Bond Characteristics and Valuation

29. The interest rate risk premium is the:

A. additional compensation paid to investors to offset rising prices.
B. compensation investors demand for accepting interest rate risk.
C. difference between the yield to maturity and the current yield.
D. difference between the market interest rate and the coupon rate.
E. difference between the coupon rate and the current yield.
Refer to section 7.7
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Learning Objective: 7-5
Section: 7.7
Topic: Interest rate risk premium

40. Which one of the following relationships is stated correctly?
A. The coupon rate exceeds the current yield when a bond sells at a discount.
B. The call price must equal the par value.
C. An increase in market rates increases the market price of a bond.
D. Decreasing the time to maturity increases the price of a discount bond, all else constant.
E. Increasing the coupon rate decreases the current yield, all else constant.
Refer to sections 7.1 and 7.2
AACSB: N/A
Bloom's: Comprehension
Difficulty: Intermediate
Section: 7.1 and 7.2
Topic: Bond characteristics

41. Green Roof Inns is preparing a bond offering with a 6 percent, semiannual coupon and a face
value of $1,000. The bonds will be repaid in 10 years and will be sold at par. Given this, which
one of the following statements is correct?
A. The bonds will become discount bonds if the market rate of interest declines.
B. The bonds will pay 10 interest payments of $60 each.
C. The bonds will sell at a premium if the market rate is 5.5 percent.
D. The bonds will initially sell for $1,030 each.
E. The final payment will be in the amount of $1,060.
AACSB: N/A
Section: 7.1
Topic: Bond values

42. A newly issued bond has a 7 percent coupon with semiannual interest payments. The bonds
are currently priced at par value. The effective annual rate provided by these bonds must be:
A. 3.5 percent.
B. greater than 3.5 percent but less than 7 percent.
C. 7 percent.
D. greater than 7 percent.
E. Answer cannot be determined from the information provided.

AACSB: N/A
Difficulty: Basic
Section: 7.1
Topic: Effective annual rate

43. Which of the following increase the price sensitivity of a bond to changes in interest rates?
I. increase in time to maturity
II. decrease in time to maturity
III. increase in coupon rate
IV. decrease in coupon rate
A. II only
B. I and III only
C. I and IV only
D. II and III only
E. II and IV only
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 7.1
Topic: Interest rate sensitivity

45. As a bond's time to maturity increases, the bond's sensitivity to interest rate risk:
A. increases at an increasing rate.
B. increases at a decreasing rate.
C. increases at a constant rate.
D. decreases at an increasing rate.
E. decreases at a decreasing rate.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 7.1
Topic: Interest rate risk

46. You own a bond that has a 6 percent annual coupon and matures 5 years from now. You
purchased this 10-year bond at par value when it was originally issued. Which one of the
following statements applies to this bond if the relevant market interest rate is now 5.8 percent?
A. The current yield-to-maturity is greater than 6 percent.
B. The current yield is 6 percent.
C. The next interest payment will be $30.
D. The bond is currently valued at one-half of its issue price.
E. You will realize a capital gain on the bond if you sell it today.
AACSB: N/A
Section: 7.1
Topic: Interest rate effects

47. You expect interest rates to decline in the near future even though the bond market is not
indicating any sign of this change. Which one of the following bonds should you purchase now
to maximize your gains if the rate decline does occur?
A. short-term; low coupon
B. short-term; high coupon
C. long-term; zero coupon
D. long-term; low coupon
E. long-term; high coupon
AACSB: N/A
Difficulty: Basic
Section: 7.1
Topic: Interest rate risk

48. A 6 percent, annual coupon bond is currently selling at a premium and matures in 7 years.
The bond was originally issued 3 years ago at par. Which one of the following statements is
accurate in respect to this bond today?
A. The face value of the bond today is greater than it was when the bond was issued.
B. The bond is worth less today than when it was issued.
C. The yield-to-maturity is less than the coupon rate.
D. The coupon rate is greater than the current yield.
E. The yield-to-maturity equals the current yield.

AACSB: N/A
Bloom's: Analysis
Section: 7.1
Topic: Bond yields

Topic: Bond features

53. Which of the following are negative covenants that might be found in a bond indenture?
I. The company shall maintain a current ratio of 1.10 or better.
II. No debt senior to this issue can be issued.
III. The company cannot lease any major assets without approval by the lender.
IV. The company must maintain the loan collateral in good working order.
A. I and II only
B. II and III only
C. III and IV only
D. II, III, and IV only
E. I, II, and III only
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 7.2
Topic: Negative covenants

:

AACSB: N/A
Section: 7.4
Topic: Zero-coupon bond

62. Which one of the following risks would a floating-rate bond tend to have less of as compared
to a fixed-rate coupon bond?
A. real rate risk
B. interest rate risk
C. default risk
D. liquidity risk
E. taxability risk
AACSB: N/A
Section: 7.4
Topic: Floating-rate bond

Topic: Treasury bonds

75. Which one of the following statements is correct?

A. The risk-free rate represents the change in purchasing power.
B. Any return greater than the inflation rate represents the risk premium.
C. Historical real rates of return must be positive.
D. Nominal rates exceed real rates by the amount of the risk-free rate.
E. The real rate must be less than the nominal rate given a positive rate of inflation.
AACSB: N/A
Section: 7.6
Topic: Bond yields

77. You are trying to compare the present values of two separate streams of cash flows which
have equivalent risks. One stream is expressed in nominal values and the other stream is
expressed in real values. You decide to discount the nominal cash flows using a nominal annual
rate of 8 percent. What rate should you use to discount the real cash flows?
A. 8 percent
B. EAR of 8 percent compounded monthly
C. comparable risk-free rate
D. comparable real rate
E. You cannot compare the present values of these two streams of cash flows.
AACSB: N/A
Difficulty: Basic
Section: 7.6
Topic: Nominal and real rates

78. Which of the following statements is correct concerning the term structure of interest rates?
I. Expectations of lower inflation rates in the future tend to lower the slope of the term structure
of interest rates.
II. The term structure of interest rates includes both an inflation premium and an interest rate risk
premium.
III. The real rate of return has minimal, if any, affect on the slope of the term structure of interest
rates.
IV. The term structure of interest rates and the time to maturity are always directly related.
A. I and II only
B. II and IV only
C. I, II, and III only
E. I, II, and IV only
AACSB: N/A
Section: 7.7
Topic: Term structure of interest rates

79. Which two of the following factors cause the yields on a corporate bond to differ from those
on a comparable Treasury security?
I. inflation risk
II. interest rate risk
III. taxability
IV. default risk
A. I and II only
B. III and IV only
C. I, II, and IV only
E. I, II, III, and IV

AACSB: N/A
Difficulty: Basic
Topic: Determinants of bond yields

25. An increase in which of the following will increase the current value of a stock according to
the dividend growth model?
I. dividend amount
II. number of future dividends, provided the current number is less than infinite
III. discount rate
IV. dividend growth rate
A. I and II only
B. III and IV only
D. I, II, and IV only
AACSB: N/A
Section: 8.1
Topic: Dividend growth model

26. High Country Builders currently pays an annual dividend of $1.35 and plans on increasing
that amount by 2.5 percent each year. Valley High Builders currently pays an annual dividend of
$1.20 and plans on increasing its dividend by 3 percent annually. Given this information, you
know for certain that the stock of High Country Builders' has a higher ______ than the stock of
Valley High Builders.
A. market price
B. dividend yield
C. capital gains yield
D. total return
E. The answer cannot be determined based on the information provided.
27. The dividend growth model:

I. assumes that dividends increase at a constant rate forever.
II. can be used to compute a stock price at any point in time.
III. can be used to value zero-growth stocks.
IV. requires the growth rate to be less than the required return.
A. I and III only
B. II and IV only
C. I, III, and IV only
AACSB: N/A
Section: 8.1

28. Which one of the following is an underlying assumption of the dividend growth model?
A. A stock has the same value to every investor.
B. A stock's value is equal to the discounted present value of the future cash flows which it
generates.
C. A stock's value changes in direct relation to the required return.
D. Stocks that pay the same annual dividend have equal market values.
E. The dividend growth rate is inversely related to a stock's market price.
AACSB: N/A
Section: 8.1

29. Answer this question based on the dividend growth model. If you expect the market rate of
return to increase across the board on all equity securities, then you should also expect:
A. an increase in all stock values.
B. all stock values to remain constant.
C. a decrease in all stock values.
D. dividend-paying stocks to maintain a constant price while non-dividend paying stocks
decrease in value.
E. dividend-paying stocks to increase in price while non-dividend paying stocks decrease in
value.
AACSB: N/A
Section: 8.1


A. The capital gains yield is the annual rate of change in a stock's price.
B. Preferred stocks have constant growth dividends.
C. A constant dividend stock cannot be valued using the dividend growth model.
D. The dividend growth model can be used to compute the current value of any stock.
E. An increase in the required return will decrease the capital gains yield.
AACSB: N/A
Topic: Stock features

32. Supernormal growth is a growth rate that:

A. is both positive and follows a year or more of negative growth.
B. exceeds a firm's previous year's rate of growth.
C. is generally constant for an infinite period of time.
D. is unsustainable over the long term.
E. applies to a single, abnormal year.

AACSB: N/A
Difficulty: Basic
Section: 8.1
Topic: Supernormal growth

34. Winston Co. has a dividend-paying stock with a total return for the year of -6.5 percent.
Which one of the following must be true?
A. The dividend must be constant.
B. The stock has a negative capital gains yield.
C. The dividend yield must be zero.
D. The required rate of return for this stock increased over the year.
E. The firm is experiencing supernormal growth.
AACSB: N/A
Section: 8.1
Topic: Total return

35. The two-stage dividend growth model evaluates the current price of a stock based on the
assumption a stock will:
A. pay an increasing dividend for a period of time and then cease paying dividends altogether.
B. increase the dividend amount every other year.
C. pay a constant dividend for the first two quarters of each year and then increase the dividend
the last two quarters of each year.
D. grow at a fixed rate for a period of time after which it will grow at a different rate indefinitely.
E. pay increasing dividends for a fixed period of time, cease paying dividends for a period of
time, and then commence paying increasing dividends for an indefinite period of time.
AACSB: N/A
Difficulty: Basic
Section: 8.1
Topic: Two-stage dividend growth

36. Which one of the following sets of dividend payments best meets the definition of two-stage
growth as it applies to the two-stage dividend growth model?
A. no dividends for 5 years, then increasing dividends forever
B. $1 per share annual dividend for 2 years, then $1.25 annual dividends forever
C. decreasing dividends for 6 years followed by one final liquidating dividend payment
D. dividends payments which increase by 2, 3, and 4 percent respectively for 3 years followed by
a constant dividend thereafter
E. dividend payments which increase by 10 percent per year for 5 years followed by dividends
which increase by 3 percent annually thereafter
AACSB: N/A
Difficulty: Basic
Section: 8.1
Topic: Two-stage dividend growth

37. Which one of the following rights is never directly granted to all shareholders of a publicly-
held corporation?
A. electing the board of directors
B. receiving a distribution of company profits
C. voting either for or against a proposed merger or acquisition
D. determining the amount of the dividend to be paid per share
E. having first chance to purchase any new equity shares that may be offered
AACSB: N/A
Difficulty: Basic
Section: 8.2
Topic: Shareholder rights

Topic: Preferred shareholder rights

42. Boston Free Press has a dividend policy whereby the firm pays a constant annual dividend of
$2.40 per share of common stock. The firm has 1,000 shares of stock outstanding. The
company:
A. must always show a current liability of $2,400, ($2.40 × 1,000), for dividends payable.
B. must still declare each dividend before it becomes an actual company liability.
C. is obligated to pay $2.40 per share each year in perpetuity.
D. will be declared in default if it does not pay at least $2.40 per share per year on a timely basis.
E. has a liability that must be paid at a later date should the company miss paying an annual
dividend payment.

