Course Questions Flashcards

Question

A large corporation is looking to merge with another large corporation. Which financial institution can help them do this? * Private equity institution * Investment bank * Pension fund * Central bank

Answer 1

Investment bank Correct! Investment banks facilitate complex financial deals, like mergers.

Answer 2

* Lagging Correct! Lagging indicators change after the economy changes.

Answer 3

* To regulate inflation and unemployment Correct! Regulating inflation and unemployment is the main objective of the Federal Reserve and central banks, and it is accomplished by adjusting the interest rate.

Answer 4

* It may indicate an economic downturn. Correct! An inverted yield curve reflects the expectation that the economy will have low or negative growth in the future.

Answer 5

* They are analyzed during economic shifts to provide information about the current state of the economy. o Correct! Coincident indicators help analysts see the big picture of economic trends.

Answer 6

* To protect investors

Answer 7

* Investment institutions Correct! Investment institutions provide both individuals and firms access to financial markets.

Answer 8

* Private equity Correct! This is the role of a buyout private equity firm.

Answer 9

* Leading Correct. Leading indicators change before the economy changes.

Answer 10

It may indicate an economic downturn. Correct! Since the long-term Treasury interest rate is lower than the short-term rate, it has an inverted yield curve, which may indicate an economic downturn.

Answer 11

* Moral Correct! Moral reflects one’s beliefs about right and wrong, good and bad, or just and unjust.

Answer 12

* An ethical action is based on accepted standards of conduct. Correct! An ethical action conforms to accepted standards of conduct.

Answer 13

* Moral Correct! This is not a legal issue because the new practice complies with the law, and it is not an ethical issue because it is a commonly accepted practice within the industry. It is a moral issue because it deals with Lucas’s own sense of right and wrong.

Answer 14

* Legal Correct! A legal error would result in a predetermined penalty by the government.

Answer 15

* Nora is considering investing in a risky asset just to meet her monthly goal. Correct! Nora is caught between the obligation to meet her goal and the obligation to keep her clients’ money safe. As an investment manager, she is obligated to do what is best for the client.

Answer 16

* It often leads to decreased shareholder value for the business. Correct! Unethical behavior can lead to very costly results.

Answer 17

* Saving money by paying inadequate wages to workers overseas Correct! Other countries may not have laws that protect workers, such as minimum wage laws.

Answer 18

* Bondholders are primarily interested in making sure they will be paid back. Correct! If a company takes on a riskier project, there is a higher probability of the project being unsuccessful, which means that the bondholders may put themselves at a higher risk of not receiving their loan back.

Answer 19

* Safe projects with a higher chance of providing sufficient compensation Correct! Bondholders provide money for a company for a certain period of time and want companies to pay them back for their investment.

Answer 20

* A manager purchases a company car and allocates it as a company expense. Correct! This is a luxury that does not improve shareholder value and costs the company money.

Answer 21

* Aligning managers’ interests with shareholders’ interests Correct! This is most commonly done by compensating management with shares of ownership in the company.

Answer 22

* Consider all stakeholders involved Correct! First, you should identify and define the problem. Second, consider alternative courses of action. Third, consider all stakeholders involved.

Answer 23

An action that is in accordance with the laws and rules set by an authority. Correct! Legal means to follow the laws and rules set by an authority.

Answer 24

* Give a personal recommendation of the company’s product while explaining its performance relative to the market over the past several years. Correct! Giving a recommendation to sell a product is fine, but you should never hide other information. Sharing information about index funds and comparing your product to others is a fair action to take for the client.

Answer 25

* To make the company’s performance look good Correct! A manager might manipulate accounting procedures to inflate the earnings of a company, which would optimize bonuses and stock-price-related benefits for management.

Answer 26

* Managers follow their own interests instead of the owners’ interest. Correct! An agency problem occurs when the agent (a manager) does not act in the best interest of the owners.

Answer 27

Set a strict covenant that the company cannot easily achieve. Correct! By setting a strict covenant, there is a risk that the company may not meet its obligation, which would deter the company from taking on risky projects.

Answer 28

* Accepting a wide variety of deposits, offering investment products, providing loans, and brokering financial transactions Correct! Financial institutions such as banks, insurance companies, and mutual fund companies provide these services.

Answer 29

* To maximize individual utility Correct! You set goals and act to increase your satisfaction or happiness by taking care of necessities and achieving priorities.

Answer 30

* Making financing decisions Correct! Once investment decisions are made, a financial manager considers different possibilities of financing sources for the investments. This may include issuing new stocks and bonds.

Answer 31

* It helps individuals compare the costs and benefits of an action to determine whether to take that action. Correct! Any financial decision should make sense in terms of its costs and benefits.

Answer 32

* Primary market Correct! This is the purpose of a primary market.

