Finance 300 Test 1

Financial management deals with the maintenance and creation of economic value or wealth. True
The fundamental goal of a business is to maximize the retained earnings available to the​ corporation’s shareholders. False
The payment of a dividend to current shareholders will have no impact on a​ corporation’s share price because the cash paid is not available to future potential shareholders who may want to buy the​ corporation’s stock. False
Only a​ firm’s financial decisions affect its stock prices. False
The primary goal of a publicly owned corporation is to​ ________. Maximize shareholder wealth
Shareholder wealth maximization means Maximizing the price of existing common stock
Which of the following goals of the firm are synonymous​ (equivalent) to the maximization of shareholder​ wealth? maximization of the total market value of the​ firm’s common stock
Which of the following is the most important goal that a corporation should strive​ for? Maximize shareholder wealth
When making financial​ decisions, managers should always look at​ marginal, or incremental cash flows. True
An investment project is acceptable if the total cash received over the life of the project exceeds the total cash spent over the life of the project. False
Cash flows and profits are​ synonymous; in other​ words, higher cash flows equal higher profits. False
The risk−return trade−off implies that the return on a riskless asset must be zero. False
An efficient market is one where the prices of the assets traded in that market fully reflect all available information at any instant in time. True
Beginning in 2007 the United States experienced its most severe financial crisis since the Great Depression of the 1930s. True
To measure​ value, the concept of time value of money is used to bring the future benefits and costs of a​ project, measured by its cash​ flows, back to the present.
The expected return on a riskless asset is greater than zero due to an expected return for delaying consumption.
The principle of risk−return trade−off means that a rational investor will only take on higher risk if he expects a higher return.
Investors generally​ don’t like risk.​ Therefore, a typical investor will only take on additional risk if he expects to be compensated in the form of additional return.
As of​ today, the most severe economic crisis to afflict the United States economy is considered to be The Great Depression of the 1930’s
The financial manager most directly responsible for producing the​ company’s financial statements and directing its cost accounting functions is the Controller
The three basic types of issues addressed by the study of finance are capital​ budgeting, capital structure​ decisions, and working capital management.
Cash and credit management are typically the responsibility of the Treasurer
Capital budgeting is concerned with what long−term investments a firm should undertake.
Determining the best way to raise money to fund a​ firm’s long−term investments is called The capital structure decision
Its ability to raise capital by selling stock makes the corporation the best form of organization in terms of raising capital. True
The procedure by which significant changes may be made to a​ partnership, such as admission of a new partner or termination of the​ partnership, are governed by each state so no partnership agreement is needed. False
A limited partnership provides limited liability to only to limited partners who do not participate in the management of the business.
Limited partnerships are not as prevalent as corporations because it is easier to transfer ownership by selling common stock than it is to sell partnership.
The true owners of the corporation are the Common stockholders
Advantages of the corporate form of business organization include Easier transfer of ownership
Due to unstable world​ markets, most large U.S. corporations do almost all of their business in the United States. False
Even though many U.S.​ companies, including General​ Electric, IBM, Walt​ Disney, and American​ Express, have successfully restructured their operations to expand​ internationally, not many foreign firms have made their mark in the United States. False
It is important to evaluate a corporate​ manager’s financial decision by measuring the effect the decision should have on the​ corporation’s stock price if everything else were held constant. True
Shareholder selection committees select potential board of director nominees ensuring that board members will monitor management sufficiently to protect shareholder interests. False
Each financial decision made by a corporate manager can be evaluated by its direct impact on the​ corporation’s stock price. False
In a sole​ proprietorship, the owner is personally responsible without limitation for the liabilities incurred. True
A corporate treasurer is typically responsible for cash​ management, credit​ management, and raising capital. True
Corporate managers should accept investment projects that maximize profits in the short run because of the time value of money. False
Determining how a firm should raise money to fund its long−term investments is referred to as capital structure decisions True
The chief financial officer​ (CFO) is responsible for overseeing financial​ planning, corporate strategic​ planning, and controlling the​ firm’s cash flow. True