AACSB: N/A
Difficulty: Basic
Section: 8.2
Topic: Dividends

43. Which one of the following statements related to corporate dividends is correct?

A. Dividends are nontaxable income to shareholders.
B. Dividends reduce the taxable income of the corporation.
C. The Chief Executive Officer of a corporation is responsible for declaring dividends.
D. The Chief Financial Officer of a corporation determines the amount of dividend to be paid.
E. Corporate shareholders may receive a tax break on a portion of their dividend income.
AACSB: N/A
Difficulty: Basic
Section: 8.2
Topic: Dividend features

44. Which one of these statements related to preferred stock is correct?

A. Preferred shareholders normally receive one vote per share of stock owned.
B. Preferred shareholders determine the outcome of any election that involves a proxy fight.
C. Preferred shareholders are considered to be the residual owners of a corporation.
D. Preferred stock normally has a stated liquidating value of $1,000 per share.
E. Cumulative preferred shares are more valuable than comparable non-cumulative shares.
46. Which of the following features do preferred shareholders and bondholders frequently have
in common?
I. lack of voting rights
II. conversion option into common stock
III. annuity payments
IV. fixed liquidation value
A. I and II only
B. III and IV only
C. II, III, and IV only
D. I, III, and IV only
AACSB: N/A
Difficulty: Basic
Section: 8.2
Topic: Preferred stock and debt

6. The internal rate of return is defined as the:

A. maximum rate of return a firm expects to earn on a project.
B. rate of return a project will generate if the project in financed solely with internal funds.
C. discount rate that equates the net cash inflows of a project to zero.
D. discount rate which causes the net present value of a project to equal zero.
E. discount rate that causes the profitability index for a project to equal zero.
AACSB: N/A
Difficulty: Basic
Section: 9.5
Topic: Internal rate of return

8. There are two distinct discount rates at which a particular project will have a zero net present
value. In this situation, the project is said to:
A. have two net present value profiles.
B. have operational ambiguity.
C. create a mutually exclusive investment decision.
D. produce multiple economies of scale.
E. have multiple rates of return.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 9.5
Topic: Multiple rates of return

12. Which one of the following will decrease the net present value of a project?
A. increasing the value of each of the project's discounted cash inflows
B. moving each of the cash inflows back to a later time period
C. decreasing the required discount rate
D. increasing the project's initial cost at time zero
E. increasing the amount of the final cash inflow
AACSB: N/A
Difficulty: Basic
Section: 9.1
Topic: Net present value

13. Which one of the following methods determines the amount of the change a proposed project
will have on the value of a firm?
A. net present value
B. discounted payback
C. internal rate of return
D. profitability index
E. payback
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 9.1

14. If a project has a net present value equal to zero, then:

A. the total of the cash inflows must equal the initial cost of the project.
B. the project earns a return exactly equal to the discount rate.
C. a decrease in the project's initial cost will cause the project to have a negative NPV.
D. any delay in receiving the projected cash inflows will cause the project to have a positive
NPV.
E. the project's PI must be also be equal to zero.

AACSB: N/A
Difficulty: Basic
Learning Objective: 9-1 and 9-7
Topic: Net present value and profitability index

15. Rossiter Restaurants is analyzing a project that requires $180,000 of fixed assets. When the
project ends, those assets are expected to have an aftertax salvage value of $45,000. How is the
$45,000 salvage value handled when computing the net present value of the project?
A. reduction in the cash outflow at time zero
B. cash inflow in the final year of the project
C. cash inflow for the year following the final year of the project
D. cash inflow prorated over the life of the project
E. not included in the net present value
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 9.1
Topic: Net present value and salvage value

16. Which one of the following increases the net present value of a project?
A. an increase in the required rate of return
B. an increase in the initial capital requirement
C. a deferment of some cash inflows until a later year
D. an increase in the aftertax salvage value of the fixed assets
E. a reduction in the final cash inflow
AACSB: N/A
Difficulty: Basic
Section: 9.1

18. Which one of the following is a project acceptance indicator given an independent project
with investing type cash flows?
A. profitability index less than 1.0
B. project's internal rate of return less than the required return
C. discounted payback period greater than requirement
D. average accounting return that is less than the internal rate of return
E. modified internal rate of return that exceeds the required return
Refer to sections 9.3 through 9.6
AACSB: N/A
Difficulty: Basic
Section: 9.3 through 9.6
Topic: Decision rules

19. Why is payback often used as the sole method of analyzing a proposed small project?
A. Payback considers the time value of money.
B. All relevant cash flows are included in the payback analysis.
C. It is the only method where the benefits of the analysis outweigh the costs of that analysis.
D. Payback is the most desirable of the various financial methods of analysis.
E. Payback is focused on the long-term impact of a project.
AACSB: N/A
Difficulty: Basic
Section: 9.2
Topic: Payback

20. Which of the following are advantages of the payback method of project analysis?
I. works well for research and development projects

II. liquidity bias
III. ease of use
IV. arbitrary cutoff point
A. I and II only
B. I and III only
C. II and III only
D. II and IV only
E. II, III, and IV only

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 9.2
Topic: Payback advantages

21. Samuelson Electronics has a required payback period of three years for all of its projects.
Currently, the firm is analyzing two independent projects. Project A has an expected payback
period of 2.8 years and a net present value of $6,800. Project B has an expected payback period
of 3.1 years with a net present value of $28,400. Which projects should be accepted based on the
payback decision rule?
A. Project A only
B. Project B only
C. Both A and B
D. Neither A nor B
E. Answer cannot be determined based on the information given.
AACSB: N/A
Difficulty: Basic
Section: 9.2
Topic: Payback decision rule

22. A project has a required payback period of three years. Which one of the following
statements is correct concerning the payback analysis of this project?
A. The cash flows in each of the three years must exceed one-third of the project's initial cost if
the project is to be accepted.
B. The cash flow in year three is ignored.
C. The project's cash flow in year three is discounted by a factor of (1 + R) .
3
D. The cash flow in year two is valued just as highly as the cash flow in year one.
E. The project is acceptable whenever the payback period exceeds three years.
AACSB: N/A
Difficulty: Basic
Section: 9.2
Topic: Payback

23. A project has a discounted payback period that is equal to the required payback period. Given
this, which of the following statements must be true?
I. The project must also be acceptable under the payback rule.

II. The project must have a profitability index that is equal to or greater than 1.0.
III. The project must have a zero net present value.
IV. The project's internal rate of return must equal the required return.
A. I only
B. I and II only
C. II and III only
AACSB: N/A
Bloom's: Analysis
Section: 9.3
Topic: Discounted payback

24. Which one of the following statements related to payback and discounted payback is
correct?
A. Payback is a better method of analysis than is discounted payback.
B. Discounted payback is used more frequently in business than is payback.
C. Discounted payback does not require a cutoff point like the payback method does.
D. Discounted payback is biased towards long-term projects while payback is biased towards
short-term projects.
E. Payback is used more frequently even though discounted payback is a better method.
AACSB: N/A
Difficulty: Basic
Topic: Payback and discounted payback

25. Applying the discounted payback decision rule to all projects may cause:
A. some positive net present value projects to be rejected.
B. the most liquid projects to be rejected in favor of the less liquid projects.
C. projects to be incorrectly accepted due to ignoring the time value of money.
D. a firm to become more long-term focused.
E. some projects to be accepted which would otherwise be rejected under the payback rule.
AACSB: N/A
Difficulty: Basic
Section: 9.3
Topic: Discounted payback

26. Which one of the following correctly applies to the average accounting rate of return?
A. It considers the time value of money.
B. It measures net income as a percentage of the sales generated by a project.
C. It is the best method of analyzing mutually exclusive projects from a financial point of view.
D. It is the primary methodology used in analyzing independent projects.
E. It can be compared to the return on assets ratio.
AACSB: N/A
Difficulty: Basic
Section: 9.4
Topic: Average accounting return

27. Which one of the following is an advantage of the average accounting return method of
analysis?
A. easy availability of information needed for the computation
B. inclusion of time value of money considerations
C. the use of a cutoff rate as a benchmark
D. the use of pre-tax income in the computation
E. use of real, versus nominal, average income
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 9.4

28. Which of the following are considered weaknesses in the average accounting return method
of project analysis?
I. exclusion of time value of money considerations

II. need of a cutoff rate
III. easily obtainable information for computation
IV. based on accounting values
A. I only
B. I and IV only
C. II and III only
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 9.4

29. Which one of the following statements related to the internal rate of return (IRR) is correct?
A. The IRR yields the same accept and reject decisions as the net present value method given
mutually exclusive projects.
B. A project with an IRR equal to the required return would reduce the value of a firm if
accepted.
C. The IRR is equal to the required return when the net present value is equal to zero.
D. Financing type projects should be accepted if the IRR exceeds the required return.
E. The average accounting return is a better method of analysis than the IRR from a financial
point of view.
AACSB: N/A
Difficulty: Basic
Section: 9.5

30. The internal rate of return:

A. may produce multiple rates of return when cash flows are conventional.
B. is best used when comparing mutually exclusive projects.
C. is rarely used in the business world today.
D. is principally used to evaluate small dollar projects.
E. is easy to understand.
AACSB: N/A
Difficulty: Basic
Section: 9.5

31. Tedder Mining has analyzed a proposed expansion project and determined that the internal
rate of return is lower than the firm desires. Which one of the following changes to the project
would be most expected to increase the project's internal rate of return?
A. decreasing the required discount rate
B. increasing the initial investment in fixed assets
C. condensing the firm's cash inflows into fewer years without lowering the total amount of
those inflows
D. eliminating the salvage value
E. decreasing the amount of the final cash inflow
AACSB: N/A
Difficulty: Basic
Section: 9.5

32. The internal rate of return is:

A. the discount rate that makes the net present value of a project equal to the initial cash outlay.
B. equivalent to the discount rate that makes the net present value equal to one.
C. tedious to compute without the use of either a financial calculator or a computer.
D. highly dependent upon the current interest rates offered in the marketplace.
E. a better methodology than net present value when dealing with unconventional cash flows.
AACSB: N/A
Difficulty: Basic
Section: 9.5

33. Which of the following statements related to the internal rate of return (IRR) are correct?
I. The IRR method of analysis can be adapted to handle non-conventional cash flows.
II. The IRR that causes the net present value of the differences between two project's cash flows
to equal zero is called the crossover rate.
III. The IRR tends to be used more than net present value simply because its results are easier to
comprehend.
IV. Both the timing and the amount of a project's cash flows affect the value of the project's
IRR.
A. I and II only
B. III and IV only
AACSB: N/A
Section: 9.5

34. Douglass Interiors is considering two mutually exclusive projects and have determined that
the crossover rate for these projects is 11.7 percent. Project A has an internal rate of return (IRR)
of 15.3 percent and Project B has an IRR of 16.5 percent. Given this information, which one of
the following statements is correct?
A. Project A should be accepted as its IRR is closer to the crossover point than is Project B's
IRR.
B. Project B should be accepted as it has the higher IRR.
C. Both projects should be accepted as both of the project's IRRs exceed the crossover rate.
D. Neither project should be accepted since both of the project's IRRs exceed the crossover rate.
E. You cannot determine which project should be accepted given the information provided.
AACSB: N/A
Section: 9.5

35. You are comparing two mutually exclusive projects. The crossover point is 12.3 percent. You
have determined that you should accept project A if the required return is 13.1 percent. This
implies you should:
A. always accept project A.
B. be indifferent to the projects at any discount rate above 13.1 percent.
C. always accept project A if the required return exceeds the crossover rate.
D. accept project B only when the required return is equal to the crossover rate.
E. accept project B if the required return is less than 13.1 percent.
AACSB: N/A
Difficulty: Basic
Section: 9.5
Topic: Crossover rate

36. Graphing the crossover point helps explain:

A. why one project is always superior to another project.
B. how decisions concerning mutually exclusive projects are derived.
C. how the duration of a project affects the decision as to which project to accept.
D. how the net present value and the initial cash outflow of a project are related.
E. how the profitability index and the net present value are related.
AACSB: N/A
Difficulty: Basic
Section: 9.5
Topic: Crossover point

37. A project with financing type cash flows is typified by a project that has which one of the
following characteristics?
A. conventional cash flows
B. cash flows that extend beyond the acceptable payback period
C. a year or more in the middle of a project where the cash flows are equal to zero
D. a cash inflow at time zero
E. cash inflows which are equal in amount

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 9.5
Topic: Financing cash flows

38. Which of the following statements generally apply to the cash flows of a financing type
project?
I. nonconventional cash flows

II. cash outflows exceed cash inflows prior to any time value adjustments
III. cash for services rendered is received prior to the cash that is spent providing the services
IV. the total of all cash flows must equal zero on an unadjusted basis
A. I only
B. I and III only
C. II and IV only
D. I, II, and III only
AACSB: N/A
Section: 9.5

39. Which one of the following statements is correct in relation to independent projects?

A. The internal rate of return cannot be used to determine the acceptability of a project that has
financing type cash flows.
B. A project with investing type cash flows is acceptable if its internal rate of return exceeds the
required return.
C. A project with financing type cash flows is acceptable if its internal rate of return exceeds the
required return.
D. The net present value profile is upsloping for projects with both investing and financing type
cash flows.
E. Projects with financing type cash flows are acceptable only when the internal rate of return is
negative.
AACSB: N/A
Section: 9.5

41. Roger's Meat Market is considering two independent projects. The profitability index
decision rule indicates that both projects should be accepted. This result most likely does which
one of the following?
A. conflicts with the results of the net present value decision rule
B. assumes the firm has sufficient funds to undertake both projects
C. agrees with the decision that would also apply if the projects were mutually exclusive
D. bases the accept/reject decision on the same variables as the average accounting return
E. fails to provide useful information as the firm must reject at least one of the projects
44. Which one of the following is the best example of two mutually exclusive projects?
A. building a retail store that is attached to a wholesale outlet
B. producing both plastic forks and spoons on the same assembly line at the same time
C. using an empty warehouse to store both raw materials and finished goods
D. promoting two products during the same television commercial
E. waiting until a machine finishes molding Product A before being able to mold Product B
AACSB: N/A
Difficulty: Basic
Section: 9.5
Topic: Mutually exclusive projects

45. Southern Chicken is considering two projects. Project A consists of creating an outdoor

eating area on the unused portion of the restaurant's property. Project B would use that outdoor
space for creating a drive-thru service window. When trying to decide which project to accept,
the firm should rely most heavily on which one of the following analytical methods?
A. profitability index
B. internal rate of return
C. payback
D. net present value
E. accounting rate of return
AACSB: N/A
Difficulty: Basic
Section: 9.5

46. Mutually exclusive projects are best defined as competing projects which:

A. would commence on the same day.
B. have the same initial start-up costs.
C. both require the total use of the same limited resource.
D. both have negative cash outflows at time zero.
E. have the same life span.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 9.5

47. The final decision on which one of two mutually exclusive projects to accept ultimately
depends upon which one of the following?
A. initial cost of each project
B. timing of the cash inflows
C. total cash inflows of each project
D. required rate of return
E. length of each project's life
AACSB: N/A
Difficulty: Basic
Section: 9.5

49. Which one of the following statements would generally be considered as accurate given
independent projects with conventional cash flows?
A. The internal rate of return decision may contradict the net present value decision.
B. Business practice dictates that independent projects should have three distinct accept
indicators before a project is actually implemented.
C. The payback decision rule could override the net present value decision rule should cash
availability be limited.
D. The profitability index rule cannot be applied in this situation.
E. The projects cannot be accepted unless the average accounting return decision ruling is
positive.
AACSB: N/A
Difficulty: Basic
Section: 9.7
Topic: Independent projects

50. In actual practice, managers frequently use the:
I. average accounting return method because the information is so readily available.