Answer 33

* Investment institution Correct! Investment institutions provide individuals and firms access to financial markets.

Answer 34

* Pension funds Correct! Pension funds specialize in retirement funds.

Answer 35

* Lagging indicator Correct! CPI usually changes after the economy as a whole changes.

Answer 36

* The accepted standards of conduct that guide a person’s behavior Correct! Ethical refers to the accepted standards of conduct that guide a person’s behavior.

Answer 37

* Agency problem due to conflicting interests Correct! Accounting manipulation by management in pursuit of higher stock-related compensation is an example of an agency problem.

Answer 38

* Interest rate Correct! This is the definition of interest rate.

Answer 39

* As a percentage Correct! Interest is the percentage of the principal that a lender receives or that a borrower pays to use the money.

Answer 40

* It allows borrowers to pay to use the assets of another entity to accomplish their own goals. Correct! Because the funds do not belong to borrowers, they must pay to use them. This payment is the interest rate.

Answer 41

* Opportunity cost Correct! The required rate of return is composed of opportunity cost, risk, and inflation.

Answer 42

* There is greater risk involved and a higher opportunity cost. Correct! There is greater risk because you cannot ensure the return of your investment for a longer period of time, and there is a higher opportunity cost because you cannot use that money for other things for a longer period of time.

Answer 43

* Buying a brand new car worth $25,000 Correct! Buying a new car would be considered an opportunity cost because it is something you are giving up by keeping the money in your savings account.

Answer 44

* Inflation Correct! The price of the car simply went up by $1,562 due to inflation.

Answer 45

* Risk premium Correct! Risk premium is the compensation that investors take for the risk they must bear.

Answer 46

* Nominal rate Correct! The nominal rate is the rate at which invested money grows for a certain period and is the interest rate most often used in your daily life.

Answer 47

* Risk-free rate Correct! The risk-free rate describes the rate of return on an investment with no risk, so it just measures inflation and opportunity cost.

Answer 48

Workers want higher wages to keep their standard of living as prices increase, which pushes the prices even higher.

Answer 49

An increase in demand often causes an insufficient supply in the market, which causes prices to go up until the demand is once again equal to the supply.

Answer 50

Prices rise.

Answer 51

* Annual percentage rate Correct! The APR is the annual interest rate that is charged for borrowing money or that is earned through investment, and it is calculated on an annual basis.

Answer 52

* It is the minimum rate that a firm must surpass to accept a project. Correct! When a financial manager decides whether to invest in a certain project, the projected return needs to meet the minimum rate of return, or else the firm must “hurdle” the rate in order to accept the project.

Answer 53

* The rate at which the average price level of a basket of goods and services in an economy increases Correct! The rate at which the average price level of a basket of goods and services in an economy increases is the inflation rate.

Answer 54

* Inflation and opportunity cost Correct! The risk-free rate includes inflation and opportunity cost.

Answer 55

* Based on the inflation rate, she should expect this stock to provide a return higher than this for the associated risk. Correct! Since the inflation of 2–3% will reduce any nominal returns she receives by this amount, she would want a higher return to accommodate for the opportunity costs and risks associated with the investment.

Answer 56

Ordinary annuity Correct! This is the definition of an ordinary annuity. The keys are “at the end of each period,” “fixed period,” and “equal payments.”

Answer 57

* Future value Correct. Future value measures the worth of relative past cash flows. The $39,248.14 is relative future to other cash flows.

Answer 58

* Time value of money Correct! The time value of money is the concept that today’s dollar is worth more than a dollar in the future.

Answer 59

* A 30-year mortgage Correct! Even though the interest rate is the same, the longer the loan is, the more interest you pay for the mortgage.

Answer 60

* Because the benefits of investments received at different times are comparable only when you consider the time value of money Correct! With the time value of money, you can find today’s value of future cash flows to compare the costs and benefits of different investments.

Answer 61

* 1 Correct! The type is the cash flow type in the PV function. 1 = BEGIN, or an indication of an annuity due.

Answer 62

* PV function Correct! Since you are looking for a relative past value of future cash flows, you should use the PV function in Excel.

Answer 63

* NPV Correct! You can use one NPV function to find the present value of uneven cash flows.

Answer 64

* Annuity Correct. The fixed amount of $100 given every month is an annuity.

Answer 65

A return is the gain or loss on an investment over some period of time.

Answer 66

A hypothesized estimate of future returns under different scenarios based on expectational data

Answer 67

* Present value Correct. The $30,000 is invested before any cash flows, so it is a relative past cash flow. Therefore, this is the present value.

Answer 68

* The possibility that the realized or actual return will differ from the expected return Correct! This is an appropriate definition of risk.

Answer 69

* Market risk cannot be diversified away, and firm-specific risk can. Correct! Market risk is inherent in the economy as a whole and therefore cannot be diversified away.

