Finance Revision Quiz Answers PDF

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FINANCE PRACTICE QUIZ ANSWERS Revision Quiz 0: Subject Readiness Check Q: Long-term debt can be computed by: A: Adding net working capital to total fixed assets and then subtracting owners' equity. Q: Le Son Ltd., has current liabilities of $11,700 and accounts receivable of $15,200. The firm has total assets of $43,400 and net fixed assets of $24,800. The owners' equity has a book value of $21,000. What is the amount of the net working capital? A: $6,900 NWC = CA - CL CL = $11,700 Total Assets = Current Assets + Non-Current Assets (i.e the net fixed assets) So CA = $43,400-24,800 = 18,600 NWC = CA- CL = 18,600-11,700 = $6,900 Q: A tangible asset: A: is a fixed asset with a physical existence

Q: A current asset is defined as an asset that: A: normally converts to cash within one year.

Q: A balance sheet is a financial statement that: A: reflects a firm's accounting value on a particular date.

Q: Shareholders' equity can be defined as: A: The residual value of a company after all debts have been paid.

Q: Grunzel Potters, Ltd., has net working capital of $2,100, net fixed assets of $23,600, current liabilities of $1,800, and long-term debt of $14,700. What is the value of the shareholders' equity? A: $11,000

Total Assets = Total Liabilities + Total Equity rearrange so E = A-L Net working Capital (NWC) = $2,100 and Current Liabilities (CL) = $1,800 NWC = CA-CL so rearrange to get Current Assets,

CA = NWC + CL = 2,100 + 1,800 = $3,900 Total Liabilities, L = CL and Non-Current Liabilities (i.e. long-term debt) = 1,800 + 14,700 = $16,500 Total Assets, A = CA and Non-Current Assets (i.e. net fixed assets) = 3,900 + 23,600 = $27,500 Shareholders Equity, E = A - L = 27,500 - 16,500 = $11,000 Q: Which of these accounts are included in net working capital? I. accounts payable II. bonds payable III. equipment IV. cash A: I and IV only

Q: Earnings per share (EPS) is defined as: A: Net profit divided by the number of outstanding shares

Q: A noncash item is defined as: A: An expense charged against revenues that does not affect the cash flow of a firm Q: Which one of the following is a current asset? A: Inventory Revision Quiz 1: Introduction Q: A primary market transaction is: A: One that involves the sale of financial assets for the first time Q: The ________ market provides the means for transferring ownership of securities. A: Secondary Q: Short-term assets and short-term liabilities are referred to as the firm's: A: Working capital Q: Businesses can be legally structured as: A: Any of the above (company, partnership, sole proprietorship) Q: Companies, potentially, have an infinite life because: A: Of separation of ownership and management Q: Agency costs are incurred by a company because: A: All of the above (Separation of ownership and management, Managers pursue their own goals at shareholders’ expense, Managers may not attempt to maximise the value of the firm to shareholders.)

Q: The market where existing securities are bought and sold is: A: The secondary market Q: Any situation where a potential conflict can arise between the firm's owners and its managers is referred to as a(n): A: Agency Problem Q: Generally, a company is owned by the: I) Managers; II) Board of Directors; III) Shareholders A: III Only Q: The following are examples of intangible assets except: A: Building Q: When a security is sold in the financial markets for the first time, then: A: Funds flow to the issuer from the investor Q: The primary goal of financial management is to maximise the: A: Market value of the equity Q: A firm's investment decision is also called the: A: Capital budgeting decision Revision Quiz 2: Time Value of Money 1 Q: The Back Row Co. invested $125,000 at 8 percent compounded annually for 3 years. How much interest on interest did the company earn over this period of time? A: $2,464 "Interest on Interest" means how much extra the company has earned as the interest is compounded, rather than being simple interest. So you will need to calculate how much interest would be earned with simple interest and compare it to how much earned with compounding. The difference between the two is "interest on interest". Step 1: Calculate Simple Interest. PV = 125,000; i=.08; n=3 INT = PV x i x n = 125,000 x 0.08 x 3 = $30,000 Step 2: Calculate Compound Interest = FV-PV FV = PV(1+i)n = 125,000x(1+.08)^3 = $157,464 Interest = FV-PV = 157,464 - $125,000 = $32,464 Step 3: Calculate Interest on Interest = Compound Interest - Simple Interest = $32,464 $30,000 = $2,464