II. internal rate of return because the results are easy to communicate and understand.
III. discounted payback because of its simplicity.
IV. net present value because it is considered by many to be the best method of analysis.
A. I and III only
B. II and III only
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 9.7
Topic: Capital budgeting practice

51. Kristi wants to start training her most junior assistant, Amy, in the art of project analysis.
Amy has just started college and has no experience or background in business finance. To get her
started, Kristi is going to assign the responsibility for all projects that have initial costs less than
$1,000 to Amy to analyze. Which method is Kristi most apt to ask Amy to use in making her
initial decisions?
A. discounted payback
B. profitability index
C. internal rate of return
D. payback
E. average accounting return
AACSB: N/A
Bloom's: Application
Difficulty: Basic
Section: 9.7

54. Western Beef Exporters is considering a project that has an NPV of $32,600, an IRR of 15.1
percent, and a payback period of 3.2 years. The required return is 14.5 percent and the required
payback period is 3.0 years. Which one of the following statements correctly applies to this
project?
A. The net present value indicates accept while the internal rate of return indicates reject.
B. Payback indicates acceptance.
C. The payback decision rule could override the accept decision indicated by the net present
value.
D. The payback rule will automatically be ignored since both the net present value and the
internal rate of return indicate an accept decision.
E. The net present value decision rule is the only rule that matters when making the final
decision.
AACSB: N/A
Difficulty: Basic
Section: 9.7

55. You are considering a project with conventional cash flows and the following characteristics:

Which of the following statements is correct given this information?

I. The discount rate used in computing the net present value was less than 11.63 percent.
II. The discounted payback period must be less than 2.98 years.
III. The discount rate used in the computation of the profitability ratio was 11.63 percent.
IV. This project should be accepted as the internal rate of return exceeds the required return.
A. I and II only
B. III and IV only
AACSB: N/A
Bloom's: Analysis
Section: 9.7
Topic: Capital budgeting methods

56. Which of the following are definite indicators of an accept decision for an independent
project with conventional cash flows?
I. positive net present value

II. profitability index greater than zero
III. internal rate of return greater than the required rate
IV. positive internal rate of return
A. I and III only
B. II and IV only
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 9.7
Topic: Capital budgeting methods

1. The difference between a firm's future cash flows if it accepts a project and the firm's future
cash flows if it does not accept the project is referred to as the project's:
A. incremental cash flows.
B. internal cash flows.
C. external cash flows.
D. erosion effects.
E. financing cash flows.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.1
Topic: Incremental cash flows

2. The fact that a proposed project is analyzed based on the project's incremental cash flows is
the assumption behind which one of the following principles?
A. underlying value principle
B. stand-alone principle
C. equivalent cost principle
D. salvage principle
E. fundamental principle
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.1
Topic: Stand-along principle

3. Which one of the following costs was incurred in the past and cannot be recouped?
A. incremental
B. side
C. sunk
D. opportunity
E. erosion
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.2
Topic: Sunk cost

4. The option that is foregone so that an asset can be utilized by a specific project is referred to as
which one of the following?
A. salvage value
B. wasted value
C. sunk cost
D. opportunity cost
E. erosion
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.2
Topic: Opportunity cost

5. Which one of the following best describes the concept of erosion?

A. expenses that have already been incurred and cannot be recovered
B. change in net working capital related to implementing a new project
C. the cash flows of a new project that come at the expense of a firm's existing cash flows
D. the alternative that is forfeited when a fixed asset is utilized by a project
E. the differences in a firm's cash flows with and without a particular project
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.2
Topic: Erosion

6. Which one of the following best describes pro forma financial statements?
A. financial statements expressed in a foreign currency
B. financial statements where the assets are expressed as a percentage of total assets and costs
are expressed as a percentage of sales
C. financial statements showing projected values for future time periods
D. financial statements expressed in real dollars, given a stated base year
E. financial statements where all accounts are expressed as a percentage of last year's values
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.3
Topic: Pro forma financial statements

7. Which one of the following is the depreciation method which allows accelerated write-offs of
property under various lifetime classifications?
A. IRR
B. ACRS
C. AAR
D. straight-line to zero
E. straight-line with salvage
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.4
Topic: Accelerated cost recovery system

8. The depreciation tax shield is best defined as the:

A. amount of tax that is saved when an asset is purchased.
B. tax that is avoided when an asset is sold as salvage.
C. amount of tax that is due when an asset is sold.
D. amount of tax that is saved because of the depreciation expense.
E. amount by which the aftertax depreciation expense lowers net income.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.5
Topic: Depreciation tax shield

9. The annual annuity stream of payments that has the same present value as a project's costs is
referred to as which one of the following?
A. yearly incremental costs
B. sunk costs
C. opportunity costs
D. erosion cost
E. equivalent annual cost
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.6
Topic: Equivalent annual cost

10. Kelley's Baskets makes handmade baskets for distribution to upscale retail outlets. The firm
is currently considering making handmade wreaths as well. Which one of the following is the
best example of an incremental operating cash flow related to the wreath project?
A. storing supplies in the same space currently used for materials storage
B. utilizing the basket manager to oversee wreath production
C. hiring additional employees to handle the increased workload should the firm accept the
wreath project
D. researching the market to determine if wreath sales might be profitable before deciding to
proceed
E. planning on lower interest expense by assuming the proceeds of the wreath sales will be used
to reduce the firm's currently outstanding debt
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.1
Topic: Relevant cash flows

11. Danielle's is a furniture store that is considering adding appliances to its offerings. Which of
the following should be considered incremental cash flows of this project?
I. utilizing the credit offered by a supplier to purchase the appliance inventory
II. benefiting from increased furniture sales to appliance customers
III. borrowing money from a bank to fund the appliance project
IV. purchasing parts for inventory to handle any appliance repairs that might be necessary
A. I and II only
B. III and IV only

AACSB: N/A
Difficulty: Basic
Topic: Relevant cash flows

12. The stand-alone principle advocates that project analysis should be based solely on which
one of the following costs?
A. sunk
B. total
C. variable
D. incremental
E. fixed
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.1
Topic: Incremental costs

13. Which one of the following is an example of a sunk cost?

A. $1,500 of lost sales because an item was out of stock
B. $1,200 paid to repair a machine last year
C. $20,000 project that must be forfeited if another project is accepted
D. $4,500 reduction in current shoe sales if a store commences selling sandals
E. $1,800 increase in comic book sales if a store commences selling puzzles
AACSB: N/A
Difficulty: Basic
Section: 10.2
Topic: Sunk cost

14. G & L Plastic Molders spent $1,200 last week repairing a machine. This week the company
is trying to decide if the machine could be better utilized if they assigned it a proposed project.
When analyzing the proposed project, the $1,200 should be treated as which type of cost?
A. opportunity
B. fixed
C. incremental
D. erosion
E. sunk
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.2
Topic: Sunk cost

15. Which one of the following best illustrates erosion as it relates to a hot dog stand located on
the beach?
A. providing both ketchup and mustard for its customer's use
B. repairing the roof of the hot dog stand because of water damage
C. selling fewer hot dogs because hamburgers were added to the menu
D. offering French fries but not onion rings
E. losing sales due to bad weather
AACSB: N/A
Difficulty: Basic
Section: 10.2
Topic: Erosion

16. Which of the following should be included in the analysis of a new product?

I. money already spent for research and development of the new product
II. reduction in sales for a current product once the new product is introduced
III. increase in accounts receivable needed to finance sales of the new product
IV. market value of a machine owned by the firm which will be used to produce the new product
A. I and III only
B. II and IV only
AACSB: N/A
Difficulty: Basic
Section: 10.2
Topic: Incremental cash flows

17. You are considering the purchase of a new machine. Your analysis includes the evaluation of
two machines which have differing initial and ongoing costs and differing lives. Whichever
machine is purchased will be replaced at the end of its useful life. You should select the machine
which has the:
A. longest life.
B. highest annual operating cost.
C. lowest annual operating cost.
D. highest equivalent annual cost.
E. lowest equivalent annual cost.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.6

18. The bid price is:

A. an aftertax price.
B. the aftertax contribution margin.
C. the highest price you should charge if you want the project.
D. the only price you can bid if the project is to be profitable.
E. the minimum price you should charge if you want to financially breakeven.
AACSB: N/A
Difficulty: Basic
Section: 10.6
Topic: Bid price

19. Which one of the following will increase a bid price?

A. a decrease in the fixed costs
B. a reduction in the net working capital requirement
C. a reduction in the firm's tax rate
D. an increase in the salvage value
E. an increase in the required rate of return
AACSB: N/A
Section: 10.6
Topic: Bid price

20. All of the following are related to a proposed project. Which of these should be included in
the cash flow at time zero?
I. purchase of $1,400 of parts inventory needed to support the project
II. loan of $125,000 used to finance the project
III. depreciation tax shield of $1,100
IV. $6,500 of equipment needed to commence the project
A. I and II only
B. I and IV only
C. II and IV only
AACSB: N/A
Difficulty: Basic
Section: 10.4
Topic: Project cash flows

21. Changes in the net working capital requirements:

A. can affect the cash flows of a project every year of the project's life.
B. only affect the initial cash flows of a project.
C. only affect the cash flow at time zero and the final year of a project.
D. are generally excluded from project analysis due to their irrelevance to the total project.
E. reflect only the changes in the current asset accounts.
AACSB: N/A
Difficulty: Basic
Section: 10.4
Topic: Net working capital

22. Which one of the following is a project cash inflow? Ignore any tax effects.
A. decrease in accounts payable
B. increase in inventory
C. decrease in accounts receivable
D. depreciation expense based on MACRS
E. equipment acquisition
AACSB: N/A
Difficulty: Basic
Section: 10.4
Topic: Project cash flows

23. Net working capital:

A. can be ignored in project analysis because any expenditure is normally recouped at the end of
the project.
B. requirements, such as an increase in accounts receivable, create a cash inflow at the beginning
of a project.
C. is rarely affected when a new product is introduced.
D. can create either a cash inflow or a cash outflow at time zero of a project.
E. is the only expenditure where at least a partial recovery can be made at the end of a project.
AACSB: N/A
Difficulty: Basic
Section: 10.4

24. The operating cash flow of a cost cutting project:

A. is equal to the depreciation tax shield.
B. is equal to zero because there is no incremental sales.
C. can only be analyzed by projecting the sales and costs for a firm's entire operations.
D. includes any changes that occur in the current accounts.
E. can be positive even though there are no sales.
AACSB: N/A
Difficulty: Basic
Section: 10.6
Topic: Cost reduction project

25. Pro forma statements for a proposed project should:

I. be compiled on a stand-alone basis.
II. include all the incremental cash flows related to the project.
III. generally exclude interest expense.
IV. include all project-related fixed asset acquisitions and disposals.
A. I and II only
B. II and III only
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.3
Topic: Pro forma statement


A. Project analysis should only include the cash flows that affect the income statement.
B. A project can create a positive operating cash flow without affecting sales.
C. The depreciation tax shield creates a cash outflow for a project.
D. Interest expense should always be included as a cash outflow when analyzing a project.
E. The opportunity cost of a company-owned building that is going to be used in a new project
should be included as a cash inflow to the project.
AACSB: N/A
Difficulty: Basic
Section: 10.6
Topic: Cost cutting project

27. A company that utilizes the MACRS system of depreciation:

A. will have equal depreciation costs each year of an asset's life.
B. will have a greater tax shield in year two of a project than it would have if the firm had opted
for straight-line depreciation, given the same depreciation life.
C. can depreciate the cost of land, if it so desires.
D. will expense less than the entire cost of an asset.
E. cannot expense any of the cost of a new asset during the first year of the asset's life.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.4
Topic: MACRS depreciation

28. Morris Motors just purchased some MACRS 5-year property at a cost of $216,000. Which
one of the following will correctly give you the book value of this equipment at the end of year
2?

