Financial Management Flashcards
Out of present value of single amount or present value of an annuity (if they are for the same amount), which will yield a higher value ?
The present value of a single amount has to be less than the present value of a annuity of equal amounts due within the same or less time.
Which will yield the highest value an annuity for 3 years or an annuity for 4 years?
If the annuities are for the same amount, the longer the annuity, the higher the present value.
What is the market rate of interest on a one-year U.S. Treasury bill?
The market rate of interest on a one-year U.S. Treasury bill would be the risk-free rate plus the inflation premium (for the expected rate of inflation during the life of the security), or 2% + 1% = 3%.
One-year U.S. Treasury bills are considered free of default risk, liquidity risk (because there is a very large and active secondary market for T-bills), and maturity risk (because they are for only one year).
How do you calculate effective interest when compensation balance requirement is involve?
The effective interest rate is calculated as the cost of borrowing divided by the funds available for use. In this question, the annual cost of borrowing is $40,000 ($500,000 x .08 = $40,000) and the funds available are $400,000 ($500,000 x [1.0 -.20] = $400,000). Therefore, the effective interest rate is $40,000/$400,000 = .10,
How is real interest computed?
The real interest rate is the stated (or nominal) rate of interest for a period less the rate of inflation for that period. If someone earned 2% on the checking account for the year and inflation for the year was 3%, then real interest rate was: 2% - 3% = -1%.
Which U.S. GAAP approach to determining fair value converts future amounts to current amounts?
Converting future amounts to current amounts is an income approach to determining fair value under the U.S. GAAP framework. Specifically, the use of discounted cash flows to determine the current value of those flows is an example of the income approach to determining fair value.
Conceptually, which U.S. GAAP approach for determining value is most likely to provide the best evidence of fair value?
The market approach to determining value will most likely provide the best evidence of fair value. The market approach is based on using prices or other relevant information generated by actual market transactions for assets or liabilities that are identical or comparable to those being valued.
Which of the following characteristics, if any, should be taken into account in valuing a specific item?
Location and condition.
Both location and condition of an item should be taken into account in assigning value to the item.
Under U.S. GAAP requirements, valuation may be based on what?
Exit price and not entry price.
Under U.S. GAAP, valuation should be based on an exit price and not on an entry price. An exit price is the price that would be received to sell an asset or be paid to transfer a liability in an orderly transaction between market participants as of the measurement date.
Which of the following types of active markets, if any, would be considered as providing level 1 inputs under the U.S. GAAP hierarchy of inputs for fair value determination?
Both the New York Stock Exchange and Over-the-Counter Market are the basis for level 1 inputs under the U.S. GAAP hierarchy of inputs for fair value determination. Both are active markets for the trading of securities.
A graph that plots beta would show the relationship between what?
Asset return and benchmark return.
A graph which plots beta would show the relationship between the return of an individual asset and the return of the entire class of that asset, as reflected in a benchmark return for the class.
How do you compute required rate of return for the investment?
Required rate = Risk-free rate + Beta(Expected rate - Risk-free rate)
Same as calculating cost of capital by using CAPM=
C=R+B(M-R) : cost of capital=risk free rate+beta(market rate of return-risk free rate).
What is most likely the nominal risk-free rate of return in the U.S.?
In the U.S., the rate paid on U.S. Treasury Bonds is considered the risk-free rate of return; that is, the rate of return that is paid for delayed use of funds by investing them, without any risk premium attached to or paid for default risk.
What are the limitations of the capital asset pricing model?
(a) It assumes that there are no restrictions on borrowing at the risk-free rate of return. (b) It assumes that no external costs are associated with the investment.(c) It fails to consider risk derived from other than variances from the asset class benchmark.
The time value money is not limitation because does consider the time value of money.
Which one of the following beta values indicates the least volatility? A. Beta = .5 B. Beta = .8 C. Beta = 1.0 D. Beta = 1.5
A beta of .5 indicates that the item to which it relates is one-half as volatile as the benchmark for all comparable items. A beta of .5 is less volatile than any higher beta.
