Pre Assessment

Question 1

In which way is accounting different from finance?

Accounting forecasts future performance, given the past, while finance records past performance.
Accounting is about budgeting, saving, and borrowing, while finance is about investing, forecasting, and lending.
Accounting is backward looking, while finance is focused on the future.
Accounting is focused on allocating capital, while finance is focused on bringing in capital.

Answer 1

Accounting is backward looking, while finance is focused on the future.

Question 2

What is the main question that both individuals and companies must consider when making financial decisions to reach a goal?

Will this decrease the amount of cash available?
Will the benefits of the action outweigh the costs?
Will this decision require debt or equity financing?
Will utility be maximized through this decision?

Answer 2

Will the benefits of the action outweigh the costs?

Question 3

A financial manager at a company is trying to determine whether to issue new stocks or new bonds to cover the costs of a project the company is doing the next year.

Which main task in business finance is this situation an example of?

Making investment decisions
Making financing decisions
Managing working capital
Managing interdepartmental loans

Answer 3

Making financing decisions

Question 4

How can investing help a person reach personal financial goals?

It provides access to potential revenue or increases in value to help meet goals faster.
It helps a person understand how money was spent previously in order to reliably predict future expenses.
It provides a guaranteed future outcome in order to predictably meet financial goals.
It ensures money is placed in a safe, risk-free, and easily accessible financial asset.

Answer 4

It provides access to potential revenue or increases in value to help meet goals faster.

Question 5

A sign company is planning to have an initial public offering (IPO). In which type of market will its stock first be sold to the public?

Efficient market
Secondary market
Primary market
Money market

Answer 5

Primary market

Question 6

Which type of economic indicator changes after the economy changes and helps identify trends in the long term?

Lagging indicator
Coincident indicator
Leading indicator
Yield curve indicator

Answer 6

Lagging indicator

Question 7

How does an investment institution, such as a mutual fund, facilitate the circulation of money in the economy?

By insuring deposits in investment accounts up to $250,000 to promote public confidence
By accepting deposits of money, paying interest on deposits, and providing loans to individuals and organizations
By providing individuals and firms access to financial markets to buy or sell financial securities
By raising capital on a contractual basis, such as an insurance contract

Answer 7

By providing individuals and firms access to financial markets to buy or sell financial securities

Question 8

Which type of economic indicator is used by governments and policymakers to implement or alter policies in an effort to avoid or minimize the effects of an economic downturn?

Lagging indicator
Coincident indicator
Leading indicator
Correlated indicator

Answer 8

Leading indicator

Question 9

Suppose an individual does not eat chocolate because eating chocolate goes against personal beliefs. Which type of standard is this?

Legal
Ethical
Moral
Financial

Answer 9

Moral

Question 10

Which action is based upon moral standards?

Although there is no company policy regarding it, a financial manager chooses not to accept gifts from the company’s clients to avoid creating a conflict of interest.
Since it is generally accepted in the company that no personal information about clients should be released without written permission, a financial manager denies the request for a third party to access its data.
As outlined in the company’s policies, a financial manager hires a third-party entity to review all annual report filings to ensure they are compliant with applicable generally accepted accounting principles (GAAP).
As mandated by government regulations, a financial manager files a registration statement with the U.S. Securities and Exchange Commission (SEC) before offering equity securities for sale.

Answer 10

Although there is no company policy regarding it, a financial manager chooses not to accept gifts from the company’s clients to avoid creating a conflict of interest.

Question 11

What should a potential bondholder (lender) do to prevent a company (borrower) from taking on risky projects?

Separate owners from management so their interests do not conflict
Release managers who do not attempt to maximize immediate shareholder value
Encourage manipulation of accounting procedures to optimize the company’s profit
Set strict covenants that the company cannot uphold if it chooses a risky project

Answer 11

Set strict covenants that the company cannot uphold if it chooses a risky project

Question 12

What is the term for an individual’s beliefs concerning what is and is not acceptable to personally do?

Morals
Ethics
Honesty
Laws

Answer 12

Morals

Question 13

Which factor contributes to the inflation of the prices of goods and services over time?

