FIN 370 Week 5 Final Exam questions with answers

12) Which of the following financial ratios is the best measure of the operating effectiveness of a firm’s management?

1. Current ratio
2. Gross profit margin
3. Answer: Return on investment
4. Quick ratio

13) Northwest Bank pays a quoted annual (nominal) interest rate of 4.75%. However, it pays interest (compouned) daily using a 365-day year. What is the effective annual rate of return (APY)?

4. 4.75%
5. 5.02%
6. Answer: 4.86%
7. 3.61%

14) Suppose that you wish to save for your child's college education by opening up an educational IRA. You plan to deposit $100 per month into the IRA for the next 18 years. Assume that you will be able to earn 10%, compounded monthly, on your investment. How much will you have accumulated at the end of 18 years?

1. $21,600
2. $54,719
3. Answer: $60,056
4. $85,920
5. $33,548

15) You have $10,000 to invest. You do not want to take any risk, so you will put the funds in a savings account at the local bank. Of the following choices, which one will produce the largest sum at the end of 22 years?

1. An account that compounds interest annually
2. Answer: An account that compounds interest daily
3. An account that compounds interest monthly
4. An account that compounds interest quarterly

16) The primary purpose of a cash budget is to:

1. Answer: provide a detailed plan of future cash flows.
2. determine the level of investment in current and fixed assets.
3. determine accounts payable.
4. determine the estimated income tax for the year.

17) Which of the following is NOT a basic function of a budget?

1. Answer: Budgets compare historical costs of the firm with its current cost performance.
2. Budgets indicate the need for future financing.
3. Budgets provide the basis for corrective action when actual figures differ from the budgeted figures.
4. Budgets allow for performance evaluation.

18) Which of the following statements about the percent-of-sales method of financial forecasting is true?

1. Answer: It involves estimating the level of an expense, asset, or liability for a future period as a percent of the forecast for sales revenues.
2. It is the least commonly used method of financial forecasting.
3. It is a much more precise method of financial forecasting than a cash budget would be.
4. It projects all liabilities as a fixed percentage of sales.

19) Which of the following is a non-cash expense?

1. Packaging costs
2. Answer: Depreciation expenses
3. Interest expense
4. Administrative salaries

20) A plant can remain operating when sales are depressed:

1. in an effort to cover at least some of the variable cost.
2. Answer: if the selling price per unit exceeds the variable cost per unit.
3. to help the local economy.
4. unless variable costs are zero when production is zero.

21) The break-even model enables the manager of a firm to:

1. determine the quantity of output that must be sold to cover all operating costs.
2. calculate the minimum price of common stock for certain situations.
3. set appropriate equilibrium thresholds.
4. determine the optimal amount of debt financing to use.

22) How long will it take $750 to double at 8% compounded annually?

1. Answer: 9 years
2. 6.5 years
3. 48 months
4. 12 years

23) Which of the following is the formula for compound value?

1. Answer: FV_n = P(1+i)ⁿ
2. FV_n = (1+i)/P
3. FV_n = P(1+i)^-n
4. FV_n = P/(1+i)ⁿ

24) The present value of a single future sum:

1. increases as the number of discount periods increase.
2. is generally larger than the future sum.
3. increases as the discount rate increases.
4. Answer: depends upon the number of discount periods.

25) Which of the following is NOT considered a permanent source of financing?

1. Corporate bonds
2. Common stock
3. Answer: Commercial paper
4. Preferred stock

26) A toy manufacturer following the hedging principle will generally finance seasonal inventory build-up prior to the Christmas season with:

1. common stock.
2. selling equipment.
3. preferred stock.
4. Answer: trade credit.

27) Which of the following is considered to be a spontaneous source of financing?

1. Operating leases
2. Accounts receivable
3. Answer: Accounts payable
4. Inventory

28) We compute the profitability index of a capital-budgeting proposal by:

1. multiplying the IRR by the cost of capital.
2. dividing the present value of the annual after-tax cash flows by the cost of capital.
3. multiplying the cash inflow by the IRR.
4. Answer: dividing the present value of the annual after-tax cash flows by the cost of the project.

29) Your company is considering a project with the following cash flows: Initial outlay = $1,748.80 Cash flows Years 1–6 = $500 Compute the IRR on the project.

1. Answer: 18%
2. 9%
3. 24%
4. 11%

30) For the NPV criteria, a project is acceptable if the NPV is____, while for the profitability index, a project is acceptable if the profitability index is ___.

1. greater than one, greater than zero
2. less than zero, greater than the required return
3. greater than zero, less than one
4. Answer: greater than zero, greater than one

31) You have been asked to analyze a capital investment proposal. The project’s cost is $2,775,000. Cash inflows are projected to be $925,000 in Year 1; $1,000,000 in Year 2; $1,000,000 in Year 3; $1,000,000 in Year 4; and $1,225,000 in Year 5. Assume that your firm discounts capital projects at 15.5%. What is the project’s MIRR?

1. 16.73%
2. 12.62%
3. Answer: 19.99%
4. 10.44%

32) Which of the following is considered to be a deficiency of the IRR?

1. It fails to utilize the time value of money.
2. It fails to properly rank capital projects.
3. It is not useful in accounting for risk in capital budgeting.
4. Answer: It could produce more than one rate of return.

33) Most firms use the payback period as a secondary capital-budgeting technique, which, in a sense, allows them to control for risk.

Answer: True

34) ABC Service can purchase a new assembler for $15,052 that will provide an annual net cash flow of $6,000 per year for five years. Calculate the NPV of the assembler if the required rate of return is 12%. (Round your answer to the nearest $1.)

