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Finance Flashcards

Finance exam 1

Which one of the following questions is a working capital management decision? How much inventory should be on hand for immediate sale?
Which one of the following terms is defined as a mixture of a firm’s debt and equity financing Capital Structure
The decision to issue additional shares of stock is an example of: a capital structure decision
Sam, Alfredo, and Juan want to start a small U.S. business. Juan will fund the venture but wants to limit his liability to his initial investment and has no interest in the daily operations. Sam will contribute his full efforts on a daily basis but has limited funds to invest in the business. Alfredo will be involved as an active consultant and manager and will also contribute funds. Sam and Alfredo are willing to accept liability for the firm’s debts as they feel they have nothing to lose by doing so. All three individuals will share in the firm’s profits and wish to keep the initial organizational costs of the business to a minimum. Which form of business entity should these individuals adopt? Limited Partnership
A business partner whose potential financial loss in the partnership will not exceed his or her investment in that partnership is called a: limited partner
Corporate Dividends are: taxable income of the recipient even though that income was previously taxed.
A business created as a distinct legal entity and treated as a legal “person” is called a(n): corporation
Which one of the following is a primary market transaction? Sale of a new share of stock to an individual investor
Which one of the following actions by a financial manager is most apt to create an agency problem? Increasing current profits when doing so lowers the value of the company’s equity
Which one of the following is an agency cost? Hiring outside accountants to audit the company’s financial statements
Noncash items refer to: expenses that do not directly affect cash flows.
The _____ tax rate is equal to total taxes divided by total taxable income. average
The percentage of the next dollar you earn that must be paid in taxes is referred to as the _____ tax rate. marginal
Which one of the following accounts is the most liquid? Accounts Receivable
A positive cash flow to stockholders indicates which one of the following with certainty? The dividends paid exceeded the net new equity raised.
The cash flow related to interest payments less any net new borrowing is called the: cash flow to creditors.
Cash flow to stockholders is defined as: dividend payments less net new equity raised.
Which one of the following is an expense for accounting purposes but is not an operating cash flow for financial purposes? Interest Expense
RJ’s has a fixed asset turnover rate of 1.26 and a total asset turnover rate of .97. Sam’s has a fixed asset turnover rate of 1.31 and a total asset turnover rate of .94. Both companies have similar operations. Based on this information, RJ’s must be doing which one of the following? Utilizing its total assets more efficiently than Sam’s
Ratios that measure a firm’s liquidity are known as _____ ratios. short-term solvency
Ratios that measure how efficiently a firm manages its assets and operations to generate net income are referred to as _____ ratios. profitability
If a company produces a return on assets of 14 percent and also a return on equity of 14 percent, then the firm: has an equity multiplier of 1.0.
Nan and Neal are twins. Nan invests $5,000 at 7 percent at age 25. Neal invests $5,000 at 7 percent at age 30. Both investments compound interest annually. Both twins retire at age 60 and neither adds nor withdraws funds prior to retirement. Which statement is correct? Nan will have more money than Neal at any age.
Your grandmother has promised to give you $10,000 when you graduate from college. If you speed up your graduation by one year and graduate two years from now rather than the expected three years, the present value of this gift will: increase.
Renee invested $2,000 six years ago at 4.5 percent interest. She spends all of her interest earnings immediately so she only receives interest on her initial $2,000 investment. Which type of interest is she earning? Simple interest
You are comparing two investment options that each pay 6 percent interest, compounded annually. Both options will provide you with $12,000 of income. Option A pays $2,000 the first year followed by two annual payments of $5,000 each. Option B pays three annual payments of $4,000 each. Which one of the following statements is correct given these two investment options? Assume a positive discount rate. (No calculations needed.) Option B has a higher present value at Time 0.
Which one of the following statements related to annuities and perpetuities is correct? A perpetuity comprised of $100 monthly payments is worth more than an annuity of $100 monthly payments provided the discount rates are equal.
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Finance Flashcards

Personal Finance Midterm 2

It is not a good idea to use credit to live beyond one’s means.