Decrease in costs of production
Increase in demand for goods and services
Increase in purchasing power of goods and services
Decrease in employee demand for higher wages

Answer 13

Increase in demand for goods and services

Question 14

Why can compounding interest be a good tool but also a significant detriment?

Compounding interest can be a good tool because it summarizes the required return, but it is a detriment because it requires a larger cost of capital.
Compounding interest can be a good tool to understand the time value of money, but it is a detriment because it does not take inflation into account.
Compounding interest can be a good tool to understand opportunity cost, but it is a detriment because it does not take risk into account.
Compounding interest can be a good tool because it allows a lender to gain interest on interest, but it is a detriment because it causes a borrower to pay interest on interest.

Answer 14

Compounding interest can be a good tool because it allows a lender to gain interest on interest, but it is a detriment because it causes a borrower to pay interest on interest.

Question 15

Which component of the required rate of return takes into account the loss of potential gain from other alternatives?
Risk
Inflation
Opportunity cost
Hurdle rate

Answer 15

Opportunity cost

Question 16

How is inflation calculated?

Inflation is calculated by determining the rate at which the average price level of particular goods and services increases over a period of time in an economy.
Inflation is determined by the federal government at a target rate of 2% a year.
Inflation is calculated by determining the rate at which the demand for particular goods and services has increased over a period of time in an economy.
Inflation is built into the economy and will rise as employees receive salary raises.

Answer 16

Inflation is calculated by determining the rate at which the average price level of particular goods and services increases over a period of time in an economy.

Question 17

Based on the following information about the stocks of several companies, which stock displays the greatest amount of risk?

Stock A: Return = 22.22%, Standard Deviation = 9.99%

Stock B: Return = 15.05%, Standard Deviation = 7.35%

Stock C: Return = 38.83%, Standard Deviation = 4.54%

Stock D: Return = 5.69%, Standard Deviation = 5.32%

Stock A
Stock B
Stock C
Stock D

Answer 17

Stock A

Question 18

What is the relationship between risk and return?

The lower risk an investor takes, the faster the investor expects to receive a return.
The higher risk an investor takes, the higher return the investor expects to receive.
The lower risk an investor takes, the higher return the investor expects to receive.
The higher risk an investor takes, the slower the investor expects to receive a return.

Answer 18

The higher risk an investor takes, the higher return the investor expects to receive.

Question 19

An investor is considering purchasing stock in a certain company, but the investor’s financial advisor suggests purchasing stocks in multiple companies instead of just one.

Which risk management technique is this financial advisor suggesting?

Risk separation
Risk avoidance
Risk transfer
Risk diversification

Answer 19

Risk diversification

Question 20

An energy company discovers that a new bill has been proposed to change the amount of fuel that can be exported outside the country. If passed, this could have a serious negative effect on the company’s revenues. Some of the company’s competitors are obtaining insurance policies to compensate for this risk, but since the energy company believes the likelihood of this bill passing is low, it chooses to do nothing—ultimately taking responsibility for this particular risk instead of trying to transfer the risk through an insurance policy.

Which risk management technique is this choice an example of?

Risk avoidance
Risk separation
Diversification
Risk retention

Answer 20

Risk retention

Question 21

*Which type of ratio should be used to examine the cost efficiency of a firm’s production?

Liquidity
Efficiency
Market
Profitability

Answer 21

Profitability

Question 22

What is the process of analyzing financial data with ratios to compare a firm’s performance to competitors?

Benchmarking
Auditing
Evaluating
Valuing

Answer 22

Benchmarking

Question 23

*Which action will increase the return on equity of a firm?

Increasing the liquidity of the firm
Decreasing the debt financing of the firm
Increasing the asset usage efficiency of the firm
Decreasing the profitability of the firm

Answer 23

Increasing the asset usage efficiency of the firm

Question 24

Based on the information in the chart below, what can you conclude about Company A’s ability to collect its accounts receivable (AR)?

