Multiple Choice Questions Flashcards
- (LO 1.1) Which of the following is true about finance?
a. Finance is the study of how and under what terms
savings (money) are allocated between lenders and
borrowers.
b. Finance is different from economics because economics
does not study how resources are allocated.
c. All parts of finance are not integrated.
d. Business finance is the only important part of finance.
a. Finance is the study of how and under what terms
savings (money) are allocated between lenders and
borrowers.
- (LO 1.2) According to Canada’s national balance sheet,
which of the following items is not a real asset?
a. Land
b. Machinery and equipment
c. Stocks
d. Residential structures
c. Stocks
- (LO 1.3) Which of the following is a correct combination
of primary fund lenders and fund borrowers in the financial
system?
a. Households and government
b. Households and non‐residents
c. Businesses and households
d. Government and non‐residents
a. Households and government
- (LO 1.3) Which of the following financial intermediaries
does not transform the nature of the underlying financial
securities?
a. Banks
b. Insurance firms
c. Mutual funds
d. Pension funds
c. Mutual funds
- (LO 1.4) A small investor from New Brunswick has just
purchased 100 common shares of a telecommunications
firm on the Toronto Stock Exchange. This is the first time
the investor has purchased this stock. This transaction is
an example of
a. a primary market transaction because it is the first
time the investor has bought the stock.
b. a primary market transaction because the money the
investor has invested will go directly to the firm.
c. a secondary market transaction because the investor
has bought the stock from other investors.
d. none of the above; this is a large block trade and will
be done using the OTC market (the “third market”).
c. a secondary market transaction because the investor
has bought the stock from other investors.
- (LO 1.4) What are secondary market transactions? How
do secondary markets facilitate the primary markets?
Secondary market transactions are those where ownership of existing shares changes hands, but the corporations or governments who originally issued the securities receive no financing; trading takes place between investors.
This is critical to the functioning of the primary markets, because governments and companies would not be able to raise financing if investors were unable to sell their investments if necessary.
- (LO 2.1) Which statement about sole proprietorships is
false?
a . The business has unlimited liability.
b. The business is easy to set up.
c. The business is hard to sell.
d. The income is taxed at a corporate rate.
d. The income is taxed at a corporate rate.
- (LO 2.2) Which of the following is the goal of a corporation?
a . operate in the legal sense
b . act in the “social interest”
c. maximize the wealth of its shareholders
d . all of the above
c. maximize the wealth of its shareholders
- (LO 2.4) What is the most important purpose of share
incentive plans?
a . compensate straight salary
b . align the interests of managers and shareholders
c . reward management
d. boost the share price
b . align the interests of managers and shareholders
- (LO 2.1) Janice borrowed $100,000 from friends and family to start her company (a sole proprietorship). Business has been poor recently, and Janice has decided to cease operations and liquidate the firm. She expects to obtain $108,000 from selling the assets of the company. How much money will the debt holders receive, and how much will be left for Janice? Would these figures be different if the company had been a corporation?
When operating as a sole proprietorship, all of the assets of the company belong to the owner; the company’s debts are also the owner’s debts. Janice will have to pay her friends and family (the debtholders) the full $100,000 they are owed. This will leave her with $8,000.
A corporation exists independently from its owners. The $108,000 obtained from selling the assets will first be used to pay the debtholders what they are owed. Any remaining funds will be paid to Janice. Because the value of the assets is greater than the money owed to the debtholders, the payments are the same as they were with the sole proprietorship.
- (LO 2.1) Suppose Janice obtains only $93,000 when she sells all the assets of the firm described in Practice Problem 18. How much money would the debt holders receive if the business were a corporation? If it were a sole proprietorship? How much would Janice receive in each case?
The debtholders will receive the entire $93,000 obtained from selling the assets. The remaining $7,000 that they were owed will not be paid because the company has no more funds. Furthermore, the limited liability of shareholders in a corporation means that the debtholders have no legal right to expect Janice to pay them the rest of the money. Nonetheless, Janice receives nothing from the asset sale.
