STUDY GUIDE FOR MIDTERM 1

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) Which of the following best describes why the Valuation Principle is a key concept in making financial
decisions?
A) It allows fixed assets and liquid assets to be valued correctly.
B) It shows how to make the costs and benefits of a decision comparable so that we can weigh them
properly.
C) It shows how to assign monetary value to intangibles such as good health and well-being.
D) It gives a good indication of the net worth of a person, item, or company and can be used to estimate
any changes in that net worth.

2) Which of the following types of firms does NOT have limited liability?
A) limited partnerships B) corporations
C) sole proprietorships D) none of the above

3) Over four-fifths of all U.S. business revenue is generated by which type of firms?
A) partnerships B) sole proprietorships
C) corporations D) limited partnerships

4) What is the major way in which the roles and obligations of the owners of a limited liability company differ
from the roles and obligations of limited partners in a limited partnership?
A) The owners of a limited liability company can take an active role in running the company.
B) The owners of a limited liability company have personal obligation for debts incurred by the
company.
C) The owners of a limited liability company can withdraw from the company without the company
being dissolved.
D) There is no separation between the company and its owners in a limited liability company.

5) A C corporation earns $8.30 per share before taxes and the company pays a dividend of $4.00 per share. The
corporate tax rate is 39%, the personal tax rate on dividends is 15%, and the personal tax rate on
non-dividend income is 36%. What is the after-tax amount an individual would receive from the dividend?
A) $4.76 B) $3.40 C) $2.72 D) $4.08

6) A sole proprietorship is owned by ________.

A) shareholders B) two or more persons
C) bankers D) one person

7) Which of the following is NOT an advantage of a sole proprietorship?

A) single taxation B) ease of setup
C) no separation of ownership and control D) unlimited liability

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 8) Which of the following would be best considered to be an agency conflict problem in the behavior of the
following financial managers?
A) Michael chooses to enhance his firm's reputation at some cost to its shareholders by sponsoring a team
of athletes for the Olympics.
B) Bill chooses to pursue a risky investment for the company's funds because his compensation will
substantially rise if it succeeds.
C) Sue instructs her staff to skip safety inspections in one of the company's factories, knowing that it will
likely fail the inspection and incur significant costs to fix.
D) James ignores an opportunity for his company to invest in a new drug to fight Alzheimer's disease,
judging the drug's chances of succeeding as low.

9) A factory owner wants his workers to produce as many widgets as they can so he pays his workers based on
how many widgets they produce. However, in order to make sure that the workers do not rush and produce
a large number of poorly made widgets, he checks the widgets at random at various stages of their
manufacture. If a defect is found in a widget, the pay of the entire section of the factory responsible for that
defect is docked. How is this factory owner seeking to solve the agency conflict problem in this case?
A) by maximizing the information that the principal obtains about the behavior of the agents
B) by making the agents into principals themselves
C) by supplying incentives so the agents act in the way principal desires
D) by ensuring that all workers co-operate to maximize the gains of their section

10) In which of the following relationships is an agency conflict problem LEAST likely to arise?
A) the relationship between a hire -car company and the persons who hire that company's cars regarding
the treatment of those cars
B) the relationship between high-level military officers and the soldiers who serve under them regarding
the willingness of the soldiery to take risks
C) the relationship between a restaurateur and the suppliers of produce to that restaurant regarding the
freshness of the produce supplied
D) the relationship between a driver and the passengers in a car regarding the safe driving of that car

11) A corporate raider gains a controlling fraction of the shares of a poorly managed company and replaces the
board of directors. How does the corporate raider hope to make a profit in this case?
A) by the sale of the assets held by the company that hold most of its value
B) by removing the employees expectations of the continued poor performance of the company
C) by motivating the board of directors and other stakeholders in the company to make difficult
short-term decisions that will increase the long-term viability of the company
D) by the rise in the value of the stock held by the raider when the new board of directors is judged to be
superior to the ousted board of directors

12) Why is it difficult to determine the market price of a private corporation's shares at any point in time?
A) It has a limited number of owners.
B) The price of its shares is fixed by the owners.
C) There is no organized market for its shares.
D) It is difficult to obtain enough information to accurately value such a company.

