FINA 300: Exam #1 – Flashcards
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A successful investment is one that increases the value of the firm. T or F
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True
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Corporations that do not issue financial securities such as stock or debt obligations: -will not be able to increase sales. -cannot be profitable. -may not be able to generate sufficient funds to fulfill their needs. -do not face double taxation of their profits.
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may not be able to generate sufficient funds to fulfill their needs
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Which of the following would be considered a capital budgeting decision? -Planning to issue common stock rather than issuing preferred stock -Deciding to expand into a new line of products, at a cost of $5 million -Repurchasing shares of common stock -Issuing debt in the form of long-term bonds
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Deciding to expand into a new line of products, at a cost of $5 million
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The overall goal of capital budgeting projects should be to: -decrease the firm's reliance on debt. -increase the firm's sales. -increase the firm's outstanding shares of stock. -increase the wealth of the firm's shareholders.
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increase the wealth of the firm's shareholders
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The term "capital structure" refers to: -the manner in which a firm obtains its long-term sources of funding. -the length of time needed to repay debt. -whether the firm invests in capital budgeting projects. -which specific assets the firm should invest in.
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the manner in which a firm obtains its long-term sources of funding
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Which of the following would not be considered a real asset? -A corporate bond -A machine -A patent -A factory
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A corporate bond
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Which of the following statements best distinguishes the difference between real and financial assets? -Real assets have less value than financial assets. -Real assets are tangible; financial assets are not. -Financial assets represent claims to income that is generated by real assets. -Financial assets appreciate in value; real assets depreciate in value.
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Financial assets represent claims to income that is generated by real assets
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Which of the following would not be considered a financial asset? -A patent -A personal IOU -A checking account balance -A share of stock
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A patent
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The stockholders in a sole proprietorship are represented by: -the owner of the firm. -the general partner of the firm. -the board of directors of the firm. -no one; sole proprietorships have no stockholders.
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no one; sole proprietorships have no stockholders
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Which of the following would be considered an advantage of the sole proprietorship form of organization? -Wide access to capital markets -Unlimited liability -A pool of expertise -Profits taxed at only one level
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Profits taxed at only one level
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One common reason for partnerships to convert to a corporate form of organization is that the partnership: -faces rapidly growing financing requirements. -wishes to avoid double taxation of profits. -has issued all of its allotted shares. -agreement expires after ten 10 years.
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faces rapidly growing financing requirements
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When a corporation fails, the maximum that can be lost by an investor protected by limited liability is: -the amount of the initial investment. -the amount of the profit on the investment. -the amount necessary to pay the corporation's debts. -the amount of the investor's personal wealth.
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the amount of the initial investment
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Unlimited liability is faced by the owners of: -corporations. -partnerships and corporations. -sole proprietorships and partnerships. -all forms of business organization.
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sole proprietorships and partnerships
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A board of directors is elected as a representative of the corporation's: -top management. -stakeholders. -shareholders. -customers.
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shareholders
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The legal "life" of a corporation is: -coincidental with that of its CEO. -equal to the life of its board of directors. -permanent, as long as shareholders don't change. -permanent, regardless of current ownership.
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permanent, regardless of current ownership
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"Double taxation" refers to: -all partners paying equal taxes on profits. -corporations paying taxes on both dividends and retained earnings. -paying taxes on profits at the corporate level and dividends at the personal level. -the fact that marginal tax rates are doubled for corporations.
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paying taxes on profits at the corporate level and dividends at the personal level
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A corporation is considered to be closely held when: -only a few shareholders exist. -the market value of the shares is stable. -it operates in a small geographic area. -management also serves as the board of directors.
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only a few shareholders exist
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Corporations are referred to as public companies when their: -shareholders have no tax liability. -shares are held by the federal or state government. -stock is publicly traded. -products or services are available to the public.
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stock is publicly traded
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A common problem for closely held corporations is: -lack of access to substantial amounts of capital. -that shareholders receive only one vote each. -the separation of ownership and management. -an abundance of agency problems.
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lack of access to substantial amounts of capital
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Which of the firm's financial managers is most likely to be involved with obtaining financing for the firm? -Treasurer -Controller -Chief Operating Officer -Board of directors
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Treasurer
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In a large corporation, budget preparation would most likely be conducted by the: -treasurer. -controller. -chief financial officer. -financial manager.