1. $7,621
2. $1,056
3. Answer: $6,577
4. $4,568

35) The firm should accept independent projects if:

1. the IRR is positive.
2. the payback is less than the IRR.
3. the NPV is greater than the discounted payback.
4. Answer: the profitability index is greater than 1.0.

36) The NPV assumes cash flows are reinvested at the:

1. IRR.
2. NPV.
3. real rate of return.
4. Answer: cost of capital.

37) The average cost associated with each additional dollar of financing for investment projects is:

1. the incremental return.
2. Answer: the marginal cost of capital.
3. risk-free rate.
4. beta.

38) The most expensive source of capital is:

1. preferred stock.
2. Answer: new common stock.
3. debt.
4. retained earnings.

39) PepsiCo uses 30-year Treasury bonds to measure the risk-free rate because:

1. these bonds are essentially free of business risk.
2. Answer: they capture the long-term inflation expectations of investors associated with investments in long-term assets.
3. these bonds are essentially free of interest rate risk.
4. none of the above.

40) Shawhan Supply plans to maintain its optimal capital structure of 30% debt, 20% preferred stock, and 50% common stock far into the future. The required return on each component is: debt–10%; preferred stock–11%; and common stock–18%. Assuming a 40% marginal tax rate, what after-tax rate of return must Shawhan Supply earn on its investments if the value of the firm is to remain unchanged?

1. 18.0%
2. Answer: 13.0%
3. 10.0%
4. 14.2%

41) Bender and Co. is issuing a $1,000 par value bond that pays 9% interest annually. Investors are expected to pay $918 for the 10-year bond. Bender will have to pay $33 per bond in flotation costs. What is the cost of debt if the firm is in the 34% tax bracket?

1. Answer: 7.23%
2. 9.01%
3. 9.23%
4. 11.95%

42) The XYZ Company is planning a $50 million expansion. The expansion is to be financed by selling $20 million in new debt and $30 million in new common stock. The before-tax required rate of return on debt is 9%, and the required rate of return on equity is 14%. If the company is in the 40% tax bracket, what is the marginal cost of capital?

1. 14.0%
2. 9.0%
3. Answer: 10.6%
4. 11.5%

43) Zybeck Corp. projects operating income of $4 million next year. The firm’s income tax rate is 40%. Zybeck presently has 750,000 shares of common stock which have a market value of $10 per share, no preferred stock, and no debt. The firm is considering two alternatives to finance a new product: (a) the issuance of $6 million of 10% bonds, or (b) the issuance of 60,000 new shares of common stock. If Zybeck issues common stock this year, what will projected EPS be next year?

1. $2.33
2. $1.67
3. Answer: $2.96
4. $2.10

44) Lever Brothers has a debt ratio (debt to assets) of 40%. Management is wondering if its current capital structure is too conservative. Lever Brothers’s present EBIT is $3 million, and profits available to common shareholders are $1,560,000, with 342,857 shares of common stock outstanding. If the firm were to instead have a debt ratio of 60%, additional interest expense would cause profits available to stockholders to decline to $1,440,000, but only 228,571 common shares would be outstanding. What is the difference in EPS at a debt ratio of 60% versus 40%?

• $3.25
• $4.50
• $2.00
• Answer: $1.75

45) Lever Brothers has a debt ratio (debt to assets) of 20%. Management is wondering if its current capital structure is too conservative. Lever Brothers’s present EBIT is $3 million, and profits available to common shareholders are $1,680,000, with 457,143 shares of common stock outstanding. If the firm were to instead have a debt ratio of 40%, additional interest expense would cause profits available to stockholders to decline to $1,560,000, but only 342,857 common shares would be outstanding. What is the difference in EPS at a debt ratio of 40% versus 20%?

1. $1.16
2. Answer: $0.88
3. $1.95
4. $2.12

46) A bond sold simultaneously in several different foreign capital markets, but denominated in a currency different from the country in which the bond is issued, is called a(n):

1. floating bond.
2. Answer: Eurobond.
3. international capital bond.
4. world bond.

47) Which of the following statements about exchange rates is true?

1. Exchange rates were fixed prior to establishing a floating-rate international currency system, and all countries set a specific parity rate for their currency relative either to the Canadian or to the U.S. dollar.
2. Day-to-day fluctuations in exchange rates currently are caused by changes in parity rates.
3. Answer: A floating-rate international currency system has been operating since 1973.
4. All of the choices.

48) Capital markets in foreign countries:

1. offer lower returns than those obtainable in the domestic capital markets.
2. Answer: provide international diversification.
3. in general are becoming less integrated due to the widespread availability of interest rate and currency swaps.
4. all of the choices.

49) A spot transaction occurs when one currency is:

1. exchanged for another currency at a specified price.
2. traded for another at an agreed-upon future price.
3. Answer: immediately exchanged for another currency.
4. deposited in a foreign bank.

50) If the quote for a forward exchange contract is greater than the computed price, the forward contract is:

1. a good buy.
2. at equilibrium.
3. undervalued.
4. Answer: overvalued.

51) The interplay between interest rate differentials and exchange rates such that both adjust until the foreign exchange market and the money market reach equilibrium is called the:

1. Answer: interest rate parity theory.
2. arbitrage markets theory.
3. balance of payments quantum theory.
4. purchasing power parity theory.

52) One reason for international investment is to reduce:

1. Answer: portfolio risk.
2. beta risk.
3. price-earnings (P/E) ratios.
4. advantages in a foreign country.

53) An important (additional) consideration for a direct foreign investment is:

1. Answer: political risk.
2. maximizing the firm’s profits.
3. attaining a high international P/E ratio.
4. all of the above.

54) Buying and selling in more than one market to make a riskless profit is called:

1. profit maximization.
2. cannot be determined from the above information.
3. Answer: arbitrage.
4. international trading.