FIN 534 MIDTERM PART 1

Question 1
Which of the following statements is
CORRECT?
Answer
The New York Stock Exchange is an
auction market with a physical location.
Capital market transactions involve
only the purchase and sale of equity securities, i.e., common stocks.
If an investor sells shares of stock
through a broker, then this would be a primary market transaction.
Consumer automobile loans are
evidenced by legal documents called “promissory notes,” and these
individual notes are traded in the money market.
While the distinctions are blurring
as investment banks are today buying commercial banks, and vice versa,
investment banks generally specialize in lending money, whereas commercial
banks generally help companies raise capital from other parties.
Question
2
Which of the following statements is
CORRECT?
Answer
Capital market instruments include
both long-term debt and common stocks.
An example of a primary market
transaction would be your uncle transferring 100 shares of Wal-Mart stock to
you as a birthday gift.
The NYSE does not exist as a
physical location; rather, it represents a loose collection of dealers who
trade stocks electronically.
If your uncle in New York sold 100
shares of Microsoft through his broker to an investor in Los Angeles, this
would be a primary market transaction.
While the two frequently perform
similar functions, investment banks generally specialize in lending money,
whereas commercial banks generally help companies raise large blocks of capital
from investors.
Question
3
You recently sold 100 shares of your
new company, XYZ Corporation, to your brother at a family reunion. At the
reunion your brother gave you a check for the stock and you gave your brother
the stock certificates. Which of the following statements best describes this
transaction?
Answer
This is an example of an exchange of
physical assets.
This is an example of a primary
market transaction.
This is an example of a direct
transfer of capital.
This is an example of a money market
transaction.
This is an example of a derivatives
market transaction
Question
4
Which of the following
statements is CORRECT?
Answer
While the distinctions are blurring,
investment banks generally specialize in lending money, whereas commercial
banks generally help companies raise capital from other parties.
A security whose value is derived
from the price of some other “underlying” asset is called a liquid
security.
Money market mutual funds usually
invest most of their money in a well-diversified portfolio of liquid common
stocks.
Money markets are markets for common
stocks and long-term debt.
The NYSE operates as an auction
market, whereas the Nasdaq is a dealer market.
Question
5
Money markets are markets for
Answer
Foreign stocks.
Consumer automobile loans.
U.S. stocks.
Short-term debt securities.
Long-term bonds.
Question
6
Which of the following could explain
why a business might choose to operate as a corporation rather than as a sole
proprietorship or a partnership?
Answer
Corporations generally find it
relatively difficult to raise large amounts of capital.
Less of a corporation’s income is
generally subjected to taxes than would be true if the firm were a partnership.
Corporate shareholders escape
liability for the firm’s debts, but this factor may be offset by the tax
disadvantages of the corporate form of organization.
Corporate investors are exposed to
unlimited liability.
Corporations generally face
relatively few regulations.
Question
7
You recently sold 200 shares of
Apple stock to your brother. The transfer was made through a broker, and the
trade occurred on the NYSE. This is an example of:
Answer
An over-the-counter market
transaction
A futures market transaction.
A primary market transaction.
A secondary market transaction.
A money market transaction.
Question
8
Which of the following statements is
CORRECT?
Answer
If expected inflation increases,
interest rates are likely to increase.
If individuals in general increase
the percentage of their income that they save, interest rates are likely to
increase.
If companies have fewer good
investment opportunities, interest rates are likely to increase.
Interest rates on all debt
securities tend to rise during recessions because recessions increase the
possibility of bankruptcy, hence the riskiness of all debt securities.
Interest rates on long-term bonds
are more volatile than rates on short-term debt securities like T-bills.
Question
9
Which of the following statements is
CORRECT?
Answer
The maximum federal tax rate on
personal income in 2010 was 50%.
Since companies can deduct dividends
paid but not interest paid, our tax system favors the use of equity financing
over debt financing, and this causes companies’ debt ratios to be lower than
they would be if interest and dividends were both deductible.
Interest paid to an individual is
counted as income for tax purposes and taxed at the individual’s regular tax
rate, which in 2010 could go up to 35%, but dividends received were taxed at a
maximum rate of 15%.