All of the following are useful ways to build a strong credit rating except Apply for a long-term loan and occasionally be late with a payment.
If your monthly before-tax income is $2,000 and your monthly take-home pay is $1,500, your maximum monthly consumer credit payments should not exceed $300.
With open account credit, one can often avoid interest charges if the account balance is paid in full every month.
Ann Marie accumulated a large balance on her credit card while in college. She is trying to get it paidoff as quickly as possible and wants to roll the balance onto a new credit card. She now uses a credit cardonly for emergencies. What should Ann Marie look for in a credit card given the large balance and the way she plans to use the card? low APR.
Interest rates on ____ are typically lower than on any other form of consumer credit. home equity lines of credit
Persons with very poor credit ratings can still get ____ credit cards secured
Theresa is a bit of a spendthrift. She has trouble saying no when it comes to buying things. Which of the following cards would keep her out of debt? debitrebate
The ____ is really a second mortgage on your home. home equity line of credit
The quality of your credit rating is maintained by meeting credit obligations as contracts require.
All of the following are key items lenders look at in granting credit except religious affiliations
A credit card can provide an interest-free loan if you pay the entire balance on or before the due date.
Anna uses her credit card regularly, but she pays the total balance monthly. Anna should look for acredit account with no annual feelong grace period
A consumer loan probably would not be used to buy back-to-school clothes.
Regarding student loans, which of the following is not true? There is no limit on how much can be borrowed with each loan.
If your installment loan has a variable interest rate, you cannot accurately predict the total interest you will pay on the loan.
Credit unions lend money to qualified people who are members.
Besides the finance charge, you should also consider ____ when you shop for a consumer loan. loan maturitytotal cost of the loancollateral requirementsprepayment penalties
A single-payment loan usually matures in one year or less
The annual percentage rate (APR) on a single-payment loan for $1,000 at a simple interest rate of12% is 12%.
Sometimes it may be better to use savings rather than credit to make a purchase. This would be recommended when the cost of borrowing is greater than the interest earned on the savings.
The outstanding balance on a $10,000 loan to be repaid in 24 monthly installments at an annualinterest rate of 12% after Month One is (monthly payment is $470.73): $9,629.27
Jackie pays $20 every time she visits her doctor. She is covered by a(n) HMO.IPA.PPO.
Medicare provides health care coverage to persons age ____ or those who are ____. 65 and over; collecting disability under Social Security
Gabe is 58 years old and has been dependent on a cane for a couple of years. Gabe fears that he mayneed long-term care services some day in the future. His net worth is $400,000 and he receives $50,000per year in a pension. He considers himself to be in excellent health and has never had a serious healthscare like a heart attack, stroke, or cancer. He eats lots of bran and exercises regularly. Which of thefollowing policies would you recommend to Gabe? Gabe should buy a long-term care policy with a long elimination period, lifetime benefits, anda COLA.
Ben’s health coverage charges a low ($15) deductible each time he visits the doctor or hospital. Otherthan the low per-service deductible, there is very little cost sharing. However, Ben must go to the healthcare providers listed by the provider of the health coverage. If he goes to a provider that is not on the list,there is very little coverage. Which of the following types of entity most likely provides Ben’s healthcoverage? HMO
Suppose a person has a health insurance policy with a $500 calendar-year deductible, a $2,000 out-of-pocketcap, and an 80% coinsurance provision. If this person suffers a $600 covered loss, how much willthe insurance company pay? (Assume no previous losses have occurred.) $80
Nick has a comprehensive health care policy with a $250 per-calendar-year deductible, an 80% coinsurance provision, and a $1,000 copayment cap per calendar year. In January, Nick had a $600 claim for which the insurance company paid $280. Nick experiences another unrelated claim in October resulting in total bills of $5,000. How much will Nick have to pay for the second claim? $930
Which of the following best describes a “pre-existing condition”? A physical or mental problem you had at the time you bought the policy
The insurance designed to help with nursing home or in-home care due to chronic illness is called long-term care insurance.