Answer 70

* Firm-specific risk is the risk associated with problems that companies may face because of lawsuits, labor problems, or management decisions, among other factors. Correct! This is the appropriate definition of firm-specific risk.

Answer 71

* Firm-specific risk Correct! Firm-specific risk can be diversified away.

Answer 72

* Risk separation involves dispersing assets geographically instead of concentrating them in one location. Correct! This is the main difference between the two techniques.

Answer 73

* Buying home insurance—risk is transferred from the policyholder to the insurer Correct! This is a correct example of risk transfer.

Answer 74

1980 because the real rate was higher than in 2010

Answer 75

An example of market risk where the value of a bond is affected by changes in interest rates

Answer 76

* Both companies and individuals retain risk when they believe that the cost of pursuing an activity is less than the alternative. Correct! This is the correct reasoning behind risk retention.

Answer 77

* Utility companies have low systematic risk because as the market moves up and down, their level of risk will also move up and down but in a diminished way. Correct! Different firms have different levels of systematic risk.

Answer 78

* Stock investments are more risky over a shorter period of time than over a longer period of time. Correct! Time diversification refers to the idea that stock investments are more risky over a shorter period of time than over a longer period of time.

Answer 79

* The risk is higher for an investment with a higher return. Correct! The higher the risk an investor takes, the higher the reward the investor is compensated with.

Answer 80

* The expected return is based on expectational data and the probability of different scenarios occurring. Correct. The expected return is calculated from hypothesized or “best-guess” estimates of future prices or returns in different scenarios.

Answer 81

* Idiosyncratic risk Correct! Idiosyncratic risk is the same as firm-specific risk. Since the strike will most likely affect only this firm, it is a firm-specific risk.

Answer 82

* Operating risk—depends on the effect of the firm’s operating decisions on its operating costs Correct! This is the correct description of operating risk.

Answer 83

* Diversification Correct! The question stem is the definition of diversification.

Answer 84

* A firm-specific risk that comes from the probability of a loss resulting from a borrower’s failure to repay a contractual obligation

Answer 85

* Compound interest Correct. The compound interest is known as interests on interests and the principal instead of only on the principal.

Answer 86

* Inflation rate Correct. The question stem is the definition of inflation rate.

Answer 87

* An annuity due Correct. An annuity due is a series of equal payments made at the beginning of consecutive periods.

Answer 88

* Holding period return Correct. This is the definition of holding period return.

Answer 89

* Standard deviation Correct. Standard deviation is used to measure the total risk of securities.

Answer 90

* Interest rate risk Correct. This is the risk that changes in interest rates will impact the value of a bond.

Answer 91

* A firm’s ratios are compared with those of a benchmark peer group to determine the firm’s relative strength and performance. Correct! This is called cross-sectional analysis and is common in financial analysis.

Answer 92

* Because they are not regulated and can be changed or invented according to a firm’s needs Correct! Because financial ratios are an internal management tool, they are not subject to external rules and regulations.

Answer 93

* Ratios can be used to determine whether a firm is maximizing shareholder wealth. Correct! Ratios are used to evaluate managerial actions so shareholders can determine how effectively and profitably managers are using their invested capital.

Answer 94

* Benchmarking Correct! Benchmarking allows management to see how firms differ from one another and evaluate their performance relative to each other.

Answer 95

* Liquidity ratios Correct! Liquidity ratios measure a firm’s ability to meet short-term obligations without raising external capital.

Answer 96

* Because different types of ratios are needed to get information about different parts of a firm Correct! Using only one type of ratio in a full financial analysis of a firm would not tell you very much information about the firm. It is through the calculation of many ratios that an analyst will be able to see the bigger picture of the firm.

Answer 97

* What proportions of equity and debt a firm uses to finance its assets Correct! This information gives insight into the financial structure of a firm.

Answer 98

* Its liquidity ratio is increasing. Correct! Liquidity is a measure of the ability of a firm to convert short-term assets into cash. Paying off short-term loans quickly is an indication that a firm is quite liquid, so the firm’s liquidity ratio would be increasing.

Answer 99

* Liquidity Correct! A current ratio is a liquidity ratio because it assesses whether a firm can meet short-term obligations.

Answer 100

* The current ratio includes inventory in current assets, and the quick ratio does not. Correct! Inventory is the least liquid of all current assets. By not including inventory, the quick ratio is a more stringent test of a firm’s ability to meet short-term obligations.

Answer 101

* This firm is expected to grow in the future. Correct! The market-to-book ratio measures the growth prospects of a company. If the ratio is greater than 1, then the company is expected to grow.

Answer 102

* The percent of revenue that is retained as profit for the firm Correct! The net margin is net income divided by sales, which tells us how much a firm actually gets to keep after paying all its expenses.

