock

A patent

The stockholders in a sole proprietorship are represented by:
-the owner of the firm.
-the general partner of the firm.
-the board of directors of the firm.
-no one; sole proprietorships have no stockholders.

no one; sole proprietorships have no stockholders

Which of the following would be considered an advantage of the sole proprietorship form of organization?
-Wide access to capital markets
-Unlimited liability
-A pool of expertise
-Profits taxed at only one level

Profits taxed at only one level

One common reason for partnerships to convert to a corporate form of organization is that the partnership:
-faces rapidly growing financing requirements.
-wishes to avoid double taxation of profits.
-has issued all of its allotted shares. -agreement expires after ten 10 years.

faces rapidly growing financing requirements

When a corporation fails, the maximum that can be lost by an investor protected by limited liability is:
-the amount of the initial investment.
-the amount of the profit on the investment.
-the amount necessary to pay the corporation's debts.
-the amount of the investor's personal wealth.

the amount of the initial investment

Unlimited liability is faced by the owners of: -corporations.
-partnerships and corporations.
-sole proprietorships and partnerships.
-all forms of business organization.

sole proprietorships and partnerships

A board of directors is elected as a representative of the corporation's:
-top management.
-stakeholders.
-shareholders.
-customers.

shareholders

The legal "life" of a corporation is:
-coincidental with that of its CEO.
-equal to the life of its board of directors.
-permanent, as long as shareholders don't change.
-permanent, regardless of current ownership.

permanent, regardless of current ownership

"Double taxation" refers to:
-all partners paying equal taxes on profits.
-corporations paying taxes on both dividends and retained earnings.
-paying taxes on profits at the corporate level and dividends at the personal level.
-the fact that marginal tax rates are doubled for corporations.

paying taxes on profits at the corporate level and dividends at the personal level

A corporation is considered to be closely held when:
-only a few shareholders exist.
-the market value of the shares is stable.
-it operates in a small geographic area.
-management also serves as the board of directors.

only a few shareholders exist

Corporations are referred to as public companies when their:
-shareholders have no tax liability.
-shares are held by the federal or state government.
-stock is publicly traded.
-products or services are available to the public.

stock is publicly traded

A common problem for closely held corporations is:
-lack of access to substantial amounts of capital.
-that shareholders receive only one vote each.
-the separation of ownership and management.
-an abundance of agency problems.

lack of access to substantial amounts of capital

Which of the firm's financial managers is most likely to be involved with obtaining financing for the firm?
-Treasurer
-Controller
-Chief Operating Officer
-Board of directors

Treasurer

In a large corporation, budget preparation would most likely be conducted by the: -treasurer.
-controller.
-chief financial officer.
-financial manager.

controller

Corporate managers are expected to make corporate decisions that are in the best interest of:
-top corporate management.
-the corporation's board of directors.
-the corporation's shareholders.
-all corporate employees.

the corporation's shareholders

The primary goal of corporate management should be to:
-maximize the number of shareholders.
-maximize the firm's profits.
-minimize the firm's costs.
-maximize the shareholders' wealth.

maximize the shareholders' wealth.

Which of the following appears to be the most appropriate goal for corporate management?
-Maximizing market value of the company's shares
-Maximizing the company's market share
-Maximizing the current profits of the company
-Minimizing the company's liabilities

Maximizing market value of the company's shares

Profit maximization is not a well-defined corporate objective because:
-it leaves open the question of which year's profits.
-higher profits does not necessarily mean a better rate of return.
-profits can be changed by using different accounting rules.
-all of these.

all of these

Corporate financing comes ultimately from:
-savings by households and foreign investors.

-cash generated from the firm's operations.

-the financial markets and intermediaries.

-the issue of shares in the firm.

savings by households and foreign investors

A company can pay for its expansion in all the following ways except:

-by using the earnings generated from its sale of obsolete equipment.

-by persuading the director's mother to make a personal loan to the company.

-by purchasing bonds in the secondary market.

-by selling stock certificates for a new subsidiary.

by purchasing bonds in the secondary market

Excess cash held by a firm should be:

-reinvested by the firm in projects offering the highest rate of return.

-reinvested by the firm in projects offering rates of return higher than the cost of capital.

-reinvested by the firm in the financial markets.

-distributed to bondholders in the form of extra coupon payments.

reinvested by the firm in projects offering rates of return higher than the cost of capital

Compared to buying stocks and bonds directly, what are the advantages of investing in a mutual fund?

-Mutual funds are efficiently diversified and professionally managed.

