C124

Question 1

If accounts receivable increases, what is impact on CFO?

Answer 1

CFO decreases

Question 2

Are actual taxes paid the same as shown on GAAP income statement?

Answer 2

No. Actual taxes: IRS rules Income statement: GAAP

Question 3

Which decisions require using subjective estimates?

Answer 3

​Economic life of a new asset

Question 4

If there is a 30% chance of a recession, what is the probability of expansion?
​

Answer 4

70% - - the sum of the probabilities must equal 100%

Question 5

How much interest is paid on a 6% bond over 2 years and 3 months?
​

Answer 5

6% x 1000 = $60 per year $60 x 2.25 = $135

Question 6

How does a “prudent investor” select investments?
​

Answer 6

Seeks the highest return for “appropriate” amount

Question 7

What do points on the Efficient Frontier measure?
​

Answer 7

The maximum return for a given level of risk; maximum Return-to-risk ratio

Question 8

What is Beta?
​

Answer 8

Measure of a stock’s risk relative to the market

Question 9

Why are accurate forecasts important?
​

Answer 9

Plan for resources for production; accurate evaluation of capital projects

Question 10

Which ratio is used in valuing a private company?
​

Answer 10

PE ratio in the “Comparable Multiples” method

Question 11

What are the 3 costs associated with holding inventory?

Answer 11

​Product, storage, and opportunity

Question 12

What risk is eliminated by a diversified portfolio?
​

Answer 12

Idiosyncratic risk – risk affecting a single firm

Question 13

What are the impacts of outsourcing?

Answer 13

​Fewer U.S. jobs and lower priced products

Question 14

What are the impacts of tariffs?
​

Answer 14

More U.S. jobs and higher product costs for consumers

Question 15

What securities are exempt from federal income taxation?
​

Answer 15

Municipal bond interest is tax-exempt. Treasury securities ARE taxable

Question 16

Why would a firm prefer to issue bonds rather than stock?

Answer 16

​Debt has lower required return; debt interest is tax deductible

Question 17

Impact on APY as the number of interest payments per year increase?

Answer 17

​APY increases

Question 18

What is the present value of future cash flows of a stock called?

Answer 18

​Intrinsic value = it is the “real” value of the stock; PV of cash to investor

Question 19

What indicates if a stock is a “good investment”?

Answer 19

The price of the stock is less than the “intrinsic value”

Question 20

In event of bankruptcy, what is the order of claims settlement?

Answer 20

Creditors, bonds, subordinated debt, Preferred stock, Common stock.

Question 21

What is a spontaneous account?

Answer 21

​One that changes with the level of sales - - current assets & liabilities.

Question 22

What is a discretionary account?
​

Answer 22

One that changes due to management decision - - bonds outstanding.

Question 23

If the financial ratios of 2 firms are compared, what is it called?

Answer 23

​Cross-sectional analysis

Question 24

What financial structure causes profitability to be more volatile?

Answer 24

Leverage: higher leverage ratios mean more volatile profits

Question 25

If debt is cheaper than equity, why not all debt?

Answer 25

​Bankruptcy risk: equity is the cushion against bankruptcy.

Question 26

If interest rates increase, what is the impact on WACC?

Answer 26

​Required returns on debt and equity increase - - thus WACC increases.

Question 27

The Prospectus contains what information?

Answer 27

​Audited financial statements, description of security, operating info.

Question 28

What is the purpose of the SEC? ​

Answer 28

To ensure that US investors in the U.S. markets are well informed.

Question 29

Why would totally domestic firm worry about international trade?

Answer 29

Competition from foreign firm imports to US

Question 30

If a firm’s ROE is greater than ROA, what does that mean?

Answer 30

The firm uses debt financing wisely to increase profitability.

Question 31

What is term that refers to corporate managers acting in their own interests rather than the stockholders? ​

Answer 31

Agency Cost. How to avoid? Tie compensation to stock price

Question 32

What is a “secured loan” or “secured bond”? ​

Answer 32

Firm pledges collateral to back the loan or bond, eliminating bankruptcy risk.

Question 33

What is “free cash flow”? ​

Answer 33

Cash flows from operations minus cash necessary for reinvestment in PPE

Question 34

Why would APY be greater than APR? ​

Answer 34

Interest payments more frequently than annually

Question 35

What determines when revenue is “recognized” on the income statement?

Answer 35

When the product is shipped or delivered to the customer

Question 36

What is possible bad side-effect of a high sales-to-inventory ratio?

Answer 36

​Lost sales because of lack of inventory

Question 37

What type of security can be exchanged for stock?

Answer 37

​Convertible bond

Question 38

What are the results of a firm moderately increasing leverage?

Answer 38

​Increased ROE, increased profit volatility, and decrease in WACC.

Question 39

What is goal of IFRS (International Financial Reporting Standards)?

Answer 39

Create a uniform set of accounting rules across countries.

Question 40

What is difference between Gordon Growth and CAPM? ​

Answer 40

CAPM: statistically measured; Growth model is just conceptual.

Question 41

How does a good credit rating from S&P and Moody’s affect the firm?

Answer 41

​Lowers the cost of financing.

Question 42

What are the 4 categories of financial ratios?

Answer 42

​Liquidity, efficiency, financing, profitability

Question 43

What are the 3 pitfalls of using financial ratios?

Answer 43

​Seasonal, timing, accounting

Question 44

Why does a firm hold cash?

Answer 44

“Operating balance”: pay bills; “Reserve balance”: for unforeseen cash needs.

Question 45

What permits the sales of securities without detailed SEC registration?