One problem with maximization of shareholder wealth as a goal is that it ignores risk taken by the​ firm’s financial decisions. False
If the stock market is​ efficient, then investors do not need to read the Wall Street Journal or research companies before they select which stocks to buy because market prices already reflect all publicly available information. False
Profits represent money that can be​ spent, and as​ such, form the basis for determining the value of financial decisions. False
The corporation is a legal entity separate from its​ owners; thus it is possible for the corporation to continue even upon the death of one or more shareholders. True
Shareholder wealth maximization means maximizing the price of the existing common stock. True
There is no legal distinction made between the assets of the business and the personal assets of any of the owners in the limited partnership. False
Shareholders react to poor investment or dividend decisions by causing the total value of the​ firm’s stock to​ fall, and they react to good decisions by bidding the price of the stock up. True
The root cause of agency problems is conflicts of interest. True
The owners of a corporation enjoy limited liability. True
A limited liability company​ (LLC) is taxed like a partnership but provides limited liability for its​ owners, similar to a corporation. True
An income statement reports a​ firm’s cumulative revenues and expenses from the inception of the firm through the income statement date. False
Owners equity increases each period by the amount of the​ corporation’s positive net cash flow. False
If two companies have the same revenues and operating​ expenses, their net incomes will still be different if one company finances its assets with more debt and the other company with more equity. True
Common−sized income statements restate the numbers in the income statement as a percentage of sales to assist in the comparison of a​ firm’s financial performance across time and with competitors. True
Net profit margin is equal to the gross profit margin times the operating profit margin. False
Earnings before​ taxes, or taxable​ income, is equal to operating income minus financing costs. True
Earnings available to common shareholders represents income that may be reinvested in the firm or distributed to its owners. True
The basic format of an income statement is Sales − Expenses​ = Profits.
Gross profit is equal to Sales – COGS
The accounting book value of an asset represents the historical cost of the asset rather than its current market value or replacement cost. True
A​ firm’s income statement reports the results from operating the business for a period of​ time, while the​ firm’s balance sheet provides a snapshot of the​ firm’s financial position at a specific point in time. True
If a​ company’s cash balance increases during the​ year, and the company also reports positive net​ income, then the​ company’s retained earnings balance must increase. False
Fixed assets are assets whose balances will remain the same throughout the year. False
Accounting rules specify that assets on the balance sheet must be reported at current market​ value, because this is the valuation most useful to potential investors. False
Liquidity refers to the ability to quickly convert an asset into cash without lowering the selling price. True
The two principal sources of financing for corporations are Debt and equity
Net working capital is equal to current assets – current liabilites
The statement of cash flow explains the changes that took place in the​ firm’s cash balance over the period of interest. True
A company with negative net income will also have negative operating cash flow. False
When a company sells a piece of equipment or​ land, any gain​ (sales price less the book value of the asset or residual​ value) is thought to be a capital gain. False
It is possible for two companies to have the same financial​ performance, but their financial statements can be​ different, depending on how and when the managers choose to report certain transactions. True
Common – sized income statements are used to compare companies that have the same amount of revenues. False
A balance sheet is a statement of the financial position of the firm on a given​ date, including its asset​ holdings, liabilities, and equity. True
The balance sheet equation is Total Assets​ = Total Revenues − Total Liabilities. False
Changes in depreciation expense do not affect operating income because depreciation is a non−cash expense. False
In the United​ States, financial statements are prepared following the Financial Accounting Standards​ Board’s generally accepted accounting principles​ (GAAP). True
Profits−to−Sales relationships are defined as profit margins. True
The increase in​ owners’ equity for a given period is equal to Net income – dividends
International Financial Reporting Standards​ (IFRS) is a set of principle−based accounting standards that were established by the International Accounting Standards Board​ (IASB). True
Earnings available to common shareholders is equal to a​ corporation’s positive net cash flow over a given​ period, typically one year. False
The balance sheet reflects the accounting​ equation: Assets​ = Liabilities​ + Owners’ Equity. True
Common−sized balance sheets show each account as a percentage of total sales to help analysts in comparing companies of difference sizes. False
