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.