business finance exam Flashcards
1
Q
What does value mean?
A
Depends on expected cash flows which are evaluated in terms of timing and risk.
2
Q
What is the agency problem?
A
When managers act in their own interests rather than those of the shareholders.
3
Q
What are the agency costs?
A
Costs incurred due to managers pursuit of their own interests.
4
Q
What is corporate governance?
A
Refers to the rules, processes, and laws by which companies are operated, controlled and regulated.
5
Q
Which of the following managerial goals, if followed by the manager, is least likely to result in an agency problem?
A
Pursue corporate goals
6
Q
Which of the following statements regarding the cost of capital is true?
A
The weighted average cost of capital is the minimum return required to maintain firm value.
7
Q
Which of the following is least correct with respect to the function of securities exchanges in creating efficient markets?
A
Control the supply and demand for securities through price
8
Q
If shares from different industries are added to an ordinary share portfolio, which type of risk is most likely to be reduced?
A
Unique risk
9
Q
Which of the following represents the cost of long-term financing to a firm, incorporating the returns required by their various investors?
A
Cost of capital
10
Q
Which of the following theories only explains why the yield curve is upward sloping?
A
Liquidity preference theory
11
Q
Of the following, which is the best example of an acceptable outcome of appropriate corporate governance practices?
A
A member of the Board of Directors disclosing to the board chairman a potential conflict of interest
12
Q
Preference shares are valued as if they were ________.
A
A perpetuity
13
Q
The ________ method of equity valuation is used to value preference shares.
A
Zero-growth model
14
Q
Unsystematic or diversifiable risk is not relevant to most investors, because:
A
It can be eliminated through diversification
15
Q
Which of the following is most correct concerning the slope of the security market line?
A
It represents the market risk premium
16
Q
Profit maximisation is not considered to be an appropriate primary financial goal for a firm and its financial manager because it:
A
Ignores timing of benefits, Tends to be short-term focused, Fails to adequately consider risk, Is less objective than cash flows
17
Q
Assuming all else is unchanged, which of the following statements about the market price of zero-coupon bonds is TRUE?
A
The market price increases as the time to maturity approaches
18
Q
Macro events only are reflected in the performance of the market portfolio because
A
Unique risks have been diversified away
19
Q
Investment projects that plot above the security market line would be considered to have:
A
A positive NPV
20
Q
The line plotted to fit observations of a stock’s returns versus the market’s returns determines the:
A
Beta of the stock
21
Q
Stock returns can be explained by the stock’s _________ and the stock’s __________.
A
Beta; unique risk
22
Q
Which of the following statements relating to the agency issue is NOT true?
A
In agency theory, owners are the agents of managers
23
Q
The only market in which the issuer is directly involved in the transaction. → The money market comprising suppliers and demanders of short term funds. → Market where existing securities are traded between investors. →
A
Primary market, Money market, Secondary market
24
Q
How is it possible to invest only in the market portfolio yet have a portfolio beta of 1.5?
A
Borrow funds to increase your investment
25
A stock's beta measures the:
Variability in the stock's returns compared to that of the market portfolio
26
Stock prices reflect the ________ of the company.
Expected future cash flows
27
Which of the following is most likely correct for a diversified stock portfolio that exhibits a higher standard deviation than the market index?
The portfolio contains fairly aggressive stocks.
28
Investors are willing to purchase stocks having high P/E ratios because
They expect these shares to have greater growth opportunities
29
According to the dividend discount model, the current value of a stock is equal to the:
Present value of all expected future dividends
30
What happens to a firm that reinvests its earnings at a rate equal to the firm's required return?
Its stock price will remain constant
31
A proposed project has a positive NPV when evaluated at the company's cost of equity. If the firm employs debt in its capital structure, will the project remain acceptable after evaluation with the WACC?
Yes, using the WACC will increase the NPV
32
Which of the following is correct for a bond currently selling at a premium to par?
Its current yield is lower than its coupon rate
33
What causes bonds to sell for a premium compared to face value?
The bonds have a higher than market coupon rate
34
A tax shield is equal to the reduction in:
Tax liability resulting from a deductible expense
35
If the company cost of capital is 20% and a proposed project's cost of capital is 15%, then discounting the projects' cash flows at 20% would:
Be incorrect
36
The WACC is used to value:
Projects with the same risk as the firm's current business
37
The tax treatment regarding the sale of existing assets which are depreciable and used in business and are sold for less than the book value results in:
A tax benefit from an ordinary loss
38
A tax liability is created upon the sale of an asset whenever:
The asset's market value exceeds its book value
39
A firm is evaluating a proposal which has an initial investment of $35,000 and has cash flows of $10,000 in year 1, $20,000 in year 2, and $20,000 in year 3. The payback period of the project is:
2.25 years
40
The preferred approach for risk adjustment of capital budgeting cash flows, from a practical viewpoint, is:
Risk-adjusted discount rates
41
An investor owns 5,000 shares, which is 1% of a corporation's outstanding stock before a share repurchase. The investor did not sell any of his stock during the 25,000 share repurchase. Which of the following statements is correct?