13) Which of the following is a measure of the aggregate price level of collections of pre -selected stocks?
A) NASDAQ B) S&P 500 C) Euronext D) NYSE

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14) Which of the following is NOT a role of financial institutions?
A) printing money for borrowers B) moving funds though time
C) spreading out risk-bearing D) moving funds from savers to borrowers

15) What is the main reason that it is necessary for public companies to follow the rules and format set out in the
Generally Accepted Accounting Principles (GAAP) when creating financial statements?
A) It makes it easier to compare the financial results of different firms.
B) It ensures that important budgetary information is not omitted.
C) It ensures that information on the performance of public companies is reported on cash-basis
accounting.
D) It ensures that the market value of assets and debt are reported accurately.

16) Which of the following is NOT a financial statement that every public company is required to produce?
A) balance sheet B) income statement
C) statement of sources and uses of cash D) statement of stockholders' equity

17) Heavy Duty Company, a manufacturer of power tools, decides to offer a rebate of $130 on its 16-inch
mid-range chain saw, which currently has a retail price $490. Heavy Duty's marketers estimate that, as a
result of the rebate, sales of this model will increase from 60,000 to 80,000 units next year. The profit margin
for Heavy Duty before the rebate is $180. Based on the given information, is the decision to give the rebate a
wise one?
A) Yes, since the benefits are $7,300,000 more than the costs.
B) No, since costs are $6,800,000 more than benefits.
C) Yes, since the benefits are $3,400,000 more than the costs.
D) No, since costs are $7,800,000 more than benefits.

18)
Country Australia Chile Iceland New Zealand South Africa
Abalone Cost AUD 93,500 CLP 50,990,000 ISK 5,400,000 NZD 104,000 ZAR 640,000
Exchange
Rate: $1 U.S. = 1.1 AUD 585 CLP 61 ISK 1.3 NZD 7.8 ZAR

Refer to the table above. An international seafood supplier is offered 9.52 million yen today for 1000 pounds
of abalone frozen in the shell. One thousand pounds of abalone can be sourced from various countries at the
prices shown above. The current market exchange rates between the United States and the other relevant
currencies are also shown. In addition, $1 U.S. = 102 yen. What is the value, in U.S. dollars, of the best deal
the international seafood supplier can make?
A) $14,333 B) $14,833 C) $13,333 D) $12,333

19) You own 1000 shares of Newstar Financial stock, currently trading for $57 per share. You are offered a deal
where you can exchange these stocks for 900 shares of Amback Financial Group stock, currently trading at
$63 per share. What is the value of this trade, if you choose to make it?
A) $300 B) -$300 C) -$340 D) -$320

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20) Which of the following statements regarding the Law of One Price is INCORRECT?
A) If equivalent goods or securities trade simultaneously in different competitive markets, then they will
trade for the same price in both markets.
B) At any point in time, the price of two equivalent goods trading in different competitive markets will
be the same.
C) One useful consequence of the Law of One Price is that when evaluating costs and benefits to
compute a net present value (NPV), we can use any competitive price to determine a cash value,
without checking the price in all possible markets.
D) An important property of the Law of One Price is that it holds even in markets where arbitrage is
possible.

21) A lender lends $10,100 , which is to be repaid in annual payments of $2070 for 6 years. Which of the
following shows the timeline of the loan from the lender's perspective?

A) Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

- $2070 $2070 $2070 $2070 $2070 $2070
$10,100

B) Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

0 $2070 $2070 $2070 $2070 $2070

C) Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

- $2070 $4070 $6070 $8070 $10,070 $12,070
$10,100

D) Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

- $2070 $2070 $2070 $2070 $2070
$10,100

22) Which of the following situations is best described by the timeline shown below?

Date 0 1 2 3 4 5
(Months)
Cash -$250 -$250 -$250 -$250 -$250 -$250
Flows

A) You receive payments of $250 per month for five months.

B) You receive payments of $250 per month for six months.
C) You make payments of $250 per month for six months.
D) You make payments of $250 per month for five months.

23) Why should you approach every problem by drawing a timeline?

A) A timeline can be used to schedule events which are yet to occur.
B) A timeline eliminates the majority of flawed financial decisions.
C) A timeline allows you to quickly sum cash flows over time.
D) A timeline identifies events in a transaction or investment which might otherwise be easily
overlooked.

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24) Which of the following statements is INCORRECT based on the time value of money?
A) We refer to (1 - rf) as the interest rate factor for risk-free cash flows.
B) For most financial decisions, costs and benefits occur at different points in time.
C) In general, money today is worth more than money in one year.
D) We define the risk-free interest rate (rf) for a given period as the interest rate at which money can be
borrowed or lent without risk over that period.

