FINANCIAL MANAGEMENT I PRACTICE SET FOR EXAM 1

TRUE / FALSE:
1. Financial statements are accounting reports issued periodically by a firm which present information on the
past performance of the firm, a summary of the firm's assets and the financing of those assets, and a
prediction of the firm's future performance.

TRUE

2. In a limited partnership, there is no liability for the debts of the partnership.

FALSE – In limited partnership there are 2 classes of partners. General partners have
unlimited liability, while limited partners are liable only for the amount of their
investment in the partnership. Don’t mix limited partnership with limited liability
partnership (LLP) and limited liability company (LLC) – see lecture notes and textbook

3. The balance sheet shows the assets, liabilities, and stockholders' equity of a firm over a given period of
time.
FALSE - The balance sheet shows the assets, liabilities and shareholders’ equity at a
given date, for ex. on 31/12/2019.
On the other hand, income statement shows the firm’s revenues and expenditures (and
thus profits) over some past period, for ex. 01/01/2019-31/12/2019

4. We cannot apply the growth perpetuity equation for negative growth.

FALSE – growth rate (g) can be negative – there is no reason why cash flows could not
decrease from year to year. However, when it is positive, it should be lower than interest
rate (r) in order PV=CF/(r-g) formula to work.

5. Stockholders’ equity is the difference between a firm’s assets and current liabilities, as shown on the
balance sheet.
FALSE – it is the difference between a firm’s assets and TOTAL liabilities

6. Non Interest Bearing Current Liabilities include accounts payable and accruals.

TRUE

7. A perpetuity is a stream of equal cash flows that occurs at regular intervals and lasts forever.

TRUE

MULTIPLE CHIOCE QUESTIONS (ONLY 1 ANSWER IS CORRECT)

1. Which of the following accounts has the highest EAR?

A) one that pays 6.1% every six months
B) one that pays 1.0% per month – see xls file PROBLEM SET_TVM_Solutions
C) one that pays 12.6% per year
D) one that pays 3% every three months

2. Many companies have provided managers with executive stock options, which:
A) are a form of incentive contracts
B) can serve as a mechanism of aligning the interests of shareholders and managers
C) can offer managers an incentive to run the company in such a way that enhances shareholder
wealth as well as their own

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 D) A, B and C
3. Net operating profit after taxes (NOPAT):
A) is the after-tax profit a company would have if it had no debt and no investments in non-operating
assets
B) excludes the effects of financing decisions
C) is a better measure of operating performance than is net income
D) A, B and C

4. Which of the following balance sheet equations is INCORRECT?

A) Assets - Liabilities = Shareholders' Equity
B) Assets = Liabilities + Shareholders' Equity
C) Assets - Current Liabilities = Long Term Liabilities
D) Assets - Current Liabilities = Long Term Liabilities + Shareholders' Equity

5. Which ratio would you use to measure the financial health of a firm by assessing that firm’s leverage?
A) debt-equity or debt-asset ratio
B) market-to-book ratio (this is market value ratio)
C) operating margin (this is profitability ratio)
D) current or quick ratio (this is liquidity ratio)

6. On August 19, 2004 Google IPO offered 19,605,052 shares at a price of U.S. $85 per share, which were
sold in an online auction. Which of the following statements best describes why these are considered a
primary market transaction?
A) The transaction was between the corporation and investors.
B) Shares of Google from this time onward could be traded between investors on a stock exchange. –
this is secondary market feature
C) The shares were the first to be publicly issued by Google.
D) Google was at the time a recently founded company seeking capital with which to expand.

On the primary markets, a corporation issues stock and receives proceeds (money) from investors
that buy stock. On primary market a corporation can issue the stock for the first time in the initial
public offering-IPO, but also primary market involves raising money by selling a new issue of stocks
by a public corporation.
On the secondary market, investors trade between themselves, buying and selling already outstanding
securities. A corporation that issued security doesn’t receive proceeds and is not directly involved.

7. Which of the following is NOT one of the financial statements that must be produced by a public company?
A) the balance sheet
B) the income statement
C) the statement of cash flows
D) the statement of activities

8. What is a firm's gross profit?

A) the difference between the sales and other income generated by the firm, and all costs, taxes, and
expenses incurred by the firm in a given period
B) the difference between sales revenues and the costs associated with those sales. – see Lecture
notes 3, slide 7
C) the difference between sales revenues and cash expenditures associated with those sales.
D) all of the above

9. Which of the following is NOT a reason why financial managers must take great care when making
investment decisions?
A) These investment decisions determine whether the firm will add value for its owners.
B) These investments determine the long-term directions in which the company may move.
C) These investment decisions determine the corporations mix of debt and equity.
D) These investment decisions typically involve substantial costs which must be carefully weighed

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 against their potential benefits.
10. A ________ is when a rich individual or organization purchases a large fraction of the stock of a poorly
performing firm and in doing so gets enough votes to replace the board of directors and the CEO.
A) shareholder proposal
B) leveraged buyout
C) shareholder action
D) hostile takeover

11. Why is a stock exchange like London Stock Exchange considered a secondary market?
A) It trades the second largest volume of shares in the world.
B) Shares sold on it are exchanged between investors without any involvement of the issuing
corporation.
C) The exchange has rules that attempt to ensure that bid and ask prices do not get too far apart
D) London Stock Exchange is called a secondary market because NYSE is considered a primary
market.

12. Which of the following is NOT an operating expense?

A) interest expense – it is financing expense
B) depreciation and amortization
C) selling, general, and administrative expenses
D) research and development

B, C and D are operating expenses – when subtracted from gross profit one gets operating income
(EBIT).

13. EVA measures:

A) all the costs of running the business, both operating and financing
B) only operating cost
C) only financing cost
D) EVA is not related to cost of business

14. Investment (capital budgeting) decisions refers to:

A) What long-term investment should the firm undertake?
B) What is optimum structure of financing, i.e. should corporation use more debt or equity when
financing long term investment?
C) How should the firm manage its short-term assets and liabilities, such as cash?
D) Should the firm pay out a dividend to the shareholders or reinvest the profit?

15. What is the major advantage corporations have over other business entities?
A) It is easier for a corporation to raise capital than other forms of businesses.
B) A corporation is treated as a separate legal entity for tax and legal purposes.
C) A corporation's shares can be freely traded among its shareholders.
D) All of the above are advantages that a corporation has over other business forms.

16. You are given two choices of investments, Investment A and Investment B. Both investments have the same
future cash flows. Investment A has a discount rate of 5%, and Investment B has a discount rate of 4%.
Which of the following is true?
A) The present value of cash flows in Investment A is higher than the present value of cash flows in
Investment B.
B) The present value of cash flows in Investment A is lower than the present value of cash flows
in Investment B.
C) The present value of cash flows in Investment A is equal to the present value of cash flows in
Investment B.

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D) No comparison can be made - we need to know the cash flows to calculate the present value.

Since both investments have the same future cash flows, we don’t need to know the value of those
flows to compare their PVs if we know interest rate.

The higher the interest rate, the lower the present value. PV=CF / (1+r)^N

On the other hand, the higher the interest rate, the higher the future value. FV=CF * (1+r)^N