True False Practice PDF

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Practice these and you will know the multiple choice on exams!...

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True-False Practice Questions (All statements are False. Words or phrases in RED make the statement False.)

Try to identify the issue to which each statement refers

Exam #1 Introduction (Chapter 1) Note: See also the Power Point presentation, “Finance 3101: Things You Need to Know” found on the Home Page of the All-Sections Canvas course. 1. According to the Order of Operations, exponents are applied before the expression in parentheses, division is to be completed before multiplication, and addition and subtraction are to be completed before multiplication and division. [FORMULA3] 2. A simple percent change represents a change as part of the new or later value. [FORMULA1] 3. To change a decimal value to a percent, divide by 10. [FORMULA2] 4. In a Normal Distribution, there is a 68% chance that an actual return will exceed the average return minus one standard deviation. [FORMULA5] 5. For a given mean, a larger standard deviation reflects less uncertainty. [FORMULA5] 6. If both the top and bottom of a fraction increase, there is no way to tell in which direction the value of the whole fraction would change. [FORMULA4] 7. The “Cycle of Money” involving investors and a corporation refers to the corporation lending money to investors who then return cash to the corporation. [EQ1] 8. The capital budgeting area deals with how the firm should be financed. [EQ2] 9. The capital structure area deals with how much of a firm’s assets should be held in cash, inventory and accounts receivable. [EQ2] 10. The goal of the corporate financial manager is to maximize the firm’s profits. [EQ3] 11. There are four major factors that determine stock prices. [EQ4] 12. In order to maximize stock prices, financial managers should try to generate as little cash as possible, have that cash come as late as possible and with the maximum amount of risk. [EQ4] 13. When you purchase an existing share of stock you are participating in a “primary” market transaction. [EQ5] 16. The total return on any investment equals the capital gain part minus the income part. [FORMULAS 6&7]

TVM Lump Sums (Chapter 3) 1. PVs are rightward on a time line and FVs are leftward on the time line. [EQ3] 2. PVs are later values and FVs are earlier values. [EQ3] 3. PVs represent the amount that an earlier amount will grow into. [EQ3] 4. FVs represent what you need to invest earlier to have it grow into a specified later amount. [EQ3] 5. Discounting is the process used to find a FV. [EQ5] 6. What is “discounted” from the PV is the interest part to arrive at the FV. [EQ5] 7. With compound interest, interest is earned every period only on the original starting amount. [EQ6] 8. Ceteris paribus, as a depositor and for the same annual interest rate, you would prefer simple interest to compound interest. [EQ6] 9. Lump sums are multiple cash flows. [EQ7] 10. There are a total of 3 variables in the basic Chapter 3 TVM formulas. [EQ8] 11. The right-hand side variables in the FV formula represent the 3 key factors determining stock prices. [EQ9] 12. Ceteris paribus, the FV and the discount rate are inversely related. [EQ 10&11] 13. The number of years it would take an investment to double is approximately equal to the annual interest rate times 72. [EQ12]

TVM Multiple Cash Flows (Chapter 4) 1. We’ve discussed 4 different multiple cash flow patterns. [EQ1] 2. Annuities are equal cash flows that go on forever. [EQ1] 3. There are 2 formulas on our formula sheet for Chapter 4 that contain the variable “PMT”. [CHAPTER 4 FORMULAS] 4. We can determine which “PMT” we’re being asked to solve for by noting what the problem provides in terms of r and n. [EQ7] 5. When given the annual withdrawals desired during the retirement period, FVA tells us the amount we should have accumulated by the time we retire. [EQ12] 6. Given the amount needed at the beginning of the retirement period, the annual deposits needed during the working period can be found by solving for “PMT” in the PVA formula. [EQ 12] 7. “PMT” in the FVA formula tells us the periodic mortgage payments for a fixed-rate fully amortized loan. [EQ8] 8. The interest part of a fixed mortgage loan payment can be found by multiplying the periodic interest rate by the ending balance for a given period. [EQ9]

9. For fixed-rate fully amortized mortgage loans, more of the fixed payment goes towards interest as we approach the end of the loan term. [EQ10] 10. We can find the amount needed to pay off a mortgage loan at any point in time by solving for the FV of the remaining payments. [EQ11]