25) Sara wants to have $600,000 in her savings account when she retires. How much must she put in the account
now, if the account pays a fixed interest rate of 8%, to ensure that she has $600,000 in 20 years?
A) $231,712 B) $180,221 C) $139,541 D) $128,729

26) An investment will pay you $120 in one year and $200 in two years. If the interest rate is 4%, what is the
present value of these cash flows?
A) $320.00 B) $307.69 C) $300.29 D) $304.91

27) Which of the following investments has a higher present value, assuming the same (strictly positive) interest
rate applies to both investments?

Year Investment X Investment Y

1 $5,000 $11,000
2 $7,000 $9,000
3 $9,000 $7,000
4 $11,000 $5,000

A) Investment Y has a higher present value.

B) Investment X has a higher present value.
C) Investment X and Investment Y have the same present value, since the total of the cash flows is the
same for both.
D) No comparison can be madewe need to know the interest rate to calculate the present value.

28) Which of the following is true about perpetuities?

A) Since a perpetuity generates cash flows every period infinitely, the cash flow generated equals the PV
times the interest rate.
B) Since a perpetuity generates cash flows every period infinitely, initial cash outflow must be discounted
to calculate the present value.
C) Since a perpetuity generates cash flows every period infinitely, its FV is the same as its PV.
D) Since a perpetuity generates cash flows every period infinitely, there is no way to solve for the cash
flow using the present value and the interest rate.

29) You are borrowing money to buy a car. If you can make payments of $320 per month starting one month
from now at an interest rate of 12%, how much will you be able to borrow for the car today if you finance the
amount over 4 years?
A) $7291.00 B) $17,012.34 C) $14,582.00 D) $12,151.67

30) Since your first birthday, your grandparents have been depositing $1200 into a savings account on every one
of your birthdays. The account pays 6% interest annually. Immediately after your grandparents make the
deposit on your 18th birthday, the amount of money in your savings account will be closest to ________.
A) $44,504.14 B) $37,086.78 C) $51,921.49 D) $22,252.07

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31) Since your first birthday, your grandparents have been depositing $100 into a savings account every month.
The account pays 9% interest annually. Immediately after your grandparents make the deposit on your 18th
birthday, the amount of money in your savings account will be closest to ________.
A) $32,181 B) $64,362 C) $75,089 D) $53,635

32) Which of the following statements regarding annuities is FALSE?

A) The difference between an annuity and a perpetuity is that a perpetuity ends after some fixed number
of payments.
B) An annuity is a stream of N equal cash flows paid at regular intervals.
C) Most car loans, mortgages, and some bonds are annuities.
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D) PV of an annuity = C × 1 1 -
r (1 + r) N

33) Clarissa wants to fund a growing perpetuity that will pay $10,000 per year to a local museum, starting next
year. She wants the annual amount paid to the museum to grow by 5% per year. Given that the interest rate
is 9%, how much does she need to fund this perpetuity?
A) $250,000.00 B) $125,000.00 C) $200,000.00 D) $300,000.00

34) Martin wants to provide money in his will for an annual bequest to whichever of his living relatives is
oldest. That bequest will provide $4000 in the first year, and will grow by 7% per year, forever. If the interest
rate is 9%, how much must Martin provide to fund this bequest?
A) $160,000.00 B) $100,000.00 C) $200,000.00 D) $240,000.00

35) Which of the following statements regarding growing perpetuities is FALSE?

A) We assume that r < g for a growing perpetuity.
B) A growing perpetuity is a cash flow stream that occurs at regular intervals and grows at a constant
rate forever.
C) PV of a growing perpetuity = C
r-g
D) To find the value of a growing perpetuity one cash flow at a time would take forever.

36) Dan buys a property for $210,000 . He is offered a 30-year loan by the bank, at an interest rate of 8% per year.
What is the annual loan payment Dan must make?
A) $18,653.76 B) $22,384.51 C) $26,115.26 D) $29,846.02

37) A bank is negotiating a loan. The loan can either be paid off as a lump sum of $80,000 at the end of four
years, or as equal annual payments at the end of each of the next four years. If the interest rate on the loan is
6%, what annual payments should be made so that both forms of payment are equivalent?
A) $25,602 B) $29,259 C) $18,287 D) $14,630

38) Matthew wants to take out a loan to buy a car. He calculates that he can make repayments of $5000 per year.
If he can get a four-year loan with an interest rate of 7.9 %, what is the maximum price he can pay for the
car?
A) $23,237 B) $19,918 C) $16,598 D) $26,557

39) What is the internal rate of return (IRR) of an investment that requires an initial investment of $11,000 today
and pays $15,400 in one year's time?
A) 43% B) 40% C) 44% D) 37%

