Fin Midterm Questions and Answers

Fin Midterm Questions and Answers 1. Which of the following best describes why the Valuation Principle is a key concept in making financial decisions? It shows how to make the costs and benefits of a decision comparable so that we can weigh them properly. 2. Which of the following is typically the major factor in limiting the growth of sole proprietorships? The amount of money that can be raised by such firms is limited by the fact that the single owner must make good on all debts. 3. Which of the following features of a corporation is LEAST accurate? earnings from a corporation are taxed only once 4. What is the process of double taxation for the stockholders in a C corporation? B. The corporation is taxed on the profits it makes, and the owners are taxed when this profit is distributed to them 5. Why in general do financial managers make financial decisions in a corporation, rather than the owners making these decisions themselves? There are often many owners, and they can often change as they buy and sell stock. 6. A company that produces racing motorbikes has several models that sell well within the motorcycle racing community and which are very profitable for the company. Despite having a profitable product, why must this company take care to ensure that it has sufficient cash on hand to meet its obligations? New models will require a lot of money to develop and bring to market before they generate any revenue. 7. Whose interests should a financial manager consider paramount when making a decision? the stockholders who have risked their money to become owners of the company 8. How do the shareholders of most corporations exercise their control of that corporation? by electing members of a board of directors 9. Which of the following is NOT a function of the board of directors? day-to-day running of the company 10. Which of the following would be best considered to be an agency conflict problem in the behavior of the following financial managers? Bill chooses to pursue a risky investment for the company's funds, because his compensation will substantially rise if it succeeds. 11. In which of the following relationships is an agency conflict problem LEAST likely to arise? the relationship between a driver and the passengers in a car regarding the safe driving of that car 12. What is the most common way that agency conflict problems are addressed in most corporations? by minimizing the number of decisions that a manager makes where there is a conflict between the managers interests and those of the shareholders 13. Which of the following should be true for an asset to be considered liquid? It can be easily bought and sold and the selling price is very close to the buying price at a given point in time. 14. Why is it difficult to determine the market price of a private corporation's shares at any point in time? There is no organized market for its shares. 15. What is the main reason that it is necessary for public companies to follow the rules and format set out in the Generally Accepted Accounting Principles (GAAP) when creating financial statements It makes it easier to compare the financial results of different firms 16. Which of the following best describes why a firm produces financial statements? to provide interested parties, both inside and outside the company, with an overview of the longterm and short-term financial condition of a business 17. Which of the following best describes why the left and right sides of a balance sheet are equal? The assets must equal liabilities plus stockholder's equity, because stockholders' equity is the difference between the assets and the liabilities. 18. A small company has current assets of $112,000 and current liabilities of $117,000. Which of the following statements about that company is most likely to be true? Since net working capital is negative, the company will not have enough funds to meet its obligations. 19. What is the main problem in using a balance sheet to provide an accurate assessment of the value of a company's equity? Valuable assets such as the company's reputation, the quality of its work force, and the strength of its management are not captured on the balance sheet. 20. Which of the following balance sheet equations is INCORRECT? A) The balance sheet provides a snapshot of the firm's financial position at a given point in time. B) The balance sheet lists the firm's assets and liabilities. C) The balance sheet reports stockholders' equity on the right-hand side. D) The balance sheet reports liabilities on the left-hand side. The balance sheet reports liabilities on the left-hand side. 21. A public company has a book value of $128 million. They have 20 million shares outstanding, with a market price of $4 per share. Which of the following statements is true regarding this company? Investors believe the company's assets are not likely to be profitable its market value is worth less than its book value. 22. Which ratio would you use to measure the financial health of a firm by assessing that firm's leverage? debt-equity or equity multiplier ratio 23. Company A has current assets of $42 billion and current liabilities of $41 billion. Company B has current assets of $2.7 billion and current liabilities of $1.8 billion. Which of the following statements is correct, based on this information? Company A is less likely than Company B to have sufficient working capital to meet its short-term needs. 