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D076- ALL UNIT TESTS Questions and Answers
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What are the main services offered by financial institutions? - ✔✔Accepting a wide variety of deposits, offering investment products, providing loans, and brokering financial transactions What is the main objective of personal financial goals? - ✔✔To maximize individual utility Which task does the financial manager of a firm perform that involves the issuance of new stocks and bonds? - ✔✔Making financing decisions Why is understanding the definition of finance important in managing personal finances? - ✔✔It helps individuals compare the costs and benefits of an action to determine whether to take that action. In which type of market would a company issue bonds or stocks for the first time? - ✔✔Primary market Which type of financial institution is a mutual fund? - ✔✔Investment institution Which financial institution specializes in managing and administering retirement funds? - ✔✔Pension funds Which type of economic indicator is the consumer price index? - ✔✔Lagging indicator
What does the term ethical refer to? - ✔✔The accepted standards of conduct that guide a person's behavior A company's officers and board of directors are selling their stocks in the firm at higher prices due to false accounting reports that made the stock seem more valuable than it truly was. Which ethical issue is occurring in this situation? - ✔✔Agency problem due to conflicting interests Which area of finance involves deciding which assets to invest in to create wealth in the future? - ✔✔Investments What is the main goal of a firm? - ✔✔To maximize owner wealth What are financial managers doing if they evaluate whether it is worth spending money on research and development for a new product? - ✔✔Making an investment decision Which type of financial market is where securities such as stocks and bonds are traded after their initial issuance? - ✔✔The secondary financial market What type of financial institution is an insurance company? - ✔✔Contractual Which financial institution invests funds contributed by a company to provide retirement funds for the company's employees? - ✔✔Pension fund Personal income is which type of economic indicator? - ✔✔Coincident
What is the term for the risk that changes in interest rates will impact the value of a bond? - ✔✔Interest rate risk What is another name for the cost of capital? - ✔✔Discount rate What is the name for the minimum rate of return that an investor or lender will accept for investments?
- ✔✔Required rate of return The nominal interest rate of an investment is 8%, and the inflation rate is 3%. What is the real interest rate? - ✔✔5% Which action reduces the future value of cash flows? - ✔✔Receive all cash flows later than expected. How is risk defined in finance? - ✔✔The possibility that the realized or actual return will differ from what we expect Which example below is considered a market risk factor? - ✔✔An unexpected change in interest rate occurs. Why are ratios useful for analyzing and comparing company performance between firms of different sizes? - ✔✔They provide standardization. You are the financial manager of a firm. The firm is small and is struggling to collect cash from accounts receivable. Also, due to the nature of industry, inventories are illiquid. To make sure that the firm has
enough cash holdings for short-term obligations, you decide to create a new ratio of cash to short-term obligations. What is this scenario an example of? - ✔✔Flexibility Why are activity ratios also called efficiency ratios or asset use efficiency ratios? - ✔✔Because they measure how well a company uses its assets to generate sales or cash. What type of ratio is used to consider how a firm is financed and to assess a firm's ability to pay interest and pay back long-term obligations? - ✔✔Financing ratios What does a net margin of 7% indicate? - ✔✔For every dollar of revenue, 7 cents remain for the equity holders after all other costs are covered. Firm A has an average collection period of 67 days, and the industry norm is 40 days. What can the firm do in order to be competitive with accounts receivable management in the industry? - ✔✔Tighten the credit standards for its customers. What is the difference between the current ratio and the quick ratio? - ✔✔Inventory is excluded in the calculation of the quick ratio. Which term is used to describe the stock of a firm with market-to-book ratio of less than 1? - ✔✔Value stock What does inventory turnover assess? - ✔✔The inventory management of a firm
What does high inventory turnover relative to the industry and competitors indicate? - ✔✔The firm does not hold enough inventory and is making its customers wait longer to receive their purchased goods. What is the difference between return on assets (ROA) and return on equity (ROE)? - ✔✔ROE considers the capital structure of a company, while ROA does not. MiniCo recently spun off of BigCo. Both companies have the same leverage and asset turnover ratios, but MiniCo is underperforming on its return on equity to shareholders. If MiniCo would like to improve its return on equity, which action would help? - ✔✔Reduce costs to improve its overall profitability. What is the name for a forecast of short-term events that helps a company understand if it has sufficient cash? - ✔✔Cash budget What is the purpose of a monthly cash budget? - ✔✔To control cash inflows and outflows so you can balance income with expenditures and savings In which situation would a firm need to borrow cash? - ✔✔When the beginning cash balance plus the net cash is less than the minimum cash balance required for the month How can you use the envelope method of budgeting to monitor cash flows? - ✔✔Put the amount of money budgeted for each category of your expenses into labeled envelopes and then spend the money in each envelope on expenses in that category. How should you go about making changes to your budget? - ✔✔Prioritize the changes you want to make and then implement them gradually one by one to make sure they work.