A. $216,000/(1 + 0.20 + 0.32)
B. $216,000 × (1 - 0.20 - 0.32)
C. $216,000 × (0.20 + 0.32)
D. [$216,000 × (1 - 0.20)] × (1 - 0.32)
E. $216,000/[(1 + 0.20)(1 + 0.32)]
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.4

29. Keyser Petroleum just purchased some equipment at a cost of $67,000. What is the proper
methodology for computing the depreciation expense for year 2 if the equipment is classified as
5-year property for MACRS?

A. $67,000 × (1 - 0.20) × 0.32
B. $67,000/(1 - 0.20 - 0.32)
C. $67,000 × (1 + 0.32)
D. $67,000 × (1 - 0.32)
E. $67,000 × 0.32
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.4

30. The current book value of a fixed asset that was purchased two years ago is used in the
computation of which one of the following?
A. depreciation tax shield
B. tax due on the salvage value of that asset
C. current year's operating cash flow
D. change in net working capital
E. MACRS depreciation for the current year
AACSB: N/A
Difficulty: Basic
Section: 10.4
Topic: Tax on salvage value

31. The net book value of equipment will:

A. remain constant over the life of the equipment.
B. vary in response to changes in the market value.
C. decrease at a constant rate when MACRS depreciation is used.
D. increase over the taxable life of an asset.
E. decrease slower under straight-line depreciation than under MACRS.
AACSB: N/A
Difficulty: Basic
Section: 10.4
Topic: Book value

32. Three years ago, Knox Glass purchased a machine for a 3-year project. The machine is being
depreciated straight-line to zero over a 5-year period. Today, the project ended and the machine
was sold. Which one of the following correctly defines the aftertax salvage value of that
machine? (T represents the relevant tax rate)
A. Sale price + (Sales price - Book value) × T
B. Sale price + (Sales price - Book value) × (1 - T)
C. Sale price + (Book value - Sale price) × T
D. Sale price + (Book value - Sale price) × (1 - T)
E. Sale price × (1 - T)
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.4
Topic: Aftertax salvage value

33. Which one of the following is a correct method for computing the operating cash flow of a
project assuming that the interest expense is equal to zero?
A. EBIT + D
B. EBIT - T
C. NI + D
D. (Sales - Costs) × (1 - D) × (1- T)
E. (Sales - Costs) × (1 - T)
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.5
Topic: Bottom up operating cash flow

34. The operating cash flow for a project should exclude which one of the following?
A. taxes
B. variable costs
C. fixed costs
D. interest expense
E. depreciation tax shield
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.5
Topic: Operating cash flow

35. The bottom-up approach to computing the operating cash flow applies only when:
A. both the depreciation expense and the interest expense are equal to zero.
B. the interest expense is equal to zero.
C. the project is a cost-cutting project.
D. no fixed assets are required for a project.
E. both taxes and the interest expense are equal to zero.
AACSB: N/A
Difficulty: Basic
Section: 10.5
Topic: Bottom-up operating cash flow

36. The top-down approach to computing the operating cash flow:

A. ignores noncash expenses.
B. applies only if a project increases sales.
C. applies only to cost cutting projects.
D. is equal to sales - costs - taxes + depreciation.
E. is used solely to compute a bid price.

AACSB: N/A
Difficulty: Basic
Section: 10.5
Topic: Top-down operating cash flow

37. Increasing which one of the following will increase the operating cash flow assuming that the
bottom-up approach is used to compute the operating cash flow?
A. erosion effects
B. taxes
C. fixed expenses
D. salaries
E. depreciation expense
AACSB: N/A
Difficulty: Basic
Section: 10.5
Topic: Bottom-up operating cash flow

38. Which one of the following statements is correct concerning bid prices?

A. The bid price is the maximum price that a firm should bid.
B. A firm can submit a bid that is higher than the computed bid price and still break even.
C. A bid price ignores taxes.
D. A bid price should be computed based solely on the operating cash flows of the project.
E. A bid price should be computed based on a zero percent required rate of return.
AACSB: N/A
Difficulty: Basic
Section: 10.6
Topic: Bid price

39. Dan is comparing three machines to determine which one to purchase. The machines sell for
differing prices, have differing operating costs, differing machine lives, and will be replaced
when worn out. Which one of the following computational methods should Dan use as the basis
for his decision?
A. internal rate of return
B. operating cash flow
C. equivalent annual cost
D. depreciation tax shield
E. bottom-up operating cash flow
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.6

40. The equivalent annual cost method is useful in determining:

A. which one of two machines to purchase if the machines are mutually exclusive, have differing
lives, and are a one-time purchase.
B. the tax shield benefits of depreciation given the purchase of new assets for a project.
C. the operating cash flows of a cost-cutting project.
D. which one of two investments to accept when the investments have different required rates of
return.
E. which one of two machines should be purchased when the machines are mutually exclusive,
have different machine lives, and will be replaced once they are worn out.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.6

41. When using the equivalent annual cost as a basis for deciding which equipment should be
purchased, the equipment under consideration must fit which two of the following criteria?
I. differing productive lives
II. differing manufacturers
III. required replacement at end of economic life
IV. differing initial cost
A. I and II
B. I and III
C. I and IV
D. II and IIII
E. II and IV
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.6

42. The equivalent annual cost considers which of the following?

I. required rate of return
II. operating costs
III. need for replacement
IV. aftertax salvage value
A. I and II only
B. II and IV only
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.6

43. The bid price always assumes which one of the following?

A. A project has a one-year life.
B. The aftertax net income of the project is zero.
C. The net present value of the project is zero.
D. Any assets purchased will have a positive salvage value at the end of the project.
E. Assets will be depreciated based on MACRS.
AACSB: N/A
Difficulty: Basic
Section: 10.6
Topic: Bid price

44. Which one of the following would make a project unacceptable?
A. cash inflow for net working capital at time zero
B. requiring fixed assets that would have no salvage value
C. an equivalent annual cost that exceeds that of an alternative project
D. lack of revenue generation
E. a depreciation tax shield that exceeds the value of the interest expense
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.6

45. Decreasing which one of the following will increase the acceptability of a project?
A. sunk costs
B. salvage value
C. depreciation tax shield
D. equivalent annual cost
E. accounts payable requirement
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 10.6

46. Dexter Smith & Co. is replacing a machine simply because it has worn out. The new machine
will not affect either sales or operating costs and will not have any salvage value at the end of its
5-year life. The firm has a 34 percent tax rate, uses straight-line depreciation over an asset's life,
and has a positive net income. Given this, which one of the following statements is correct?
A. As a project, the new machine has a net present value equal to minus one times the machine's
purchase price.
B. The new machine will have a zero rate of return.
C. The new machine will generate positive operating cash flows, at least in the first few years of
its life.
D. The new machine will create a cash outflow when the firm disposes of it at the end of its life.
E. The new machine creates erosion effects.

\
Multiple Choice Questions

1. You own a stock that you think will produce a return of 11 percent in a good economy and 3
percent in a poor economy. Given the probabilities of each state of the economy occurring, you
anticipate that your stock will earn 6.5 percent next year. Which one of the following terms
applies to this 6.5 percent?
A. arithmetic return
B. historical return
C. expected return
D. geometric return
E. required return
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.1
Topic: Expected return

2. Suzie owns five different bonds valued at $36,000 and twelve different stocks valued at
$82,500 total. Which one of the following terms most applies to Suzie's investments?
A. index
B. portfolio
C. collection
D. grouping
E. risk-free
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.2
Topic: Portfolio

3. Steve has invested in twelve different stocks that have a combined value today of $121,300.
Fifteen percent of that total is invested in Wise Man Foods. The 15 percent is a measure of which
one of the following?
A. portfolio return
B. portfolio weight
C. degree of risk
D. price-earnings ratio
E. index value
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.2
Topic: Portfolio weight

4. Which one of the following is a risk that applies to most securities?

A. unsystematic
B. diversifiable
C. systematic
D. asset-specific
E. total
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.4
Topic: Systematic risk

5. A news flash just appeared that caused about a dozen stocks to suddenly drop in value by
about 20 percent. What type of risk does this news flash represent?
A. portfolio
B. nondiversifiable
C. market
D. unsystematic
E. total
AACSB: N/A
Difficulty: Basic
Section: 13.4
Topic: Unsystematic risk

6. The principle of diversification tells us that:

A. concentrating an investment in two or three large stocks will eliminate all of the unsystematic
risk.
B. concentrating an investment in three companies all within the same industry will greatly
reduce the systematic risk.
C. spreading an investment across five diverse companies will not lower the total risk.
D. spreading an investment across many diverse assets will eliminate all of the systematic risk.
E. spreading an investment across many diverse assets will eliminate some of the total risk.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.5
Topic: Diversification

7. The _____ tells us that the expected return on a risky asset depends only on that asset's
nondiversifiable risk.
A. efficient markets hypothesis
B. systematic risk principle
C. open markets theorem
D. law of one price
E. principle of diversification
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.6

8. Which one of the following measures the amount of systematic risk present in a particular
risky asset relative to the systematic risk present in an average risky asset?
A. beta
B. reward-to-risk ratio
C. risk ratio
D. standard deviation
E. price-earnings ratio
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.6
Topic: Beta

9. Which one of the following is a positively sloped linear function that is created when expected
returns are graphed against security betas?
A. reward-to-risk matrix
B. portfolio weight graph
C. normal distribution
D. security market line
E. market real returns
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.7
Topic: Security market line

10. Which one of the following is represented by the slope of the security market line?
A. reward-to-risk ratio
B. market standard deviation
C. beta coefficient
D. risk-free interest rate
E. market risk premium
AACSB: N/A
Difficulty: Basic
Section: 13.7

11. Which one of the following is the formula that explains the relationship between the expected
return on a security and the level of that security's systematic risk?
A. capital asset pricing model
B. time value of money equation
C. unsystematic risk equation
D. market performance equation
E. expected risk formula
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.7
Topic: Capital asset pricing model

12. Treynor Industries is investing in a new project. The minimum rate of return the firm requires
on this project is referred to as the:
A. average arithmetic return.
B. expected return.
C. market rate of return.
D. internal rate of return.
E. cost of capital.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.8
Topic: Cost of capital

13. The expected return on a stock given various states of the economy is equal to the:
A. highest expected return given any economic state.
B. arithmetic average of the returns for each economic state.
C. summation of the individual expected rates of return.
D. weighted average of the returns for each economic state.
E. return for the economic state with the highest probability of occurrence.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.1

14. The expected return on a stock computed using economic probabilities is:

A. guaranteed to equal the actual average return on the stock for the next five years.
B. guaranteed to be the minimal rate of return on the stock over the next two years.
C. guaranteed to equal the actual return for the immediate twelve month period.
D. a mathematical expectation based on a weighted average and not an actual anticipated
outcome.
E. the actual return you should anticipate as long as the economic forecast remains constant.
AACSB: N/A
Difficulty: Basic
Section: 13.1

15. The expected risk premium on a stock is equal to the expected return on the stock minus the:
A. expected market rate of return.
B. risk-free rate.
C. inflation rate.
D. standard deviation.
E. variance.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.1
Topic: Risk premium

16. Standard deviation measures which type of risk?

A. total
B. nondiversifiable
C. unsystematic
D. systematic
E. economic

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.1
Topic: Standard deviation

17. The expected rate of return on a stock portfolio is a weighted average where the weights are
based on the:
A. number of shares owned of each stock.
B. market price per share of each stock.
C. market value of the investment in each stock.
D. original amount invested in each stock.
E. cost per share of each stock held.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.2

18. The expected return on a portfolio considers which of the following factors?

I. percentage of the portfolio invested in each individual security
II. projected states of the economy
III. the performance of each security given various economic states
IV. probability of occurrence for each state of the economy
A. I and III only
B. II and IV only
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.2

19. The expected return on a portfolio:

I. can never exceed the expected return of the best performing security in the portfolio.
II. must be equal to or greater than the expected return of the worst performing security in the
portfolio.
III. is independent of the unsystematic risks of the individual securities held in the portfolio.
IV. is independent of the allocation of the portfolio amongst individual securities.
A. I and III only
B. II and IV only
C. I and II only
AACSB: N/A