Generally Accepted Accounting Principles​ (GAAP) is a set of principle−based accounting standards established by the Financial Accounting Standards Board​ (FASB). False
The more debt a company uses to finance its​ assets, the lower will be its operating income due to higher interest expense. False
When the present financial ratios of a firm are compared with similar ratios for another firm in the same industry it is called trend analysis. False
​Theoretically, market values of assets are better for evaluating the creation of shareholder wealth than accounting​ numbers, but accounting numbers are used because they are more readily available. True
Financial ratios are often reported by industry or line of business because differences in the type of business can make ratio comparisons uninformative or even misleading. True
Common stockholders may use financial ratios to monitor manager actions to help lessen agency problems. True
Accounting information is used in financial ratio analysis because it is theoretically the best data to guide financial decision False
Common−size balance sheets are balance sheets of companies with almost identical total assets​ (within 2% of each​ other). False
Ratios are used to standardize financial​ information, thereby making it easier to interpret. True
How managers choose to finance the business affects the​ company’s risk, and as a​ result, the rate of return stockholders receive on their investments. True
Return on equity is driven by​ (1) the spread between the operating return on assets and the interest​ rate, and​ (2) changes in the debt ratio. True
Borrowing money causes a​ corporation’s return on operating assets to decrease because of the interest that must be paid. False
Financial ratios are useful for measuring performance because maximizing the return on equity for common shareholders is the primary goal of financial managers. False
If company A has a lower average collection period than company​ B, then company A will have a higher accounts receivable turnover. True
Operating return on assets​ (OROA) is equal to operating profit margin times fixed assets turnover. False
Lower asset turnover ratios are generally indicative of more efficient asset management. False
A high debt ratio can be favorable because higher leverage may result in a higher return on equity. True
A common method of evaluating a​ firm’s financial ratios is to compare the current values of the​ firm’s ratios to its own ratios from prior periods. This is referred to as trend analysis. True
The astute financial manager will seek to attain the highest current ratio possible. False
DuPont analysis indicates that the return on equity may be boosted above the return on assets by using leverage​ (debt). True
The computation of return on​ equity, or​ ROE, does not include retained earnings as part of common equity because retained earnings includes all net income for the company since its inception and analysts are trying to calculate the return for just the current year. False
The current ratio of a firm would equal its quick ratio whenever The firm has no inventory
Financial ratios are used by personnel in​ marketing, human​ resources, and other groups within a​ firm, not just by the finance and accounting personnel. True
Seasonality causes comparability problems in ratio analysis. A common solution is to use an average account balance as opposed to an ending account balance. True
Financial ratios cannot be used to evaluate the creation of shareholder wealth because they are based on accounting numbers that reflect historical cost and not current market values. False
Borrowing more money will always increase a​ company’s return on equity because the company is using financial​ leverage, but it also adds to the riskiness of the company. False
When comparing inventory turnover​ ratios, other things being​ equal, A higher inventory turnover is preferred to improve liquidity
How managers choose to finance the business does not affect the rate of return to shareholders because the rate of return is based on how the company uses the assets it​ has, not whether or not they paid for the assets with debt or equity. False
Ratios that examine profit relative to investment are useful in evaluating the overall effectiveness of the​ firm’s management. True
Operating return on assets is equal to the operating profit margin times total asset turnover. True
Ratios of almost all companies are easily comparable because all public companies prepare their financial reports based upon generally accepted accounting principles. False
Financial ratios are used by managers inside the company and by​ lenders, credit−rating ​agencies, and investors outside of the company. True
Financial ratios that are higher than industry averages may indicate problems that are as detrimental to the firm as ratios that are too low. True
Trend analysis is the forecasting of the​ firm’s financial ratios for a future time period by using its own ratios from previous periods. False
Seasonality is introduced into financial ratios by averaging monthly account​ balances, and thus it is recommended that ending account balances be used. False
Financial ratios are useful for evaluating performance but should not be used for making financial projections. False