If the business were a sole proprietorship, the debtholders would receive the $93,000 from the sale of assets. However, they would also have the right to force Janice to pay them the extra $7,000 they were owed. Janice would not only receive no money from the sale of the assets, she would have to pay the extra $7,000!
- (LO 2.4) When you hired Dan to manage your business,
you agreed to pay him a bonus of 10 percent of profits at
the end of each year. The company now has a choice
between two projects (it can take on only one of them).
Project A will generate profits of $50,000 per year, and
detailed financial calculations show that it will increase
the value of the firm by $123,100. Project B will generate
profits of $40,000 per year but will increase the firm’s value by $125,600. Which project is Dan likely to choose and why? Which project would you, the owner of the firm,
prefer?
Dan is likely to prefer Project A because it will result in a $5,000 annual bonus for him, whereas Project B would provide only a $4,000 annual bonus. On the other hand, you (the owner) would be better off choosing Project B as it creates more value.
- (LO 3.4) Which of the following is not a current asset?
a. cash
b. marketable securities
c. inventories
d. land
d. land
- (LO 3.2) The balance sheet for a small firm shows total
assets of $529,500 and total liabilities of $379,000. What is the shareholders ’ equity?
Assets = Liabilities + Shareholders’ Equity
Assets - Liabilities = Shareholders’ Equity
$529,500 - $379,000 = Shareholders’ Equity
Shareholders’ Equity = 150,500
- (LO 3.3) A firm’s net earnings are $85 million and it has 60 million shares outstanding. Determine its earnings per share.
Earnings per Share = Net Income / Number of Shares
EPS = $85M / 60M =$1.42
What is a firm’s net working capital?
Current Assets - Current Liabilities
2. (LO 4.2) Which of the following ratios is not in the DuPont system? a . net profit margin b . leverage c . asset turnover d . current ratio
d . current ratio
- (LO 4.2) To increase return on equity (ROE),
a . increase equity, all else being unchanged.
b . decrease debt outstanding, all else being unchanged.
c . decrease corporate tax rate, all else being unchanged.
d . decrease earnings after tax, all else being unchanged.
c . decrease corporate tax rate, all else being unchanged.
To increase return on equity (ROE), we could decrease equity, increase debt level, decrease corporate tax rate (increase NI), or increase earnings after tax (NI), holding all the others unchanged.
How do we calculate a company’s Gross Profit Margin and Operating Margin?
Gross Profit Margin = (Revenues - Cost of Goods Sold) / Revenues
Operating Margin = EBIT / Revenues
- (LO 4.6) The current ratio is measured as
a. current assets minus current liabilities.
b. current assets divided by current liabilities.
c. cash and cash equivalents divided by current
liabilities.
d. current liabilities divided by current assets.
b. current assets divided by current liabilities.
Current ratio indicates how many dollars of current assets are available for one dollar of current liabilities.
How do we calculate the ROE ratio, simplified?
ROE = Net Income / Shareholders’ Equity
How do we calculate the leverage ratio?
Leverage Ratio = Total Assets / Shareholders’ Equity
How do we calculate the ROA ratio, simplified?
ROA = Net Income / Total Assets
In the DuPont System, what are the two components of ROA?
Net Profit Margin (Operating Efficiency) = Net Income / Revenues
Turnover Ratio (Asset Use Efficiency - Measure of Productivity) = Revenues / Total Assets
- (LO 4.7) The shares of Corine’s Candies Inc. are currently trading at $18.20. There are four million shares outstanding. The company’s 2016 net income was $5.2 million.
Find the market value of equity for the company and the
P/E ratio of the shares.
Market value of equity = Current price per share x Number of shares = $18.20 x 4M = $72.8M
P/E Ratio = Price per share / Earnings per share
Earnings per share = net income / Number of shares
P/E Ratio = $18.20 / ($5.2M / 4M)
P/E Ratio = 14
- (LO 5.2, 5.3) What is the total amount accumulated after
six years if someone invests $ 1,000 today with a simple
annual interest rate of 8 percent? How about with a compound annual interest rate of 8 percent?
a . $ 1,400, $ 1,469
b . $ 1,469, $ 1,400
c . $ 1,480, $ 1,587
d . $ 1,600, $ 1,816
c . $ 1,480, $ 1,587
- (LO 5.2, 5.3) At the end of 2015, Malcolm invested $ 10,000 in two bank accounts. The expected value of each bank account for the years 2015 to 2026 are represented graphically.
