Exam I: Practice

EXAM I: PRACTICE

1. / The forecast of cash receipts and disbursements for the next planning period is called a:
a. / Pro forma income statement.
b. / Statement of cash flows.
c. / Cash budget.
d. / Receivables analysis.
e. / Credit analysis.
2. / Which of the following statements is false?
a. / While marginal and average tax rates often differ, it is the average tax rate that is relevant for most financial decisions.
b. / The book value of an asset on the balance sheet can be very different from its market value.
c. / Net income as calculated from the income statement is not the net cash flow of the firm.
d. / Non-cash items are expenses charged against revenues that do not directly affect cash flow.
e. / The cash flow identity states that all net cash flows earned by the firm are distributed in whole to its creditors and shareholders.
3. / If taxable income is $92,000, then the ______.
a. / average tax rate is 21.1%
b. / average tax rate is 34.0%
c. / marginal tax rate is 15.0%
d. / marginal tax rate is 25.0%
e. / marginal tax rate is 39.0%
4. / An insurance company promises to pay Jane $1 million on her 65th birthday in return for a one-time payment of $125,000 today. (Jane just turned 30.) At what rate of interest would Jane be indifferent between accepting the company's offer and investing the premium on her own?
a. / 3.4%
b. / 4.5%
c. / 5.1%
d. / 6.1%
e. / 7.2%
5. / The interest rate used to calculate the present value of future cash flows is called the ______rate.
a. / free interest
b. / annual interest
c. / compound interest
d. / simple interest
e. / discount

In a growing midwestern town, the number of eating establishments at the end of each of the last five years are as follows:

Year 1 = 273; Year 2 = 279; Year 3 = 302; Year 4 = 320; Year 5 = 344

6. / Between the end of year 2 and the end of year 3, the number of eating establishments grew at a rate of ______compounded annually.
a. / 5.2%
b. / 6.7%
c. / 7.6%
d. / 8.2%
e. / 9.3%
7. / Which of the following statements is/are false, all else the same?
I. Present values increase as the discount rate increases.
II. Present values increase the further away in time the future value.
III. Present values are always smaller than future values when both r and t are positive.
a. / I only
b. / I and II only
c. / II only
d. / III only
e. / II and III only
8. / The present value factor for annuities is calculated as:
a. / (1 + present value factor)/r
b. / (1 – present value factor)/r
c. / Present value factor + (1/r)
d. / (Present value factor*r) + (1/r)
9. / At the end of each year for the next 8 years you will receive cash flows of $500. If the appropriate discount rate is 7.5%, how much would you pay for this annuity?
a. / $4,000.00
b. / $5,841.22
c. / $1,259.47
d. / $2,928.65
e. / $3,148.30
10. / A machine costs $150 and requires $80 in maintenance for each year of its 3 year life. After 3 years, this machine will be replaced. If the machine is straight-line depreciable to zero and has no salvage value, what is the EAC? Assume a tax rate of 35% and a discount rate of 15%.
a. / –$ 44.67
b. / –$100.20
c. / –$154.51
d. / –$200.25
e. / –$228.77
11. / Which of the following is/are true?
I. Setting the bid price requires finding the point at which project NPV is zero.
II. In a cost-cutting proposal the reduction in costs has the same effect as an increase in sales.
III. EAC is used to evaluate mutually exclusive projects with different lives if the projects are expected to be continuously replicated.
a. / III only
b. / I and II only
c. / I and III only
d. / II and III only
e. / I, II, and III

The managers of PonchoParts, Inc. plan to manufacture engine blocks for classic cars from the 1960’s era. They expect to sell 250 blocks annually for the next 5 years. The necessary foundry and machining equipment will cost a total of $800,000 and will be depreciated on a straight-line basis to zero over the project's life. The firm expects to be able to dispose of the manufacturing equipment for $150,000 at the end of the project. Labor and materials costs total $500 per engine block, fixed costs are $125,000 per year. Assume a 35% tax rate and a 12% discount rate.

12. / Assume that management believes that auto restorers will pay $3,000 retail per engine block. What is the NPV of this project?
a. / $260,769
b. / $401,187
c. / $521,309
d. / $628,744
e. / $644,678
13. / The cash flow tax savings generated as a result of a firm's tax-deductible depreciation expense is called (the) ______.
a. / aftertax depreciation savings
b. / depreciable basis
c. / depreciation tax shield
d. / operating cash flow
e. / aftertax salvage value
14. / What is the profitability index (PI) of the following investment if the required return = 10%?
Year: 0 1 2 3
Cash Flow: -$150 $50$75$75
a. / 0.94
b. / 1.09
c. / 1.18
d. / 1.27
e. / 1.45
15. / Which capital investment evaluation technique is described by the following characteristics? (1) Closely related to NPV; (2) Easy to understand and communicate; (3) May lead to incorrect decisions when comparing mutually exclusive investments; (4) May be useful when the available investment budget is limited.
a. / NPV
b. / PI
c. / IRR
d. / AAR
e. / Payback period
16. / Which of the following investment criteria is the least consistent relative to the goal of maximizing shareholder wealth?
a. / Discounted payback
b. / Average accounting return
c. / Profitability index
d. / Net present value
e. / Internal rate of return
17. / You have discovered from looking at charts of past stock prices that if you buy just after a stock price has declined for three consecutive days, you make money every time! If this also holds in the future, then this is clearly a violation of _____ market efficiency.
a. / weak form
b. / semi-weak form
c. / semi-strong form
d. / strong form
e. / NYSE stock

