Finance and risk management - international business - Practice Exam 1

MC-questions

Question 1

A company has a semi-annual coupon bond outstanding. A decrease in the market required rate of return will have an effect on this bond. Which effect is meant here:

1. Increase of the market price
2. Increase of the coupon rate
3. Decrease of the market price
4. Decrease of the coupon rate

Question 2

A firm is comparing two different capital structure plans, an all-equity plan (Plan I) and a levered plan (Plan II). Under Plan I, the firm would have 178,500 shares outstanding. Under Plan II, there would be 71,400 shares outstanding and €1.79 million in debt outstanding. The interest rate on the debt is 10% and there are no taxes. What is the break-even EBIT?

1. €341,414.14
2. €351,111.11
3. €298,333.33
4. €287,878.78

Question 3

Consider the the dividend growth model, an increase in which of the following will increase the current value of an equity?

I. Dividend amount

II. Number of future dividends

III. Discount rate

IV. Dividend growth rate

1. I, II, and III only
2. I, II, and IV only
3. I, II, III, and IV
4. III and IV only

Question 4

A company is considering a new project. The project will require €500,000 for new non-current assets, €200,000 for additional inventory, and €40,000 for additional trade receivables. Short-term debt is expected to increase by €150,000. What is the project's cash flow at time zero, which is the sum of investments in new non-current assets and net working capital?

1. -€890,000
2. -€614,000
3. -€590,000
4. -€500,000

Question 5

A conflict of interest between the shareholders and the management of a firm is called:

1. shareholders' liability
2. corporate activism
3. corporate breakdown
4. the agency problem

Question 6

Daphne invested €1000 seven years ago at 5 per cent interest. She spends her earnings as soon as she earns any interest so she only receives interest on her initial €1000 investment. Which type of interest is Daphne earning?

1. Complex interest
2. Interest on interest
3. Compound interest
4. Simple interest

Question 7

Shareholders' equity is best described as:

1. equal to total assets plus total liabilities.
2. includes long-term debt, preferred stock, and ordinary equity.
3. the residual value of a firm.
4. increases in value whenever total assets increases.

Question 8

Consider the following features for a bond:

I. It is a discounted price

II. It is a price at a premium

III. The yield-to-maturity is less than the coupon rate

IV. The yield-to-maturity exceeds the coupon rate

Which of the following features currently apply to a bond that has a market price that is lower than its face value?

1. I and III only
2. I and IV only
3. II and III only
4. II and IV only

Question 9

M&M Proposition I with taxes is based on the concept that:

1. the value of a firm increases as the firm's debt increases because of the interest tax shield.
2. the optimal capital structure is the one that is totally financed with equity.
3. the capital structure of a firm does not matter because investors can use homemade leverage.
4. a firm's WACC is unaffected by a change in the firm's capital structure.

Question 10

Decisions that are made by financial managers should primarily be focused on increasing which one of the following?

1. The total sales
2. The growth rate of the firm
3. The gross profit per unit produced
4. The market value per share of outstanding equity

Question 11

A proposed expansion project is expected to increase sales of the company by €35,000 and increase cash expenses by €21,000. The project will cost €24,000 and will be depreciated using straight-line depreciation to a zero book value over the 4-year life of the project. The company store has a marginal tax rate of 30%. What is the operating cash flow of the project using the tax shield approach?

1. €14,600
2. €11,600
3. €7,800
4. €5,600

Question 12

This morning a baker agreed to pay a supplier €4.40 a bushel for 5,000 bushels of wheat that the supplier will ship to the factory four months from now. What is this legally binding agreement called?

1. Spot contract
2. Swap
3. Floating contract
4. Forward contract

Question 13

Which one of the following is a capital budgeting decision?

1. Deciding whether or not to purchase a new machine for the production line.
2. Deciding how to refinance a debt issue that is maturing.
3. Determining how much inventory to keep on hand.
4. Determining how many shares of equity to issue.

Question 14

Assume that the total cost of a university education will be €20,000 when your child enters college in 5 years. You presently have €16,400 to invest. What annual rate of interest must you earn on your investment in an account paying semi-annual interest payment to cover the cost of your child's university education?

