Final Exam

Question 1

Which of the following statements is TRUE?
A. Bankruptcy occurs whenever a firm is unable to meet obligations or reports negative book equity.
B. A Chapter 7 bankruptcy allows a firm to reorganize and continue operations as “debtor-in-possession.”
C. Under bankruptcy, trade creditors have lower priority than secured bank loans.
D. Financial distress and bankruptcy costs cause WACC to decrease as leverage increases.

Answer 1

c

Question 2

Which of the following statements is FALSE?
A. Interest expense reduces taxable income and net income but not EBIT.
B. When a company repurchases its shares using proceeds from new issues of debt, its future expected earnings per share increases.
C. ‘Homemade leverage’ is the use of personal borrowing to adjust the overall amount of financial leverage to which the individual investor is exposed.
D. Under M&M assumptions which ignore special benefits and costs of debt, leverage has a substantial impact on total firm value and on WACC.

Answer 2

d

Question 3

Which of the following statements is FALSE?
A. Like typical large US companies, Apple uses about 60% debt in its capital structure.
B. In a Chapter 7 bankruptcy liquidation, employees and trade creditors have lower priority among claimants than senior and secured lenders.
C. In a bankruptcy reorganization, middle managers or ‘white collar’ employees lose their jobs more commonly than production workers or ‘blue collar’ employees.
D. Following a Chapter 11 filing a few years earlier and failed attempts to negotiate concessions with its unions, Hostess again in 2012 filed for bankruptcy with the intent to liquidate its assets.

Answer 3

a

Question 4

Which of the following statements is TRUE?
A. Leverage reduces the expected values of both EBIT and net income.
B. Leverage increases expected ROE but decreases expected EPS.
C. Leverage decreases the volatility of both ROE and EPS.
D. Investors can create their own leverage within their own portfolios.

Answer 4

d

Question 5

BNM is comparing different capital structures. Plan A is all equity with 20m (million) shares outstanding. Plan B would result in 14m shares and $150m in debt. Plan C would result in 11m shares and $225m in debt. The interest rate on the debt is 8 percent. Ignoring taxes, compare these plans assuming that expected EBIT is $45m. Of the three plans, the firm will have the highest expected EPS with \_\_\_\_\_ and the lowest expected EPS with \_\_\_\_\_.
A.	Plan A; Plan B
B.	Plan A; Plan C
C.	Plan C; Plan A
D.	Plan B; Plan C

Answer 5

c

Question 6

When is a firm insolvent from an accounting perspective?
A. When the firm is unable to meet its financial obligations in a timely manner
B. When the firm’s debt exceeds the value of the firm’s equity
C. When the firm has a negative net worth
D. When the firm’s revenues cease

Answer 6

c

Question 7

Which of the following statements is FALSE?
A. Legal bankruptcy occurs when the firm or creditors bring petitions to a federal court for bankruptcy.
B. Bankruptcy refers to the legal proceeding for liquidating or reorganizing a business.
C. Technical insolvency occurs when a firm has a negative net worth, because the book value of its liabilities are less than the book value of its assets.
D. Liquidation is the termination of the firm as a going concern, whereas reorganization is the financial restructuring of a struggling firm to attempt to continue operations as a going concern.

Answer 7

c

Question 8

Which of the following statements is FALSE?
A. MM Proposition 1, if there are no taxes, states the value of the firm does not depend whatsoever on its capital structure.
B. MM Proposition 2, if there are no taxes, explains how the cost of equity decreases as the firm increases its use of debt financing.
C. Because interest expense is tax deductible, leverage increases the firm’s value by the amount of the present value of the interest tax shield.
D. Because interest expense is tax deductible, a firm’s WACC decreases as firms rely more heavily on debt financing.