Interest Rates & Bonds (Chapters 5 & 6) 1. The penalty for spending before earning is the interest rate from the point of view of the creditor. [EQ1] 2. Ceteris paribus, as the frequency of compounding increases, the APR will exceed the EAR by greater and greater amounts. [EQ3] 3. The periodic rate will always be greater than the APR. [EQ3] 4. The Fisher Effect illustrates the inverse relationship between inflation and nominal interest rates. [EQ5] 5. We can find the nominal interest rate by subtracting the default and maturity premiums from the sum of the real rate and inflation. [EQ8] 6. Interest rates were high in the late 1970s and early 1980s because of unusually low default premiums. [EQ7] 7. In the period 1950 – 1999 changes in the real rate were the main factor causing nominal interest rates to change. [EQ7&10] 8. At maturity, investors must repay a bond’s par value to its issuer. [EQ11&12] 9. A $1,000 par value bond with an annual coupon rate of 5% would pay $100 in interest every 6 months. [EQ11&12] 10. Ceteris paribus, bond prices move in the opposite direction from their coupon rates. [EQ12] 11. Discount bonds are always worth less than par value at maturity. [EQ17] 12. The YTM on a premium bond will be above its coupon rate. [EQ17] 13. Par bonds sell for less than par value. [EQ17] 14. You can earn very high returns by purchasing zero-coupon bonds at a premium. [EQ17] 15. If you buy a bond at a discount and hold it to maturity, you will experience a capital loss. [EQ17] 16. Capital losses always increase the investor’s rate of return. [EQ17; FORMULA6]

EXAM #2 Risk & Return (Chapter 8)

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”Diversifiable” risk, “Company specific” risk, “Systematic” risk and “Market”

Stocks or Equities (Chapter 7) 1. Unlike investors in bonds, investors in stocks do not have the opportunity to realize capital gains. [FORMULAS6&7&33; EQ1] 2. Bonds have no finite maturities but stocks do. [EQ1] 3. Just like bonds, stocks are worth their par value at maturity. [EQ1] 4. When a corporation liquidates it assets, stockholders get paid before bondholders. [EQ1] 5. Dealers’ bid prices always exceed their ask prices. [EQ2] 6. When you purchase a share of stock, you would pay the bid price. [EQ3] 7. The limited liability feature of equities means that investors cannot lose money on stocks. [EQ4] 8. You should sell stocks if you expect a bull market in equities. [EQ4] 8. Ceteris paribus, faster (constant) growth in dividends would increase a stock’s market price per share. [EQ7]

Financial Statements (Chapter 2) 1. COGS appears on the liability side of the BS. [EQ1&3] 2. The balance sheet identity indicates that total liabilities can be found by subtracting total assets from total equity. [EQ2] 3. EBIT can be found by subtracting all operating expenses and taxes from revenue. [EQ3] 4. Treatment of Current Liabilities is one of the factors cited by our author for why NI and CF may be different. [EQ6] 5. Changes in depreciation expense do not affect a firm’s cash position. [EQ 7] 6. Ceteris paribus, an increase in accounts receivable would increase CFFA. [FORMULAS 43-48; EQ8] 7. If a firm’s CFFA or “free cash flow” is negative, this means that the firm will be unable to pay any cash dividends. [EQ8] 8. If there is no change in gross fixed assets from one year to the next, then net fixed assets would have to have increased. [FORMULAS 45&46] 9. Accounts payable represents short-term loans extended to the suppliers by the corporation. [EQ9] 10. A decrease in inventory constitutes a use of cash. [EQ10] 11. An increase in accounts payable constitutes a use of cash while an increase in accounts receivable constitutes a source of cash. [EQ10]

Capital Structure (Chapter 16) 1. Capital structure refers to the make-up of the left-hand side of the balance sheet. [EQ1] 2. The central question involved with capital structure is the amounts of short-term assets and liabilities should a corporation have. [EQ1] 3. The two key features of “leverage” are that something is fixed and something is minimized. [EQ2] 4. The advantage of equity over debt is that equity is a cheaper form of financing for a corporation. [EQ5] 5. Adding debt will be beneficial for owners if the cost of borrowing exceeds the return earned on the borrowed funds. [EQ7] 6. The NPV Profile Graph can be used to illustrate the impact on owners of various levels of debt. [EQ7] 7. In the EBIT Breakeven Graph, as the level of debt increases, the line representing this level of debt becomes flatter. [EQ7] 8. The higher the level of EBIT, the less owners benefit from the use of debt financing. [EQ7] 9. The greater the use of debt, the less the volatility of EPS [EQ7]

10. A firm’s cost of capital is a weighted average of its cost of goods sold and its cost of debt. [EQ8] 11. As a firm substitutes debt for equity, its cost of capital begins to go up. [EQ9] 12. A firm’s optimal capital structure is one at which its cost of capital is at a maximum. [EQ10&11]