Which one of the following characteristics is not an advantage of the Black-Scholes option pricing model?
A. Incorporates the probability that the price of the stock will pay off within the time to expiration.
B. Incorporates the probability that the option will be exercised.
C. Discounts the exercise price.
D. Accommodates options when the price of the underlying stock changes significantly and rapidly.
Accommodates options when the price of the underlying stock changes significantly and rapidly.
The Black-Scholes option pricing model does not accommodate options when the price of the underlying stock changes significantly and rapidly. The Black-Scholes model assumes that the stock for which the option is being valued increases in small increments.
Charles Allen was granted options to buy 100 shares of Dean Company stock. The options expire in one year and have an exercise price of $60.00 per share. An analysis determines that the stock has an 80% probability of selling for $72.50 at the end of the one-year option period and a 20% probability of selling for $65.00 at the end of the year. Dean Company's cost of funds is 10%. Which one of the following is most likely the current value of the 100 stock options? A. $1,000 B. $1,100 C. $6,875 D. $7,100
(A)The stock has an 80% chance of selling at $72.50 at the end of the option period. That is $12.50 above the option price. The stock has a 20% chance of selling at $65.00 at the end of the option period. That is $5.00 above the option price. Therefore, the value of the option is:
[(.80 x $12.50) + (.20 x $ 5.00)]/1.1T, or
[($10.00) + ($1.00)]/1.10, or
$11.00/1.10 = $10.00 x 100 shares = $1,000
Which one of the following is not a limitation of the basic Black-Scholes option pricing model?
A. It fails to consider the probability that the option will be exercised.
B. It assumes the stock does not pay dividends.
C. It assumes the risk-free rate of return used for discounting remains constant during the option period.
D. It assumes the option can be exercised only at the expiration date.
A. It fails to consider the probability that the option will be exercised.
Failing to consider the probability that the option will be exercised is not a limitation of the basic Black-Sholes option pricing model. The basic Black-Scholes option pricing model does consider the probability (likelihood) that the option will be exercised.
Which one of the following is not a factor routinely considered in valuing a stock option?
A. Time until expiration date.
B. Risk-free rate of return.
C. Exercise price of the option.
D. Industry classification of the stock.
Correct!
The industry classification of the stock is not a factor routinely considered in valuing a stock option.
Which one of the following options, A through D, is most likely to have the greatest value (all other things being equal)?
Expiration Risk-Fre Interest Rate Stock Beta
A 3 Yrs. 3.0% 2.00
B 1 Yr. 4.0% 1.00
C 2 Yrs. 2.0% 1.60
D 8 Yrs. 4.5% 4.00
Option D is most likely to have the greatest value. The value of a stock option generally increases the longer the time to expiration, the higher the risk-free interest rate, and the higher the volatility of the stock. Of the options A through D, option D has the longest time to expiration, is in the highest risk-free interest rate environment, and the related stock has the highest beta.
A business with a net book value of $150,000 has an appropriate fair value of $120,000. Charles Harvey, one of three owners, has decided to sell his 10% interest in the business. Which one of the following is most likely the amount at which Harvey can sell his interest? A. $40,000 B. $15,000 C. $12,000 D. less $12,000
D. less $12,000
How is the P/E ratio for a share of common computed?
Market price/EPS.
The price/earnings (P/E) ratio is computed as the market price of the stock divided by the earnings per share (EPS). Note that both values are on a per share basis and the resulting calculation shows the relationship between the price of a share of stock in the market and the earnings for each share of stock.
Which one of the following is not a major approach for assigning a value to an entire going business? A. Market approach. B. Income approach. C. Cost approach. D. Asset approach.
C. Cost approach.
The cost approach is not a major approach to assigning value to an entire going business. The market approach, the income approach and the asset approach are the major approaches to assigning value to an entire going business.