-Investment returns are never taxed until withdrawn from the fund.

-You can buy additional shares in the fund or cash out at any time.

-All of these.

Mutual funds are efficiently diversified and professionally managed

Banks cover the costs of the service they provide primarily via:

-a management fee.

-a service charge.

-an interest rate differential.

-an operating fee.

an interest rate differential

Which of the following financial intermediaries has shown a preference for investing in long-term financial assets?

-Commercial banks

-Insurance companies

-Finance companies

-Savings banks

Insurance companies

Insurance companies can usually cover the claims of policyholders because:

-the incidence of claims normally averages out.

-they issue thousands of insurance policies.

-the cost of paying for claims has already been factored into the price of the policies.

-all of these.

all of these

U.S. bonds and other debt securities are mostly held by:

-institutional investors.

-households.

-foreign investors.

-state and local governments.

institutional investors

Liquidity is important to a mutual fund because:

-a fund that is less liquid will attract more investors.

-the fund's shareholders may want to redeem their shares at any time.

-the fund's managers need liquidity to trade actively.

-the fund needs to distribute payouts to its shareholders and managers periodically.

the fund's shareholders may want to redeem their shares at any time.

When corporations need to raise funds through stock issues, they rely on the:

-primary market.

-secondary market.

-tertiary market.

-centralized NASDAQ exchange.

primary market

A share of IBM stock is purchased by an individual investor for $75 and later sold to another investor for $125. Who profits from this sale?

-IBM.

-The first investor.

-The second investor.

-Profit is split between IBM and the investor.

The first investor

When Patricia sells her General Motors common stock at the same time that Brian purchases the same amount of GM stock, GM receives:

-the dollar value of the transaction.

-the dollar amount of the transaction, less brokerage fees.

-only the par value of the common stock.

-nothing

nothing

Which of the following financial markets is in one centralized location?

-NYSE

-NASDAQ

-The over-the-counter market

-The European Monetary Union

NYSE

Which of the following financial markets is not located in one centralized location?

-NYSE

-LSE

-NASDAQ

-CBOT

NASDAQ

A bond differs from a share of stock in that:

-a bond represents a claim on the firm.

-a bond has more risk.

-a bond has guaranteed returns.

-a bond has a maturity date.

a bond has a maturity date

Short-term financing decisions commonly occur in the:

-primary markets.

-secondary markets.

-capital markets.

-money markets

money markets

Long-term financing decisions commonly occur in the:

-option markets.

-secondary markets.

-capital markets.

-money markets

capital markets

You can buy silver in the:

-capital markets.

-foreign exchange markets.

-commodities markets.

-option markets

commodities markets

One reason suggesting that banks may be better than individuals at matching lenders to borrowers is that banks:

-can shift loan risk to their deposit customers.

-are motivated by the potential for profit.

-do not have any income tax liability.

-have information to evaluate creditworthiness.

have information to evaluate creditworthiness

Financial markets and intermediaries:

-channel savings to real investment.

-enable investors and businesses to reduce risk.

-provide liquidity.

-all of these

all of these

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

-The assets are more fully depreciated.

-The assets are growing in value.

-The assets are increasing in maturity.

-The assets are becoming less liquid

The assets are becoming less liquid

A balance sheet portrays the value of a firm's assets and liabilities:

-over an annual period.

-over any stated period of time.

-at any stated point in time.

-only at the end of the calendar year

at any stated point in time

Which of the following assets is likely to be considered the most liquid?

-Marketable securities

-Net fixed assets

-Accounts payable

-Inventories

Marketable securities

If the value of a firm's net fixed assets equals the value of the accumulated depreciation, from an accounting context the fixed assets are:

-new.

-fully depreciated.

-one-half depreciated.

-equal in value to the firm's current assets

one-half depreciated

If the balance sheet of a firm indicates that total assets exceed current liabilities plus shareholders' equity, then the firm has:

-no retained earnings.

-long-term debt.

-no accumulated depreciation.

-current assets

long-term debt

Net working capital is calculated by taking the difference between:

-total assets and total liabilities.

-inventory and accounts payable.

-current assets and current liabilities.

-cash and long-term debt.

current assets and current liabilities

A balance sheet may be considered backward-looking from the perspective that:

-it works backward, starting with net income.

-it records historic, not current values.

-it cannot forecast the future.

-it records costs over many previous periods.

it records historic, not current values

Which of the following is correct for a fully depreciated asset?

-Market value is zero.

-Market value is greater than book value.

-Book value is greater than market value.