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controller
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Corporate managers are expected to make corporate decisions that are in the best interest of: -top corporate management. -the corporation's board of directors. -the corporation's shareholders. -all corporate employees.
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the corporation's shareholders
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The primary goal of corporate management should be to: -maximize the number of shareholders. -maximize the firm's profits. -minimize the firm's costs. -maximize the shareholders' wealth.
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maximize the shareholders' wealth.
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Which of the following appears to be the most appropriate goal for corporate management? -Maximizing market value of the company's shares -Maximizing the company's market share -Maximizing the current profits of the company -Minimizing the company's liabilities
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Maximizing market value of the company's shares
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Profit maximization is not a well-defined corporate objective because: -it leaves open the question of which year's profits. -higher profits does not necessarily mean a better rate of return. -profits can be changed by using different accounting rules. -all of these.
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all of these
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Corporate financing comes ultimately from: -savings by households and foreign investors. -cash generated from the firm's operations. -the financial markets and intermediaries. -the issue of shares in the firm.
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savings by households and foreign investors
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A company can pay for its expansion in all the following ways except: -by using the earnings generated from its sale of obsolete equipment. -by persuading the director's mother to make a personal loan to the company. -by purchasing bonds in the secondary market. -by selling stock certificates for a new subsidiary.
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by purchasing bonds in the secondary market
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Excess cash held by a firm should be: -reinvested by the firm in projects offering the highest rate of return. -reinvested by the firm in projects offering rates of return higher than the cost of capital. -reinvested by the firm in the financial markets. -distributed to bondholders in the form of extra coupon payments.
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reinvested by the firm in projects offering rates of return higher than the cost of capital
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Compared to buying stocks and bonds directly, what are the advantages of investing in a mutual fund? -Mutual funds are efficiently diversified and professionally managed. -Investment returns are never taxed until withdrawn from the fund. -You can buy additional shares in the fund or cash out at any time. -All of these.
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Mutual funds are efficiently diversified and professionally managed
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Banks cover the costs of the service they provide primarily via: -a management fee. -a service charge. -an interest rate differential. -an operating fee.
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an interest rate differential
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Which of the following financial intermediaries has shown a preference for investing in long-term financial assets? -Commercial banks -Insurance companies -Finance companies -Savings banks
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Insurance companies
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Insurance companies can usually cover the claims of policyholders because: -the incidence of claims normally averages out. -they issue thousands of insurance policies. -the cost of paying for claims has already been factored into the price of the policies. -all of these.
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all of these
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U.S. bonds and other debt securities are mostly held by: -institutional investors. -households. -foreign investors. -state and local governments.
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institutional investors
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Liquidity is important to a mutual fund because: -a fund that is less liquid will attract more investors. -the fund's shareholders may want to redeem their shares at any time. -the fund's managers need liquidity to trade actively. -the fund needs to distribute payouts to its shareholders and managers periodically.
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the fund's shareholders may want to redeem their shares at any time.
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When corporations need to raise funds through stock issues, they rely on the: -primary market. -secondary market. -tertiary market. -centralized NASDAQ exchange.
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primary market
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A share of IBM stock is purchased by an individual investor for $75 and later sold to another investor for $125. Who profits from this sale? -IBM. -The first investor. -The second investor. -Profit is split between IBM and the investor.
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The first investor
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When Patricia sells her General Motors common stock at the same time that Brian purchases the same amount of GM stock, GM receives: -the dollar value of the transaction. -the dollar amount of the transaction, less brokerage fees. -only the par value of the common stock. -nothing
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nothing
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Which of the following financial markets is in one centralized location? -NYSE -NASDAQ -The over-the-counter market -The European Monetary Union
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NYSE
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Which of the following financial markets is not located in one centralized location? -NYSE -LSE -NASDAQ -CBOT
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NASDAQ
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A bond differs from a share of stock in that: -a bond represents a claim on the firm. -a bond has more risk. -a bond has guaranteed returns. -a bond has a maturity date.