20. If a stock portfolio is well diversified, then the portfolio variance:

A. will equal the variance of the most volatile stock in the portfolio.
B. may be less than the variance of the least risky stock in the portfolio.
C. must be equal to or greater than the variance of the least risky stock in the portfolio.
D. will be a weighted average of the variances of the individual securities in the portfolio.
E. will be an arithmetic average of the variances of the individual securities in the portfolio.
AACSB: N/A
Difficulty: Basic
Section: 13.5

21. The standard deviation of a portfolio:

A. is a weighted average of the standard deviations of the individual securities held in the
portfolio.
B. can never be less than the standard deviation of the most risky security in the portfolio.
C. must be equal to or greater than the lowest standard deviation of any single security held in
the portfolio.
D. is an arithmetic average of the standard deviations of the individual securities which comprise
the portfolio.
E. can be less than the standard deviation of the least risky security in the portfolio.
AACSB: N/A
Difficulty: Basic
Section: 13.2

22. The standard deviation of a portfolio:

A. is a measure of that portfolio's systematic risk.
B. is a weighed average of the standard deviations of the individual securities held in that
portfolio.
C. measures the amount of diversifiable risk inherent in the portfolio.
D. serves as the basis for computing the appropriate risk premium for that portfolio.
E. can be less than the weighted average of the standard deviations of the individual securities
held in that portfolio.
AACSB: N/A
Section: 13.5

23. Which one of the following statements is correct concerning a portfolio of 20 securities with
multiple states of the economy when both the securities and the economic states have unequal
weights?
A. Given the unequal weights of both the securities and the economic states, the standard
deviation of the portfolio must equal that of the overall market.
B. The weights of the individual securities have no effect on the expected return of a portfolio
when multiple states of the economy are involved.
C. Changing the probabilities of occurrence for the various economic states will not affect the
expected standard deviation of the portfolio.
D. The standard deviation of the portfolio will be greater than the highest standard deviation of
any single security in the portfolio given that the individual securities are well diversified.
E. Given both the unequal weights of the securities and the economic states, an investor might be
able to create a portfolio that has an expected standard deviation of zero.
AACSB: N/A
Bloom's: Analysis
Section: 13.2

24. Which one of the following events would be included in the expected return on Sussex
stock?
A. The chief financial officer of Sussex unexpectedly resigned.
B. The labor union representing Sussex' employees unexpectedly called a strike.
C. This morning, Sussex confirmed that its CEO is retiring at the end of the year as was
anticipated.
D. The price of Sussex stock suddenly declined in value because researchers accidentally
discovered that one of the firm's products can be toxic to household pets.
E. The board of directors made an unprecedented decision to give sizeable bonuses to the firm's
internal auditors for their efforts in uncovering wasteful spending.
AACSB: N/A
Difficulty: Basic
Section: 13.3


A. The unexpected return is always negative.
B. The expected return minus the unexpected return is equal to the total return.
C. Over time, the average return is equal to the unexpected return.
D. The expected return includes the surprise portion of news announcements.
E. Over time, the average unexpected return will be zero.
AACSB: N/A
Difficulty: Basic
Section: 13.3
Topic: Unexpected returns

26. Which one of the following statements related to unexpected returns is correct?

A. All announcements by a firm affect that firm's unexpected returns.
B. Unexpected returns over time have a negative effect on the total return of a firm.
C. Unexpected returns are relatively predictable in the short-term.
D. Unexpected returns generally cause the actual return to vary significantly from the expected
return over the long-term.
E. Unexpected returns can be either positive or negative in the short term but tend to be zero
over the long-term.
AACSB: N/A
Difficulty: Basic
Section: 13.3
Topic: Unexpected returns

27. Which one of the following is an example of systematic risk?

A. investors panic causing security prices around the globe to fall precipitously
B. a flood washes away a firm's warehouse
C. a city imposes an additional one percent sales tax on all products
D. a toymaker has to recall its top-selling toy
E. corn prices increase due to increased demand for alternative fuels
AACSB: N/A
Difficulty: Basic
Section: 13.4

28. Unsystematic risk:
A. can be effectively eliminated by portfolio diversification.
B. is compensated for by the risk premium.
C. is measured by beta.
D. is measured by standard deviation.
E. is related to the overall economy.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.4

29. Which one of the following is an example of unsystematic risk?
A. income taxes are increased across the board
B. a national sales tax is adopted
C. inflation decreases at the national level
D. an increased feeling of prosperity is felt around the globe
E. consumer spending on entertainment decreased nationally
AACSB: N/A
Difficulty: Basic
Section: 13.4

30. Which one of the following is least apt to reduce the unsystematic risk of a portfolio?
A. reducing the number of stocks held in the portfolio
B. adding bonds to a stock portfolio
C. adding international securities into a portfolio of U.S. stocks
D. adding U.S. Treasury bills to a risky portfolio
E. adding technology stocks to a portfolio of industrial stocks
AACSB: N/A
Difficulty: Basic
Section: 13.5

31. Which one of the following statements is correct concerning unsystematic risk?

A. An investor is rewarded for assuming unsystematic risk.
B. Eliminating unsystematic risk is the responsibility of the individual investor.
C. Unsystematic risk is rewarded when it exceeds the market level of unsystematic risk.
D. Beta measures the level of unsystematic risk inherent in an individual security.
E. Standard deviation is a measure of unsystematic risk.
AACSB: N/A
Difficulty: Basic

32. Which one of the following statements related to risk is correct?

A. The beta of a portfolio must increase when a stock with a high standard deviation is added to
the portfolio.
B. Every portfolio that contains 25 or more securities is free of unsystematic risk.
C. The systematic risk of a portfolio can be effectively lowered by adding T-bills to the portfolio.
D. Adding five additional stocks to a diversified portfolio will lower the portfolio's beta.
E. Stocks that move in tandem with the overall market have zero betas.
AACSB: N/A
Difficulty: Basic
Section: 13.5
Topic: Risk

33. Which one of the following risks is irrelevant to a well-diversified investor?

A. systematic risk
B. unsystematic risk
C. market risk
D. nondiversifiable risk
E. systematic portion of a surprise
AACSB: N/A
Difficulty: Basic
Section: 13.5

34. Which of the following are examples of diversifiable risk?

I. earthquake damages an entire town
II. federal government imposes a $100 fee on all business entities
III. employment taxes increase nationally
IV. toymakers are required to improve their safety standards
A. I and III only
B. II and IV only
C. II and III only
D. I and IV only
E. I, III, and IV only
AACSB: N/A
Difficulty: Basic
Section: 13.5

35. Which of the following statements are correct concerning diversifiable risks?

I. Diversifiable risks can be essentially eliminated by investing in thirty unrelated securities.
II. There is no reward for accepting diversifiable risks.
III. Diversifiable risks are generally associated with an individual firm or industry.
IV. Beta measures diversifiable risk.
A. I and III only
B. II and IV only
C. I and IV only
D. I, II and III only
AACSB: N/A
Difficulty: Basic

36. Which one of the following is the best example of a diversifiable risk?

A. interest rates increase
B. energy costs increase
C. core inflation increases
D. a firm's sales decrease
E. taxes decrease
AACSB: N/A
Difficulty: Basic
Section: 13.5

37. Which of the following statements concerning risk are correct?

I. Nondiversifiable risk is measured by beta.
II. The risk premium increases as diversifiable risk increases.
III. Systematic risk is another name for nondiversifiable risk.
IV. Diversifiable risks are market risks you cannot avoid.
A. I and III only
B. II and IV only
C. I and II only
D. III and IV only
AACSB: N/A
Difficulty: Basic
Section: 13.5
Topic: Systematic and unsystematic risk

38. The primary purpose of portfolio diversification is to:

A. increase returns and risks.
B. eliminate all risks.
C. eliminate asset-specific risk.
D. eliminate systematic risk.
E. lower both returns and risks.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.5

39. Which one of the following indicates a portfolio is being effectively diversified?

A. an increase in the portfolio beta
B. a decrease in the portfolio beta
C. an increase in the portfolio rate of return
D. an increase in the portfolio standard deviation
E. a decrease in the portfolio standard deviation
AACSB: N/A
Difficulty: Basic
Section: 13.5

40. How many diverse securities are required to eliminate the majority of the diversifiable risk
from a portfolio?
A. 5
B. 10
C. 25
D. 50
E. 75
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.5

41. Systematic risk is measured by:

A. the mean.
B. beta.
C. the geometric average.
D. the standard deviation.
E. the arithmetic average.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.6

42. Which one of the following is most directly affected by the level of systematic risk in a
security?
A. variance of the returns
B. standard deviation of the returns
C. expected rate of return
D. risk-free rate
E. market risk premium
AACSB: N/A
Difficulty: Basic
Section: 13.7
Topic: CAPM

43. Which one of the following statements is correct concerning a portfolio beta?

A. Portfolio betas range between -1.0 and +1.0.
B. A portfolio beta is a weighted average of the betas of the individual securities contained in the
portfolio.
C. A portfolio beta cannot be computed from the betas of the individual securities comprising the
portfolio because some risk is eliminated via diversification.
D. A portfolio of U.S. Treasury bills will have a beta of +1.0.
E. The beta of a market portfolio is equal to zero.
AACSB: N/A
Difficulty: Basic
Section: 13.6
Topic: Beta

44. The systematic risk of the market is measured by:

A. a beta of 1.0.
B. a beta of 0.0.
C. a standard deviation of 1.0.
D. a standard deviation of 0.0.
E. a variance of 1.0.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.6
Topic: Beta

45. At a minimum, which of the following would you need to know to estimate the amount of
additional reward you will receive for purchasing a risky asset instead of a risk-free asset?
I. asset's standard deviation
II. asset's beta
III. risk-free rate of return
IV. market risk premium
A. I and III only
B. II and IV only
C. III and IV only
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.7
Topic: CAPM

46. Total risk is measured by _____ and systematic risk is measured by _____.

A. beta; alpha
B. beta; standard deviation
C. alpha; beta
D. standard deviation; beta
E. standard deviation; variance
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.6
Topic: Risk measures

47. The intercept point of the security market line is the rate of return which corresponds to:
A. the risk-free rate.
B. the market rate.
C. a return of zero.
D. a return of 1.0 percent.
E. the market risk premium.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.7

48. A stock with an actual return that lies above the security market line has:
A. more systematic risk than the overall market.
B. more risk than that warranted by CAPM.
C. a higher return than expected for the level of risk assumed.
D. less systematic risk than the overall market.
E. a return equivalent to the level of risk assumed.
AACSB: N/A
Difficulty: Basic
Section: 13.7

49. The market rate of return is 11 percent and the risk-free rate of return is 3 percent. Lexant
stock has 3 percent less systematic risk than the market and has an actual return of 12 percent.
This stock:
A. is underpriced.
B. is correctly priced.
C. will plot below the security market line.
D. will plot on the security market line.
E. will plot to the right of the overall market on a security market line graph.
AACSB: N/A
Difficulty: Basic
Section: 13.7

50. Which one of the following will be constant for all securities if the market is efficient and
securities are priced fairly?
A. variance
B. standard deviation
C. reward-to-risk ratio
D. beta
E. risk premium
AACSB: N/A
Difficulty: Basic
Section: 13.7
Topic: Reward-to-risk ratio

51. The reward-to-risk ratio for stock A is less than the reward-to-risk ratio of stock B. Stock A
has a beta of 0.82 and stock B has a beta of 1.29. This information implies that:
A. stock A is riskier than stock B and both stocks are fairly priced.
B. stock A is less risky than stock B and both stocks are fairly priced.
C. either stock A is underpriced or stock B is overpriced or both.
D. either stock A is overpriced or stock B is underpriced or both.
E. both stock A and stock B are correctly priced since stock A is riskier than stock B.
AACSB: N/A
Bloom's: Analysis
Section: 13.7

52. The market risk premium is computed by:

A. adding the risk-free rate of return to the inflation rate.
B. adding the risk-free rate of return to the market rate of return.
C. subtracting the risk-free rate of return from the inflation rate.
D. subtracting the risk-free rate of return from the market rate of return.
E. multiplying the risk-free rate of return by a beta of 1.0.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.7
Topic: Market risk premium

53. The excess return earned by an asset that has a beta of 1.34 over that earned by a risk-free
asset is referred to as the:
A. market risk premium.
B. risk premium.
C. systematic return.
D. total return.
E. real rate of return.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.7
Topic: Risk premium

54. The _____ of a security divided by the beta of that security is equal to the slope of the
security market line if the security is priced fairly.
A. real return
B. actual return
C. nominal return
D. risk premium
E. expected return
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 13.7

55. The capital asset pricing model (CAPM) assumes which of the following?
I. a risk-free asset has no systematic risk.
II. beta is a reliable estimate of total risk.
III. the reward-to-risk ratio is constant.
IV. the market rate of return can be approximated.
A. I and III only
B. II and IV only
AACSB: N/A
Section: 13.7
Topic: CAPM