Disability income insurance provides benefits that are designed to substitute for lost income.
Bob and Barbara Castle are each 39 years old and have sought your advice with regard to theirfinancial affairs. Bob is a school administrator making $75,000 per year and Barbara is not employedoutside of the home. The Castles’ net worth is approximately $190,000. They have three kids, ages 6, 10, and 14. You have determined that the Castles currently have adequate life, health, auto, andhomeowner’s insurance. Which of the following forms of insurance is likely to fulfill their highest priorityremaining risk-management need? disability income insurance
The Affordable Care Act requires insurance companies to set premiums based on all of the following except gender.
A good rule to remember when considering the use of credit is that the product purchased on credit should outlive the amount of time it takes to pay it off. True
Always paying cash is helpful in establishing a high level of creditworthiness. False
The key to creditworthiness is to keep your debt safety ratio as high as possible. False
Secured credit cards require that the cardholder put up collateral in order to get the card. True
The more credit cards one has, the better one’s credit score. False
Families who have a source of income and who want to retain their assets above the protected amount would select Chapter 13 rather than Chapter 7 bankruptcy. True
The student loans with the lowest rates of interest and the best loan terms are the PLUS loans False
Variable-rate loans are desirable if interest rates are expected to fall in the future. True
When comparing two installment loans with the same principal and APR, the loan with the longer maturity will have the lower monthly payment and the higher total costs. True
Simple interest on an installment loan is calculated as Amount of Loan × Interest Rate × Term of Loan. True
You have a better chance of choosing your own doctor with a PPO than with an HMO. True
Health insurance policies automatically cover all family members. False
Long-term care insurance provides protection against the cost of extended hospital stays. False
Under the Affordable Care Act (ACA), family health care insurers must allow parents to retain their children on their health plans up to age 28. False
Medicare and Medicaid are hospital and physicians coverage, respectively. False
As an Health Maintenance Organization (HMO) member, you may have co-payments but no deductibles. True
Under the Affordable Care Act (ACA), all Americans are required to have or buy health insurance or pay a penalty True
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Finance Flashcards

chapter 5 finance

Travis is buying a car and will finance it with a loan which requires monthly payments of $265 for the next 4 years. His car payments can be described by which one of the following terms?a. perpetuity b. annuity c. consold. lump sume. factor b
Janis just won a scholarship that will pay her $500 a month, starting today, and continuing for the next 48 months. Which one of the following terms best describes these scholarship payments?a. ordinary annuity b. annuity due c. consol d. ordinary perpetuity e. perpetuity due b
The Jones brothers recently established a trust fund that will provide annual scholarships of $12,000 indefinitely. These annual scholarships can best be described by which one of the following terms?a. ordinary annuity b. annuity due c. amortized payment d. perpetuity e. continuation d
A perpetuity in Canada is frequently referred to as which one of the following? a. consul b. infinity c. forever cash d. Dowrye. forevermore a
The stated interest rate is the interest rate expressed: a. as if it were compounded one time per yearb. as the quoted rate compounded by 12 period per year c. in terms of the rate charged per dayd. in terms of the interest payment made each period e. in terms of an effective rate d
Anna pays 1.5 percent interest monthly on her credit card account. When the interest rate on that debt is expressed as if it were compounded only annually, the rate would be referred to as the: a. annual percentage rateb. compounded ratec. quoted rated. stated ratee. effective annual rate e
Lee pays one percent per month interest on his credit card account. When his monthly rate is multiplied by 12, the resulting answer is referred to as the: a. annual percentage rateb. compounded ratec. effective annual rated. perpetual ratee. simple rate a
Which one of the following will decrease the present value of an annuity?a. increase in the annuity’s future value b. increase in the payment amount c. increase in the time period d. decrease in the discount ratee. discount in the annuity payment e
Christie is buying a new car today and is paying $500 cash down payment. She will finance the balance at 7.25 percent interest. Her loan requires 36 equal monthly payments of $450 each with the first payment due 30 days from today. Which one of the following statements is correct concerning this purchase? a. the present value of the car is equal to $500 + (36x$450)b. the $500 is the present value of the purchase c. the car loan is an annuity due d. to compare the initial loan amount, you must use a monthly interest ratee. the future value of the loan is equal to 36 x $450 d