You are a financial manager of a company. The marketing department has informed you that the projected sales growth for the upcoming year is 15%. As you conduct financial forecasting, you increase cash, accounts receivable, and inventory accounts by 15%—the same as the projected sales growth. What type of accounts are these? - ✔✔Spontaneous accounts What does it mean when a firm's calculated discretionary financing needed (DFN) is negative? - ✔✔The firm needs to consider getting extra financing from the bank. Which account is a spontaneous account? - ✔✔Accounts payable Why is the sustainable growth rate (SGR) useful? - ✔✔It gives the maximum growth rate that allows a firm to maintain its current financial ratios without issuing new equity. You are analyzing fixed assets to create pro forma financial statements for your company. You realize that, since sales will increase next year, you will also need your manufacturing capacity to increase by the same amount. Currently, you are operating at maximum capacity. You buy an entire new factory and multiple pieces of equipment that increase capacity to much more than you need to meet the sales growth. Which concept describes why such a large purchase was necessary? - ✔✔Fixed assets are lumpy. Jerry wants to begin budgeting his money. What are three principles that he should know before beginning the budgeting process? - ✔✔Keep records; understand the key areas of savings, expenses, and income; and eliminate consumer debt.
What would an analyst predict for a potential investment with an NPV of zero? - ✔✔The project would earn exactly the rate of return required by the firm. A financial analyst for the company Bobby's Books has been asked to evaluate a potential investment using a method that considers the time value of money. Is there more than one way to do this? - ✔✔Yes, the analyst could use both the NPV and the IRR. If two projects are mutually exclusive, which decision-making criterion will help you make the best decision about which project to accept? - ✔✔Net present value (NPV) Why might a firm prefer to raise debt capital through bonds instead of stocks? - ✔✔Bonds do not require a firm to give up any ownership. Why is it appropriate to calculate the value of a bond in the same way that the present value of an annuity is calculated? - ✔✔Bonds pay a coupon every six months, pay a constant coupon amount, and have a maturity date. Why is it important to consider the cost of capital in an ideal evaluation method of capital investment? - ✔✔Because cash flows for a project may be uncertain What must be determined in order to compare the values of two projects with differently timed cash flows that does not need to be determined for projects with similarly timed cash flows? - ✔✔Opportunity cost
What is the disadvantage of debt financing? - ✔✔Debt financing does not actually achieve an optimal capital structure for a company. How do you factor sunk costs into capital investment analysis? - ✔✔For the purposes of analysis, sunk costs are irrelevant. Beckingham Sports is an American sporting goods company. Based on a $400,000 market study and a $600,000 fee for consulting spent prior to the project, the firm can increase its annual operating cash flow by $3,000,000 by selling overseas. Because the firm was considering the expansion, it spent $2,000,000 to purchase a land for new factory and equipment. However, someone is making an offer to pay the company $3,000,000 for the land it purchased for the new factory. What is relevant to include in the company's capital budgeting decision? - ✔✔3,000,000 for the offer price of the land Why is NPV the most reliable method for evaluating investments? - ✔✔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. Suppose you are a manager at a firm. One of your financial analysts places a report on your desk of valuation calculations for some potential investment projects. When you look at the calculations later, you notice that the analyst did not indicate if she used the NPV or IRR method. However, you do notice that the results of the calculations are all percentages. What can you conclude? - ✔✔The analyst used the IRR method. You are considering a project that has a profitability index of 1. What does this mean? - ✔✔The project has the internal rate of return equal to the cost of capital.