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a bond has a maturity date
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Short-term financing decisions commonly occur in the: -primary markets. -secondary markets. -capital markets. -money markets
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money markets
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Long-term financing decisions commonly occur in the: -option markets. -secondary markets. -capital markets. -money markets
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capital markets
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You can buy silver in the: -capital markets. -foreign exchange markets. -commodities markets. -option markets
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commodities markets
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One reason suggesting that banks may be better than individuals at matching lenders to borrowers is that banks: -can shift loan risk to their deposit customers. -are motivated by the potential for profit. -do not have any income tax liability. -have information to evaluate creditworthiness.
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have information to evaluate creditworthiness
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Financial markets and intermediaries: -channel savings to real investment. -enable investors and businesses to reduce risk. -provide liquidity. -all of these
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all of these
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In general, what is changing as you read down the left-hand side of a balance sheet? -The assets are more fully depreciated. -The assets are growing in value. -The assets are increasing in maturity. -The assets are becoming less liquid
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The assets are becoming less liquid
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A balance sheet portrays the value of a firm's assets and liabilities: -over an annual period. -over any stated period of time. -at any stated point in time. -only at the end of the calendar year
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at any stated point in time
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Which of the following assets is likely to be considered the most liquid? -Marketable securities -Net fixed assets -Accounts payable -Inventories
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Marketable securities
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If the value of a firm's net fixed assets equals the value of the accumulated depreciation, from an accounting context the fixed assets are: -new. -fully depreciated. -one-half depreciated. -equal in value to the firm's current assets
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one-half depreciated
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If the balance sheet of a firm indicates that total assets exceed current liabilities plus shareholders' equity, then the firm has: -no retained earnings. -long-term debt. -no accumulated depreciation. -current assets
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long-term debt
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Net working capital is calculated by taking the difference between: -total assets and total liabilities. -inventory and accounts payable. -current assets and current liabilities. -cash and long-term debt.
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current assets and current liabilities
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A balance sheet may be considered backward-looking from the perspective that: -it works backward, starting with net income. -it records historic, not current values. -it cannot forecast the future. -it records costs over many previous periods.
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it records historic, not current values
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Which of the following is correct for a fully depreciated asset? -Market value is zero. -Market value is greater than book value. -Book value is greater than market value. -The relationship between market and book values is indeterminable.
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The relationship between market and book values is indeterminable
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Depreciation expense is used to: -allocate costs to all departments of the firm. -determine when an asset is fully paid off. -allocate historical cost over the life of an asset. -equate the historical cost and market values of an asset.
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allocate historical cost over the life of an asset
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When subtracting an asset's accumulated depreciation from its historic cost, the resulting value is termed the: -book value of the asset. -market value of the asset. -depreciation expense. -current asset value.
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book value of the asset
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Which of the following statements is true for a corporation with $1 million market value of equity, $2 million market value of assets, and 1,000 shares of outstanding stock? -Market value of liabilities exceeds book value of liabilities. -Market value of liabilities equals $1 million. -Book value per share equals $1,000. -Market value per share equals $2,000
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Market value of liabilities equals $1 million
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Calculate the EBIT for a firm with $4 million total revenues, $3.5 million cost of goods sold, $500,000 depreciation expense, and $120,000 interest expense. -$500,000 -$380,000 -$0 -($120,000)
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$0
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Retained earnings result from: -the sale of additional shares of stock to investors. -income not paid to shareholders. -an excess of assets over liabilities. -market values that exceed book values
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income not paid to shareholders
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Which of the following values would most likely interest a shareholder? -Book value of equity -Market value of equity -Historical cost of equity -none of these
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Market value of equity
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What happens to the market value of a firm's equity as the book value of the firm's equity increases? -It increases by the same amount. -It decreases by the same amount. -It remains constant. -There is no set relationship to determine this outcome
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There is no set relationship to determine this outcome
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Which of the following is more likely to be correct if market value of equity is less than book value of equity? -Investors anticipate excellent earning potential. -Investors anticipate low earning potential. -Assets have been fully depreciated. -The company is bankrupt.
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Investors anticipate low earning potential
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If market values of equity exceed book values of equity, then: -equity has been depreciated too rapidly. -the firm uses accrual-based accounting. -profit potential is expected to be attractive. -the firm is holding too much cash.