Entity Percentage of Sales on Credit AR Turnover AR Collection Period
Industry 30% 12 30.42
Company A 30% 7 52.14

Company A collects its accounts receivable in a highly variable pattern compared to the industry.
Company A collects its accounts receivable just as quickly as the average of other firms in the industry.
Company A is more efficient at collecting its accounts receivable than the industry.
Company A is less efficient at collecting its accounts receivable than the industry.

Answer 24

Company A is less efficient at collecting its accounts receivable than the industry.

Question 25

Which principle of ratio analysis means that ratios are open for analyst interpretation, are not governed by rules, and allow creativity to work according to a particular company or asset?

Flexibility
Focus
Standardization
Evaluation

Answer 25

Flexibility

Question 26

Why might an investor be concerned by how Company A is achieving its higher-than-industry return on equity?

Entity Net Profit Margin Total Asset Turnover Leverage Multiplier Return on Equity
Company A 7% 1.25 2.5 21.88%
Company B 15% 1.30 1.3 25.35%
Industry 8% 1.30 1.5 15.6%

The company is more efficient than the industry at using its assets to generate sales, and this may be unsustainable.
The company’s significantly higher use of debt could present a financial risk.
The company has a higher amount of profit generated per sales earned when compared to the industry.
The company’s return on assets is significantly higher than the industry’s.

Answer 26

The company’s significantly higher use of debt could present a financial risk.

Question 27

An investor is analyzing a portfolio to decide if there are any stocks that should be removed from the pool of financial securities. Quiet Flag Industries, a company the investor has invested in, has just released its annual report.

Which method should the investor use to see if the company has improved?

Trend analysis
Progress measurement
Focus analysis
Cross-sectional analysis

Answer 27

Trend analysis

Question 28

Which type of ratios are banks and lenders most concerned about?

Profitability
Liquidity
Efficiency
Activity

Answer 28

Liquidity

Question 29

*Which ratio helps an analyst evaluate whether a company can cover its short-term obligations?

Current ratio
Net margin
Return on equity
Market-to-book ratio

Answer 29

Current ratio

Question 30

*Net Profit Margin Total Asset Turnover Leverage Multiplier Return on Equity
Company 1 20.00% 1.5 2.5 75.0%
Company 2 15.00% 0.83 2.0 25.0%
Company 3 10.00% 0.5 3.0 15.0%

Given the table above, what does the DuPont framework indicate about return on assets?

All returns are based on the firm’s profitability and efficiency.
The firm’s market ratio helps determine the price of the stock.
Return on assets is based on the amount of the firm’s debt and equity.
A firm can still have a high return on assets with low net income.

Answer 30

All returns are based on the firm’s profitability and efficiency.

Question 31

An investment analyst is concerned about a construction company’s ability to sell its inventory to meet current obligations, because much of the inventory (commercial buildings) it builds and sells takes longer than a year to construct.

Which ratio should this analyst use to consider the effect of the firm’s inventory on the firm’s ability to meet current obligations?

Leverage ratio
Inventory ratio
Quick ratio
Current ratio

Answer 31

Quick ratio

Question 32

An employee was recently hired as a financial analyst and asked to create a cash budget for the employee’s division for the next year.

Which component should the employee exclude from the budget?

Payment toward the line of credit that is due next month
Payments to suppliers that will be made over the next six months
Purchase of inventory for sales that the employee will make this year
Purchase of equipment that will be bought in three years

Answer 32

Purchase of equipment that will be bought in three years

Question 33

What are the benefits of using the traditional envelope method to track cash flows?

It enables users to connect bank and credit card accounts to automatically update income and expenses.
It automatically separates expenses into categories so users can quickly assess their purchases during the month.
It requires users to carefully track specific expenses and write down their income and spending for the month.
It is simple and helps ensure that users do not spend more than the cash that they have available.

Answer 33

It is simple and helps ensure that users do not spend more than the cash that they have available.

Question 34

A company calculated variances of a budget and actual cash flows that indicate the firm’s strengths and weaknesses in cash flows and its budgeting process.

Which major use of cash budgeting is this an example of?