Hannah is the financial manager of a firm. A project that she has recommended has been approved and will cost $5 million. Since the company does not have enough cash on reserve, Hannah must figure out how to raise enough money to start the project. She can choose whether to issue new bonds, new stocks, a mortgage loan, or some combination of those options. What task is Hannah performing in this scenario? - ✔✔Making a financing decision Maria and Mateo are setting financial goals. They decide that they need to save $200 each month to reach their goal of taking their children to visit their grandparents in Spain next summer. What is the objective of setting such a goal? - ✔✔To maximize individual utility Which professional works with individuals to help them achieve their financial goals? - ✔✔Financial planner Omar is about to purchase a new car for $30,000. He knows he wants to buy the car, but he is still trying to decide how to pay for it. He has barely over $30,000 in his bank account. He can either take out an auto loan from a bank or use a mix of cash and an auto loan. In this scenario, what is Omar doing? - ✔✔Financing a goal Which responsibility is a focus of the U.S. Securities and Exchange Commission? - ✔✔To protect investors Which type of financial institution provides individuals and firms access to financial markets? - ✔✔Investment institutions
Which financial institution includes entities that receive money from institutional investors and wealthy individuals to buy troubled companies to improve them and earn returns by selling them or going public? - ✔✔Private equity Yield curve is which type of economic indicator? - ✔✔Leading About a year ago, the short-term Treasury bill had 1.54% interest and the long-term Treasury note had 2.54% interest. This week, the 1-year Treasury bill has an interest rate of 3.13%, while the 10-year Treasury note has an interest rate of 2.28%. What does this information indicate about the future economy? - ✔✔It may indicate an economic downturn. What does the term legal describe? - ✔✔An action that is in accordance with the laws and rules set by an authority. Jack is a personal financial advisor. He is with a new client, and the client is asking him what he recommends for her portfolio. Jack knows that his firm's investment product performed well last year, but its performance changes from year to year—some years it is better than the market, and some years it is not. Also, the fee to invest in the product is higher than the fee to invest in a market index fund. If Jack sells his company's investment product, the customer's loyalty to the company is doubled. Which actions should Jack take? - ✔✔Give a personal recommendation of the company's product while explaining its performance relative to the market over the past several years. Why might a manager manipulate accounting procedures? - ✔✔To make the company's performance look good Which situation is an example of an agency problem? - ✔✔Managers follow their own interests instead of the owners' interest.