Q: You need $30,000 in cash to buy a house 4 years from today. You expect to earn 4 percent, compounded quarterly, on your savings. How much do you need to deposit today if this is the only money you save for this purpose? A: $25,584.64 This problem is asking you to calculate the PV of the deposit you know you will need in 4 years' time. You have been given FV = $30,000; I = .04/4 and n=4x4=16 PV = FV(1+i)-n PV = 30,000x (1+.04/4)^-16 = $25,584.64 Q: Suzy wishes to accumulate $500,000 at the end of four and a half years. How much should she deposit now, if the interest rate is 10% per annum compounded monthly? A: $319,409.11 Calculate PV, given a FV amount. Use the compound interest formula PV = FV(1+i)-n FV = 500,000 i = interest rate per period (i.e. per month) = .10/12 n= total number of compounding periods (i.e. total number of months) = 4.5 years x 12 months per year = 54 PV = 500,000(1+.10/12)^-54 = $319,409.11 Q: How much interest is earned if $5,000 is invested in a 2 year term deposit paying 8% p.a. with interest compounded quarterly? Q: $858.30 To calculate the total amount of interest earned, calculate FV using compound interest and subtract the initial amount invested (the PV). FV = PV(1+i)n PV = $5,000 i = interest rate per period (i.e. per quarter) = .08/4 = .02 n = total number of compounding periods (i.e. total number of quarters) = 2 years x 4 quarters per year = 8 FV = 5,000(1.02)^8 = $5,858.30 FV-PV = interest earned = 5,858.30 - 5,000 = $858.30 Q: If you invest $10,000 now, and your investment pays 7% per annum, how much will you have in three years if compounded annually? A: $12,250.43 This is asking you to calculate Future value using compound interest. FV = PV(1+i)n PV = 10,000 i = interest rate per period = .07 n = total number of compounding periods = 3 so FV = 10,000(1+.07)^3 = $12,250.43 Q: The relationship between the present value and the interest rate is best described as:

A: Inverse Q: All else constant, the present value will __________ as the period of time decreases, given an interest rate greater than zero. A: Increase Q: You have borrowed $1,000 from a friend, with an agreement to pay interest at an annual rate of 15% p.a. compounding daily. If you repay your friend after 180 days, how much do you need to repay? A: $1,076.76 This is asking you to calculate FV using compound interest. PV = amount borrowed = $1,000 i = interest rate per period = .15/365 n = total number of compounding periods = 180 FV = 1,000(1+.15/365)^180 = $1,076.76 Q: If you invest $10,000 now, and your investment pays 7% per annum, how much will you have in three years if compounded annually? A: $12,250.43 This is asking you to calculate Future value using compound interest. FV = PV(1+i)n PV = 10,000 i = interest rate per period = .07 n = total number of compounding periods = 3 so FV = 10,000(1+.07)^3 = $12,250.43 Q: Assume that on 1 July 2015 you deposited $1,000 into a savings account that pays 5% p.a. compounding quarterly. How much will you have in your account on 1 July 2018? A: $1,160.75 This is asking you to calculate FV using compound interest. FV=PV(1+i)n PV = amount deposited = $1,000 i= interest rate per period (i.e. each quarter) = .05/4 = .0125 n= total number of compounding periods = 3 years x 4 quarters per year = 12 FV = 1000(1+.0125)^12 = $1,160.75 Q: The interest rate on a personal loan is 3% per month. What is the effective annual rate? A: 42.58% p.a. compounded yearly An effective rate compounds yearly. i=interest rate per period = .03 m= no of compounding periods in a year = 12 EAR = (1+i)m - 1 = (1+.03)^12 - 1 = 0.42576 = 42.58%