Answer 45

​Rule 144A (in U.S. markets) and Reg S (in foreign markets)

Question 46

The market risk premium for stocks is compensation for what?

Answer 46

​Systematic risk: that is, risk that cannot be diversified away.

Question 47

What happens if a firm adopts a project with a negative NPV?

Answer 47

Since the value of the firm is decreased, the stock price falls.

Question 48

If a bond’s yield is greater than the coupon rate, what is its price?

Answer 48

​Discount price

Question 49

What does the Modigliani-Miller (M&M) theory state?

Answer 49

​The debt-equity ratio does not affect WACC.

Question 50

What does recent evidence say about the M&M theory?

Answer 50

​The debt-equity ratio does affect WACC.

Question 51

If forecasted sales is greater SGR, what actions might a firm take?

Answer 51

​Sell bonds or stock and reduce dividend payouts.

Question 52

Are “sunk costs” included in the Initial Cash Flow of a capital project?

Answer 52

​No. Sunk costs have already been incurred, before evaluating the project.

Question 53

Which type of stock has voting rights?

Answer 53

​Common stock has voting rights; preferred stock does not.

Question 54

Which type of stock has voting rights?

Answer 54

​Common stock has voting rights; preferred stock does not.

Question 55

What are two ways to incent customers to pay sooner?

Answer 55

Discount for early payment; shorter period for full payment (i.e., shorter credit cycle)

Question 56

Firm A has greater operating leverage than firm B. If sales of both increase, what is impact?

Answer 56

​Firm A’s profit increases more than Firm B’s profit

Question 57

What items appear in an income statement, but not in statement of cash flows?

Answer 57

Accrual items such as depreciation expense and credit sales.

Question 58

57. Investment grade bonds have what Standard & Poor’s rating?

Answer 58

BBB or higher. Below BBB is deemed as “junk bonds”

Question 59

If a bond is down- graded (i.e., from AAA to A), what happens?

Answer 59

The price drops to increase the required return to compensate for increased risk.

Question 60

If corporate income tax rates increase, what is impact on WACC?

Answer 60

WACC decreases because the after-tax cost of bonds decreases.

Question 61

Diversification can eliminate what type of risk?

Answer 61

It eliminates idiosyncratic risk, but not systematic risk.

Question 62

What ratios are used in Working Capital Management?

Answer 62

Ratios that contain a current asset and/or current liability

Question 63

Capital budgeting require what 3 cash flows?

Answer 63

Initial cash outlay, yearly cash inflows, terminal cash flow

Question 64

Which security includes to right to vote in annual meetings?

Answer 64

Common stock

Question 65

What technique reduces risk in an investment portfolio?

Answer 65

Diversification

Question 66

What is a leveraged buyout?

Answer 66

Firm uses debt to buy another firm.

Question 67

Who oversees the systematic risk in banks?

Answer 67

FSOC Financial Stability Oversight Council

Question 68

Which cash flow statement refers to daily operations?

Answer 68

Cash Flow Operations

Question 69

If a firm changes the mix of bonds and stock, what impact on WACC?

Answer 69

It changes. I may increase or decrease

Question 70

What item is added to the balance sheet from the income statement?

Answer 70

Depreciation expense is added to Accumulated Depreciation

Question 71

What is impact of inflation?

Answer 71

Increases the cost of items; decreases the “real value” of cash flows

Question 72

What should a company do to manage working capital?

Answer 72

Collect quickly and pay slowly.

Question 73

What technique is used to reduce risk?

Answer 73

Hedging through futures, forwards, or swaps

Question 74

What are “recorded entries” versus “estimated entries”?

Answer 74

Purchase price of machine is “recorded”; depreciation is “estimated”

Question 75

Why would a firm’s stock price increase more than the industry average?

Answer 75

The firm’s profits from operations were better.

Question 76

How does WACC affect a firm’s growth rate?

Answer 76

A low WACC means there are more profitable investment opportunities

Question 77

The Prospectus includes what information?

Answer 77

Audited financial statements and firm business risks.

Question 78

Sarbanes Oxley requires what information to be disclosed?

Answer 78

Off-balance sheet risk, annual audit of internal controls.

Question 79

What does the Volker rules state?

Answer 79

Prohibits hedge fund investments by banks.

Question 80

What does FINRA do?

Answer 80

Monitor sales practices by securities dealers

Question 81

Why are investors more willing to sell stocks with gains than stocks with losses?

Answer 81

Investors are reluctant to acknowledge losses; hope for price rebound.

Question 82

What types of investments are most liquid?

Answer 82

Short term securities such as Treasury bills

Question 83

If a firm elects to skip scheduled dividends on preferred stock, what must it do?

Answer 83

Pay skipped preferred stock dividends before paying any common stock dividends.

Question 84

Why is it difficult to determine the value of a stock?

Answer 84

Uncertainty about the right inputs to the formulas

Question 85

What is Pecking Order Theory?

Answer 85

Preferred order of financing: retained earnings, debt, and lastly equity.

Question 86

What is “dividends in arrears”?

Answer 86

The firm elects to delay paying preferred stock dividends

Question 87

What security is referred to as a “hybrid”?

Answer 87

Preferred stock: has features like bonds and common stock

Question 88

How is the value of a firm measured in the “replacement cost” method?

Answer 88

Firm value based on the current market prices of the firm’s assets.

Question 89

The replacement cost method works for what type of assets?

Answer 89

Tangible assets with a market value; not intangible assets

Question 90

What types of borrowing does not required collateral?

Answer 90

“Unsecured” bonds/loans as opposed to “secured” bonds/loans