Assessment of future needs
Corrective action
Performance evaluation
Standardization

Answer 34

Performance evaluation

Question 35

Which process is a person engaging in when making a personal budget and keeping a record of cash flows?

Monitoring
Tracking
Revising
Forecasting

Answer 35

Tracking

Question 36

*Which type of expense is a magazine subscription?

Asset expense
Fixed expense
Monitored expense
Variable expense

Answer 36

Variable expense

Question 37

Which tool is forward-looking and thus helps decision makers understand how actions taken today can affect their firm’s future performance?

Accounting
Financial statements
Ratio analysis
Financial forecasting

Answer 37

Financial forecasting

Question 38

*A company is developing a financial forecast for the next year. The company plans to implement a new factory that will increase production and resulting sales by 20%.

Since the company’s assets are increasing significantly, what else must increase?

Financing
Gross margin
Accounts receivable turnover
Profit turnover

Answer 38

Financing

Question 39

*A company that manufactures televisions must obtain financing to increase the company’s inventory levels. A manager at the company knows that current investment markets are tight, and it may be difficult for the company to obtain additional financing for the next year. The manager wants to propose a way for the firm to reduce its discretionary financing needed (DFN).

What should the manager suggest to reduce next year’s DFN?

Increase the amount spent on fixed assets to increase production capacity
Lower the amount of dividends that are paid out to shareholders next year
Increase sales growth, resulting in a larger amount of revenue coming into the firm
Lower the net margin by decreasing the sales prices and maintaining current costs

Answer 39

Lower the amount of dividends that are paid out to shareholders next year

Question 40

What is the term for the rate that allows a firm to maintain its present financial ratios without issuing new equity or increasing debt?

Steady state growth rate
Sustainable growth rate
Capital growth rate
Sales growth rate

Answer 40

Sustainable growth rate

Question 41

*Which method is most commonly used for determining a company’s DFN?

Sustainable growth rate
Company multiples
Historical regression
Percent of sales

Answer 41

Percent of sales

Question 42

Freedom Rock Bicycles has a sales capacity of $10 million. When sales exceed this capacity, the company must invest $200,000 in new equipment. Freedom Rock Bicycles had sales of $9 million in one year, and it projects a sales growth of 10%. The net fixed assets in the year were $500,000.

By how much will the company’s discretionary financing need increase?

$0
$50,000
$200,000
$900,000

Answer 42

$0

Question 43

Why are financial models helpful in financial forecasting?

Models show the future supply schedule for a firm, which allows for negotiation with suppliers.
Models are required by the SEC when a firm plans to issue additional stock on the public market.
Models allow users to see the complex relationships between sales and other aspects of the business.
Models provide credibility to a firm’s financial statements for government agencies to review.

Answer 43

Models allow users to see the complex relationships between sales and other aspects of the business.

Question 44

A firm is currently operating at 75% capacity with current sales of $34 million.

Will the firm need to acquire additional fixed assets if its sales are predicted to increase by $6 million next year?

No, because the increase in sales will exceed the firm’s sales capacity.
Yes, because the increase in sales will exceed the firm’s sales capacity.
Yes, because the increase in sales will not exceed the firm’s sales capacity.
No, because the increase in sales will not exceed the firm’s sales capacity.

Answer 44

No, because the increase in sales will not exceed the firm’s sales capacity.

Question 45

*How does an analyst use the hurdle rate?

It is used to calculate the IRR for a project and determine its value.
It is used to determine the time frame of a project.
It is used to compare with the IRR to determine whether a project should be accepted.
It is used with the IRR as a method to find the required payment amount for a project.

Answer 45

It is used to compare with the IRR to determine whether a project should be accepted.

Question 46

Which term refers to the metrics and calculations that use tools such as net present value (NPV), internal rate of return (IRR), and profitability index (PI) to evaluate investments?

Accounting investment criteria
Capital budgeting criteria
Security analysis criteria
Projected financing criteria

Answer 46

Capital budgeting criteria

Question 47

*What would profitability index (PI) be useful for?