Lolo invested $30,000 today in an account that gives 3% interest. Starting one year from today, she will be able to pull out little over $3,500 a year. What does the $30,000 represent? - ✔✔Present value What makes the expected return subjective and different from other types of returns? - ✔✔The expected return is based on expectational data and the probability of different scenarios occurring. A company that produces soap, shampoo, lotion, and other personal care products has recently taken a hit due to a competitor's new product line. The company decides to reduce wages for its labor force to save money while the company focuses on building up its reputation again, but the company's labor force goes on strike to protest the pay cuts. What type of risk does the strike represent? - ✔✔Idiosyncratic risk Which description below correctly identifies one type of price risk? - ✔✔Operating risk—depends on the effect of the firm's operating decisions on its operating costs What is the name for the process of "spreading" money over many different assets? - ✔✔Diversification What is default risk? - ✔✔A firm-specific risk that comes from the probability of a loss resulting from a borrower's failure to repay a contractual obligation A company currently has a ratio of 1.5 but hopes to improve the ratio to 2 to align more with the industry benchmark. To achieve this goal, costs were cut in production through an investment in efficient equipment, and the company achieved a higher profit margin. If this continues, you are certain that the firm will achieve its goal in two years. What is this an example of? - ✔✔Progress measurement
For what purpose are market ratios used? - ✔✔To evaluate the current share price of a public firm's stock You are considering starting a new business to sell Widgets in your hometown. You can import the Widgets at a low cost, and you hope to be able to sell them for significantly more. Which ratio can help you calculate how much profit you will earn from the sale of each Widget? (Assume you are only considering the cost of the Widget, not any other operating costs.) - ✔✔Gross margin What allows an investor to determine which financial activities are contributing to changes in the return on equity? - ✔✔DuPont framework Knowing that you are taking this finance class, a friend asks you about two investment opportunities he is considering. He wants to know which of the firms is using its assets more efficiently to generate sales. Which set of information could help you determine this? - ✔✔Firm A has an asset turnover of 4, and Firm B has an asset turnover of 2.5. W&H Company wants to create a cash budget to better manage its cash flows. The financial manager knows that the firm's labor costs and materials costs are too high for the level of sales each month. The firm also needs to keep better track of its cash flows to assess its need for additional financing through short-term loans. W&H Inc.'s labor costs each month are an example of which item in a cash budget? - ✔✔Cash disbursement W&H Company wants to create a cash budget to better manage its cash flows. The financial manager knows that the firm's labor costs and materials costs are too high for the level of sales each month. The
You are a financial manager of a company. The marketing department has informed you that the projected sales growth for the upcoming year is 10%. As you conduct financial forecasting, you keep the long-term liabilities the same amount as the previous year and will discuss this account with the other managers later. What type of account is long-term liabilities? - ✔✔Discretionary account What does the discretionary financing needed (DFN) tell us? - ✔✔The total amount of funding that management will need to obtain through discretionary financing sources Company ABC would like to continue to grow, but in order to maintain control of all decisions and ownership, it wants to avoid issuing new stock. Which calculation will show the company's leadership the fastest that ABC can grow? - ✔✔Sustainable growth rate What is the major purpose of financial forecasting? - ✔✔To inform a company how business decisions will impact future growth A potential project to expand the size of an apartment complex will cost $100,000. Its calculated net present value is $5,000. Given this information, which statement is correct? - ✔✔The project should be accepted because it has a positive NPV. Why is it important to have an accurate, carefully calculated required rate of return as part of the NPV? - ✔✔An inaccurate required rate estimate could cause a firm to reject good projects or accept bad projects. The YTM of a bond went from 8% to 7%. What can be predicted about the price of the bond? - ✔✔It will increase.
A company is trying to decide which of four projects to invest in. Project 1 has an IRR of 14% and an NPV of $54,000. Project 2 has an IRR of 11% and an NPV of $67,000. Project 3 has an IRR of 9% and an NPV of $60,000. Project 4 has an IRR of 13% and an NPV of $47,000. If the company can do only one project, which project should it choose to add the greatest value to the firm? - ✔✔Project 2 The company Betsy's Wigs is considering three potential projects that are not mutually exclusive. The IRR, NPV, and PI for each project are listed in the table below. Use this information to rank the projects in the order in which Betsy's Wigs should accept them to bring the most value to the firm. Project 1 23% $820 1. Project 2 18% $880 1. Project 3 21% $790 1.35 - ✔✔Project 3, Project 2, Project 1 What is an opportunity cost? - ✔✔The loss of the ability to use an asset toward the next best project once you have invested it in another project Which scenario is an example of an opportunity cost that is not associated with cash flows? - ✔✔Albert decides to stay home and study for his test instead of going to the movies. How do corporations and purchasers of financial securities view returns? - ✔✔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.