56. According to CAPM, the amount of reward an investor receives for bearing the risk of an
individual security depends upon the:
A. amount of total risk assumed and the market risk premium.
B. market risk premium and the amount of systematic risk inherent in the security.
C. risk free rate, the market rate of return, and the standard deviation of the security.
D. beta of the security and the market rate of return.
E. standard deviation of the security and the risk-free rate of return.
AACSB: N/A
Difficulty: Basic
Section: 13.7
Topic: Risk premium

57. Which one of the following should earn the most risk premium based on CAPM?
A. diversified portfolio with returns similar to the overall market
B. stock with a beta of 1.38
C. stock with a beta of 0.74
D. U.S. Treasury bill
E. portfolio with a beta of 1.01
AACSB: N/A
Difficulty: Basic
Section: 13.7
1. The length of time between the purchase of inventory and the receipt of cash from the sale of
that inventory is called the:
A. operating cycle.
B. inventory period.
C. accounts receivable period.
D. accounts payable period.
E. cash cycle.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.2
Topic: Operating cycle

2. The length of time that elapses between the day a firm purchases an inventory item and the
day that item sells is called the:
A. operating cycle.
E. cash cycle.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.2
Topic: Inventory period

3. The length of time between the sale of inventory and the collection of the payment for that
sale is called the:
A. operating cycle.
E. cash cycle.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.2
Topic: Accounts receivable period

4. The length of time between the day a firm purchases an item from its supplier until the day
that supplier is paid for that purchase is called the:
A. operating cycle.
E. cash cycle.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.2
Topic: Accounts payable period

5. Central Supply purchased a toboggan for inventory this morning and paid cash for it. The time
period between today and the day Central Supply will receive cash from the sale of this toboggan
is called the:
A. operating cycle.
E. cash cycle.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.2
Topic: Cash cycle

6. A graphical representation of the operating and cash cycles is called a(n):
A. operating chart.
B. cash flow time line.
C. production flow line.
D. component chart.
E. working time line.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.2
Topic: Cash flow time line

7. Costs that increase as a firm acquires additional current assets are called _____ costs.
A. carrying
B. shortage
C. order
D. safety
E. trading
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.3
Topic: Carrying costs

8. Costs that decrease as a firm acquires additional current assets are called _____ costs.
A. carrying
B. shortage
C. debt
D. equity
E. payables
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.3
Topic: Shortage costs

9. Steve has estimated the cash inflows and outflows for his hardware store for next year. The
report that he has prepared recapping these cash flows is called a:
A. pro forma income statement.
B. sales projection.
C. cash budget.
D. receivables analysis.
E. credit analysis.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.4
Topic: Cash budget

10. Taylor Supply has made an agreement with its bank that it can borrow up to $10,000 at any
time over the next year. This arrangement is called a(n):
A. floor loan.
B. open loan.
C. compensating balance.
D. line of credit.
E. bank note.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.5
Topic: Line of credit

11. Money deposited by a borrower with the bank in a low or non-interest-bearing account as a

condition of a loan agreement is called a:
A. compensating balance.
B. secured credit deposit.
C. letter of credit.
D. line of credit.
E. pledge.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.5
Topic: Compensating balances

12. Brustle's Pottery either factors or assigns all of its receivables to other firms. This is known
as:
A. accounts receivable financing.
B. pledged financing.
C. capital funding.
D. daily funding.
E. capital financing.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.5
Topic: Accounts receivable financing

13. Rose's Gift Shop borrows money on a short-term basis by pledging its inventory as collateral.
This is an example of a(n):
A. debenture.
B. line of credit.
C. banker's acceptance.
D. working loan.
E. inventory loan.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.5
Topic: Inventory loan

14. Which one of the following increases cash?

A. granting credit to a customer
B. purchasing new machinery
C. making a payment on a bank loan
D. purchasing inventory
E. accepting credit from a supplier
AACSB: N/A
Difficulty: Basic
Section: 18.1
Topic: Sources and uses of cash

15. Which of the following are uses of cash?

I. collecting a receivable
II. increasing inventory
III. obtaining a bank loan
IV. paying a supplier for previous purchases
A. I and III only
B. II and IV only
C. I and II only
AACSB: N/A
Difficulty: Basic
Section: 18.1
Topic: Sources and uses of cash

16. Which one of the following will increase net working capital? Assume the current ratio is
greater than 1.0.
A. paying a supplier for a previous purchase
B. paying off a long-term debt
C. selling inventory at cost
D. purchasing inventory on credit
E. selling inventory at a profit on credit
AACSB: N/A
Difficulty: Basic
Section: 18.1

17. Which one of the following will decrease the net working capital of a firm? Assume the
current ratio is greater than 1.0.
A. selling inventory at cost
B. collecting payment from a customer
C. paying a payment on a long-term debt
D. selling a fixed asset for book value
E. paying a supplier for the purchase of an inventory item
AACSB: N/A
Difficulty: Basic
Section: 18.1

18. Which of the following are sources of cash?

I. decrease in inventory
II. increase in accounts receivable
III. repayment of a bond
IV. sale of preferred stock
A. I and III only
B. I and IV only
C. II and III only
AACSB: N/A
Difficulty: Basic
Section: 18.1
Topic: Sources of cash

19. Which of the following will increase the operating cycle?

I. increasing the inventory turnover rate
II. increasing the payables period
III. decreasing the receivable turnover rate
IV. decreasing the inventory level
A. I only
B. III only
C. II and IV only
D. I and IV only
E. II and III only
AACSB: N/A
Difficulty: Basic
Section: 18.2

20. Which one of the following equals the operating cycle?

A. cash cycle plus accounts receivable period
B. inventory period plus the accounts receivable period
C. inventory period plus the accounts payable period
D. accounts payable period minus the cash cycle
E. accounts payable period plus the accounts receivable period
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.2

21. Which one of the following will decrease the operating cycle?

A. decreasing the inventory turnover rate
B. decreasing the accounts payable period
C. increasing the accounts receivable turnover rate
D. increasing the accounts payable period
E. increasing the accounts receivable period
AACSB: N/A
Difficulty: Basic
Section: 18.2

22. The operating cycle describes how a product:

A. is priced.
B. is sold.
C. moves through the current asset accounts.
D. moves through the production process.
E. generates a profit.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.2

23. Which of the following determines the length of the operating cycle?

I. cash cycle
II. inventory period
III. accounts payable period
IV. accounts receivable period
A. I and III only
B. II and IV only
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.2

24. Which of the following will increase the cash cycle, all else constant?
I. increasing the inventory period
II. decreasing the accounts receivable turnover rate
III. increasing the accounts payable period
IV. decreasing the accounts receivable period
A. I and II only
B. III and IV only
C. I and IV only
AACSB: N/A
Difficulty: Basic
Section: 18.2
Topic: Cash cycle

25. An increase in which one of the following will decrease the cash cycle, all else equal?
A. payables turnover
B. days sales in inventory
C. operating cycle
D. inventory turnover rate
E. accounts receivable period
AACSB: N/A
Difficulty: Basic
Section: 18.2
Topic: Cash cycle

26. Metal Designs, Inc., historically produced products for inventory. Now, the firm only
produces a product when it receives an actual order from a customer. All else equal, this change
will:
A. increase the operating cycle.
B. lengthen the accounts receivable period.
C. shorten the accounts payable period.
D. decrease the cash cycle.
E. decrease the inventory turnover rate.
AACSB: N/A
Difficulty: Basic
Section: 18.2
Topic: Cash cycle

27. Which of the following statements are correct?

I. An increase in the accounts payable period shortens the cash cycle.
II. The cash cycle is equal to the operating cycle minus the inventory period.
III. A negative cash cycle is preferable to a positive cash cycle.
IV. The cash cycle plus the accounts receivable period is equal to the operating cycle.
A. I only
B. III and IV only
C. I and III only
D. I and IV only
AACSB: N/A
Difficulty: Basic
Section: 18.2
Topic: Cash cycle

28. Which one of the following statements is correct concerning the cash cycle?
A. The longer the cash cycle, the more likely a firm will need external financing.
B. Increasing the accounts payable period increases the cash cycle.
C. A positive cash cycle is preferable to a negative cash cycle.
D. The cash cycle can exceed the operating cycle if the payables period is equal to zero.
E. Offering early payment discounts to customers will tend to increase the cash cycle.
AACSB: N/A
Difficulty: Basic
Section: 18.2
Topic: Cash cycle

29. Which of the following actions will tend to decrease the inventory period?
I. discontinuing all slow-selling merchandise
II. selling obsolete inventory below cost just to get rid of it
III. buying raw materials only as needed for the manufacturing process
IV. producing goods on demand versus for inventory
A. I and III only
B. II and IV only
AACSB: N/A
Difficulty: Basic
Section: 18.2
Topic: Inventory period

30. Which one of the following actions will tend to increase the accounts receivable period?
Assume the accounts receivable period is currently 34 days.
A. tightening the standards for granting credit to customers
B. refusing to grant additional credit to any customer who pays late
C. increasing the finance charges applied to all customer balances outstanding over thirty days
D. granting discounts for cash sales
E. eliminating the discount for early payment by credit customers
AACSB: N/A
Difficulty: Basic
Section: 18.2

31. An increase in which one of the following is an indicator that an accounts receivable policy is
becoming more restrictive?
A. bad debts
B. accounts receivable turnover rate
C. accounts receivable period
D. credit sales
E. operating cycle
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.2

32. If you pay your suppliers five days sooner, then:

A. your payables turnover rate will decrease.
B. you may require additional funds from other sources to fund the cash cycle.
C. the cash cycle will decrease.
D. your operating cycle will increase.
E. the accounts receivable period will decrease.
AACSB: N/A
Difficulty: Basic
Section: 18.2

33. Which one of the following will increase the accounts payable period, all else constant?
A. an increase in the cost of goods sold account value
B. an increase in the ending accounts payable balance
C. an increase in the cash cycle
D. a decrease in the operating cycle
E. an increase in the accounts payable turnover rate
AACSB: N/A
Difficulty: Basic
Section: 18.2

34. Which one of the following managers determines which customers must pay cash and which
can charge their purchases?
A. purchasing manager
B. credit manager
C. controller
D. production manager
E. payables manager

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.2
Topic: Organizational chart

36. A firm with a flexible short-term financial policy will:

A. maintain a low balance in accounts receivables.
B. only have minimal amounts, if any, invested in marketable securities.
C. invest heavily in inventory.
D. have low cash balances.
E. have tight restrictions on granting credit to customers.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.3
Topic: Short-term financial policy

37. Which one of the following is indicative of a short-term restrictive financial policy?

A. purchasing inventory on an as-needed basis
B. granting credit to all customers
C. investing heavily in marketable securities
D. maintaining a large accounts receivable balance
E. keeping inventory levels high
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.3

38. Which of the following are associated with a restrictive short-term financial policy?
I. little, if any, investment in marketable securities
II. liberal credit terms for customers
III. low cash balances
IV. increasing inventory levels
A. I and III only
B. II and IV only
C. I and IV only
D. III and IV only
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.3

39. The Lumber Mart recently replaced its management team. As a result, the firm is
implementing a restrictive short-term policy in place of the flexible policy under which the firm
had been operating. Which of the following should the employees expect as a result of this
policy change?
I. reduction in sales due to stock outs
II. greater inventory selection
III. decreased sales due to the new accounts receivable credit policy
IV. decreased investment in marketable securities
A. I and II only
B. II and IV only
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.3

40. A flexible short-term financial policy:

A. increases a firm's need for long-term financing.
B. minimizes net working capital.
C. avoids bad debts by only selling items for cash.
D. maximizes fixed assets and minimizes current assets.
E. is most appropriate for a firm with relatively high carrying costs and relatively low shortage
costs.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.3

41. A flexible short-term financial policy:

I. increases shortage costs due to frequent cash-outs.
II. tends to increase sales as compared to a restrictive policy.
III. requires a sizeable investment in current assets.
IV. incurs more carrying costs than a restrictive policy.
A. I and IV only
B. II and III only
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.3

42. Shortage costs include which of the following?

I. disruption of production schedules
II. inventory ordering costs
III. lost customer goodwill
IV. brokerage costs
A. I and II only
B. II and III only
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.3
Topic: Shortage costs

43. The optimal investment in current assets for an operating firm occurs at the point where:
A. both shortage costs and carrying costs equal zero.
B. shortage costs are equal to zero.
C. carrying costs are equal to zero.
D. carrying costs exceed shortage costs.
E. the total costs of holding current assets is minimized.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.3
Topic: Optimal point


A. A firm with a restrictive financing policy secures sufficient long-term financing to fund all its
assets.
B. A firm with a flexible financing policy frequently invests in marketable securities.
C. A firm with a flexible financing policy tends to use short-term financing on a frequent basis.
D. Firms tend to avoid short-term financing under both restrictive and flexible financing policies.
E. Firms with seasonal sales select flexible financing policies.
AACSB: N/A
Difficulty: Basic
Section: 18.3
Topic: Asset financing policies