A linear graph represents an account paying _______ interest, while a curved graph represents an account paying _______ interest.
simple; compound
- (LO 5.3) Suppose an investor wants to have $15 million to retire 25 years from now. How much would she have to
invest today if her annual rate of return is equal to 5
percent?
a . $ 6,666,667
b . $ 4,429,542
c . $ 600,000
d . $ 21,345
b . $ 4,429,542
- (LO 5.2, 5.3) Which of the following is false?
a. The longer the time period, the smaller the present
value, given a $100 future value and holding the
interest rate constant.
b. The greater the interest rate, the greater the present
value, given a $100 future value and holding the time
period constant.
c. A future dollar is always less valuable than a dollar
today if interest rates are positive.
d. The discount factor is the reciprocal of the compound
factor.
b. The greater the interest rate, the greater the present
value, given a $100 future value and holding the time
period constant.
7 . (LO 5.3) Maggie deposits $ 10,000 today and is promised a return of $ 16,000 in eight years. What is the implied annual rate of return?
a. 5.86%
b. 7.16%
c. 6.39%
d. 6.05%
d. 6.05%
- (LO 5.3) How long will it take Mike to triple his investment if he can earn an annual rate of return of 9 percent?
a. 15.5 years
b. 13.9 years
c. 12.7 years
d. 10 years
c. 12.7 years
- (LO 5.4) Jan plans to invest $ 2,000 in an equity fund every year end beginning this year. The expected annual return on the fund is 15 percent. How much would she expect to have at the end of 20 years?
a . $ 237,620
b . $ 176,424
c . $ 204,887
d . $ 178,424
c . $ 204,887
- (LO 5.4) Jan plans to invest $ 2,000 in an equity fund every year end beginning this year. The expected annual return on the fund is 15 percent. She plans to invest for 20 years. What is the present value of Jan’s investments?
a . $ 12,625
b . $ 12,519
c . $ 14,396
d . $ 12,396
b . $ 12,519
- (LO 5.4) What is the present value of a perpetuity with an annual year‐end payment of $ 1,500 and expected annual rate of return equal to 12 percent?
a . $ 14,000
b . $ 13,500
c . $ 11,400
d . $ 12,500
d . $ 12,500
- (LO 5.3) When Jon graduates in three years, he wants to throw a big party, which will cost $800. To have this
amount available, how much does he have to invest
today if he can earn a compound return of 5 percent
per year?
N = 3; FV = 800; I/Y = 5; PMT = 0
PV = 691.07
- (LO 5.6) If Alysha puts $ 50,000 in a savings account paying 6 percent per year, determine how much money she will have in total at the end of the first year if interest is
compounded:
a. annually
b. monthly
c. daily
k = (1 + QR/m)^(m/f) - 1
PV = -50,000; PMT = 0;
a. annually (m = 1): k = 0.06; FV = 53,000
b. monthly (m = 12): k = 0.0617; FV = 53,085
c. daily (m = 365): k = 0.0618; FV = 53,090
- (LO 5.4) Mary‐Beth is planning to live in a university residence for three years while completing her degree. The annual cost for food and lodging is $ 6,500 and must be paid at the start of each school year. What is the total present value of Mary‐Beth ’ s residence fees if the discount rate (interest rate) is 6 percent per year?
N = 3; I/Y = 6; PMT = -6,500
PV = 18,417.05
- (LO 5.4) Grace, a retired librarian, would like to donate
some money to her alma mater to endow a $ 5,000 annual scholarship. The first scholarship will be awarded in five years. The university will manage the funds and expects to earn 3 percent per year. How much will Grace have to donate so that the endowment fund never runs out?