Answer 8

b

Question 9

Which of the following statements is FALSE about initial public offerings?
A. IPOs are often underwritten by a syndicate of investment banks for a 7% spread on average
B. IPOs must be registered with the SEC, which costs about 3% in accounting and legal fees
C. An IPO’s exact price is published in a red-herring two weeks before selling begins
D. IPOs are underpriced on average by about 19%

Answer 9

c

Question 10

Which of the following is NOT a justification for IPO underpricing?
A. Young firms tend to be very risky.
B. The best IPOs are oversubscribed.
C. Underwriters like to avoid lawsuits.
D. It benefits the existing shareholders.

Answer 10

d

Question 11

Which of the following statements is FALSE?
A. The preliminary document provided to potential investors for their review of new shares to be issued as they wait for the shares to be cleared for sale is called a red herring.
B. The legal document that is provided to potential investors and describes a new security offering is called a prospectus.
C. The advertisement, commonly found in financial newspapers, that announces a public offering of securities and provides the name of the underwriters is called a tombstone.
D. Firms that assists issuers by pricing and selling new securities to the general public are called venture capitalists.

Answer 11

d

Question 12

Which of the following statements is FALSE?
A. The direct fees paid by the issuer to the underwriter syndicate is called the spread, which is the difference between the price the issuer receives and the offer price paid by new shareholders.
B. Direct expenses include filing fees, legal fees, and taxes and are costs incurred by the issuer that are not part of the compensation to underwriters.
C. For initial public offerings, losses arise when shares are sold below their true value; hence, the underpricing of IPOs is an additional implicit cost to the issuer.
D. A delayed registration permits a firm to register an offering under SEC 415 and then issue the securities over a two-year period.

Answer 12

d

Question 13

Which of the following statements is TRUE?
A. The venture capital market is the primary source of financing for established firms with proven profitability.
B. Firm commitment underwriting is far less prevalent for large issues than best efforts underwriting, which is likely due to the lower uncertainty of smaller issues.
C. The direct and indirect costs of going public can be substantial, and once a firm goes public, it will not be able to easily raise additional capital.
D. A Green Shoe provision gives the underwriters the right to purchase additional shares at the offer price to cover overallotments.

Answer 13

d

Question 14

Which of the following statements is TRUE?
A. The key risk for a flexible short-term financing policy is losing credit access.
B. A ‘fortress’ balance sheet generally includes restrictive short-term financial policies.
C. A restrictive short-term financing policy has high carrying costs and low shortage costs.
D. Borrowing short-term to meet peak needs and maintaining a cash reserve for emergencies is described as a compromise policy for short-term financing.

Answer 14

d

Question 15

Which one of the following statements is correct?
A. Firms that follow restrictive financial policies can generally avoid short-term debt financing.
B. Short-term borrowing is generally more expensive than long-term borrowing.
C. Long-term interest rates tend to be more volatile than short-term rates.
D. A firm is less apt to face financial distress if it adopts a flexible financial policy rather than a restrictive policy.

Answer 15

d

Question 16

Which was a source of cash, increasing a firm’s cash balance, all else equal?
A. $20 million shares repurchased in the open market.
B. Accounts payable increased by $50 million.
C. $15 million in sales from inventory on credit, simultaneously increasing accounts receivable by $15 million.
D. $60 million of short-term debt was paid off and partially refinanced with $40 million in long-term debt.

Answer 16

b

Question 17

Which one of the following activities is a source of cash?
A.	Decreasing long-term debt
B.	Decreasing accounts receivable 
C.	Increasing fixed assets
D.	Repurchasing shares of stock

Answer 17

b

Question 18

All else constant, which one of the following will decrease the cash cycle?
A. Decreasing the credit period granted to a customer
B. Decreasing the inventory turnover rate
C. Decreasing the accounts payable period
D. Decreasing the accounts receivable turnover rate

Answer 18

a

Question 19

Which of the following statements is FALSE?
A. Increasing long-term debt, or borrowing over the long term, increases cash.
B. Decreasing current assets other than cash, such as collecting accounts receivable, is considered a source of cash.
C. Increasing current liabilities, such as getting a 90-day loan, will decrease cash.
D. Increasing current assets other than cash, such as extending more credit to customers, is considered a use of cash.