Answer 103

* Net margin Correct! Net margin, total asset turnover, and leverage multiplier are the components of return on equity.

Answer 104

* It allows the company to determine how its abilities to generate profits, manage assets, and use financing contribute to the return on equity. Correct! The DuPont framework breaks the return on equity into each of these components using the profit margin, total asset turnover, and leverage ratio.

Answer 105

* Increasing debt financing Correct! Increasing debt financing increases the leverage multiplier, which means that the ROE increases.

Answer 106

* Return on assets Correct! ROE is ROA times leverage multiplier.

Answer 107

* SmallDog has a higher ROA than BigDog. Correct! Since SmallDog has no debt, the leverage multiplier of SmallDog is smaller than that of BigDog. Since both companies have the same ROE, SmallDog must have a higher ROA.

Answer 108

* Successfully cutting production costs to boost net margin Correct! Increasing net margin increases the ROE.

Answer 109

* Decreasing equity financing and increasing net margin Correct! Decreasing equity financing increases the leverage multiplier, therefore increasing ROE, and increasing net margin also increases ROE.

Answer 110

* Progress measurement Correct! You are comparing the company’s ratio to the goal and checking how the company is progressing toward the goal.

Answer 111

To evaluate the current share price of a public firm’s stock Correct! Market ratios are used to evaluate whether the current share of a public firm’s stock is correctly priced.

Answer 112

* Gross margin Correct! Gross margin tells you the percent of sales that become gross profit. The rest of the money earned from sales is used for the production of goods.

Answer 113

DuPont framework Correct! Decomposing the DuPont framework enables analysis of fundamental performance to determine which financial activities are contributing to changes in the return on equity.

Answer 114

* Firm A has an asset turnover of 4, and Firm B has an asset turnover of 2.5. Correct! Asset turnover is an indicator of how well a firm uses its assets to generate sales. Since Firm A generates $4 of sales for every $1 of assets, it is using its assets more efficiently.

Answer 115

They provide standardization. Correct! Ratios standardize financial data to make them comparable across firms, even those of distinctly different sizes.

Answer 116

* Flexibility Correct! Ratio analysis is flexible, so you can create a new ratio given the need of the firm.

Answer 117

* Because they measure how well a company uses its assets to generate sales or cash. Correct. Activity ratios measure how well a company uses its assets to generate sales or cash.

Answer 118

* Financing ratios Correct! Financing ratios consider how a firm is financed.

Answer 119

* For every dollar of revenue, 7 cents remain for the equity holders after all other costs are covered. Correct! Net margin tells us the percentage of sales that will become net income, which is the amount remaining for the equity holders.

Answer 120

Tighten the credit standards for its customers. Correct! The credit standards are too loose, so the customers are not paying Firm A as quickly as they are paying other competitors in the industry. Tightening the credit standards would shorten the average collection period.

Answer 121

* Inventory is excluded in the calculation of the quick ratio. Correct! Since inventory is the least liquid current asset, inventory is not included in the calculation.

Answer 122

* Value stock Correct! An M/B ratio of less than 1 is considered a value stock.

Answer 123

* The inventory management of a firm Correct! Inventory turnover tells us how well a firm is managing its inventory.

Answer 124

* Firm 1 is using a higher proportion of debt to finance its operations. Correct! The third component of return on equity is the leverage multiplier. Since the firms’ profit margins and asset turnovers are the same, it must be the leverage multiplier that is different. Using a higher amount of debt would result in a larger leverage multiplier and an overall higher return on equity.

Answer 125

Trend analysis

Answer 126

Cross-sectional analysis

Answer 127

Which type of ratio are suppliers interested in? Liquidity ratios

Answer 128

Liquidity ratios

Answer 129

Average collection period

Answer 130

On average, a firm takes 70 days to collect accounts receivable.

Answer 131

The firm does not hold enough inventory and is making its customers wait longer to receive their purchased goods.

Answer 132

ROE considers the capital structure of a company, while ROA does not.

Answer 133

Reduce costs to improve its overall profitability.

Answer 134

* Variances show that certain managers or divisions are not meeting targets. Correct! Cash budgets provide a basis for performance evaluation, and significant variance from predicted income, saving, and expense predictions indicates that management has not accurately assessed company operations.

Answer 135

* Keep records; develop savings, income, and expense strategies; and use a method that meets your needs and objectives Correct! All three of these principles are included in the six principles of budgeting as discussed in the course. The other three principles are know yourself; understand the key areas of savings, income, and expenses; and eliminate consumer debt and minimize long-term debt.

Answer 136

* Between one month and one year Correct! Cash budgets are not useful if they forecast less than one month, and it is not necessary for cash budgets to extend beyond one year in the future.