The investor owns more than 1% of the corporation
42
Consistent with the dividend irrelevance theory, "homemade" dividends are created by:
Selling a portion of your non-dividend paying holdings
43
When a corporation issues permanent debt, the value of all its securities:
Increases by the present value of the tax shield
44
M&M demonstrated that in perfect markets a firms choice of capital structure
Does not affect its value
45
The manager of XYZ Corp feels that a dividend increase will increase stock price because many investors value stock with a dividend-discount model. Why might the dividend irrelevance theory disagree with this assertion?
Future dividend growth may slow due to less retained earnings
46
Beginning with a zero-leverage company, as debt is substituted for equity in the capital structure ________.
The overall cost of capital first declines, reaches a minimum, and then rises
47
It is generally believed that the value of the firm
Is maximised when the WACC is minimised
48
Automatic dividend reinvestment plans allow firms to:
Reduce their cash outflow to shareholders
49
Debt may be the preferred form of external financing for many firms because:
Equity issuance is considered by investors to be a negative sign
50
When a firm declares a special cash dividend of $1 per share, shareholders realize that the:
Dividend is not likely to be repeated
51
If taxes are present in a market then:
Expected return on equity increases as financial leverage increases
52
Dividend policy is a trade-off between ___________ and ___________.
Retained earnings; issuing stock
53
Those who benefit from the interest tax shield are:
Equity holders
54
When a company expects to maintain its dividend payments in the future, it will issue:
Regular dividends
55
Firms with substantial amounts of free-cash-flow often discover that:
They have become takeover targets
56
The ......... uses no, or very little, safety stock:
Just-in-time system
57
One of the reasons why proxy fights are rarely successful is that:
Management can use corporate resources to defend against the fight
58
Conglomerate mergers involve companies in:
Unrelated lines of business
59
If the firm's credit period is decreased, the sales volume can be expected to ________, the investment in accounts receivable can be expected to _________, and the bad debt expenses can be expected to _________
Decrease; decrease; decrease
60
A merger is defined as
The combination of two or more firms, in which the resulting firm maintains the identity of one of the firms, usually the larger one
61
Proxy fights are conducted in order to achieve a goal of:
Replacing the current board and management team
62
In which merger-type would it be least likely to observe economies of scale?
Vertical
63
What is net working capital?
The difference between a company's current assets and current liabilities
64
What is leverage?
Results from the use of fixed operating or financing costs to magnify returns to the firms' owners
65
What are the types of leverage?
Operating and financing
66
What is business risk?
The risk of a firm being unable to cover its operating costs
67
What is operating leverage?
The use of fixed operating costs to magnify the effects of changes in sales on the firms' earnings before income and taxes. Operating leverage is the change in EBIT caused by a change in quantity sold.
68
What does the agency problem refer to?
The conflict that exists between managers of a business and the shareholders.
69
Which of the following statements is FALSE?
The interest rates that are quoted by banks and other financial institutions are real interest rates.
70
Consider an investment that will pay you $150 in year one. Each year after that, you will receive a payment on the anniversary of the last payment that is 3.5% larger than the last payment. This pattern of payments will continue forever. If the interest rate is 6% per annum, what is the value of this investment today?
$6,000
71
Mary wishes to purchase a new house in 8 years. She is planning to purchase the house using proceeds from the sale of her current property which is worth $100,000 now and its value is growing at 6% a year. Suppose the new house is currently worth $200,000 increasing at 7% year. In addition to the value of her old property, how much additional money should she deposit at the end of each year in an account paying 5% annual interest in order to be able to buy the new house in 8 years?
$19,295
72
Super Systems Inc. has a required rate of return of 16.5% and a beta of 1.75. If the expected return on the market is 13%, what is the market risk premium?
4.67%
73
The higher an asset's beta,
the more responsive it is to changing market returns.
74
MSB Financial anticipates a 10% annual rate in the growth of dividends for the next three years. Thereafter, the company and market analysts estimate growth at 5% per year indefinitely. The company just paid a $2.00 per share dividend on its common stock. The stock’s beta is 0.8, the risk-free rate of interest is 6%, and the rate of return on the market is 12%. What is the company’s current stock price?