Answer 19

c

Question 20

Which of the following statements is TRUE?
A. Activities that increase cash are called uses of cash, and activities that decrease cash are called sources of cash.
B. Sources of cash always involve increasing a liability or equity account, or decreasing an asset account (other than cash); for example, decreasing fixed assets by selling some property, plant, and equipment, is considered a source of cash.
C. The accounts payable period is the time between the sale of inventory and the collection of the receivable.
D. The operating cycle is the time period between cash disbursement and cash collection.

Answer 20

b

Question 21

Which of the following statements is FALSE?
A. Shortage costs typically decrease with the level of investment in current assets.
B. Increasing long-term debt increases cash.
C. A ‘fortress’ balance sheet is typified by flexible policies with higher carrying costs, extra cash, and generous receivables, but creates the risk of a mismatch between short-term assets financed with long-term financial claims like bonds.
D. Instability in financial markets has led corporations to choose restrictive short-term financial policies.

Answer 21

d

Question 22

Which of the following statements is FALSE?
A. Float equals the difference between the cash balance available at the bank and the cash balance recorded on the firm’s books, and float also equals the sum of the disbursement float and the collection float (which is negative).
B. Firms prefer to maintain a net collection float, rather than a net disbursement float, because they are receiving more money than they are spending.
C. Firms often invest idle cash in money market securities which are short-term, safe, and easily marketable
D. The income from investing excess cash in T-Bills is exempt from all state taxes, but the income from investing it in munis is exempt from all federal taxes.

Answer 22

b

Question 23

Which of the following refers to a customer's willingness to meet his or her credit obligations?
A.	Character
B.	Capacity
C.	Capital
D.	Conditions

Answer 23

a

Question 24

Which of the following statements is FALSE?
A. Promissory notes are the most common credit instrument.
B. The evidence of indebtedness in an open account is the invoice.
C. For commercial drafts, the buyer accepts it and commits to payment before delivery.
D. Banker’s acceptances are commonly used in international trade.

Answer 24

a

Question 25

Which of the following statements is FALSE?
A. Credit management trades off the carrying the cost of extending credit to buyers against the goal of increasing sales.
B. The credit period is typically longer for perishable goods and for buyers with higher credit risk.
C. Terms of sale “2/10 net 45” indicates a 2% discount if paid within 10 days, with the total amount due in 45 days if the discount is not taken.
D. Banker’s acceptances are credit commitments made before delivery, are guaranteed by banks, and are common in international trade.

Answer 25

b

Question 26

Which one of the following is most indicative of a flexible short-term financial policy?
A. High ratio of short-term debt to long-term debt
B. High ratio of current assets to sales
C. Low level of net working capital
D. Relatively low level of liquidity

Answer 26

b

Question 27

Which of the following statements is FALSE?
A. Firms seek to manage their cash by keeping no more than is needed on hand, because holding cash has an opportunity cost, namely, the returns that could be earned by investing the money.
B. The optimal credit policy for a firm depends on many specific factors, but generally involves trading off the cost of granting credit, such as the carrying costs of receivables and the possibility of non-payment, against the benefits in terms of increased sales.
C. In the five Cs of credit, capacity refers to the customer’s willingness to meet credit obligations out of operating cash flows.
D. In the five Cs of credit, collateral are the assets pledged by the customer for security in case of default.

Answer 27

c

Question 28

Which of the following will decrease the value of a call?
A. An increase in the underlying stock price over the strike price
B. An increase in the risk-free interest rate
C. Less time to expiration as days pass
D. An increase in the volatility of the underlying stock’s returns

Answer 28

c

Question 29

Which of the following statements is TRUE?
A. The value of a call option can never be negative.
B. The value of a call decreases as the price of the underlying stock increases.
C. The value of a call increases when the volatility of the underlying asset’s returns decreases.
D. The intrinsic value of a call must be zero on the expiration date.