A. Seasonal needs are financed externally when firms adhere to a flexible financing policy.
B. A flexible financing policy tends to increase the risk of encountering financial distress.
C. Long-term interest rates tend to be less volatile than short-term rates.
D. Most firms tend to finance inventory with long-term debt.
E. Short-term interest rates are generally higher than long-term rates.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.3
Topic: Financing policies

46. Assume each month has 30 days and a firm has a 60-day accounts receivable period. During
the second calendar quarter of the year, that firm will collect payment for the sales it made
during which of the following months?
A. October, November, and December
B. November, December, and January
C. December, January, and February
D. January, February, and March
E. February, March, and April
AACSB: N/A
Difficulty: Basic
Section: 18.4
Topic: Cash collections

47. The Harvester collects 25 percent of sales in the month of sale, 60 percent of sales in the
month following the month of sale, and 15 percent of sales in the second month following the
month of sale. During the month of April, the firm will collect:
A. 60 percent of February sales.
B. 15 percent of April sales.
C. 60 percent of March sales.
D. 15 percent of March sales.
E. 25 percent of February sales.
AACSB: N/A
Difficulty: Basic
Section: 18.4

48. A manufacturing firm has a 90 day collection period. The firm produces seasonal
merchandise and thus has the least sales during the first quarter of a year and the highest level of
sales during the fourth quarter of a year. The firm maintains a relatively steady level of
production which means that its cash disbursements are fairly equal in all quarters. The firm is
most apt to face a cash-out situation in:
A. the first quarter.
B. the second quarter.
C. the third quarter.
D. the fourth quarter.
E. any quarter with equal probabilities of occurrence.
AACSB: N/A
Difficulty: Basic
Section: 18.4

49. Jill is the CFO of Summertime Adventures which is a seasonal firm specializing in products
related to water sports. The firm purchases inventory one month before it is sold and pays for its
purchases 60 days after the invoice date. Sales are highest during July and August. Currently, Jill
is preparing the cash disbursements section of the firm's cash budget. Which one of the following
statements is supported by this information?
A. Inventory purchases will be highest during the months of July and August.
B. Inventory purchases will be highest during the months of May and June.
C. Payments to suppliers will be highest during the months of June and July.
D. Payments to suppliers will be highest during the months of July and August.
E. Payments to suppliers will be highest during the months of August and September.
AACSB: N/A
Difficulty: Basic
Section: 18.4
Topic: Cash disbursements

50. Which two of the following are most apt to cause a cash-out for a firm that is generally
financially sound?
I. fixed expenses
II. fixed asset purchases
III. flexible financing policy
IV. highly seasonal sales
A. I and III only
B. II and IV only
C. III and IV only
AACSB: N/A
Difficulty: Basic
Section: 18.4
Topic: Cash-out

51. Which one of the following statements is correct concerning the cash balance of a firm?
A. Most firms attempt to maintain a zero cash balance at all times.
B. The cumulative cash surplus shown on a cash budget is equal to the ending cash balance plus
the minimum desired cash balance.
C. On a cash balance report, the cumulative cash surplus at the end of May is used as June's
beginning cash balance.
D. A cumulative cash deficit indicates a borrowing need.
E. The ending cash balance must equal the minimum desired cash balance.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.4
Topic: Cash balance

52. A cumulative cash deficit indicates a firm:

A. has at least a short-term need for external funding.
B. is facing long-term financial distress.
C. will go out of business within the year.
D. is capable of funding all of its needs internally.
E. is using its cash wisely.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.4
Topic: Cash balance

53. The most common means of financing a temporary cash deficit is a:

A. long-term secured bank loan.
B. short-term secured bank loan.
C. short-term issue of corporate bonds.
D. long-term unsecured bank loan.
E. short-term unsecured bank loan.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.5
Topic: Short-term borrowing

54. The primary difference between a line of credit and a revolving credit arrangement is the:
A. type of collateral used to secure the loan.
B. length of the credit period.
C. fact that the line of credit is a secured loan and the revolving credit arrangement is unsecured.
D. fact that the line of credit is an unsecured loan and the revolving credit arrangement is
secured.
E. classification as either a committed or a noncommitted loan.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.5

55. A compensating balance:

I. is required when a firm acquires any bank financing other than a line of credit.
II. increases the cost of short-term bank financing.
III. may be required even if a firm never borrows funds.
IV. is often used as a means of paying for banking services received.
A. I and III only
B. II and IV only
C. II and III only
D. I and IV only
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.5

56. High Point Hotel (HPH) has $165,000 in accounts receivable. To finance a major purchase,
the company assigns these receivables to Cross Town Bank. Which one of the following
statements correctly describes this transaction?
A. HPH will immediately receive $165,000 and will have no further obligation related to these
receivables.
B. HPH will receive some amount of cash immediately while maintaining full responsibility for
any uncollected receivables.
C. Cross Town Bank accepts full responsibility for the collection of the accounts receivables and,
in exchange, immediately pays HPH a discounted value for its receivables.
D. Cross Town Bank accepts full responsibility for collecting the accounts receivables and pays
HPH a discounted price for the accounts collected after the normal collection period has elapsed.
E. HPH receives the full amount of its receivables upon assignment but must reimburse Cross
Town Bank for any uncollected account.
AACSB: N/A
Difficulty: Basic
Section: 18.5


A. The assignment of receivables involves selling the firm's accounts receivables at full price.
B. Lines of credit frequently require a cleanup period.
C. With maturity factoring, the borrower receives the loan amount immediately.
D. Commercial paper is short-term financing offered to highly-rated corporations by major
banks.
E. Credit card receivables funding is a relatively inexpensive method of borrowing on a short-
term basis.

AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.5

58. Which of the following are benefits derived from short-term financial planning?
I. having advance notice of when your firm will require external financing
II. being able to determine the extent of time for which a loan is required
III. having the ability to time capital expenditures in order to place the least financial burden
possible on a firm
IV. knowing for certain what your cash balance will be six months in advance
A. I and III only
B. I, II, and III only
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 18.6
Topic: Short-term financial plan

1. Yesterday, the president of RB Enterprises received a phone call from DLK, a competitor.
DLK is a sole proprietorship. An unexpected family situation has caused the owner to suddenly
want to retire and relocate closer to his family. Thus, the assets of DLK are being offered to RB
Enterprises at a bargain basement price. While RB Enterprises had not anticipated purchasing
these assets, it was decided that the opportunity was too good to pass up. This illustrates which
of the following needs to hold cash?
A. precautionary
B. transaction
C. speculative
D. compensation
E. float

AACSB: N/A
Difficulty: Basic
Section: 19.1
Topic: Speculative motive

2. GT Motors regularly issues short-term debt to finance its daily operations. Suddenly, the credit
markets froze and no funds were available for borrowing. Fortunately, the firm had some cash
reserves saved that it was able to use to fund its operations until additional credit was available.
The need to retain cash for situations such as this is referred to as which one of the following
motives for holding cash?
A. speculative
B. float
C. compensating
D. precautionary
E. transaction
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.1
Topic: Precautionary motive

3. The cash found in a cash drawer that a check-out clerk uses to make change is an example of
which of the following motives for holding cash?
A. speculative
B. daily float
C. compensating balance
D. precautionary
E. transaction
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.1
Topic: Transaction motive

4. Float is defined as the:

A. amount of cash a firm can immediately withdraw from its bank account.
B. difference between book cash and bank cash.
C. change in a firm's cash balance from one accounting period to the next.
D. amount of cash a firm has on hand.
E. cash balance according to a firm's records.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.2
Topic: Float

5. A lockbox is a:

A. special safe used by a firm for overnight storage of any cash or undeposited checks.
B. special safe used by a firm that can only be opened at prespecified times of the day.
C. box located in a bank's vault that is rented by a firm and used to hold unprocessed checks.
D. special post office box which can only be opened by prespecified postal inspectors for direct
delivery to the addressee.
E. post office box strategically located so that a firm's receivables can be collected faster.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.3
Topic: Lockbox

6. The Presque Isle Center has branch operations in three states. Each branch deals with a local
bank. However, all excess funds in these branch bank accounts are transferred on a daily basis to
the firm's primary bank located near the firm's home office. This routine of transferring cash to
the primary bank on a regular basis is referred to as:
A. cash concentration.
B. strategic cash disbursement.
C. transfer flotation.
D. payables management.
E. float management.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.3
Topic: Cash concentration

7. An account into which funds are deposited only in an amount equal to the value of the checks
presented for payment that day is called a _____ account.
A. lockbox
B. concentration
C. zero-balance
D. compensating balance
E. revolving
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.4
Topic: Zero-balance accounts

8. An account into which a firm transfers funds, usually from a master account, in an amount
sufficient to cover the checks presented for payment that day is called a _____ account.
A. lockbox
B. cleanup
C. compensating balance
D. revolving
E. controlled disbursement
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.4
Topic: Controlled disbursement account

9. The Snow Hut has analyzed the carrying and shortage costs associated with its cash holdings
and determined that the firm should ideally maintain a cash balance of $3,600. This $3,600
represents which one of the following to the firm?
A. target cash balance
B. concentration balance
C. available balance
D. selected cash amount
E. compensating balance
Refer to section 19.A
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.A
Topic: Target cash balance

10. Adjustment costs is another name for which one of the following?

A. borrowing costs
B. shortage costs
C. cash transfer costs
D. cash wire costs
E. excess cash costs
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.A
Topic: Adjustment costs

11. Why do firms need liquidity?

I. to meet compensating balance requirements
II. to take advantage of an opportunity that suddenly arises
III. to conduct daily business activities
IV. to be prepared for a financial emergency
A. I and II only
B. III and IV only
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.1
Topic: Motives for liquidity

12. Cash management primarily involves:

A. optimizing a firm's collections and disbursements of cash.
B. maximizing the income a firm earns on its cash reserves.
C. reconciling a firm's book balance with its bank balance.
D. determining the optimal level of liquidity a firm should maintain.
E. determining the best method of raising capital.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.1
Topic: Cash management

13. Disbursements float:
A. occurs when a deposit is recorded but the funds are unavailable.
B. causes the book balance to exceed the bank balance.
C. has tended to increase since the enactment of the Check Clearing Act for the 21 Century.
st
D. is a recommended source of funds for short-term investments.

E. is eliminated when payments are made electronically.
AACSB: N/A
Difficulty: Basic
Section: 19.2
Topic: Disbursement float

14. Collection float:
A. is more desirable to firms than disbursement float.
B. is totally eliminated by the installation of a lockbox system.
C. exists when a firm's available balance exceeds its book balance.
D. can be avoided by collecting payments electronically at the time of sale.
E. is eliminated by implementing a concentration banking system.

AACSB: N/A
Difficulty: Basic
Section: 19.2
Topic: Collection float


A. Net float decreases every time a firm issues a check to pay one of its suppliers.
B. A positive net float indicates that collection float exceeds disbursements float.
C. Firms prefer a zero net float over a positive net float.
D. Net float is equal to collection float minus disbursement float.
E. Net float is equal to a firm's available balance minus its book balance.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.2
Topic: Net float

16. Check kiting is:

A. used by most firms as an ethical means of handling its cash reserves.
B. the process of withdrawing all funds from a bank account as soon as the funds are available.
C. the central core of a good cash management system.
D. using uncollected cash to invest in short-term, liquid assets.
E. increasingly popular due to recent banking law changes.
AACSB: Ethics
Bloom's: Knowledge
Difficulty: Basic
Section: 19.2
Topic: Ethical issue

17. Which of the following will reduce collection time?

I. billing customers electronically rather than by mail
II. accepting debit cards but not checks as payment for a sale
III. offering cash discounts for early payment
IV. reducing the processing delay by one day
A. I and II only
B. I and III only
AACSB: N/A
Difficulty: Basic
Section: 19.3
Topic: Collection time

18. Which of the following should help reduce the total collection time for a firm?
I. opening a post office box so mail can be received earlier in the morning
II. assigning additional staff in the morning to process incoming payments
III. providing a discount for customers who pay electronically
IV. establishing preauthorized payments from customers
A. I and II only
B. III and IV only
AACSB: N/A
Difficulty: Basic
Section: 19.3

19. Which one of the following collection times is correctly described?

A. The processing delay starts when a firm mails out a billing statement and ends when the
payment is received from a customer.
B. Mailing time begins when a firm mails out a billing statement and ends when the payment is
received.
C. Collection time begins when a firm mails out a billing statement and ends when the cash
payment for that billing is available to the firm.
D. Availability delay begins when a firm deposits a customer's check into its bank account and
ends when the cash from that payment is available to the firm.
E. Processing delay begins when a firm mails out billing statements and ends when the firm
deposits the payment for that statement into its bank account.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.3

20. A lockbox system:

A. entails the use of a bank which is centrally located to collect payments on a nationwide basis.
B. is designed to deposit a customer's check into the firm's bank account prior to recording the
receipt of that check to a customer's account.
C. is used to reduce the disbursement float of a firm.
D. is efficient regardless of the locations selected for lockbox destinations.
E. automatically records payments to a customer's account when the customer's check is received
at the lockbox location.
AACSB: N/A
Difficulty: Basic
Section: 19.3
Topic: Lockbox

21. Lockboxes:
A. should be geographically located close to a firm's primary customers.
B. should be located in remote locations to increase the net disbursement float.
C. offer no additional benefit to a firm now that the Check Clearing Act for the 21 Century has
st
been enacted.
D. tend to be negative net present value projects for firms with a large number of sizeable
transactions.
E. tend to also be used as concentration accounts.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.3
Topic: Lockbox

22. Cash concentration accounts:
A. tend to increase the funds available for short-term investing.
B. tend to increase the complexity of a firm's cash management system.
C. that utilize wire transfers rather than automated clearing house transfers are less expensive to
maintain.
D. receive checks directly from all of a firm's customers.
E. are all zero-balance accounts.
AACSB: N/A
Difficulty: Basic
Section: 19.3


A. Funds received via automated clearinghouse transfers are available that day.
B. A depository transfer check is the most costly means of transferring funds into a cash
concentration account.
C. The means selected to transfer funds into a concentration account depends primarily upon the
size of the transfers.
D. Concentration accounts are used to transfer funds to lockbox locations as needed.
E. The most expedient means of transferring funds into a concentration account is a wire
transfer.
AACSB: N/A
Difficulty: Basic
Section: 19.3

24. A cash concentration account:

A. is frequently used as a source of funds for short-term investments.
B. cannot be used to cover a compensating balance requirement.
C. cannot be used to transfer funds into zero-balance accounts.
D. is generally the only bank account a firm needs to efficiently manage its cash.
E. is another name for a controlled disbursement account.