Answer 137

* Keep records; develop savings, income, and expense strategies; and use a method that meets your needs and objectives Correct! All three of these principles are included in the six principles of budgeting as discussed in the course. The other three principles are know yourself; understand the key areas of savings, income, and expenses; and eliminate consumer debt and minimize long-term debt.

Answer 138

* Cash budgets are used to forecast future financial need, aid in performance evaluation, and show when corrective action is needed. Correct! A good cash budget is used in these ways to help a firm operate more effectively and efficiently.

Answer 139

* Determine cash receipts, estimate cash disbursements, create the cash budget Correct! Doing these three things in this order can help you understand your business, understand the timing of cash flows, and keep track of borrowing requirements.

Answer 140

* Because it is specific and measurable Correct! Effective financial goals provide a specific and concrete target to focus on.

Answer 141

* Because the payment is the same amount each month Correct! A mortgage is a fixed expense, meaning that the payment amount is the same each month. Knowing which of your expenses are the same from month to month will help you budget more accurately.

Answer 142

* Compare your budgeted cash flows to your actual cash flows, and then revise the budget if necessary. Correct! This would allow you to keep your budget updated and effective so you can make the best use of your money.

Answer 143

* A graduation gift of $100 from your grandmother Correct! Since this is money, or income, coming into your cash budget, it represents a cash receipt.

Answer 144

* A rent check paid and cashed for the warehouse the company uses Correct! Since this expense is being paid this month and the cash is being withdrawn from the company’s account, this represents an example of a cash disbursement.

Answer 145

* Cash receipts, cash disbursements, and borrowing Correct! All three of these things affect cash flows in a business and should be included in a cash budget.

Answer 146

* Raw materials, rent, administrative expenses, interest, and selling expenses Correct! These are common products or services that a firm pays cash for during a specified period in order to generate sales.

Answer 147

* Sales include both cash sales and credit sales. Correct! Sales made on credit are not considered a cash receipt until the time period in which they are collected.

Answer 148

* When a person has a hard time remembering to record their cash flows and when they prefer to use a card to make purchases Correct! The software method is convenient for busy people who do not want to use cash or record cash flows by hand.

Answer 149

* Tracking your cash flows allows you to recognize where and how your money is spent so you can monitor your cash flows and revise your budget as needed. Correct! This is the first step in the budgeting process, and it is necessary in order to have an accurate budget going forward.

Answer 150

* Monitoring allows you to evaluate whether your actual cash flows are in line with your goals and to understand when correction or revision is needed. Correct! If a business did not monitor its budget, then tracking cash flows would be useless, and the business would not know if it was on track to reach its goals.

Answer 151

* Monitoring your budget allows you to identify problems, and then gradual revision and implementation of new processes allow you to fix those problems. Correct! This assures that the budget is as effective as possible at helping you reach your financial goals.

Answer 152

* Cash disbursement Correct! This is a cash disbursement for the firm because it represents cash going out during the month to pay employees.

Answer 153

* It should monitor its actual cash flows and then revise the cash budget if needed. Correct! Monitoring and revising the cash budget will allow W&H Inc. to identify and fix any problems that may arise.

Answer 154

* Cash budgets increase the lender’s trust in a firm by demonstrating the firm’s ability to make profits and repay loans. Correct! Cash budgets are detailed plans that show creditors that a firm will have enough cash from month to month to support its operations while staying within acceptable borrowing limits. A good cash budget allows creditors to feel secure in lending money to the firm.

Answer 155

* Knowing the cash position allows businesses to recognize when short-term loans are needed, while it allows individuals to analyze progress toward their personal financial goals. Correct! Individuals do not usually (and should not) need short-term loans.

Answer 156

* Monitoring involves using your tracking record to evaluate cash flows against your target, identify patterns and changes in cash flows, and gauge when correction is needed. Correct! By accessing cash flow records and knowing the remaining balance in the budget throughout the month and year, you will be able to monitor your budget in a way that will help you reach your financial goals.

Answer 157

* Financial forecasting supplements historical data with proposed investments or changes to allow for more accurate foresight. Correct! While understanding the past is key to moving forward, accounting for any proposals in your forecasts highlights where funding may be needed or where you might actually have more room to spend.

Answer 158

* To understand the implications of today’s decisions on tomorrow’s performance Correct! The goal of financial forecasting is to see the big picture of how financial decisions will affect future performance.

Answer 159

* How much financing will the firm need in the future? Correct! Finance forecasting helps us determine how much financing is needed in the future given today’s business decisions and growth.

Answer 160

* It helps decision makers understand the impacts of today’s actions on the future performance of the firm. Correct! This is the purpose of financial forecasting.

Answer 161

* To estimate how changes in cost structures or sales will impact the future cash flows and financing needs of the firm Correct! A solid financial model will allow you to see how changes in cost structures or sales growth will impact the firm’s future cash flows, financing needs, and cash budgeting.