$41.34
75
The ________ value of a bond is also called its face value. Bonds which sell
at less than face value are priced at a ________, while bonds which sell at
greater than face value sell at a ________.
par; discount; premium
76
To finance a new line of product, the ABDC Corporation has issued
$1,000,000 of bonds with a par value of $1,000, coupon rate of 6% paid semiannually, and maturity of 20 years. Compute the price of the bond if the
annual opportunity cost is 11%.
$599
77
Which of the following is FALSE?
When computing the weighted average cost of capital, the preferred
weighing scheme is book value weights
78
Factors that prevent a firm from accepting all investment projects that provide
an acceptable rate of return include:
Capital rationing.
| Mutually exclusive projects.
79
What is the NPV for the following project if its cost of capital is 15%? The
initial after tax cost is $5,000,000 and it is expected to provide after-tax
operating cash inflows of $1,800,000 in year 1,, $1,900,000 in year 2,
$1,700,000 in year 3 and $900,000 in year 4.
-$365,754.
80
When determining the initial cash outlay of an asset that is being replaced,
which of the following should NOT be included?
Incremental change in expected revenue
81
The theoretical basis from which the concept of risk-adjusted discount rates is
derived is
the capital asset pricing model.
82
What is the payback period for Buyers Support Cooperation's new project if its
initial after tax cost is $3,000,000 and it is expected to provide after-tax
operating cash inflows of $1,300,000 in year 1, $1,600,000 in year 2,
$700,000 in year 3, $1,800,000 in year 4 and $800,000 in year 5?
2.14 years.
83
Indicate which of the following is TRUE about annuities.
An annuity due is an equal payment paid or received at the beginning
of each period.
84
___________ projects do not compete with each other. The acceptance of
one _______ the others from consideration.
*Independent; does not eliminate
85
The New Zealand tax treatment regarding the sale of existing business assets
which are sold for more than the initial purchase price of the asset results in:
*recovered depreciation taxed as ordinary income and no capital gain
tax.
86
What type of firm is characterised by a heavy reliance on retained earnings to
take advantage of profitable projects and therefore payment of only a small
percentage of its earnings as dividends?
growth firm
87
Poor capital structure decisions can result in _____ the cost of capital,
resulting in ________ acceptable investments. Effective capital structure
decisions can ______ the cost of capital, resulting in ________ acceptable
investments.
*increasing; fewer; lower; more
88
The basic types of inventory are:
raw materials.
work-in-process.
finished goods.
89
Certain financing plans are termed conservative when:
the firm funds its seasonal and its permanent requirements with longterm debt
90
The motive for two firms to merge is:
synergy.
increasing managerial skills.
fund-raising.
economies of scale.
91
The use of a large amount of debt to finance the acquisition of other firms is a:
*leveraged buyout.
92
What is marginal tax rate?
Tax rate that applies to the next dollar of income earned.
93
What is average tax rate?
Calculated by dividing taxes paid by taxable income
94
What is fiance?
The science and art of how individuals and firms raise, allocate and invest money
95
What is earnings per share? (EPS)
The amount earned during the period on behalf of each outstanding share of stock, calculated by dividing the periods total earnings available for the firms stockholders by the number of shares of stock outstanding.
96
What is risk?
the chance that actual outsomes may differ from those expected
97
What is risk averse?
Requiring compensation to bear risk
98
If the expected return is greater than the required return on an asset, rational investors will:
buy the asset, which will drive the price up and cause expected return to decrease to the level of the required return
99
Which of the following statements is most correct?
One problem with following a residual dividend policy is that it can lead to erratic dividend payouts which may prevent the firm from establishing a reliable clientele of investors who prefer a particular dividend policy.
100
Which one of the following investment rules does not require the use of all possible cash flows in its calculations?
The payback period
101
Comparing net present value and internal rate of return analysis
they always result in the same accept/reject decision for independent projects.
conflicting rankings may result from differences in the magnitude and timing of project cash flows
102
Under New Zealand commercial law, it is an offence to undertake a merger or takeover:
if it results in a party acquiring or strengthening a dominant position in a market
103
Which of the following is least likely to be consistent with the optimal, primary objective of the finance manager?
Maximise profits.
104
Which of the following risk-return coordinates of a security on a graph is indicating an overpriced asset according to the Capital Asset Pricing Model?
When computing the weighted average cost of capital, the preferred weighing scheme is book value weights.
105
When making replacement decisions, the development of relevant cash flows is complicated when compared to expansion decisions due to the need to calculate ________ cash inflows.
Incremental
106
A bond that is sold to investors in the U.S. market denominated in the local currency but issued by a company from some other country, is called a:
Yankee bond
107
To manage the level of inventory, managers try to
turn over inventory as quickly as possible without losing sales from stockouts.