The maximum federal tax rate on
corporate income in 2010 was 50%.
Corporations obtain capital for use
in their operations by borrowing and by raising equity capital, either by
selling new common stock or by retaining earnings. The cost of debt capital is
the interest paid on the debt, and the cost of the equity is the dividends paid
on the stock. Both of these costs are deductible from income when calculating
income for tax purposes.
Question
10
Other things held constant, which of
the following actions would increase the amount of cash on a company’s balance
sheet?
Answer
The company purchases a new piece of
equipment.
The company repurchases common
stock.
The company pays a dividend.
The company issues new common stock.
The company gives customers more
time to pay their bills.
Question
11
Aubey Aircraft recently
announced that its net income increased sharply from the previous year, yet its
net cash flow from operations declined. Which of the following could explain
this performance?
Answer
The company’s operating income
declined.
The company’s expenditures on fixed
assets declined.
The company’s cost of goods sold
increased.
The company’s depreciation and
amortization expenses declined.
The company’s interest expense
increased.
Question
12
Which of the following statements is
CORRECT?
Answer
The primary difference between EVA
and accounting net income is that when net income is calculated, a deduction is
made to account for the cost of common equity, whereas EVA represents net
income before deducting the cost of the equity capital the firm uses.
MVA gives us an idea about how much
value a firm’s management has added during the last year.
MVA stands for market value added,
and it is defined as follows:
MVA = (Shares outstanding)(Stock price) + Book value of common equity.
EVA stands for economic value added,
and it is defined as follows:
EVA = EBIT(1 – T) – (Investor-supplied op. capital) x (A – T cost of capital).
EVA gives us an idea about how much
value a firm’s management has added over the firm’s life.
Question
13

Which of the following statements is
CORRECT?
Answer
All corporations other than
non-profit corporations are subject to corporate income taxes, which are 15%
for the lowest amounts of income and 35% for the highest amounts of income.
The income of certain small
corporations that qualify under the Tax Code is completely exempt from
corporate income taxes. Thus, the federal government receives no tax revenue
from these businesses.
All businesses, regardless of their
legal form of organization, are taxed under the Business Tax Provisions of the
Internal Revenue Code.
Small businesses that qualify under
the Tax Code can elect not to pay corporate taxes, but then their owners must
report their pro rata shares of the firm’s income as personal income and pay
taxes on that income.
Congress recently changed the tax
laws to make dividend income received by individuals exempt from income taxes.
Prior to the enactment of that law, corporate income was subject to double
taxation, where the firm was first taxed on the income and stockholders were
taxed again on the income when it was paid to them as dividends.
Question
14
Which of the following factors could
explain why Regal Industrial Fixtures had a negative net cash flow last year,
even though the cash on its balance sheet increased?
Answer
The company repurchased 20% of its
common stock.
The company sold a new issue of
bonds.
The company made a large investment
in new plant and equipment.
The company paid a large dividend.
The company had high amortization
expenses.
Question
15
Which of the following statements is
CORRECT?
Answer
The statement of cash needs tells us
how much cash the firm will require during some future period, generally a
month or a year.
The four most important financial
statements provided in the annual report are the balance sheet, income
statement, cash budget, and the statement of stockholders’ equity.
The balance sheet gives us a picture
of the firm’s financial position at a point in time.
The income statement gives us a
picture of the firm’s financial position at a point in time.
The statement of cash flows tells us
how much cash the firm has in the form of currency and demand deposits.
Question
16
Which of the following statements is
CORRECT?
Answer
Net cash flow (NCF) is defined as
follows:
NCF = Net income – Depreciation and Amortization.
Changes in working capital have no
effect on free cash flow.
Free cash flow (FCF) is defined as
follows:
FCF = EBIT(1 – T)
+ Depreciation and Amortization
– Capital expenditures required to
sustain operations
– Required changes in net operating
working capital.
Free cash flow (FCF) is defined as
follows:
FCF = EBIT(1 – T)+ Depreciation and Amortization + Capital expenditures.
Net cash flow is the same as free
cash flow (FCF).