Operating profits or EBIT is used to measure a​ firm’s profits on assets because it does not include the​ firm’s cost of debt financing. True
The current ratio and the acid test ratio both measure financial leverage. False
The goal of most financial managers is to reduce the amount of long−term debt to​ zero, thus maximizing shareholder wealth. False
It is commonly accepted that the industry average for a ratio is the ideal goal for a financial manager to achieve. False
Ratio analysis enhances our understanding of three basic attributes of​ performance: liquidity,​ profitability, and the ability to create shareholder value. True
Net income is the best measure to use for evaluating a​ firm’s profits on assets because it includes the effect of financing as well as the effect of operations. False
One weakness of the times interest earned ratio is that it includes only the annual interest expense as a finance expense and ignores other financing items such as lease payments that must be paid. True
Total asset turnover is equal to accounts receivable turnover plus inventory turnover plus fixed asset turnover. False
The expected rate of return from an investment is equal to the expected cash flows divided by the initial investment. True
The realized rate of​ return, or holding period​ return, is equal to the holding period dollar gain divided by the price at the beginning of the period. True
The risk−return trade−off that investors face on a day−to−day basis is based on realized rates of return because expected returns involve too much uncertainty. False
For a well−diversified ​investor, an investment with an expected return of​ 10% with a standard deviation of​ 3% dominates an investment with an expected return of​ 10% with a standard deviation of​ 5%. False
​Historically, investments with the highest returns have the lowest standard deviations because investors do not like risk. False
How many different securities must be owned to essentially diversify away unsystematic​ risk? ​ 20
The benefits of diversification occur as long as the investments in a portfolio are not perfectly positively correlated. True
A stock with a beta of 1.4 has​ 40% more variability in returns than the average stock. True
Adding stocks to a bond portfolio will increase the riskiness of the portfolio because stocks have higher standard deviations of returns than bonds. False
Company unique risk can be virtually eliminated with a portfolio consisting of approximately 20 securities. True
Total risk equals systematic risk plus unsystematic risk. True
The beta of a T−bill is zero. True
The slope of the characteristic line of a security is that​ security’s beta. True
Most stocks have betas between 0.60 and 1.60
Beta is a statistical measure of the relationship between an​ investment’s returns and the market return.
In an efficient​ market, a stock with a standard deviation of returns of​ 12% could have a higher expected return than a stock with a standard deviation of​ 10% because the beta for the higher standard deviation stock could be lower than the beta for the lower standard deviation stock. True
The capital asset pricing model provides a risk−return trade−off in which risk is measured in terms of beta.
The minimum rate of return necessary to attract an investor to purchase or hold a security is referred to as the Investor’s required rate of return
The T−bill return is used in the CAPM model as the risk−free rate. True
Stocks that plot above the security market line are underpriced because their expected returns exceed their risk-adjusted required returns. True
The portfolio beta is simply the sum of the betas of the individual stocks in the portfolio. False
In​ general, the required rate of return is a function of​ (1) the time value of​ money, (2) the risk of an​ asset, and​ (3) the​ investor’s attitude toward risk. True
The beta of a T−bill is one. False
Portfolio risk is typically measured by​ ________ while the risk of a single investment is measured by​ ________. Beta; Standard deviation
Portfolio performance is determined mainly by stock selection and market​ timing, with less emphasis on asset allocation. False
Another name for an​ asset’s expected rate of return is holding−period return. False
As the required rate of return of an investment​ decreases, the market price of the investment decreases. False
Negative historical returns are not possible during periods of high volatility​ (high standard deviations of​ returns) due to the risk−return trade−off. False
An investor with a required return of​ 8% for stock A will purchase stock A if the expected return for stock A is less than or equal to​ 8%. False
Small company stocks have historically had higher average annual returns than large company​ stocks, and also a higher risk premium. True
The appropriate measure for risk according to the capital asset pricing model is Beta
A rational investor will always prefer an investment with a lower standard deviation of​ returns, because such investments are less risky. False
Proper diversification generally results in the elimination of risk. False
A security with a beta of one has a required rate of return equal to the overall market rate of return. True
An all−stock portfolio is more risky than a portfolio consisting of all bonds. True
Unique security risk can be eliminated from an​ investor’s portfolio through diversification. True

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