Use the following historical data over the 1926–2000 period to answer the next two questions.

AssetAverage ReturnStandard Deviation

Large-company stocks 13.0% 20.2%

Small-company stocks 17.3% 33.4%

Long-term government bonds 5.7% 9.4%

US Treasury bills3.9% 3.2%

18. / If the returns on large-company stocks are normally distributed, for which of the following returns can you NOT state, with 95% confidence, that next year's stock return might be equal to?
a. / –30.4%
b. / –25.6%
c. / 20.3%
d. / 33.5%
e. / 52.0%
19. / Over the past 75 years, which of the following investments has been the least risky?
a. / Small company stocks
b. / Common stocks
c. / Treasury bills
d. / Treasury bonds
e. / Corporate bonds
20. / Which of the following describes a portfolio that plots above the security market line?
a. / The security is overvalued.
b. / The security's reward to risk ratio is too high.
c. / The security is providing a return that is less than expected.
d. / The security's beta is too high.
e. / The security provides a return that is less than the average return on the market.
21. / Regarding diversification, ______.
a. / most of the benefits are realized with just 20 stocks.
b. / it is the process of increasing the riskiness associated with individual assets by spreading an investment across numerous assets.
c. / it is the only type of risk that matters to a rational investor.
d. / the portfolio returns are reduced, and the standard deviation of that portfolio remains unchanged.
e. / there is no limit to the amount of risk that can be eliminated through this process.
22. / The percentage of a portfolio's total value invested in a particular asset is called that asset's:
a. / Portfolio return.
b. / Portfolio weight.
c. / Portfolio risk.
d. / Rate of return.
e. / Investment value.
23. / A firm keeps excess cash on hand in case of an industrial accident in its manufacturing plant. This is an example of a ______need for holding cash.
a. / speculative
b. / precautionary
c. / transactions
d. / deterministic
e. / compensating balances
24. / Which of the following statements is correct?
a. / In the Miller-Orr model the greater the interest rate, the greater the target cash balance.
b. / In the BAT model the greater the order cost, the higher the target cash balance.
c. / If a firm chooses to borrow, rather than invest in marketable securities, it will find that borrowing is likely to be less expensive than selling marketable securities.
d. / A firm is less likely to have to borrow to cover an unexpected cash outflow the greater its cash flow variability.
e. / A firm is less likely to have to borrow to cover an unexpected cash outflow the lower its investment in marketable securities.

A firm reported sales of $20,000 in November, $30,000 in December, and projects sales of $40,000 for January, $50,000 for February, and $35,000 for March. The firm's cost of goods sold every month is equal to 75% of the next month's sales. The firm collects its receivables in 60 days and pays its payables in 30 days. The firm begins January 1 with $50,000 in cash. All sales and purchases are on credit. Answer the following question:

25. / What are the total cash collections in March?
a. / $20,000
b. / $30,000
c. / $40,000
d. / $50,000
e. / $70,000
26. / Suppose that the inventory period is 60 days, the accounts receivable period is 30 days, and the cash cycle is 35 days. What is the accounts payable period?
a. / 35 days
b. / 45 days
c. / 55 days
d. / 90 days
e. / 135 days
27. / The process of determining the likelihood that customers will not pay is called ____.
a. / the terms of sale
b. / credit analysis
c. / the collection policy
d. / the payables policy
e. / disbursement analysis
28. / JJJ, Inc. recently extended its credit period from net 30 days to net 40 days. This represents a change in the firm's _____.
a. / collection policy
b. / terms of sale
c. / receivables policy
d. / credit-granting policy
e. / loan policy
29. / An analysis of the relation between sales volume and various measures of profitability is called:
a. / Forecasting analysis.
b. / Scenario analysis.
c. / Sensitivity analysis.
d. / Simulation analysis.
e. / Break-even analysis.
30. / The degree to which a firm or project relies on fixed production costs is called its:
a. / Operating leverage.
b. / Financial break-even.
c. / Contribution margin.
d. / Cost sensitivity.
e. / Profit margin.