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profit potential is expected to be attractive
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Which of the following cash outflows does not reduce a firm's net income? -Income taxes -Interest expense -Dividends -Depreciation expense
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Dividends
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An increase in depreciation expense will (other things equal): -increase net income. -decrease net income. -increase taxable income. -decrease the market value of assets
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decrease net income
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What is the marginal tax rate for a corporation with $60,000 taxable income and an average tax rate of 16.67% if the next-lowest marginal tax rate of 15% covers taxable incomes up to $50,000? -15.00% -16.67% -18.34% -25.00%
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25.00%
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Assuming at the $50,000 income level that the corporate tax rate increases from 15 to 25%, which of the following statements is correct for a firm with $75,000 income? -Its marginal tax rate is 15%. -Its average tax rate is 25%. -Its marginal tax rate is 18.33%. -Its average tax rate is 18.33%.
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Its average tax rate is 18.33%
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For a corporation in the 25% marginal tax bracket that incurs $70.00 in labor and materials expense, plus $15.00 in depreciation expense while generating an incremental revenue of $100.00, tax liability will increase by: -$3.75. -$7.50. -$13.75. -$25.00
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$3.75
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Which of the following statements is correct for an individual with a net income of $50,000.00, a tax liability of $10,704.50, and a 28% marginal tax rate? -The average tax rate is 17.63%. -The average tax rate is 21.41%. -The average tax rate is 28.00%. -The average tax rate is unknown but greater than the marginal tax rate.
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The average tax rate is 17.63%
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Marginal tax rates are based on: -net income. -total income. -an additional dollar of income. -earnings before interest and taxes.
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an additional dollar of income
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Which of the following forms of income can individuals defer from taxation? -Dividends -Interest -Realized capital gains -Unrealized capital gains
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Unrealized capital gains
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Advantages to a Sole Proprietorship
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-ease of formation -subject to few regulations -no corporate income taxes
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Disadvantages to a Sole Proprietorship
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-limited life -unlimited liability -difficult to raise capital
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At some point, it becomes difficult for sole proprietors to raise money because of:
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-unlimited liability -limited life
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To continue to grow, most companies have to...
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incorporate
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A corporation is...
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a distinct, permanent legal entity
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Advantages to a corporation
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-unlimited life -easy transfer of ownership -limited liability -ease of raising capital
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Disadvantages to a corporation
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-double taxation -cost of a setup and report filing
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The primary goal of a corporation is
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shareholder wealth maximization (maximizing shareholders wealth)
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Factors that Affect Stock Price
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-projected cash flows to shareholders -timing of the cash flow stream -riskiness of the cash flows
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Higher risk requires...
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higher return
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The cost of capital for a business is...
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the return investors demand to lend their money to the firm
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The cost of capital depends on...
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how risky the company is relative to other investment opportunities
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Firm's should only invest in opportunities that provide a return of...
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at least their cost of capital
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Most large companies have 3 top-level financial managers:
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-CFO -treasurer -controller
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CFO's are responsible for:
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setting the overall financial strategy of the firm
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Treasurers are responsible for:
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-cash management -raising capital -banking relationships
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Controller's are responsible for:
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-budgeting -accounting -taxes
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Capital Structure
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proportion of the company's assets funded by each type of financing
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Payout policy
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How much profit to reinvest in the company and how much to distribute to investors
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Real assets
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things that have value all by themselves
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Decisions about large investments are called
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capital budgeting decisions
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What is a bond?
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type of loan
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Maturity
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The time from when the bond was issued to when it is paid off.
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Face Value
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The amount the borrow pays the investor at the bond's maturity.
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Coupon Payment
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The amount of periodic interest payments to the investor
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Bond Price
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The amount the investor pays the bond seller
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What is a Stock?
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an ownership claim against a company's assets after deducting its liabilities
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How do stocks come into existence?
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When a company incorporates it creates stock shares that it sells to investors.
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What is an IPO?