Current Assets $100,000 current Liabilities =$30,000
Investments =$25,000 Long-term Liabilities 75,000
Fixed Assets 75,000 Common Stock 70,000
_________ Retained Earnings 25,000
Total Assets $200,000 Total L + Equity $200,000
In a common-sized balance sheet, which one of the following percentages would be shown for current liabilities? A. 15.0% B. 17.6% C. 28.5% D. 30.0%
In a common-size balance sheet, each item is measured as a percentage of total assets (or total liabilities plus equity). Thus, the calculation would be:
$30,000/$200,000 = 15.0%
Which approach to valuing a business is most likely to be appropriate when the business has been losing money and is going to be sold in a distressed sale?
The asset approach
Asset approach values a business by adding (summing) the values of the individual assets that comprise the business. When a business is losing money and is going to be sold in a distressed sale, the value of the individual assets is a better basis for valuing the business than would be other methods of valuation (e.g., market approach or income approach).
When is common-size financial statements are useful in making comparisons?
Between Entities and Over Time.
Common-size financial statements are prepared by converting each amount to a percentage of a total amount on each financial statement. For example, revenues and expenses are converted to a percentage of total revenues. Such percentages are useful in comparing financial statements between entities and over time for the same entity.
The land and building that constitute a strip shopping mall were valued using the recent sales price of a comparable strip shopping mall located across the street. The method of valuation would be an example of the A. Income approach. B. Market approach. C. Asset approach. D. Cost approach.
Using the recent sales price of a comparable asset as a basis for valuing another asset is an example of the market approach to business valuation. The market approach values a business by comparing it to other entities with highly comparable characteristics for which the value is readily determinable. For example, the value of a publicly traded entity with a readily determinable value may be used as the basis for establishing the value of a highly comparable private entity.
What is the formula use to compute the basic approach used to capitalize earnings to determine the value of a business?
Annual earnings/Required rate of return
Annual earnings is divided by the required rate of return in order to capitalize earnings, and get the value of a business. The amount so determined is the total capital value for which the annual earning would provide the required rate of return.
What are three things to consider when valuing a business?
I. Nonpublic entities are likely to be more difficult to value than publicly traded entities.
II. The conditions in the macroeconomic environment should be considered in valuing an entity.
III. The status of the industry in which a business operates should be considered in valuing the entity.
Which one of the following is not an income approach to the valuation of a business? A. Discounted cash flow. B. Comparable sales. C. Earnings multiple. D. Free cash flow.
The use of comparable sales is not an income approach to valuation of a business, it is a market approach. Under the comparable sales approach, the value of a business is determined by comparing it to other entities with comparable characteristics for which the value is more readily determinable.
Which one of the following is least likely to be the reason an entity would seek a valuation of the entity as a going concern?
A. In connection with a planned sale of the entity.
B. In connection with a property tax determination.
C. In connection with developing a buy-sell agreement among the owners.
D. In connection with developing a settlement with the estate of a recently deceased owner
An entity would not seek to determine the value of an entity as a going concern in connection with a property tax determination. Valuation for property tax purposes would be concerned only with the value of the separate taxable assets of the entity, not with the value of the entity as a going concern.
Assume the following abbreviated Income Statement:
Revenues $100,000 Cost of Goods Sold 60,000 Gross Profit $ 40,000 Operating Expenses 20,000 Finance Expense 5,000 Net Income $ 15,000
In a common-size income statement, which one of the following percentages would be shown for Finance Expense? A. 33.33% B. 12.50% C. 8.33% D. 5.00%
In a common-size income statement, each item is measures as a percentage of total revenues. Thus, the correct calculation is:
$5,000/$100,000 = 5.00%.
Which one of the following is not a qualitative forecasting method? A. Market research surveys. B. Time series models. C. Delphi method. D. Executive opinion.
Time series models are not a qualitative forecasting method. Time series models are quantitative forecasting methods that use patterns in past data to predict future values.
Which one of the following sets best reflects the relationship between the method of forecasting and the nature of forecasting?
Qualitative methods are subjective in nature while quantitative methods are objective in nature.
Business forecasting can use either quantitative or qualitative techniques. Quantitative techniques are objective in nature and rely on mathematical calculations and determinations. Qualitative techniques are subjective in nature and rely on judgment and opinion.