Which one of the following statements is true concerning annuities?a. All else equal, an ordinary annuity is more valuable than an annuity due b. All else equal, a decrease in the number of payments increases the future value of an annuity due c. An annuity with payment at the beginning of each period is called an ordinary annuity d. All else qual, an increase in the discount rate decreases the present value and increases the future value of an annuity e. All else equal, an increase in the number of annuity payments decreases the present value and increases the future value of an annuity d
Which one of the following is an example of perpetuity?a. trust income of $1,200 a year foreverb. retirement pay of $2,200 a month for 20 years c. lottery winnings of $1000 a month for life d. car payment of $260 a month for 60 months e. apartment rent payment of $800 a month for one year a
Which one of the following can be classified as an annuity but not as a perpetuity? a. increasing monthly payments foreverb. increasing quarterly payments for 6 yearsc. unequal payments each year for 9 years d. equal annual payments for life e. equal weekly payments forever d
Which one of the following statements concerning annuities is correct? a. the present value of an annuity is equal to the cash flow amount divided by the discount rate b. the annuity due has payments that occur at the beginning of each time period c. the future value of an annuity decreases as the interest rate increasesd. if unspecified, you should assume an annuity is an annuity due e. an annuity is an unending stream of equal payments occurring at equal intervals of time b
Which one of the following qualifies as an annuity?a. weekly grocery billb. clothing purchasesc. car repairs d. auto loan payments e. medical bills d
Which one of the following characteristics apply to a perpetuity? I. constant cash flow dollar amountII. Unequal cash flow dollar amount III. Limited time period IV. Infinite time period a. I and III only b. I and IV only c. II and III only d. II and IV only e. I plus either III or IV b
Which one of the following will increase the present value of an annuity, all else held constant? I. Increase in the number of payments II. Increase in the interest rateIII. Decrease in the interest rateIV. Decrease in the payment amount a. I and II only b. I and III only c. II and IV only d. I, II, and IV only e. I, III, and IV only b
You are comparing 2 annuities. Annuity A pays $100 at the end of each month for 10 years. Annuity B pays $100 at the beginning of each month for 10 years. The rate of return on both annuities is 8 percent. Which one of the following statements is correct given this information? a. The present value of A is equal to present value of B b. B will pay one more payment than A will c. The future value of A is greater than the future value of Bd. B has not a higher present value and a higher future value than A e. A has a higher future value but a lower present value than B d
Which one the following features distinguishes an ordinary annuity from an annuity due?a. number of equal paymentsb. amount of each paymentc. frequency of the payments d. annuity interest ratee. timing of the annuity payments e
Which one of the following is an ordinary annuity, but not a perpetuity? a. $75 paid at the beginning of each month period for 50 yearsb. $15 paid at the end of each monthly period for infinite period of time c. $40 paid quarterly for five years, starting todayd. $50 paid every year for ten years, starting today e. $25 paid weekly for one year, starting one week from today e
Which one of the following can not be computed?a. FV of an ordinary annuity b. FV of a perpetuity c. PV of a perpetuity d. PV of an annuity due e. PV of an ordinary annuity b
You are comparing three investments, all of which pay $100 a month and have an 8 percent interest rate. One is ordinary annuity, one is an annuity due, and the third investment is a perpetuity. Which one of the following statements is correct given these three investment options? a. To be the perpetuity, the payments must occur on the first day of each monthly period b. the ordinary annuity would be more valuable than the annuity due if both had a life of 10 yearsc. the PV of the perpetuity has to be higher than the present value of either the ordinary annuity or the annuity due d. the FV of all three investments must be equal e. the PV of all three investments must be equal c
Which one the following has the highest effective annual rate?a. 6 percent compounded annually b. 6 percent compounded semi annually c. 6 percent compounded quarterly d. 6 percent compounded monthly e. all the other answers have the same effective annual rate d
When comparing savings accounts, you should select the account that has the: a. lowest annual percentage rateb. highest annual percent ratec. highest stated rated. lowest effective annual ratee. highest effective annual rate e
A credit card has an annual percentage rate of 12.9 percent and charges interest monthly. The effective annual rate on this account: a. will be less than 12.9 percentb. can either be less than or equal to 12.9 percent c. is 12.9 percent d. can either be greater than or equal to 12.9 percent e. will be greater than 12.9 percent e