Q: What is the present value of the following cash flows at a discount rate of 8%? Year 1 $100,000 Year 2 $150,000 Year 3 $200,000 A: $379,959.86 Calculate PV today (at time 0) of all the future cash flows. Cash flows occurring in year 1 get discounted back 1 year, CF in year 2 is discounted back 2 years, and CF in year 3 is discounted back 3 years. i= interest rate per period = .08 We use the PV = FV (1+i)-n formula for each future cash flow. PV0 = CF1(1+i)-1 + CF2(1+i)-2 + CF3(1+i)-3 = 100,000(1+.08)^-1 + 150,000(1+.08)^-2 + $200,000(1+.08)^-3 = $379,959.86 Q: The interest rate on a personal loan is 3% per month. What is the nominal annual rate? A: 36% p.a. compounded monthly A nominal rate compounds more frequently than annually. i=interest rate per period = .03 m= no of compounding periods in a year = 12 The nominal annual rate = i x m = 36% p.a. compounding monthly. Q: Sancho deposits $500 in a bank account today which pays 4 percent interest, compounded annually. The amount of interest Sancho earns in year 4 will be: I. equal to the interest earned in year 3. II. greater than the interest earned in year 3. III. less than the interest earned in year 3. IV. greater than the interest earned in year 5. V. less than the interest earned in year 5. A: II and V only Q: Simple interest is the interest earned on: A: The original principal amount invested Q: You can invest money at 6% p.a. compounded half-yearly. What is the effective annual rate? A: 6.09% i= interest rate per period = .06/2 = .03 m = number of compounding periods in a year = 2 EAR = (1+i)m - 1 = (1+.03)^2 - 1 = .0609 = 6.09%

Q: You borrow $200 from a payday lending company and pay $5 interest for two weeks. What is the effective annual rate? A: 90% First calculate the interest rate per fortnightly period. This is $5 interest paid for the 2 weeks / $200 borrowed = .025 = i m = number of compounding periods in a year = 26 The effective rate = EAR = (1+i)m - 1 = (1+.025)^26 - 1 = .9002927 = 90.03% Q: The valuation calculating the present value of a future cash flow to determine its value today is called __________ valuation. A: Discounted cash flow Q: Today, you deposit $3,400 in a bank account which pays 4.5 percent simple interest. How much interest will you earn over the next 5 years? A: $765 Simple Interest = PV x i x n PV = $3,400; i=.045; n=5 So, Interest = 3,400 x .045 x 5 = $765 Q: Over a period of years, an investment in an account which pays 6 percent simple interest will: A: increase in value less than an account which pays 6 percent compound interest Q: The value of an investment after one or more periods of time is called the: A: Future Value Q: You borrow $200 from a payday lending company and pay $5 interest for two weeks. What is the nominal annual interest rate? A: 65% First calculate the interest rate per fortnightly period. This is $5 interest paid for the 2 weeks / $200 borrowed = .025 = i m = number of compounding periods in a year = 26 The nominal interest rate is the annual compounding interest rate = i x m = .025 x 26 = .65 = 65% p.a. compounding fortnightly Revision Quiz 3&4: Time Value of Money 2 & 3 Q: Your yearly loan repayments on a $500,000 loan over ten years are $72,842.96. If the interest rate is 7.5% p.a., what is the loan outstanding at the end of the first year? A: $464,657.04

Loan outstanding at end of first year (i.e. - principal remaining) can be calculated by working out how much of the first loan repayment amount of $72,842.96 is for interest, and how much repays the principal. In the first year, the annual interest charged on the loan = 500,000 x .075 = $37,500 Principal repaid in first year = loan repayment - interest = 72,842.96 - 37,500 = 35,342.96 Loan outstanding at end of first year = Beginning loan balance of 500,000 - principal repaid of 35,342.96 = $464,657.04 Q: Your yearly loan repayments on a $500,000 loan over ten years are $72,842.96. If the interest rate is 7.5% p.a., what is the amount of principal repaid in the first year? A: $35,342.96 The amount of principal repaid in the first year can be calculated by working out how much of the first loan repayment amount of $72,842.96 is for interest, and then the balance is principal repaid. In the first year, the annual interest charged on the loan = 500,000 x .075 = $37,500 Principal repaid in first year = loan repayment - interest = 72,842.96 - 37,500 = $35,342.96 Q: Your yearly loan repayments on a $500,000 loan over ten years are $72,842.96. If the interest rate is 7.5% p.a., what is the amount of interest paid in the first year? A: $37,500.00 The amount of interest paid in the first year is calculated by beginning loan balance x interest rate per period (i.e. per year in this problem): = 500,000 x .075 = $37,500