Answer 162

* Accounts that vary naturally with sales Correct! By definition, when sales increase, the increase must be matched in another account, such as receivables

Answer 163

* Spontaneous accounts Correct! Spontaneous accounts vary naturally with sales.

Answer 164

* Cost of goods sold Correct! Cost of goods sold is a spontaneous account, so if sales go up, you would expect the cost of goods sold to increase by a similar percentage. Otherwise, the company would not be able to sell products.

Answer 165

* After pro-forma financial statements are forecasted using the percent of sales method Correct! Once all the financial statements are projected according to a given set of assumptions, you can determine the financing required to fund the predicted growth in sales.

Answer 166

* Increasing the plowback ratio Correct! Increasing the plowback ratio increases projected owners’ equity and thus decreases DFN.

Answer 167

* Leave the notes payable account constant in the projected financial statements. Correct! Notes payable is a discretionary account. Thus, you should leave it constant in the projected financial statements.

Answer 168

* Forecasting spontaneous accounts Correct! Spontaneous accounts change in proportion to sales growth.

Answer 169

* The growth rate that allows a firm to maintain its present financial ratios without issuing new equity Correct! The SGR is the growth rate that allows a firm to maintain its present financial ratios without issuing new equity.

Answer 170

* Increase the net margin. Correct! Increasing net margin increases the projected owners’ equity, thus reducing the DFN.

Answer 171

* Decreasing dividend payout Correct! Decreasing dividend payout increases earnings retention and thus increases the SGR.

Answer 172

* Fixed assets Correct! You can recheck capacity analyses to verify whether the firm really needs as large of an increase in fixed assets as projected in the forecast.

Answer 173

* Invest a substantial amount of money at one time to increase capacity. Correct! Investments in fixed assets are capital-intensive, meaning they require large payments at one point in time.

Answer 174

* How much room a firm has to grow without additional investment in fixed assets Correct! By using the ratio of actual sales to percent of capacity, you can determine how much sales growth the firm can support without needing to invest in further fixed assets.

Answer 175

* The additional financing needed given a firm’s expected future growth Correct! DFN is how much additional financing the firm will need given its expectations for future growth.

Answer 176

* Discretionary account Correct! Discretionary accounts do not vary automatically with sales but are left to the discretion of management. In this scenario, you kept the long-term liabilities account the same.

Answer 177

* The total amount of funding that management will need to obtain through discretionary financing sources Correct! DFN is the difference between the projected total assets and the projected total liabilities plus owners’ equity. Any discrepancy between the sources and uses of finance is extra financing that management must obtain.

Answer 178

* Sustainable growth rate Correct! Sustainable growth rate is defined as the rate at which a firm can grow without issuing new equity. It implies that the firm’s growth comes from the return on equity less any dividends.

Answer 179

* To inform a company how business decisions will impact future growth Correct. Financial forecasting helps decision makers understand how actions taken today can impact the firm’s future performance.

Answer 180

Keep records; understand the key areas of savings, expenses, and income; and eliminate consumer debt. Correct! These are three of the six principles of budgeting. The other three are know yourself; develop savings, income, and expense strategies; and use a method that meets your needs and objectives.

Answer 181

Income, expenses, and savings Correct! Knowing these things allows you to create a statement that accurately reflects your cash flows from month to month.

Answer 182

Because the firm did not make all sales on cash Correct! Some sales are made on credit rather than cash, and a portion of credit sales are collected in the following months after the sales.

Answer 183

Track cash flows, monitor cash flows, and revise the budget Correct! Doing these things helps you to use your money in the most efficient and effective way possible.

Answer 184

Withdrawing cash at the beginning of the period and then allowing only a certain amount to be available for each category of spending Correct! The envelope method involves putting a specific portion of your budget in cash in each envelope and only spending this amount during the period.

Answer 185

Making investment and financing decisions Correct! Whatever growth a firm anticipates must eventually be financed one way or another. Any investment in capital that exceeds what the firm retains from profit generates a discretionary financing need.

Answer 186

Non-spontaneous accounts Correct! Non-spontaneous, or discretionary, accounts do not vary automatically with sales but are left to the discretion of management.

Answer 187

Notes payable Correct! Notes payable does not vary with sales, and it is based on management discretion.

Answer 188

Sustainable growth rate Correct! The sustainable growth rate is the growth rate that allows a firm to maintain its present financial ratios without issuing new equity.

Answer 189

A firm must purchase an entire fixed asset rather than just the portion needed to increase production. Correct!. A factory or a piece of equipment must be purchased as a whole.

Answer 190

The NPV is positive. Correct! The NPV is an estimate of the dollar amount that would be added to the firm’s value as a result of the investment.