1. approximately 10%
2. approximately 8%
3. approximately 4%
4. approximately 2%

Question 15

Consider that a firm has issued 10-year semi-annual coupon bonds with a face value of €1,000. If the annual coupon rate is 10% and the required rate of return of investors who are willing to buy this bond is 8%, what would be the current price of the bond?

1. Between €1,101 and €1,150
2. Between €1,051 and €1,100
3. Between €851 and €900
4. Between €801 and €850

Question 16

You are considering two mutually exclusive projects with the following cash flows.

Project A Project B

Year 0 - € 80,000 - € 80,000

Year 1 € 32,000 0

Year 2 € 32,000 0

Year 3 € 32,000 € 103,000

Which project(s) should you accept if the discount rate is 8 per cent? What if the discount rate is 9 per cent?

1. accept A at 8 percent and B at 9 percent
2. accept B at 8 percent and A at 9 percent
3. accept A at 8 percent and none of the projects at 9 percent
4. accept project A as it always has the higher NPV

Question 17

Look at the following statements considering the expected return on a well-diversified portfolio:

I. can never exceed the expected return of the best performing security in the portfolio.

II. is independent of the unsystematic risks of the individual securities held in the portfolio.

III. is independent of the allocation of the portfolio among individual securities.

IV. must be equal to or greater than the expected return of the worst performing security in the portfolio.

1. I and IV only
2. II and Ill only
3. I, II, and IV only
4. I, II, III, and IV

Question 18

Consider an asset that costs €176,000 and is depreciated straight-line to zero over its 11-year tax life. The asset is to be used in a 7-year project; at the end of the project, the asset can be sold for €22,000. The relevant tax rate is 30%. What is the after tax cash flow from the sale of this asset?

1. €42,000
2. €34,600
3. €12,600
4. €9,400

Question 19

We look at a technology firm with excellent growth prospects. The firm wishes to do something to acknowledge the loyalty of the shareholders but needs all of its available cash to fund the firm's rapid growth. The market price of the stock is currently trading at the upper end of its preferred trading range. The firm is most apt to consider which one of the following in this situation?

1. Stock split
2. Reverse stock split
3. Special cash dividend
4. Liquidating dividend

Question 20

What is the standard deviation for the following security?

State of Economy Probability of State of Economy Rate of return if state occurs

Boom 0.10 0.32

Normal 0.65 0.14

Recession 0.25 - 0.28

1. 19.94%
2. 21.56%
3. 25.8%
4. 32.08%

Question 21

Which sentence is correct about futures contracts?

1. They provide an option to purchase an asset at a specified price on the settlement date
2. They are marked to the market on a daily basis
3. They cannot be resold
4. They are identical to forward contracts except for the size of the contract

Question 22

Which one the following is the most correct about depreciation?

1. reduces taxes and increases net income.
2. is a non-cash expense which increases the cash flow from assets.
3. increases net non-current assets and net income.
4. reduces both the net non-current assets and the costs of a firm.

Question 23

Which one of the following is the best definition of the primary market?

1. market for new issues
2. market for securities of the largest firms
3. market for insured securities
4. over-the-counter market

Question 24

Which one of the following refers to the ability of shareholders to undo a firm's dividend policy and create an alternative dividend policy by selling shares or reinvesting dividends?

1. Personalization
2. Offsetting leverage
3. Homemade dividend policy
4. Recapitalization

Question 25

Consider a firm that has net working capital of €640. It's long-term debt is €4,180, total assets are €6,230, and non-current assets are €3,910. What is the amount of the total liabilities?

1. €5,860
2. €5,590
3. €4,130
4. €2,690

Question 26

A firm has annual sales of €687,400, total debt of €210,000, total equity of €365,000, and a profit margin (net Income/sales) of 5.20%. What is the ratio of return on assets (ROA)?

1. 7.78%
2. 7.02%
3. 6.48%
4. 6.22%

Question 27

You purchased six €32.50 call option contracts on ABC equity when the option was quoted at €1.80 (the premium). The option expires today when the value of ABC equity is €34.60. What is the net profit or loss on this investment?

1. €8.40
2. €2.10
3. €1.80
4. €0

Question 28

The ___________ model incorporates the time-value of money but still ignores cash flows after the cutoff date. Which word must be on the line to make this a correct sentence?