-The relationship between market and book values is indeterminable.

The relationship between market and book values is indeterminable

Depreciation expense is used to:

-allocate costs to all departments of the firm.

-determine when an asset is fully paid off.

-allocate historical cost over the life of an asset.

-equate the historical cost and market values of an asset.

allocate historical cost over the life of an asset

When subtracting an asset's accumulated depreciation from its historic cost, the resulting value is termed the:

-book value of the asset.

-market value of the asset.

-depreciation expense.

-current asset value.

book value of the asset

Which of the following statements is true for a corporation with $1 million market value of equity, $2 million market value of assets, and 1,000 shares of outstanding stock?

-Market value of liabilities exceeds book value of liabilities.

-Market value of liabilities equals $1 million.

-Book value per share equals $1,000.

-Market value per share equals $2,000

Market value of liabilities equals $1 million

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.

-$500,000

-$380,000

-$0

-($120,000)

$0

Retained earnings result from:

-the sale of additional shares of stock to investors.

-income not paid to shareholders.

-an excess of assets over liabilities.

-market values that exceed book values

income not paid to shareholders

Which of the following values would most likely interest a shareholder?

-Book value of equity

-Market value of equity

-Historical cost of equity

-none of these

Market value of equity

What happens to the market value of a firm's equity as the book value of the firm's equity increases?

-It increases by the same amount.

-It decreases by the same amount.

-It remains constant.

-There is no set relationship to determine this outcome

There is no set relationship to determine this outcome

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

-Investors anticipate excellent earning potential.

-Investors anticipate low earning potential.

-Assets have been fully depreciated.

-The company is bankrupt.

Investors anticipate low earning potential

If market values of equity exceed book values of equity, then:

-equity has been depreciated too rapidly.

-the firm uses accrual-based accounting.

-profit potential is expected to be attractive.

-the firm is holding too much cash.

profit potential is expected to be attractive

Which of the following cash outflows does not reduce a firm's net income?

-Income taxes

-Interest expense

-Dividends

-Depreciation expense

Dividends

An increase in depreciation expense will (other things equal):

-increase net income.

-decrease net income.

-increase taxable income.

-decrease the market value of assets

decrease net income

What is the marginal tax rate for a corporation with $60,000 taxable income and an average tax rate of 16.67% if the next-lowest marginal tax rate of 15% covers taxable incomes up to $50,000?

-15.00%

-16.67%

-18.34%

-25.00%

25.00%

Assuming at the $50,000 income level that the corporate tax rate increases from 15 to 25%, which of the following statements is correct for a firm with $75,000 income?

-Its marginal tax rate is 15%.

-Its average tax rate is 25%.

-Its marginal tax rate is 18.33%.

-Its average tax rate is 18.33%.

Its average tax rate is 18.33%

For a corporation in the 25% marginal tax bracket that incurs $70.00 in labor and materials expense, plus $15.00 in depreciation expense while generating an incremental revenue of $100.00, tax liability will increase by:

-$3.75.

-$7.50.

-$13.75.

-$25.00

$3.75

Which of the following statements is correct for an individual with a net income of $50,000.00, a tax liability of $10,704.50, and a 28% marginal tax rate?

-The average tax rate is 17.63%.

-The average tax rate is 21.41%.

-The average tax rate is 28.00%.

-The average tax rate is unknown but greater than the marginal tax rate.

The average tax rate is 17.63%

Marginal tax rates are based on:

-net income.

-total income.

-an additional dollar of income.

-earnings before interest and taxes.

an additional dollar of income

Which of the following forms of income can individuals defer from taxation?

-Dividends

-Interest

-Realized capital gains

-Unrealized capital gains

Unrealized capital gains

Advantages to a Sole Proprietorship

-ease of formation
-subject to few regulations
-no corporate income taxes

Disadvantages to a Sole Proprietorship

-limited life
-unlimited liability
-difficult to raise capital

At some point, it becomes difficult for sole proprietors to raise money because of:

-unlimited liability
-limited life

To continue to grow, most companies have to...

incorporate

A corporation is...

a distinct, permanent legal entity

Advantages to a corporation

-unlimited life
-easy transfer of ownership
-limited liability
-ease of raising capital

Disadvantages to a corporation

-double taxation
-cost of a setup and report filing

The primary goal of a corporation is

shareholder wealth maximization (maximizing shareholders wealth)

Factors that Affect Stock Price

-projected cash flows to shareholders
-timing of the cash flow stream
-riskiness of the cash flows

Higher risk requires...