FINAL EXAM Analysis of Financial Statements (Chapter 14) 1. “Benchmarking” can only be done using cross-section analysis. [EQ1&2] 2. Evaluating IBM’s financial ratios over the past 5 years is an example of cross-section analysis. [EQ2] 3. Common-size values on the balance sheet show each item as a percent of total equity. [EQ3] 4. “Ratio”, “proportion”, “fraction” and “sum” all mean the same. [EQ4] 5. Every ratio tells us for every one of what’s on the top, here’s how many we have of what’s on the bottom. [EQ4] 6. If sales increase by 5% and total assets fall by 1%, the TAT ratio would go down by approximately 4%. [FORMULA4] 7. A decrease in the current ratio indicates an improvement in a firm’s long-term solvency condition. [EQ5&6] 8. An increase in the cash coverage ratio means that a firm is more likely to default on its outstanding debt. [EQ6] 9. For firms with lower P/E ratios, investors are valuing each dollar of earnings more than for firms with higher P/E ratios. [EQ6] 10. Corporate managers who are doing a better job of serving owners would see their firm’s market-book ratio be lower than the ratio for managers who are not doing as good a job. [EQ6] 11. Ceteris paribus, more use of equity financing relative to debt financing would increase a firm’s ROE. [EQ7] 12. Ceteris paribus, according to the DuPont framework, an increase in the use of debt would reduce a firm’s ROE. [EQ7] 13. The higher the equity multiplier, the greater is the proportion of a firm’s assets that are financed with equity. [EQ8] 14. Because it contains no explicit measure of debt, the equity multiplier provides no information about a firm’s use of debt. [EQ8] 15. If the debt-asset ratio is 0.75, the equity multiplier would be 0.25. [EQ9] 16. Increased use of debt will result in an improvement in the cash coverage ratio. [EQ11]

Estimation of Project Cash Flows (Chapter 10) 1. Without Project A after-tax cash flows are $100 and with Project A’s cash flows are $10. which means that Project A’s incremental cash flows are $110. [EQ1] 2. Erosion costs have no impact on a project’s incremental CFs. [EQ2] 3. Use of a firm’s existing assets in a proposed project would result in a sunk cost. [EQ2] 4. Opportunity costs reduce a project’s cash flows while erosion costs and synergy gains increase those cash flows. [EQ2] 5. Temple’s payment of $1M to an architectural firm for a feasibility study for a new football stadium is an example of a synergy gain. [EQ2] 6. The salvage value is added to the original cost of an asset to get the initial capital investment. [EQ3] 7. The main components needed to estimate a project’s incremental cash flows are the initial capital investment, the change in NWC, OCF, and the firm’s market share. [EQ3] 8. Working capital accounts typically go down at the beginning of a project and are then increased later. [EQ4] 9. Cogswell Cola needed to purchase additional inventory of plastic bottles to launch its Pulsar Cola. This increase in inventory represents a positive cash flow associated with the project. [EQ4] 10. Straight-line depreciation is higher in the earlier years of a project’s life. [EQ5] 11. The book value of a long-term asset at any point in time is equal to the asset’s original cost plus all of the depreciation that has been taken on that asset. [EQ6] 12. Sale of a piece of equipment at a loss reduces the CF from salvage. [EQ7]

Cost of Capital (Chapter 11) 1. The cost of capital refers to the rate of return expected to be earned on a project. [EQ1] 2. The IRR is sometimes referred to as the “hurdle rate”. [EQ2] 3. “WACC” stands for “Why Am I Coming to Campus?” [EQ3] 4. The after-tax cost of equity is less than the before-tax cost of equity. [EQ3] 5. In deriving the cost of capital, the YTM can be used as the before-tax cost of equity. [EQ5] 6. The cost of capital uses the amounts of long-term debt and inventory as the capital structure weights. [ EQ5] 7. The preferred capital structure weights are derived from the book value of debt and equity. [EQ4&5] 8. Higher-risk uses of funds require a lower WACC. [EQ6] 9. An unlevered firm has no equity. [EQ7]

Capital Budgeting (Chapter 9) 1. The NPV is the FV of all of a project’s outflows minus the FV of all inflows. [EQ1&2] 2. The NPV tells us the expected percent impact of a proposed project on the value of a firm. [EQ1] 3. We can find the IRR through use of the IRR formula but have to use trial and error to find the NPV. [EQ2&3] 4. The capital budgeting rule is to reject a project if the IRR < NPV. [EQ4] 5. Accept/reject decisions based on the IRR rule usually conflict with those based on the NPV rule. [EQ4] 6. The NPV Profile Graph can be used to illustrate the impact on owners of various levels of debt. [EQ5] 7. When the IRR exceeds the cost of capital, the NPV will be negative. [EQ6] 8. Excel’s NPV function treats CF in year zero as the CF in year 2. [EQ7]...