BEC - Financial Management

Question 1

Basis risk

Answer 1

The risk of loss form ineffectivness of the hedge that results when offsetting investments don’t experience price changes in entirely opposite direcitons as expected.

Question 2

FCF

Answer 2

Free cash flow = NI + noncash expense + changes in WC - CapEx

Question 3

Payback period

Answer 3

Payback period = Cash outlay / Cash inflows

Question 4

Accounting rate of return (also known as simple rate of return)

Answer 4

Accounting rate of return (simple rate of return) = (avg annual incremental revenues - avg annual incremental expenses) / initial or avg investments

*Depreciation expense is explicitly recognized under the accounting rate of return approach

Question 5

Profitability index

Answer 5

Profitability index = PV of cash inflows / Project cost

A project would be economically feasible ONLY IF the PI > 1

OR

Profitability index = NPV / project cost

A project would be economically feasible if the
NPV is 0 or positive

Question 6

While both the NPV and IRR approaches wil lresult in the same accept or reject outcome, differences between the methodologies

Question 7

The after-tax cash flows are calculated by deducting tax expense from the before-tax cash flows.

Question 8

NPV and IRR criteria will always lead to the same accept or reject decision.

Question 9

A project has a present value of future net cash inflows of $120,000 and an initial investment of $110,000. Calculate the excess present value index for the project.

Answer 9

Answer: 109.1%

This answer is correct. It is calculated as follows:

Present value of future net cash inflows ÷ Initial investment × 100

= 120,000/110,000 x 100%

Question 10

The IRR uses the net incremental investment and the net annual cash flows. However, it does not include the incremental average operating income.

Question 11

Only very creditworthy firms can issue commercial paper.

Question 12

Serial bonds are attractive to investors because

Answer 12

Investors can choose the maturity date that suits their financial needs

Question 13

When calculating the cost of capital, the cost assigned to retained earnings should be

Answer 13

Lower than the cost of external common equity

Question 14

What would be the primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt?

Answer 14

To reduce the interest rate on the bonds being sold

Question 15

The calculation of depreciation is used in the determination of the net present value of an investment for which of the following reasons?

Answer 15

Depreciation increases cash flow by reducing income taxes

This answer is correct because depreciation is a noncash expense that affects future cash flows through its effect on income taxes.

Question 16

A company has an outstanding one-year bank loan of $500,000 at a stated interest rate of 8%. The company is required to maintain a 20% compensating balance in its checking account. The company would maintain a zero balance in this account if the requirement did not exist. What is the effective interest rate of the loan?

Answer 16

Answer: 10%

The effective rate is calculated by dividing the interest amount by the outstanding balance less the compensating balance requirement.

The annual interest amount is equal to $40,000 (8% × $500,000) and the compensating balance amount is equal to $100,000 (20% × $500,000). The effective interest rate is equal to 10% [$40,000 ÷ ($500,000 – $100,000)].

Question 17

issuance of common stock involves no fixed charges, no fixed maturity dates and will increase the creditworthiness of the company.

Question 18

A bond with a floating rate will generally hold a steady market value because its value will not change due to changes in prevailing interest rates.

Question 19

When a firm finances each asset with a financial instrument of the same approximate maturity as the life of the asset, it is applying

Answer 19

Answer: hedging approach

The strategy of matching asset and liability maturities is referred to as a hedging approach. The strategy helps ensure that funds are generated from the assets when the related liabilities are due.

Question 20

Which of the following is a disadvantage of the internal rate of return as a method of evaluating investments?

Answer 20

IRR has limitations when evaluating mutually exclusive projects

Question 21

Coefficient of variation

Answer 21

Coefficient of variation = std deviation / expected return

Question 22

Trade credit is the largest source of short-term financing for most small firms. It occurs automatically with the purchase of goods and services.