Q: You wish to accumulate $40,000. You make 15 quarterly deposits into a savings account with an interest rate of 2.5% per quarter. What is the amount of each deposit? A: $2,230.66 We rearrange the FV of an ordinary annuity formula to calculate PMT, the regular quarterly deposits required. PMT = FV / [ (1+i)n -1 / i ] Where FV = 40,000 i = interest rate per period (i.e. per quarter) = .025 n = total number of periods = 15 PMT = 40,000 / [ (1+.025)15 -1 / .025 ] = $2,230.66 Q: A contractual arrangement requires payments of $10,000 on 7 October 2019 and $7,000 on 7 October 2024. What is an equivalent single amount payable on 7 October 2026 at an interest rate of 12% p.a. compounding quarterly? A: $31,746.67 This problem is asking you to calculate the FV at 2026 of two separate payments.

i= interest rate per period (per quarter) = .12/4 = .03 For the $10,000 payment occurring in 2019, n = (2026-2019) x 4 quarters per year = 28 For the $7,000 payment occurring in 2024, n = (2026-2024) x 4 quarters per year = 8 FV2026 = PV2019(1+i)n + PV2024(1+i)n = 10,000(1+.03)28 + 7,000(1+.03)8 = $31,746.67 Q: You borrow $200,000. The loan requires 20 quarterly repayments at an interest rate of 8% p.a. compounded quarterly. What amount of interest is repaid in the first three months? A: $4,000.00 Interest repaid in the first three months = beginning balance of loan x interest rate per period (i.e. per quarter): = 200,000 x .02 = $4,000 Q: What is the value today of $4,000 payments per year, at a discount rate of 5% p.a. if the first payment is received five years from now and the final payment is received 20 years from now? A: $35,665.04 This problem will involve two steps. We are being asked to calculate the present value today (t=0) of an annuity that has its first payment in five years' time. The present value of an ordinary annuity formula calculates present value one time period before the first payment. That means, it will give us PV at year 4. We will then need to discount this amount back by 4 years to give us PV0. Step 1: Calculate PV of the annuity, so PV4 = PMT[ 1-(1+i)-n / i ] where PMT = 4,000; i=.05 n = total number of annuity payments = 16 (**make sure you have n correct! The annuity includes the first payment at year 5, so total number of payments = 20-5+1 = 16. If you still don't understand this, prove it to yourself - draw out a timeline and count up the number of payments to check this - or count them on your fingers.) PV4 = PMT[ 1-(1+.05)-16 / .05 ] = $43,351.08 Step 2: Take the value we have calculated for year 4 and use the compound interest formula to discount this value back four years to give a present value today (t=0) PV4 = FV4 = $43,351.08 PV0 = FV4(1+i)-n = 43,351.08(1+.05)-4 = $35,665.04 Q: Your goal is to accumulate $60,000 in seven years' time. What monthly deposit must you make into a savings account to reach your goal? Interest rates are 12% p.a. compounded monthly. A: $459.16 We rearrange the FV of an ordinary annuity formula to calculate PMT, the regular monthly deposits required. PMT = FV / [ (1+i)n -1 / i ] Where FV = 60,000 i = interest rate per period (i.e. per month) = .12/12 =.01