- Calculate funds needed at the end of four years
PV = PMT / k = 5,000 / 0.03 PV = 166,666.67
- Discount this value to today
PV = 166,667/(1.03)^4 = 148,081
- (LO 5.4) Muriel would like to support the education of her favourite grand‐nephew, Stephen, who plans to begin university in three years. How much will Muriel have to invest today, at 5 percent, to be able to give Stephen $ 6,000 at the end of each year for four years?
- Calculate funds needed at year 3
N = 4; I/Y = 5; PMT = -6,000 PV = 21,275.70
- Discount this value to today
N = 3; I/Y = 5; PMT = 0; FV = 21,275.70 PV = 18,378.75
- (LO 5.6) A bank is currently offering a savings account
paying an interest rate of 9 percent compounded quarterly. It would like to offer another account, with the same effective annual rate, but compounded monthly. What is the equivalent rate compounded monthly?
k = (1 + QR/m)^(m/f) - 1
k = (1 + 0.09/4)^(4/12) - 1 k = 0.00744 = 0.744%
k = 12 * 0.744% = 8.933%
- (LO 5.4) Felix will need $ 10,000 per year for four years to pay for tuition. How much will Felix ’ s parents have to invest at the end of each year for the eight years before he begins his studies if their savings earn compound interest at 7 percent per year? Assume the tuition payments occur at the end of each year.
- Calculate funds needed at year 8
N = 4; I/Y = 7; PMT = -10,000 PV = 33,872.11
- Find the tuition payment amount.
N = 8; I/Y = 7; FV = 33,872.11 PMT = 3,301.44
- (LO 5.4) Two friends, Abe and Betty, are planning for their retirement. Both are 20 years old and plan on retiring in 40 years with $1 million each. Betty plans on making annual deposits beginning in one year (total of 40 deposits) while Abe plans on waiting and then depositing twice as much as Betty deposits. If both can earn 5 percent per year, how long can Abe wait before he has to start making his deposits?
- Calculate Betty’s annual deposits.
N = 40; I/Y = 5; PV = 0; FV = 1,000,000 PMT = -8,278.16
- Calculate Abe’s annual deposits.
PMT = -8,278.16 * 2 PMT = -16,556.32
- Calculate Abe’s number of deposit years.
I/Y = 5; PV = 0; PMT = -16,556.32; FV = 1,000,000 N = 28.52 = 29 years
Abe can wait 11 years before he has to start making his deposits.
- (LO 5.4, 5.6) Amanda would like to borrow $ 50,000 to pay one year ’ s tuition at a private U.S. university. She would like to make quarterly payments and finish repaying the loan in five years. If the bank is quoting her a rate of 6 percent compounded monthly, determine her quarterly payment.
- Calculate the quarterly effective rate
k = (1 + QR/m)^(m/f) - 1 k = (1 + 0.06/12)^(12/4) - 1 k = 1.5075%
- Calculate her quarterly payment
N = 20; I/Y = 1.5075; PV = -50,000; FV = 0 PMT = 2,914.44
- (LO 5.4, 5.6) Wilma would like to borrow $ 250,000 to start her own business. She would like to make monthly payments to repay the loan in 10 years. If the bank is quoting her a rate of 6 percent compounded quarterly, determine her monthly payment.
- Calculate the monthly effective rate
k = (1 + QR/m)^(m/f) - 1 k = (1 + 0.06/4)^(4/12) - 1 k = 0.4975%
- Calculate her monthly payment
N = 120; I/Y = 0.4975%; PV = -250,000; FV = 0 PMT = 2,771.75
- (LO 5.4) Céline has just won a lottery. She will receive a payment of $ 6,000 at the end of each year for nine years. As an alternative, she can choose an immediate payment of $ 50,000.
a. Which alternative should she pick if the interest rate is
5 percent?
b. What would the interest rate have to be for Céline to
be indifferent about the two alternatives?
a. Which alternative should she pick if the interest rate is
5 percent?
Option 1: N = 9; I/Y = 5; FV=0; PMT = -6,000
PV = 42,646.93
Option 2: 50,000
Option B is better!
b. What would the interest rate have to be for Céline to
be indifferent about the two alternatives?
Option 1: N = 9; PV = 0; PMT = 6,000; PV = 50,000; FV = 0
I/Y = 1.5675%