Question
17
Analysts following Armstrong
Products recently noted that the company’s operating net cash flow increased
over the prior year, yet cash as reported on the balance sheet decreased. Which
of the following factors could explain this situation?
Answer
The company issued new long-term
debt.
The company cut its dividend.
The company made a large investment
in a profitable new plant.
The company sold a division and
received cash in return.
The company issued new common stock.
Question
18
If a bank loan officer were
considering a company’s request for a loan, which of the following statements
would you consider to be CORRECT?
Answer
Other things held constant, the
lower the current ratio, the lower the interest rate the bank would charge the
firm.
The lower the company’s EBITDA
coverage ratio, other things held constant, the lower the interest rate the
bank would charge the firm.
Other things held constant, the
higher the debt ratio, the lower the interest rate the bank would charge the
firm.
Other things held constant, the
lower the debt ratio, the lower the interest rate the bank would charge the
firm.
The lower the company’s TIE ratio,
other things held constant, the lower the interest rate the bank would charge
the firm.
Question
19
Which of the following statements is
CORRECT?
Answer
If a firm has the highest
price/earnings ratio of any firm in its industry, then, other things held
constant, this suggests that the board of directors should fire the president.
If a firm has the highest
market/book ratio of any firm in its industry, then, other things held
constant, this suggests that the board of directors should fire the president.
Other things held constant, the
higher a firm’s expected future growth rate, the lower its P/E ratio is likely
to be.
The higher the market/book ratio,
then, other things held constant, the higher one would expect to find the
Market Value Added (MVA).
If a firm has a history of high
Economic Value Added (EVA) numbers each year, and if investors expect this
situation to continue, then its market/book ratio and MVA are both likely to be
below average.
Question
20
A firm wants to strengthen its
financial position. Which of the following actions would increase its current
ratio?
Answer
Use cash to increase inventory
holdings
Reduce the company’s days’ sales
outstanding to the industry average and use the resulting cash savings to
purchase plant and equipment
Use cash to repurchase some of the
company’s own stock.
Borrow using short-term debt and use
the proceeds to repay debt that has a maturity of more than one year.
Issue new stock and then use some of
the proceeds to purchase additional inventory and hold the remainder as cash
Question
21
Cordelion Communications is
considering issuing new common stock and using the proceeds to reduce its
outstanding debt. The stock issue would have no effect on total assets, the
interest rate Cordelion pays, EBIT, or the tax rate. Which of the following is
likely to occur if the company goes ahead with the stock issue?
Answer
The times interest earned ratio will
decrease.
The ROA will decline.
Taxable income will decrease.
The tax bill will increase.
Net income will decrease.
Question
22
If the CEO of a large, diversified,
firm were filling out a fitness report on a division manager (i.e.,
“grading” the manager), which of the following situations would be
likely to cause the manager to receive a better grade? In all cases, assume
that other things are held constant.
Answer
The division’s DSO (days’ sales
outstanding) is 40, whereas the average for its competitors is 30.
The division’s basic earning power
ratio is above the average of other firms in its industry.
The division’s total assets turnover
ratio is below the average for other firms in its industry.
The division’s debt ratio is above
the average for other firms in the industry.
The division’s inventory turnover is
6, whereas the average for its competitors is 8.
Question
23
Considered alone, which of the
following would increase a company’s current ratio?
Answer
An increase in accounts payable.
An increase in net fixed assets.
An increase in accrued liabilities.
An increase in notes payable.
An increase in accounts receivable.
Question
24
Which of the following would,
generally, indicate an improvement in a company’s financial position, holding
other things constant?
Answer
The total assets turnover decreases.
The TIE declines.
The DSO increases.
The EBITDA coverage ratio increases.
The current and quick ratios both
decline.
Question
25
Companies A and C each reported the
same earnings per share (EPS), but Company A’s stock trades at a higher price.
Which of the following statements is CORRECT?
Answer
Company A trades at a higher P/E
ratio.
Company A probably has fewer growth
opportunities.
Company A is probably judged by
investors to be riskier.
Company A must have a higher
market-to-book ratio.
Company A must pay a lower dividend.