24. What is a firm's net income? A) the difference between the sales and other income generated by the firm, and all costs, taxes, and expenses incurred by the firm in a given period B) the last or "bottom" line of the income statement C) a measure of the firm's profitability over a given period D) all of the above D all of the above 25. Which of the following is NOT considered to be an operating expense on the income statement? A) administrative expenses and overhead B) corporate taxes C) salaries D) depreciation and amortization B) corporate taxes 26. Which of the following statements regarding the income statement is INCORRECT? A) The income statement shows the earnings and expenses at a given point in time. B) The income statement shows the flow of earnings and expenses generated by the firm between two dates. C) The last or "bottom" line of the income statement shows the firm's net income. D) The first line of an income statement lists the revenues from the sales of products or services. A) The income statement shows the earnings and expenses at a given point in time. 27. Which of the following is NOT a reason that the income statement does not accurately indicate how much cash a firm has earned? A) It includes entries for the depreciation of assets. B) It does not include entries for expenditures on inventory. C) It does not include entries for collection of money from account receivables. D) It includes cash inflows from services rendered. D) It includes cash inflows from services rendered. 28. Which of the following is the LEAST likely explanation for a firm's high ROE? A) The firm is growing. B) The firm is able to find investment opportunities that are very profitable. C) The firm has very efficient use of its assets. D) The firm enjoys high sales margins. A) The firm is growing. 29. Which of the following is the overarching principle that a financial manager should follow when making decisions? A. Decisions should be on behalf of the firm's owners that give the greatest benefit to those owners, the firm's employees, and the firm's other stakeholders B. Decisions should provide benefit to the firm without incurring costs greater than those benefits to others C. Decisions should increase the value of the firm to its investors D. Decisions should generate the greatest benefits for the firm C. Decisions should increase the value of the firm to its investors 30. What is a competitive market? a market in which a good can be bought and sold at the same price A competitive market is one where there are numerous producers that compete with one another in hopes to provide goods and services we, as consumers, want and need. In other words, not one single producer can dictate the market. Also, like producers, not one consumer can dictate the market either. This concept is also true where price and quantity of goods are concerned. One producer and one consumer can't decide the price of goods or decide the quantity that will be produced. A great example of competitive market is farming. There are thousands of farmers and not one of them can influence the market or the price based on how much they grow. All the farmer can do is grow the crop and accept whatever the current price is for that product. They do not get to determine the price they want to sell the crop for. 31. Why is the personal decision a financial manager makes as to whether to buy or to rent an apartment as a personal residence most like the professional decision that manager makes as to whether her firm should try to acquire a stake in a fast growing new Internet-based company? Both decisions should be made based upon the tradeoff benefits and costs across time. 32. Which of the following best explains why market prices are useful to a financial manager when performing a cost-benefit analysis? They can be used to convert different services and commodities into equivalent cash values which can be compared. 33. Which of the following best describes the valuation principle? The Valuation Principle shows how to make the costs and benefits of a decision comparable so that we can evaluate them properly. The value of a commodity or an asset to a firm or its investors is determined by its competitive market price. When the value of the benefits exceeds the value of the costs in terms of market prices, the decision will increase the market value of the firm. 34. Which of the following best explains why you cannot use the price of rolled oats at a local supermarket as the competitive market value of rolled oats? You can buy the oats at the price posted by the store, but the store will not buy oats from you for the same price. 35. ʺIf equivalent investment opportunities trade simultaneously in different competitive markets, then they must trade for the same price in both markets.ʺ What do we call the above statement? the Law of One Price 36. How can we convert the value of money from one point in time to another? using the current interest rate 37. You are scheduled to receive $10,000 in one year. What will be the effect of an increase in the interest rate on the present value of this cash flow? A) It will cause the present value to fall. 38. You are scheduled to receive $10,000 in one year. What will be the effect of an increase in the interest rate on the future value of this cash flow? C) It will have no effect on the future value. 39. You are given two choices of investments, Investment A and Investment B. Both investments have the same future cash flows. Investment A has a discount rate of 4%, and Investment B has a discount rate of 5%. Which of the following is true? A. The present value of cash flows in Investment A is lower than the present value of cash flows in Investment B. B. The present value of cash flows in Investment A is equal to the present value of cash flows in Investment B. C. The present value of cash flows in Investment A is higher than the present value of cash flows in Investment B. D. No comparison can be made - we need to know the cash flows to calculate the present value C. The present value of cash flows in Investment A is higher than the present value of cash flows in Investment B. 40. Which of the following is true about perpetuities? A. All else equal, the value of a perpetuity is higher when the interest rate is lower. B. All else equal, the value of a perpetuity is higher when the periodic cash flow is higher. C. If two perpetuities have the same present value and the same interest rate, they must have the same cash flows. D. All of the above are true statements. D all of the above are true statements