Which one of the following statements is correct? a. The APR is equal to the EAR for a loan that charges interest monthly b. the EAR is always greater than the APR c. the APR on a monthly loan is equal to (1 + monthly interest rate)^12 -1 d. the APR is the best measure of the actual rate you are paying on a loan e. The EAR, rather than the APR, should be used to compare both investment and loan options e
A loan has an APR of 8.5 percent. Given this, the loan must:a. have a one year termb. have a 0 percent interest ratec. charge interest annually d. must be an interest only loan e. require the accrued interest be paid in full with each monthly payment c
Scott borrowed $2,500 today. The loan agreement requires him to repay $2,685 in one lump sum payment one year from now. This type is referred to as a(n):a. interest only loanb. pure discount loanc. quoted rate loand. compound interest loane. amortized loan b
Cindy is taking out a loan today. The cash amount that she will receive today is equal to the PV of the lump sum payment which she will be required to pay 2 years from today. Which type of loan is this?a. principal only b. amortizedc. interest onlyd. compounde. pure discount e
Travis borrowed $10,000 four years ago at an annual interest rate of 7 percent. The loan term is 6 years. Since he borrowed the money, Travis has been making annual payments of $700 to the bank. Which type of loan does he have?a. interest only b. pure discount c. compound d. amortized e. complex a
Letitia borrowed $6,000 from her bank 2 years ago. The loan term is 4 years. Each year, she must repay the bank $1,500 plus the annual interest. Which type of loan does she have? a. amortized b. blended discountc. interest only d. pure discounte. complex a
Bill just financed a used car through his credit union. His loan requires payment of $275 a month for 5 years. Assuming that all payment are paid timely, his last payment will pay off the loan in full. What type of loan does Bill have?a. amortized b. complexc. pure discount d. lump sume. interest only a
You just borrowed $3,000 from your bank and agreed to repay the interest on an annual basis and the principal at the end of 3 years. What type of loan did you obtain?a. interest only b. amortizedc. perpetuald. pure discounte. lump sum a
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Finance 318 Chapter 8

The net present value of an investment represents the difference between the incestment’s cost and its market value
discounted cash flow valuation is the process of discounting an investments future cash flow
the payback period is the length of time it takes an investment to generate sufficient cash flow to enable the project to recoup its initial cost
the average net income of a project divided by the projects average book value is referred to as the projects average accounting return
which one of the following defines the internal rate of return for a project discount rate which results in a zero net present value for the project
the net present value profile illustrates how the net present value of an investment is affected by which one of the following discount rate
the possibility that more than one discount rate can cause the net present value of an investment to equal zero is referred to as multiple rates of return
both project A and B are acceptable as independent projects…. mutually exclusive
which one of the following can be defined as a benefit-cost ratio profitability index
which one of the following indicates that a project is expected to create value for its owners positive net present value
the net present value decreases as the required rate of return increases
which one of the following is generally considered to be the best form of analysis if you have to select a single method to analyze a variety of investment opportunities net present value
which one of the following statements is correct if the internal rate of return equals the required return, the net present value will equal zero
if an investment is producing a return that is equal to the required return the investments net present value will be zero
which one of the following indicates that a project should be rejected profitability index less than 1.0
which one of the following inidators offers the best assurance that a project will produce value for its owners positive npv
which one of the following statements is correct? the payback period ignores the time value of money
payback is best used to evaluate which type of projects low-cost, short-term
which one of the following is the primary advantage of payback analysis ease of use
the payback method of analysis ignores which one of the following time value of money
which one of the following methods of analysis ignore the time value of money payback
which one of the following methods of analysis has the greatest bias towards short term projects payback
which one of the following methods of analysis ignores cash flows average accounting return
which one of the following methods of anaylsis is most similar to computing the return on assets average accounting return