Answer 29

a

Question 30

Which of the following will increase the value of a call option?
A. An increase in the underlying stock price further above the strike price
B. A decrease in the risk-free interest rate
C. Less time to expiration as days pass
D. A decrease in the volatility of the underlying stock’s returns

Answer 30

a

Question 31

Which of the following is NOT an example of an option found in financial claims?
A. Employee stock options that provide incentives to align managers’ interests with shareholders
B. Bank loans in which a firm is obligated to pay interest and principle over time
C. Convertible preferred shares that can be exchanged for common shares at a pre-specified conversion ratio
D. Equity owners’ choice to repay risky debt to avoid bankruptcy

Answer 31

b

Question 32

Which of the following statements is TRUE?
A. European options are options that may be exercised at any time until its expiration date. American options, however, are options that may be exercised only on the expiration date.
B. A call option is the right to sell an asset at a fixed price during a particular period of time, while a put option is the right to buy an asset at a fixed price during a particular period of time.
C. Stock options traded on exchanges are a zero-sum game, meaning that whatever the buyer of a stock option makes, the writer or seller loses, and vice versa.
D. Sometimes an option can be worth less than zero.

Answer 32

c

Question 33

Which of the following statements is FALSE?
A. A stock split is an increase in a firm’s shares outstanding without any change in owners’ equity.
B. A reverse split is a stock split under which a firm’s number of shares outstanding is reduced.
C. A stock buyback refers to the purchase of the firm’s shares of stock by the firm’s debt holders.
D. A stock dividend is a payment in the form of stock made by a firm to its owners, diluting the value of each share outstanding.

Answer 33

c

Question 34

You own 100 shares of JKL Inc. which has 20,000,000 shares outstanding that currently sell for $40 per share. JKL has previously announced a dividend of $0.80 per share with an ex-dividend date of May 31. Assume there are no taxes or other special advantages or disadvantages of dividends. If you take no action, which of the following statements is TRUE?
A. You should expect the stock price to drop to $39.20 on May 31.
B. You should expect the value of your brokerage account portfolio to increase by $80 on May 31.
C. You should expect to receive 2 more shares of JKL in your account on May 31.
D. You should expect to own a larger fraction of JKL’s remaining outstanding shares on May 31.

Answer 34

a

Question 35

Which of the following statements is FALSE?
A. Like Johnson & Johnson (JNJ), nearly all of the 30 Dow Jones Industrial companies were forced to reduce their dividends per share in 2009 and again in 2010 due to the Great Recession.
B. Apple paid its first dividend to common shareholders in 2012, and Berkshire Hathaway has not yet paid dividends to common shareholders.
C. The dividend yield on the S&P500 has been approximately 2% in recent decades, and tends to be lower when prices rise.
D. Share repurchases have become more common over the past half century, and over the same period, the dividend yield has trended downward.

Answer 35

a

Question 36

Which of the following statements is FALSE?
A. Johnson and Johnson exemplifies a company that steadily increased its dividend amount in a stair step way roughly every year from 2001 to 2012.
B. Alcoa discontinued its dividends in 2008 and 2009, which coincided with a sharp decrease in its stock price.
C. Only about 40% of S&P 500 companies pay dividends.
D. On average, when companies increase dividends, their stock prices climb by about the same amount in magnitude as their stock prices fall when they decrease dividends.

Answer 36

d

Question 37

Cash dividends send which of the following signals to the market?
A. Agency costs will be raised since the firm will have less flexibility
B. The firm is planning on downsizing
C. The firm is currently, and expects to continue to be, profitable
D. The firm will no longer conduct stock repurchases

Answer 37

c

Question 38

Research conducted on firms’ dividend policies over time support which one of the following conclusions?
A. Aggregate dividends and stock repurchases have steadily declined in real terms.
B. Dividends are currently paid by the vast majority of firms.
C. Managers tend to smooth dividends.
D. Stock prices tend to increase whenever anticipated changes in dividends occur.

Answer 38

c