AACSB: N/A
Difficulty: Basic
Section: 19.3

25. The main purpose of a cash concentration account is to:

A. decrease collection float.
B. decrease disbursement float.
C. consolidate funds.
D. replace a lockbox system.
E. cover compensating balance requirements.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.3

26. Which one of the following statements is correct concerning a cash management system that
employs both lockboxes and a concentration bank account?
A. All customer payments must be submitted to a lockbox.
B. The party which collects the checks from the lockbox is responsible for recording the payment
on the customer's account.
C. Payments received in a lockbox are transferred immediately to the concentration account.
D. The firm's cash manager determines how the funds in the concentration account are disbursed.
E. The concentration account must be zeroed out on a daily basis.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.3

27. A zero-balance account:

A. is used to cover the compensating balance requirement of a line of credit agreement.
B. is only used to deposit funds received at local lockboxes.
C. is funded on an as-needed basis only.
D. is limited to handling payroll disbursements.
E. requires a compensating balance.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.4

28. Which one of the following statements is correct concerning zero-balance accounts?

A. Each zero-balance account is offset by a compensating balance account.
B. Zero-balance accounts are used for depositing incoming funds.
C. A master account must be used in conjunction with a zero-balance account.
D. Zero-balance accounts are used solely in conjunction with a lockbox system.
E. Zero-balance accounts are still required to maintain a minimal balance.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.4


A. The money market refers to securities that mature in two years or less.
B. Banks are prohibited from investing cash surpluses on behalf of their customers on a short-
term basis.
C. Short-term securities tend to have a high degree of interest rate risk.
D. A cyclical firm may purchase marketable securities as part of its short-term financing plan.
E. Corporations are not permitted to invest in money market mutual funds but can invest in bank
money market accounts.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.5
Topic: Management of cash surplus

30. Which two of the following are the primary reasons why firms temporarily accumulate large
cash surpluses?
I. cyclical activities
II. desire to invest funds
III. daily operations
IV. fixed asset purchases
A. I and III only
B. II and IV only
C. I and II only
D. III and IV only
E. I and IV only
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.5
Topic: Management of cash surplus

33. Money market securities have which of the following characteristics?

I. long maturities
II. low default risk
III. high degree of liquidity
IV. low rates of return
A. I and III only
B. II and III only
C. I and IV only
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.5
Topic: Short-term securities

34. A jumbo CD:

A. is issued by the federal government.
B. generally matures between 2 and 5 years.
C. is a loan of $100,000 or more to a municipality.
D. is a loan of $1 million or more on a short-term basis.
E. is a short-term loan of $100,000 or more to a commercial bank.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.5

35. Brown Trucking is buying a U.S. Treasury bill today with the understanding that the seller
will buy it back tomorrow at a slightly higher price. This investment is known as a:
A. commercial paper transaction.
B. repurchase agreement.
C. private certificate of deposit.
D. revenue anticipation note.
E. bill anticipation note.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.5

36. A repurchase agreement generally has a maximum life of:

A. 1 day.
B. a few days.
C. one month.
D. one to three months.
E. three to six months.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.5

37. A money market preferred stock:
A. has a floating dividend.
B. is sold only under a repurchase agreement.
C. is a special form of commercial paper.
D. has more price volatility than an ordinary preferred.
E. has its interest rate reset daily.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.5

38. Which of the following costs related to holding cash are minimized when the level of cash a
firm holds is optimized?
A. opportunity costs
B. trading costs
C. total costs
D. both trading and opportunity costs
E. trading costs, opportunity costs, and total costs
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.A
Topic: Cash balance

39. Which of the following statements related to the BAT model is correct?

I. The BAT model is used to determine the target cash balance for a firm.
II. The BAT model is rarely used in business due to its complex nature.
III. The BAT model is a model that helps eliminate a firm's collection float.
IV. One disadvantage of the BAT model is the fact that it assumes all cash outflows are known
with certainty.
A. I and II only
B. III and IV only
C. II and III only
D. I and III only
E. I and IV only
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.A
Topic: BAT model

40. Which of the following variables are included in the BAT model?

I. upper cash limit
II. interest rate on marketable securities
III. opportunity cost of holding cash
IV. fixed cost of each securities trade
A. II only
B. I and III only
C. II and IV only
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.A
Topic: BAT model

42. The Miller-Orr model assumes that:

A. the cash balance is depleted at regular intervals.
B. all cash flows are known with certainty.
C. the average change in the daily cash flows is positive.
D. management will set both the lower and the upper desired levels of cash.
E. the cash balance fluctuates in a random manner.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.A
Topic: Miller-Orr model

43. The Miller-Orr model:
A. recommends selling securities in an amount equal to (U* - C) when the cash balance reaches
L.
B. requires that marketable securities be sold whenever the cash balance falls below the target
level.
C. bases the optimal level of cash solely on the opportunity costs of holding cash.
D. supports the argument that the target cash balance declines as order costs increase.
E. advocates investing an amount described as (U* - C) in marketable securities when the
cash balance reaches U*.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 19.A
Topic: Miller-Orr model

44. Which of the following statements is correct?

A. A firm has a greater likelihood of needing an unexpected loan when its cash flows are
relatively constant over time.
B. The cost of borrowing affects the target cash balance of a firm.
C. Management's desire to maintain a low cash balance has no effect on the borrowing needs of a
firm.
D. The target cash balance increases as the interest rate rises.
E. The target cash balance decreases as the order costs increase.
8. You are viewing a graph which compares costs with the amount of credit extended. Both the
carrying costs and the opportunity costs of credit are depicted. What is the function called that
represents the summation of these carrying and opportunity costs?
A. opportunity cost curve
B. credit extension curve
C. credit cost curve
D. terms of sale graph
E. optimal sales graph
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 20.4
Topic: Credit cost curve

9. Assume that RSF is a wholly-owned subsidiary of the Rolled Steel Company. RSF provides
credit financing solely for large ticket items purchased from the Rolled Steel Company. Which
one of the following terms describes RSF?
A. credit department
B. parent company
C. captive finance company
D. credit union
E. service unit
11. Roger's Home Appliances offers credit to customers it deems worthy of this privilege. To
determine if a customer is worthy, the firm computes a numerical value which is used to estimate
the probability that the customer will default if credit is granted to them. The process of
computing this numerical value is referred to as:
A. credit scoring.
B. credit capacity.
C. receipts assessment.
D. conditions for credit.
E. consumer analysis.
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 20.5
Topic: Credit scoring

12. You have recently been hired as an accounting intern for Jefferson Mills. The job that you
have been assigned for today is to compile a spreadsheet that has six columns. The column
headings are: Invoice #; Customer name; < 30 days; 31-60 days; 61-90 days; > 90 days. You are
to list every unpaid invoice by customer name with the amount owed entered into the appropriate
column for the number of days between the sale date and today. Once you have completed that,
you are to sort the report by customer name and then total the amounts listed in each column.
What is this report called?
A. credit report
B. aging schedule
C. risk assessment report
D. turnover delineation
E. receivables consolidation report
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 20.6
Topic: Aging schedule

13. Bill is in charge of the inventory for Home Builder's Supply. As an inventory item gets low,
he is to restock the item by a quantity that minimizes the total inventory costs for that item. What
is this restocking quantity called?
A. short order quantity
B. refill unit quantity
C. economic order quantity
D. minimum stock level
E. re-order limit
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 20.8
Topic: Economic reorder quantity

14. Allison has developed a set of procedures for determining the amount of each raw material
that she needs to have in inventory if she is to keep her firm's assembly lines operating
efficiently. These procedures are commonly referred to by which one of the following terms?
A. first-in, first-out method
B. the Baumol model
C. net working capital planning
D. economic order procedures
E. materials requirements planning
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 20.8
Topic: Materials requirements planning

15. Which one of the following is a system for managing demand-dependent inventories that
minimizes the inventory levels of a firm?
A. just-in-time inventory
B. turnover planning
C. net working capital planning
D. inventory scoring
E. inventory ranking
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 20.8
Topic: Just-In-Time inventory

16. The terms of sale generally include which of the following?

I. type of credit instrument
II. cash discount
III. credit period
IV. discount period
A. I and III only
B. II and IV only
C. III and IV only
AACSB: N/A
Bloom's: Knowledge
Difficulty: Basic
Section: 20.1
Topic: Terms of sale

19. Which one of the following will increase a firm's investment in accounts receivables?
A. a decrease in the number of days for which credit is granted
B. a decrease in credit sales
C. an increase in cash sales
D. a decrease in the average collection period
E. an increase in average daily credit sales
AACSB: N/A
Difficulty: Basic
Section: 20.1
Topic: Investment in receivables

20. A firm's total investment in receivables depends primarily on the firm's:

A. total sales and cash discount period.
B. cash to credit sales ratio.
C. bad debt ratio.
D. average collection period and amount of credit sales.
E. amount of credit sales and cash discount percentage.
AACSB: N/A
Difficulty: Basic
Section: 20.1
Topic: Investment in receivables

21. Which one of the following time periods is included in the accounts receivable period but not
in the cash collection period?
A. the period of time between the receipt of a check and the availability of those funds
B. time it takes a firm to process incoming receipts
C. period of time a check is in the mail
D. the amount of time that it takes a bank to credit a firm's account for a deposit made

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29. The interest rate risk premium is the:

Refer to section 7.7

Refer to sections 7.1 and 7.2

Refer to section 7.1

Refer to section 7.1

Refer to section 7.1

Refer to section 7.1

Refer to section 7.1

Refer to section 7.1

Refer to section 7.1

Refer to section 7.2

Refer to section 7.4

Topic: Treasury bonds

75. Which one of the following statements is correct?

Refer to section 7.6

Refer to section 7.7

Refer to sections 7.4 and 7.7

Refer to section 8.1

27. The dividend growth model:

Refer to section 8.1

Refer to section 8.1

Refer to section 8.1

31. Which one of the following statements is correct?

Refer to sections 8.1 and 8.2

32. Supernormal growth is a growth rate that:

Refer to section 8.1

Refer to section 8.1

Refer to section 8.1

Refer to section 8.1

Refer to section 8.2

Topic: Preferred shareholder rights

Refer to section 8.2

43. Which one of the following statements related to corporate dividends is correct?

Refer to section 8.2

44. Which one of these statements related to preferred stock is correct?

Refer to section 8.2

6. The internal rate of return is defined as the:

Refer to section 9.5

Refer to section 9.5

Refer to section 9.1

Refer to section 9.1

14. If a project has a net present value equal to zero, then:

Refer to sections 9.1 and 9.6

Refer to section 9.1

Refer to section 9.1

Refer to sections 9.3 through 9.6

Refer to section 9.2

I. works well for research and development projects

Refer to section 9.2

Refer to section 9.2

Refer to section 9.2

I. The project must also be acceptable under the payback rule.

Refer to section 9.3

Refer to sections 9.2 and 9.3

Refer to section 9.3

Refer to section 9.4

Refer to section 9.4

I. exclusion of time value of money considerations

Refer to section 9.4

Refer to section 9.5

30. The internal rate of return:

Refer to section 9.5

Refer to section 9.5