108
To deter a hostile takeover, some firms compensate their key executives with a favourable compensation package in the event of a takeover, which is called:
a golden parachute.
109
An increase in a firm's product sales price would result in ________, if all else is equal.
decreases in the financial break-even point and decreases in the accounting break-even point
110
The optimal capital structure is the one that balances return and risk factors in order to maximise ____________ by minimising ____________.
market value; the average cost of capital.
111
Which of the following statements regarding corporate governance is NOT true?
New Zealand firms are free to set their own corporate governance policies without any interference or oversight by government regulation.
112
What is the market price?
the prices of the firms shares as determined by the interactions of buyers and sellers in the secondary market.
113
What does the agency problem refer to?
The conflict that exists between managers of a business and the shareholders.
114
The firm that makes itself unattractive to potential buyers to defend against a takeover, is undertaking a ______ defence.
poison pill
115
The key variables in the owner wealth maximisation process are:
cash flows and risk
116
Which type of firm is characterised by a heavy reliance on retained earnings to take advantage of profitable projects and therefore pays only a small percentage of its earnings as dividends?
A growth firm
117
When a bond is sold to investors in the local market, denominated the local currency, but issued by a company from some other country, it is called a:
foreign board
118
Which of the following risk-return coordinates of a security on a graph is indicating a fairly-priced asset according to the Capital Asset Pricing Model?
The point is on the Security Market Line.
119
Of the capital budgeting techniques listed below, which is the LEAST likely to be consistent with shareholder wealth maximisation?
payback period
120
Which of the following statements is true?
Higher flotation costs increase the cost of new ordinary shares, and that leads to an increase in a company’s weighted average cost of capital.
121
The combination of a food processing firm and an IT company is an example of a:
conglomerate merger.
122
Which of the following statements is TRUE?
Preference shares typically provide holders with a fixed annual dividend.
123
An increase in a firm's fixed costs would result in ________, if all else is equal.
Increases in the financial break-even point and increases in the accounting break-even point
124
The following statements are consistent with the Just-in-Time inventory management system EXCEPT:
It allows the firm to avoid stockouts by keeping inventories to a maximum by receiving a regular flow of components and raw materials throughout the day.
125
Factors that prevent a firm from accepting all investment projects that provide an acceptable rate of return include
Capital rationing.
| Mutually exclusive projects.
126
The book value of an asset in any given year is equal to the:
original purchase price minus accumulated depreciation
127
According to Modigliani and Miller, in a perfect capital market the implications of a firm’s choice of capital structure are that financial leverage:
has no effect on firm value.
128
An increase in a firm's variable costs would result in ________, if all else is equal.
increases in the financial break-even point and increases in the accounting break-even point
129
The firm's ability to attract shareholders whose dividend preferences are similar to the firm's dividend policy is known as the:
clientele effect.
130
The true owner/s of the corporation is/are the:
shareholders.
131
When a firm undertakes a merger in order to eliminate redundant functions or increase market share, this is an example of:
a strategic merger.
132
Tok Ltd has recently become the target for a hostile takeover by Chicken Dance Ltd. Tok has now approached Tik Ltd to compete with Chicken Dance to take over Tok Ltd. This is an example of:
a white knight defence.
133
When working with the CAPM, which of the following factors can be determined with the most precision?
the risk free rate
134
All of the following investment rules use the concept of the time value of money
net present value
profitability index
internal rate of return
annualised net present value
135
Which of the following statements is most correct?
The capital structure that minimises the firm’s cost of capital is also the capital structure that maximises the firm’s share price.
136
Which of the following risk-return coordinates of a security on a graph is indicating an under-priced asset according to the Capital Asset Pricing Model?
The point is above the Security Market Line
137
A firm may accept a project with a net present value of zero because:
the project would maintain the wealth of the firm's owners.
138
The change in net working capital when evaluating a capital budgeting decision is:
the change in current assets minus the change in current liabilities
139
Which of the following is NOT true concerning corporate governance within a firm?
It is influenced more by individual investors than by institutional investors.
140
According to the EOQ model, the total cost of a firms inventory equals the sum of:
order costs and the carrying cost of the firm's inventory.
141
A bond that is sold to investors in the local market, denominated in a currency other than the local currency, and issued by a company from some other country, is called a:
Euro bond
142
The __________ is the rate of return a firm must earn on its investments in order to maintain the market value of its securities.
cost of capital
143
Which of the following statements is correct about a stock currently selling for $50 per share that has a 16% expected return and a 10% expected capital appreciation in perpetuity?
It is expected to pay $3 in annual dividends next year.