Which one of the following sets shows each type of business forecasting in the correct method classification?
Qualitative Methods Quantitative Methods
Delphi method Causal models
Executive Opinion Delphi method
Time series models Causal models
Executive Opinion Market research surveys
The Delphi method is a qualitative method and causal models are quantitative methods of business forecasting. The Delphi method is a qualitative forecasting method that involves development of a consensus by a group of experts using a multi-stage process to converge on a forecast. Causal models make forecasts based on relationships between variables.
Which one of the following forecasting methods is based on extrapolation of past data? A. Delphi method. B. Causal models. C. Time series models. D. Market research.
Time series models are based on extrapolation of past data. Specifically, time series models use past values or patterns to predict a future value or values.
Which one of the following sets shows the most likely method appropriate for short-term and long-term forecasting?
Short-term Forecasting Long-term Forecasting
Time series models Market research surveys
Causal models Time series models
Time series models Delphi method
Delphi method Time series models
Times series models are most likely appropriate for short-term forecasting and the Delphi method is most likely appropriate for long-term forecasting. Time series models use past values or patterns to predict a future value or values, but the longer the forecasting period, the less likely will the past values or patterns be relevant to those future values. The Delphi method is a qualitative forecasting method that involves a group of experts developing a consensus using a multi-stage process to converge on a forecast, which is a particularly useful approach for long-term forecasting.
Data patterns that reflect an upward movement over a long period of time would describe which one of the following patterns?
A. Cycles.
B. Horizontal.
C. Trend.
D. Random
Trend patterns reflect an upward (or downward) movement over a long period of time.
Which one of the following is not a causal model approach to forecasting? A. Decomposition. B. Regression analysis. C. Economic statistical models. D. Input-output models.
Decomposition is not a causal model approach to forecasting. Decomposition is the removal of the effects of various patterns from a set of time series data.
Which one of the following statements describes a difference between the simple moving average and the weighted moving average times series models for forecasting?
A. The weighted moving average model uses more prior time periods in getting an average than does the simple moving average.
B. The simple moving average model is based on using the prior 12 periods for forecasting, whereas the weighted moving average can be based on any number of prior periods.
C. Under the simple moving average model for forecasting, the raw prior values are not adjusted, whereas under the weighted moving average model the prior values are adjusted.
D. The weighted moving average model for forecasting will provide a better forecast than the simple moving average model.
Under the simple moving average model for forecasting, the raw prior values are not adjusted, whereas under the weighted moving average model the prior values are adjusted.
The simple moving average uses unadjusted raw prior period values, whereas the weighted moving average uses prior data adjusted by assigning different weights (or emphasis) to some or all prior values.
Each month Fuco, Inc. forecasts its next three months sales using the average of its actual sales for the most recent 12 months. Which one of the following times series models is Fuco using to forecast sales? A. Naïve. B. Weighted moving average. C. Exponential smoothing. D. Simple moving average.
The simple moving average uses an average of a specific number of the most recent periods’ actual values, without adjusting those values, as a forecast for a future period or periods.
Which one of the following would be a time series model for forecasting that reduces random fluctuations in data? A. Deseasonalized trend. B. Weighted moving average. C. Exponential smoothing. D. Seasonal index.
Exponential smoothing is a technique to reduce random fluctuations in time series data with declining weights assigned to data as it becomes older.
Which one of the following is not a time series pattern? A. Cyclical. B. Seasonal. C. Trend. D. Naïve.
Naïve is not a times series pattern, but a simple method of forecasting that uses the immediate prior period’s actual value as a forecast for the next period.
Which of the following statements concerning the discounted payback period method of evaluating capital projects is/are correct?
I. It is useful in evaluating the liquidity of a project.
II. It measures total project profitability.
III. It results in a longer computed payback period than does the undiscounted payback period method.
A. I only. B. I and III, only. C. II and III, only. D. I, II and III
Statements I and III are correct, but statement II is not correct. The discounted payback period method does not measure the total project profitability, it measures only the period required to recover the initial investment. The total profitability or loss of the project is not assessed.