Answer 191

The cost of capital Correct! The cost of capital is affected by several things, such as different capital structures, timing of cash flows, and investment potential, which makes it difficult to calculate. An inaccurate prediction of the cost of capital may cause a firm to miss out on good projects or accept bad projects.

Answer 192

It calculates the dollar value that would be added to the firm by doing the project. Correct! The NPV is expressed as a dollar amount, and the result of the NPV calculation is exactly how much value would be added to the firm from that specific project.

Answer 193

It is not an effective way to compare projects of different sizes. Correct! NPV should not be used to compare projects of different sizes.

Answer 194

Internal rate of return (IRR) Correct! The IRR is easy to interpret, which makes it ideal for communicating the potential of an investment decision.

Answer 195

$0.00 Correct! The IRR is the rate of return that makes the NPV of a project equal to zero.

Answer 196

There are multiple sign changes in the calculation resulting in multiple IRRs, and it is impossible to tell which IRR is the correct one. Correct! Projects with unconventional cash flows must be valued using NPV.

Answer 197

Yes, because the IRR exceeds the cost of capital. Correct! When the IRR of a project is greater than the hurdle rate (the required rate of return, or cost of capital), it indicates that the company should accept the project.

Answer 198

Profitability index (PI) Correct! The PI is the ratio of discounted benefits to discounted costs.

Answer 199

It gives an idea of the return generated by a project. Correct! The PI scales different-sized projects so that their returns are comparable.

Answer 200

No, because the project would be generating cash inflows that are 20% short of the initial investment. Correct! As a rule, firms should accept only projects that have a PI greater than 1.

Answer 201

The cost of capital was underestimated, so you adjust the cost of capital to be higher. Correct! Increasing the cost of capital decreases the PI. Therefore, the new PI will be less than 1, and you should reject the project.

Answer 202

Stocks do not require the firm to repay the par value to investors. Correct! Stocks are shares of ownership in a firm, so the value of the stock is not required to be returned to investors.

Answer 203

A discount bond Correct! When the market price is less than the par price of a bond, you know that the YTM is currently higher than the coupon rate of that particular bond, so it is being sold at a discount.

Answer 204

Companies are allowed to skip payments to preferred stockholders but not to bondholders. Correct! If companies skipped bond payments, they would go into default. Companies can skip payments for preferred stock. However, by skipping these payments, companies are not able to pay common stockholders and must pay dividends in arrears at some point.

Answer 205

To purchase long-term assets for future growth Correct! Firms need funding for projects that will increase shareholder wealth in the future.

Answer 206

The PV function in Excel Correct! You should use the PV function in Excel given the rate, FV, nper, and rate input variables.

Answer 207

The growth rate is assumed to stay the same forever. Correct! Common stock valuation uses the constant growth model under the assumption that the growth rate is constant forever.

Answer 208

Capital budgeting Correct! Capital budgeting is the process of evaluating and planning for purchases of long-term assets.

Answer 209

An inaccurate required rate estimate could cause a firm to reject good projects or accept bad projects. Correct! While the required rate of return is the most difficult part of the NPV calculation to estimate, it is also the most important.

Answer 210

Project 2 Correct! The project with the highest NPV will bring the most value to the company.

Answer 211

Project 3, Project 2, Project 1 Correct! The projects with the highest PIs should be accepted first.

Answer 212

It will increase. Correct! There is an inverse relationship between YTM and the price of a bond.

Answer 213

The project should be accepted because it has a positive NPV. Correct! Because the NPV is positive, the project should be accepted.

Answer 214

Without considering every cash flow of a potential project, you do not know how the project will enhance the value of a firm. Correct! You need to include all the cash flows coming from a potential project to understand how

Answer 215

Net present value (NPV) Correct! When you compare mutually exclusive projects, you should look at how much value is added by each project, because you can do only one of them. Therefore, you should use the NPV method to choose a project.

Answer 216

It should choose the projects with the highest PIs until all capital has been used. Correct! By choosing the projects with the highest PI, Alphabet Co. will be able to use its limited capital effectively to create the most overall value for the firm.

Answer 217

It is the opportunity you forgo to invest in other options due to the time scope of an investment. Correct! Opportunity cost is the cost that you have to give up for something as a result of investing in something else.

Answer 218

Timing of cash flows is related to the opportunity cost associated with those cash flows. Correct! The cash flows of an investment need to be compared to the cash flows of other projects.

Answer 219

Project D should be chosen first given that the project will receive cash to sum to $600,000 the most quickly. Correct! Project D receives cash flows the most quickly of the four projects. Given the concept of the time value of money, Project D should generate the highest NPV.

Answer 220

A business must compensate investors for the risk that they are taking to invest in the business. Correct! Investors need a reason to part with their money.

Answer 221

The higher the risk investors have to take on, the higher return they require. Correct! Investors will take on more risk if there is potential for a higher return. The rate of return describes the inherent risk of a project.