n = total number of periods = 7 years x 12 months per year = 84 PMT = 60,000 / [ (1+.01)84 -1 / .01 ] = $459.16 Q: You borrow $200,000. The loan requires 20 quarterly repayments at an interest rate of 8% p.a. compounded quarterly. What is the loan outstanding after the first quarterly repayment? A: $191,768.66 PMT = PV / [ 1-(1+i)-n/ i ] Where PV = amount borrowed = 200,000 i = interest rate per period (i.e. per quarter) = .08/4 = .02 n = total number of periods = 20 PMT = 200,000 / [ 1-(1+.02)-20 / .02 ] = $12,231.34 Loan outstanding at end of first quarter (i.e. - principal remaining) can be calculated by working out how much of the first loan repayment amount of $12,231.34 is for interest, and how much repays the principal. In the first year, the annual interest charged on the loan = 200,000 x .02 = $4,000 Principal repaid in first quarter = loan repayment - interest = 12,231.34 - 4,000 = $8,231.34 Loan outstanding at end of first quarter = Beginning loan balance of 200,000 - principal repaid of 8,231.34 = $191,768.66 Q: Your goal is to accumulate $75,000 in five years' time. What monthly deposit must you make into a savings account to reach your goal? Interest rates are 8% p.a. compounded monthly. A: $1,020.73 We rearrange the FV of an ordinary annuity formula to calculate PMT, the regular monthly deposits required. PMT = FV / [ (1+i)n -1 / i ] Where FV = 75,000 i = interest rate per period (i.e. per month) = .08/12 n = total number of periods = 5 years x 12 months per year = 60 PMT = 75,000 / [(1+.08/12)60 -1/.08/12] = $1,020.73 Q: You borrow $200,000. The loan requires 20 quarterly repayments at an interest rate of 8% p.a. compounded quarterly. What amount of principal is repaid in the first three months? A: $8,231.34 PMT = PV / [ 1-(1+i)-n / i ] Where PV = amount borrowed = 200,000 i = interest rate per period (i.e. per quarter) = .08/4 = .02 n = total number of periods = 20 PMT = 200,000 / [ 1-(1+.02)-20 / .02 ] = $12,231.34

The amount of principal repaid in the first quarter can be calculated by working out how much of the first loan repayment amount of $12,231.34 is for interest, and then the balance is principal repaid. In the first quarter, the interest charged on the loan = 200,000 x .02 = $4,000 Principal repaid in first quarter = loan repayment - interest = 12,231.34 - 4,000 = $8,231.34 Q: What is the value today of $800 paid every six months forever, with the first $800 payment occurring nine years from today. Interest rates are 6% p.a. compounded halfyearly. A: $16,133.77 This problem is asking you to calculate the PV today (t=0) of a perpetuity beginning 9 years from today. The PV of a perpetuity formula calculates present value one period before the first payment. So we will need to take two steps - first use the PV of a perpetuity formula which will give the value one period before year 9. Then we will discount this value back to zero using the compound interest formula. PMT = 800 i = interest rate per period (i.e. per six months) = .06/.02 = .03 Step 1: The perpetuity makes its first payment at time period 18 (i.e. 9 years from now x 2 periods per year). So the PV of a perpetuity formula will calculate PV at time period 17, being one period before the first payment at time period 18. PV17 = PMT18 / i = 800/.03 = $26,666.67 Step 2: PV17 = FV17 = $26,666.67 PV0 = FV17(1+i)-n = 26,666.67(1+.03)-17 = $16,133.77 Q: What is the value today of $800 per month forever, with the first $800 payment occurring two months from today. Interest rates are 6% p.a. compounded monthly. A: $159,203.98 This problem is asking you to calculate the PV today (t=0) of a perpetuity beginning 2 periods from today. The PV of a perpetuity formula calculates present value one period before the first payment. So we will need to take two steps - first use the PV of a perpetuity formula which will give us the value at period 1. Then we will discount this value back to zero using the compound interest formula. PMT = 800 i = interest rate per period (i.e. per month) = .06/12 = .005 Step 1: PV1 = PMT2 / i = 800/.005 = $160,000 Step 2: PV1 = FV1 = $160,000 PV0 = FV1(1+i)-n = 160,000(1+.005)-1 = $159,203.98
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