higher return

The cost of capital for a business is...

the return investors demand to lend their money to the firm

The cost of capital depends on...

how risky the company is relative to other investment opportunities

Firm's should only invest in opportunities that provide a return of...

at least their cost of capital

Most large companies have 3 top-level financial managers:

-CFO
-treasurer
-controller

CFO's are responsible for:

setting the overall financial strategy of the firm

Treasurers are responsible for:

-cash management
-raising capital
-banking relationships

Controller's are responsible for:

-budgeting
-accounting
-taxes

Capital Structure

proportion of the company's assets funded by each type of financing

Payout policy

How much profit to reinvest in the company and how much to distribute to investors

Real assets

things that have value all by themselves

Decisions about large investments are called

capital budgeting decisions

What is a bond?

type of loan

Maturity

The time from when the bond was issued to when it is paid off.

Face Value

The amount the borrow pays the investor at the bond's maturity.

Coupon Payment

The amount of periodic interest payments to the investor

Bond Price

The amount the investor pays the bond seller

What is a Stock?

an ownership claim against a company's assets after deducting its liabilities

How do stocks come into existence?

When a company incorporates it creates stock shares that it sells to investors.

What is an IPO?

The first time a company sells stock to the public (Initial Public Offering)

A company sells shares in the

primary market

Subsequent trading in the stock occurs in the

secondary market

Treasury Notes and Bonds

bonds issued by the Federal Government

Municipal Bonds

bonds issued by cities and states

Corporate Bonds

bonds issued by companies

Financial Institutions

organizations or businesses that specialize in trading specific types of financial instruments and that operate in specific financial markets

What do mutual funds do?

provide investors with easy and efficient diversification, professional management, and liquidity

Liquidity refers to

the ability to quickly convert an asset into cash without having to greatly decrease its price below what would be earned if longer selling time were allowed

Balance Sheet

shows the value of a company's "stuff" as of a point in time

Assets =

Liabilities + Equity

Income Statement

shows the flow of revenues and expenses between balance sheet dates

Cash-Flow Statement

shows cash inflows and outflows between balance sheet dates

EBIT

Earnings before interest and taxes

CapX

Capital expenditures

(change)NWC

Change in net working capital

Marginal rate

Rate paid on the next $1 of taxable income

Average tax rate =

taxes paid / taxable income

FCF

free cash flow

FCF =

EBIT - taxes + depreciation - (change)NWC + CapX

marginal tax rate

% of last dollar taxed

Real or Financial Asset? :: a share of stock

financial

Real or Financial Asset? :: a personal IOU

financial

Real or Financial Asset? :: a trademark

real

Real or Financial Asset? :: a truck

real

Real or Financial Asset? :: undeveloped land

real

Real or Financial Asset? :: the balance in the firms checking account

financial

Real or Financial Asset? :: an experienced and hardworking sales force

real

Real or Financial Asset? :: a bank loan agreement

financial

the stock and bond markets are no the only financial markets. Give two or three additional examples.

-derivatives markets
-money markets
-foreign exchange markets

you are a beginning investor with only $5000 in savings. how can you achieve a widely diversified portfolio at a reasonable cost?

buy shares in a mutual fund

T or F: Financing for public corporations must flow through financial markets.

false

T or F: Financing for private corporations must flow through financial intermediaries.

false

T or F: the sale of policies is a source of financing for insurance companies.

true

T or F: almost all foreign exchange trading occurs on the floors of the FOREX exchanges in New York and London.

false

T or F: the opportunity cost of capital is the capital outlay required to undertake a real investment opportunity

false

T or F: the cost of capital is the interest rate on borrowing from a bank or other financial situation.

false

decision to invest in tangible or intangible assets

capital budgeting or capital expenditure (CAPEX) decision

assets used to produce goods and services

real assets

financial claims to the income generated by the firms real assets

financial assets

the owners of a corporation are not personally liable for its obligations

limited liability

sets overall financial strategy

CFO

minimum acceptable rate of return on capital investment

opportunity cost of capital

What are the two major decisions made by financial managers?

-the investment (capital budgeting) decision
-financing decision

what does "real asset" mean?

include all assets used in the production or sale of the firms products or services

Who are the principal financial managers in a corporation?

-controller
-CFO

what is the fundamental trade-off in investment decisions?

opportunity cost of capital (return that shareholders can earn for themselves)

market where securities are issued and traded

financial market

market for the sale of new securities by corporations

primary market

market in which previously issued securities are traded among investors

secondary market

market for debt securities

fixed-income market

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