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The first time a company sells stock to the public (Initial Public Offering)
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A company sells shares in the
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primary market
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Subsequent trading in the stock occurs in the
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secondary market
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Treasury Notes and Bonds
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bonds issued by the Federal Government
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Municipal Bonds
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bonds issued by cities and states
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Corporate Bonds
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bonds issued by companies
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Financial Institutions
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organizations or businesses that specialize in trading specific types of financial instruments and that operate in specific financial markets
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What do mutual funds do?
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provide investors with easy and efficient diversification, professional management, and liquidity
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Liquidity refers to
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the ability to quickly convert an asset into cash without having to greatly decrease its price below what would be earned if longer selling time were allowed
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Balance Sheet
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shows the value of a company's "stuff" as of a point in time
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Assets =
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Liabilities + Equity
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Income Statement
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shows the flow of revenues and expenses between balance sheet dates
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Cash-Flow Statement
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shows cash inflows and outflows between balance sheet dates
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EBIT
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Earnings before interest and taxes
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CapX
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Capital expenditures
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(change)NWC
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Change in net working capital
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Marginal rate
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Rate paid on the next $1 of taxable income
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Average tax rate =
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taxes paid / taxable income
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FCF
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free cash flow
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FCF =
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EBIT - taxes + depreciation - (change)NWC + CapX
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marginal tax rate
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% of last dollar taxed
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Real or Financial Asset? :: a share of stock
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financial
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Real or Financial Asset? :: a personal IOU
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financial
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Real or Financial Asset? :: a trademark
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real
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Real or Financial Asset? :: a truck
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real
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Real or Financial Asset? :: undeveloped land
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real
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Real or Financial Asset? :: the balance in the firms checking account
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financial
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Real or Financial Asset? :: an experienced and hardworking sales force
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real
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Real or Financial Asset? :: a bank loan agreement
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financial
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the stock and bond markets are no the only financial markets. Give two or three additional examples.
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-derivatives markets -money markets -foreign exchange markets
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you are a beginning investor with only $5000 in savings. how can you achieve a widely diversified portfolio at a reasonable cost?
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buy shares in a mutual fund
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T or F: Financing for public corporations must flow through financial markets.
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false
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T or F: Financing for private corporations must flow through financial intermediaries.
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false
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T or F: the sale of policies is a source of financing for insurance companies.
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true
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T or F: almost all foreign exchange trading occurs on the floors of the FOREX exchanges in New York and London.
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false
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T or F: the opportunity cost of capital is the capital outlay required to undertake a real investment opportunity
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false
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T or F: the cost of capital is the interest rate on borrowing from a bank or other financial situation.
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false
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decision to invest in tangible or intangible assets
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capital budgeting or capital expenditure (CAPEX) decision
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assets used to produce goods and services
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real assets
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financial claims to the income generated by the firms real assets
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financial assets
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the owners of a corporation are not personally liable for its obligations
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limited liability
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sets overall financial strategy
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CFO
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minimum acceptable rate of return on capital investment
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opportunity cost of capital
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What are the two major decisions made by financial managers?
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-the investment (capital budgeting) decision -financing decision
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what does "real asset" mean?
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include all assets used in the production or sale of the firms products or services
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Who are the principal financial managers in a corporation?
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-controller -CFO
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what is the fundamental trade-off in investment decisions?
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opportunity cost of capital (return that shareholders can earn for themselves)
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market where securities are issued and traded
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financial market
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market for the sale of new securities by corporations
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primary market
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market in which previously issued securities are traded among investors
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secondary market
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market for debt securities
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fixed-income market
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market for long-term financing
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capital market
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market for short-term financing (less than 1 year)
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money market
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where does the financing for corporations come from?
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savings (can flow through financial markets and intermediaries)
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what are the key advantages of mutual funds and pension funds?
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they allow investors to diversify in professionally managed portfolios
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what are the functions of financial markets?
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help channel savings to corporate investment, and they help match up borrowers and lenders
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value of assets or liabilities according to the balance sheet
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book value
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cash available for distribution to investors after firm pays for new investments or additions to working capital
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free cash flow
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measures the profitability of the company during the year
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income statement
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provides a snapshot of the firms assets and liabilities
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balance sheet
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measures the sources and uses of each during the year
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statement of cash flows
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current price of an asset or liability
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market value