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40) You are considering purchasing a new home. You will need to borrow $290,000 to purchase the home. A
mortgage company offers you a 20-year fixed rate mortgage (240 months) at 12% APR (1% month). If you
borrow the money from this mortgage company, your monthly mortgage payment will be closest to
________.
A) $4470 B) $3193 C) $5109 D) $2554

41) You are considering investing in a zero-coupon bond that will pay you its face value of $1000 in twelve
years. If the bond is currently selling for $496.97, then the internal rate of return (IRR) for investing in this
bond is closest to ________.
A) 8.2% B) 5.0 % C) 6.0 % D) 7.1%

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Answer Key
Testname: BUSFIN 3120AU19 STUDYGUIDE MIDTERM1

1) B
Explanation:
Topic:
2) C
Explanation:
Topic:
3) C
Explanation:
Topic:
4) A
Explanation:
Topic:
5) B
Explanation: Personal tax = $4 × 15% = $0.60 . Total = $4.00 - $0.60 = $3.40 .
Topic:
6) D
Explanation:
Topic:
7) D
Explanation:
Topic:
8) B
Explanation:
Topic:
9) C
Explanation:
Topic:
10) D
Explanation:
Topic:
11) D
Explanation:
Topic:
12) C
Explanation:
Topic:
13) B
Explanation:
Topic:
14) A
Explanation:
Topic:
15) A
Explanation:
Topic:
16) C
Explanation:
Topic:

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Answer Key
Testname: BUSFIN 3120AU19 STUDYGUIDE MIDTERM1

17) B
Explanation: 180 × 60,000 = $10,800,000; (180 - 130) × 80,000 = $4,000,000;
$10,800,000 - $4,000,000 = $6,800,000
Topic:
18) C
Explanation: 9.52 million / 102 yen = $93,333 ; cost = 104,000/1.3 NZD = $80,000;
$93,333 - $80,000 = $13,333 .
Topic:
19) B
Explanation: (-57 × 1000) + (900 × 63) = -$300
Topic:
20) D
Explanation:
Topic:
21) A
Explanation:
Topic:
22) C
Explanation:
Topic:
23) D
Explanation:
Topic:
24) A
Explanation:
Topic:
25) D
Explanation: Calculate the PV with FV = $600,000 , N = 20, and interest = 8%, which = $128,729 .
Topic:
26) C
Explanation: 120/(1.04) + 200/(1.04 2) = 115.38 + 184.91 = 300.29
Topic:
27) A
Explanation:
Topic:
28) A
Explanation:
Topic:
29) D
Explanation: N = 48
I = 12 /12
PMT = $ 320
FV = 0
PV = $12,151.67
Topic:

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Answer Key
Testname: BUSFIN 3120AU19 STUDYGUIDE MIDTERM1

30) B
Explanation: N = 18
PMT = $ 1200
I=6
PV = 0
Compute FV = $37,086.78.
Topic:
31) D
Explanation: N = 216
PMT = $ 100
I = 9/12
PV = 0
Compute FV = $53,635.167
Topic:
32) A
Explanation: A perpetuity never ends.
Topic:
33) A
Explanation: PV growth perpetuity = $ 10,000 / (0.09 - 0.05 ) = $250,000.00
Topic:
34) C
Explanation: PV growth perpetuity = $ 4000 / (0.09 - 0.07) = $200,000.00
Topic:
35) A
Explanation:
Topic:
36) A
Explanation: Calculate PMT using TVM keys: input PV = 210,000 , N = 30, and interest rate = 8%; PMT = $18,653.76.
Topic:
37) C
Explanation: Calculate PMT with FV = $80,000 , interest = 6% and N = 4, which gives PMT = $18,287.32.
Topic:
38) C
Explanation: Calculate PV using TVM keys: input PMT = $ 5000, N= 4, and interest rate = 7.9 %; PV = $16,597.5634.
Topic:
39) B
Explanation: Calculate interest rate using TVM keys: input PV = 11,000 , N = 1, and FV = -15,400 ; interest rate = 40%.
Topic:
40) B
Explanation: PV = 290,000
I=1
N = 240
FV = 0
Compute payment = $3193.15 .
Topic:

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Answer Key
Testname: BUSFIN 3120AU19 STUDYGUIDE MIDTERM1

41) C
Explanation: PV = -496.97
FV = 1000
PMT = 0
N = 12
Compute I = 6.0 %.
Topic:

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