1. Profitability index
2. Discounted Payback Period
3. Payback Period
4. Modified Internal Rate of Return

Question 29

Assume that you are borrowing €10,000 to buy a car. The terms of the loan call for payments in every two months for 3 years at 12% annual interest. What is the amount of each payment?

1. €447
2. €667
3. €946
4. €1,379

Question 30

Lucy owns an option that allows her to purchase ABC equity at €50 a share. The €50 price per share is referred to as the:

1. time value
2. intrinsic value
3. market price
4. strike price

Question 31

A company has a market value that is equal to its book value. Currently, the firm has excess cash of €1,332 and the market of value of the equity of €7,200. The firm has 600 shares outstanding. The firm has decided to spend one-third of its excess cash on a share repurchase program. How many shares will be outstanding after the share repurchase is completed?

1. 578 shares
2. 563 shares
3. 550 shares
4. 537 shares

Question 32

An equity stock has a beta of 1.09. The risk-free rate of return is 2.75 % and the market rate of return is 9.80%. What is the risk premium on this equity according to the Capital Asset Pricing Model (CAPM)?

1. 8.99%
2. 7.68%
3. 7.03%
4. 6.47%

Question 33

Which one of the following bonds is the least sensitive to interest rate risk?

1. 7-year; 4% coupon
2. 7-year; 6% coupon
3. 3-year; 4% coupon
4. 3-year; 6% coupon

Question 34

Which of the following is the most correct about the weighted average cost of capital for a firm:

1. It is unaffected by changes in corporate tax rates.
2. It remains constant when the debt-equity ratio changes.
3. It is the return investors require on the total assets of the firm.
4. It is equivalent to the after-tax cost of the firm's liabilities.

Question 35

A supplier grants your firm credit terms of 2/10, net 40. What is the effective annual rate of the discount if the firm purchases €4,600 worth of merchandise? (Assume that a year has 365 days)

1. 28.80%
2. 27.86%
3. 24.83%
4. 20.24%

Question 36

Assume that a firm paid an annual dividend of €1.15 per share last month. Today, the firm announced that future dividends will be increasing by 2.6 per cent annually. If you require a 12 per cent rate of return, how much are you willing to pay to purchase one share of this equity today?

1. €12.23
2. €12.55
3. €12.67
4. €12.72

Question 37

If a project has a net present value equal to zero, which of the following is the most correct in this case?

1. the project earns a return exactly equal to the discount rate.
2. the total of the cash inflows must equal the initial cost of the project.
3. the project's PI must be also be equal to zero.
4. a decrease in the project's initial cost will cause the project to have a negative NPV.

Question 38

A company has 30,000 shares of ordinary equity outstanding at a market price of €15 a share. The company also has a bond issue outstanding with a total face value of €277,778 which is selling for 90% of face value. The cost of equity is 16% while the before-tax cost of debt is 10%. The company has a tax rate of 30% What is the weighted average cost of capital?

1. 12.79%
2. 13.14%
3. 13.86%
4. 15.29%

Question 39

John is in charge of the inventory for a firm. As an inventory item gets low, he has to restock the item by a quantity that minimizes the total inventory costs for that item. What is this restocking quantity called?

1. Short order quantity
2. Economic order quantity
3. Re-order limit
4. Refill unit quantity

Question 40

A firm with unlimited funds must evaluate five projects. Projects 1, 2, and 3 are mutually exclusive and Projects 4 and 5 are independent. The projects are listed with their returns. The weighted average cost of capital (WACC) of the firm is 12 %.

Project Status Return (%)

• 1 Mutually exclusive 14
• 2 Mutually exclusive 13
• 3 Mutually exclusive 15
• 4 Independent 15
• 5 Independent 13

Which projects should the firm choose?

1. 3 and 4.
2. 3, 4, and 5.
3. 1, 2, 3, and 4.
4. 1, 2, 3, 4, and 5.

Answer indication MC-questions

1. A

2. C

3. B

4. C

5. D

6. D

7. C

8. B

9. A

10. D

11. B

12. D

13. A

14. C

15. A

16. D

17. C

18. B

19. A

20. A

21. B

22. B

23. A

24. C

25. A

26. D

27. C

28. B

29. B

30. D

31. B

32. B

33. D

34. C

35. B

36. B

37. A

38. A

39. B

40. B