Calculating returns for a project that does not have a definite return rate for IRR or NPV
Deciding between projects that are mutually exclusive
Computing the future value of a project in the future rather than the present value
Determining whether a firm should invest in projects with different initial outlays

Answer 47

Determining whether a firm should invest in projects with different initial outlays

Question 48

Company ABC is considering several projects for the next year as outlined in the chart below.

NPV IRR PI

Project 1 $5,600 15% 2.5
Project 2 $2,700 18% 1.7
Project 3 $8,300 17% 2.0

If the company has a limited amount of capital to spend on projects, in which order should Company ABC do the projects to create the greatest value?

Project 2, Project 3, Project 1
Project 1, Project 3, Project 2
Project 3, Project 2, Project 1
Project 3, Project 1, Project 2

Answer 48

Project 1, Project 3, Project 2

Question 49

Anna is planning to invest in some company stocks for retirement and is trying to figure out if the stocks are a good buy. She calculates the intrinsic value of one of the stocks, Quiet Flag Industries, to be $35. The stock is currently trading on the market for $30, so she decides to buy it.

Why was it a good idea for Anna to buy this stock?

The stock’s intrinsic value is greater than 1.
The stock is undervalued.
The stock’s intrinsic value is less than its actual value.
The stock is overvalued.

Answer 49

The stock is undervalued.

Question 50

How do bond payments to investors differ from stock payments to investors?

Stock payments are fixed, and bond payments are variable.
Stock payments have a shorter duration than bond payments.
Bond payments are larger than stock payments.
Bond payments are fixed, and stock payments are variable.

Answer 50

Bond payments are fixed, and stock payments are variable.

Question 51

An investor really cares about having voting rights in a firm.

Which type of financial security should this investor purchase?

Zero-coupon bonds
Secured bonds
Preferred stock
Common stock

Answer 51

Common stock

Question 52

*The lowest rate of return is required by which type of investor or lender?

Preferred stockholder
Bondholder
Bank
Common stockholder

Answer 52

Bank

Question 53

Which cash flow of a particular project would be a sunk cost?

$20,000 market value of equipment at the end of the project
$35,000 incremental cash flows for the third year of the project
$50,000 marketing study conducted three months ago for the project
$100,000 initial investment for the project

Answer 53

$50,000 marketing study conducted three months ago for the project

Question 54

Quiet Flag Industries has a large piece of land worth $250,000 that it is considering using for a miniature golf business.

When evaluating the cash flows that would result from doing this project, should Quiet Flag consider the land value? Why or why not?

Yes, the land value represents an opportunity cost.
Yes, the land value represents cannibalization.
No, the land value represents a sunk cost.
No, the land value represents an existing expense.

Answer 54

Yes, the land value represents an opportunity cost.

Question 55

What is the effect of debt financing on a firm’s income?

Debt interest payments reduce taxable income.
Debt interest payments have no effect on taxable income.
Income is taxed at a lower rate when a firm has no debt.
Income is taxed at a lower rate when a firm has more debt.

Answer 55

Debt interest payments reduce taxable income.

Question 56

*An investor is reviewing the bonds of four different companies: Company A issues AA-rated bonds. Company B issues A-rated bonds. Company C issues BB-rated bonds. Company D issues C-rated bonds.

Which company is likely to provide the lowest rate of return to the investor?

Company A
Company B
Company C
Company D

Answer 56

Company A

Question 57

How is the cost of capital used in the decision-making process for a capital investment project?

It is input into cash flow calculations.
It is used as the discount rate of cash flows.
It is part of the initial investment.
It is compared to the NPV.

Answer 57

It is used as the discount rate of cash flows.

Question 58

A pharmaceutical company recently spent $2 million developing a new drug. The company then conducts capital budgeting analysis to determine if it should produce the newly developed drug. The net present value (NPV) of the project is $1.5 million.

Why should this company produce the drug?

Because the losses due to cannibalization are less than the value of the project
Because the NPV is greater than zero
Because the development costs are greater than the value of the project
Because the project will provide a total value of $3.5 million to the company

Answer 58

Because the NPV is greater than zero