Answer 222

Interest expense on debts is paid before taxes are calculated. Correct! This describes the tax shield advantage of debt.

Answer 223

How a company will fund its assets and operations—namely, what proportions of debt and equity the business will use Correct! This correctly characterizes a finance decision.

Answer 224

Any additional cash flows, whether in or out of the firm, that are created as a result of accepting a project Correct! This is the correct definition of incremental cash flows.

Answer 225

These cash flows are not a direct result of a specific project but are a general cost to the firm. Correct! These cash flows are irrelevant to your analysis.

Answer 226

Incidental cash flows are indirect cash flows that are not explicitly revenues or costs. Nevertheless, they must be included in the analysis. Correct! Incidental cash flows are included in analysis and non-incremental cash flows are not.

Answer 227

If your company is planning on launching a product, and that product is going to steal some of the sales of another of the company’s products, that loss of sales could be an incidental cost or revenue caused by the new product. Correct! This is the correct definition of cannibalization.

Answer 228

Profitability index (PI) Correct! The PI should be used first to compare the projects and then to rank them to maximize the value of the firm.

Answer 229

Albert decides to stay home and study for his test instead of going to the movies. Correct! The opportunity cost is going to the movies.

Answer 230

The present value of the benefits of the investment outweigh the present value of the costs of the investment. Correct! If the project provides more value than it costs, then mathematically it will add value to the company.

Answer 231

Purchasers of financial securities look at returns as the amount of money they require in order to lend or give their money to the corporation that issued those securities. Correct! This is a correct description of returns from the viewpoint of investors.

Answer 232

The loss of the ability to use an asset toward the next best project once you have invested it in another project Correct! The concept of opportunity cost is that because you use an asset to invest in one project, you lose the opportunity to use the same asset to do a different project.

Answer 233

The project would earn exactly the rate of return required by the firm. Correct! An NPV of zero indicates that a project will neither add nor take away value from a firm.

Answer 234

Yes, the analyst could use both the NPV and the IRR. Correct! Both NPV and IRR take into account the time value of money.

Answer 235

Net present value (NPV) Correct! When only one project can be chosen, the PI is not useful because it does not indicate the dollar value that a project will add to or take away from a firm.

Answer 236

Bonds do not require a firm to give up any ownership. Correct! This is attractive to a firm that needs funds for a project but wishes to maintain control.

Answer 237

Bonds pay a coupon every six months, pay a constant coupon amount, and have a maturity date. Correct! Bond cash flows are an annuity, a constant amount paid every period.

Answer 238

Because cash flows for a project may be uncertain Correct! This is the reason why you should consider the cost of capital.

Answer 239

Opportunity cost Correct! Opportunity cost must be determined to analyze two such projects.

Answer 240

Debt financing does not actually achieve an optimal capital structure for a company. Correct! Debt creates a tax shield, but there should be a mixture of debt and equity in an optimal capital structure.

Answer 241

For the purposes of analysis, sunk costs are irrelevant. Correct! Sunk costs are costs that have already been incurred whether you choose to do a project or not

Answer 242

3,000,000 for the offer price of the land Correct! If you do the project, you will miss the opportunity to sell the land for$3,000,000. This is an example of an opportunity cost.

Answer 243

It considers the time value of money, it tells you the dollar value that the investment will add to the firm, and it takes risk into account. Correct! These are the main advantages of the NPV, some of which are not included in other methods of valuation, which makes NPV the most reliable.

Answer 244

The analyst used the IRR method. Correct! IRR calculations are represented as percentages because they are rates of return.

Answer 245

The project has the internal rate of return equal to the cost of capital. Correct! PI = 1 means that the break-even point is the estimated cost of capital; in other words, the cost of capital and the rate of return should be exactly the same.

Answer 246

A par bond Correct! The market price of a par bond is the same as the par value.

Answer 247

For a preferred stock, a fixed amount is paid forever to compensate the investors. Correct! This is the case for preferred stocks, which are a type of perpetuity.

Answer 248

Because the value of a cash flow today is different from the value of a cash flow of the same dollar amount in 10 years Correct! You cannot directly compare dollar amounts received at different times.

Answer 249

Alexandra decides to spend $50 on some new clothes instead of using that money to pay her electric bill. The opportunity cost is having the electricity turned off. Correct! Because she bought new clothes, she did not pay her bills.

Answer 250

Management can analyze the different inherent risks that change the cost of capital to the firm. Correct! Each project will have its own inherent risks.

Answer 251

Cost of cannibalization Correct! The cost of cannibalization is the reduction in sales of a company’s own products due to the introduction of another similar product.

Answer 252

The consulting cost spent three months prior to the start of a project Correct! Since the cost was incurred before the start of the project, this is a sunk cost.