the average accounting return measures profitability rather than cash flow
which one of the analytical methods is based on net income average accounting return
which one of the following is most closely related to the net present value profile internal rate of return
the modified internal rate of return is specifically designed to address the problems associated with which one of the following unconventional cash flows
the reinvestment approach to the modified internal rate of return compounds all the cash flows except for the initial cash flow to the end of the project
which one of the following is specifically designed to compute the rate of return on a project that has unconventional cash flows modified internal rate of return
which one of the following methods of analysis is most appropriate to use when two investments are mutually exculsive net present value
the profitability index reflects the value created per dollar invested
based on the most recent survey information presented in your textbook CFO’s tend to use which 2 methods of investment analysis the most frequently internal rate of return and net present value
Mary has just been asked to analyze an investment to determine if it is acceptable…. net present value
you were recently hired by a firm as a project analyst, the owner of the firm is unfamiliar with financial analysis profitability index
in which one of the following situations would the payback method be the preferred method of analysis investment funds available only for a limited period of time
which one of the following statements is correct the payback method is biased towards short term projects
which one of the following indicated that a project is definitely acceptable profitability index greater than 1.0
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Finance Flashcards

CH1 finance

The corporate officer generally responsible for tasks related to tax management, cost accounting,financial accounting, and data processing is the: Corporate Controller.
The corporate officer generally responsible for tasks related to cash and credit management, financialplanning, and capital expenditures is the: Corporate Treasurer.
The process of planning and managing a firm’s Long-term investments is called: Capital budgeting.
The mixture of debt and equity used by the firm to finance its operations is called: Capital structure.
The management of the firm’s short-term assets and liabilities is called: Working capital management
A business owned by a single individual is called a(n): Sole proprietorship.
A business formed by two or more individuals or entities is called a(n): Partnership.
The division of profits and losses between the members of a partnership is formalized in the: Partnership agreement.
A business created as a distinct legal entity composed of one or more individuals or entities is calleda(n): Corporation.
The document that legally establishes domicile for a corporation is called the: Articles of incorporation.
The rules by which corporations govern themselves are called: Bylaws.
The primary goal of financial management is to: Maximize the current value per share of the existing stock.
The possibility of conflict of interest between the stockholders and management of the firm iscalled: The agency problem.
Agency costs are: The costs of the conflict of interest between stockholders and management.
A stakeholder is: A person or entity including a stockholder or creditor, who potentially has a claim on the cashflows of the firm.
The original sale of securities by governments and corporations occurs in the: Primary market.
The purchase and sale of securities after the original issuance occurs in the: Secondary market.
A market where dealers buy and sell securities for themselves, at their own risk, is called a(n): Dealer market.
A market where trading takes place between buyers and sellers directly is called a(n): Auction market.
The secondary market is: The market in which securities are bought and sold after original sale.
The Chief Financial Officer of a corporation is the: Vice President of Finance.
Deciding whether or not to open a new store is part of the process known as: Capital budgeting.
Capital structure refers to: The mixture of debt and equity
Working capital management refers to: The levels of cash and inventory held.
A business that is a distinct legal entity is a: Corporation.
The primary goal of financial management is to maximize the: Current value of each share of outstanding stock.
A proxy fight is: A method used by stockholders to replace corporate management.
Suppliers, customers, and employees of a corporation are called: Stakeholders.
A proprietorship is: A business owned by an individual who has unlimited personal liability.
Conflicts that arise between the interests of managers and stockholders are referred to as: Agency problems.
The primary market includes: The sale of new securities by a corporation on an exchange.
Stocks that trade on an exchange are referred to as: Listed stocks.
An individual who buys and sells stocks for his/her own account is a: Dealer.
Tasks related to tax management, cost accounting, financial accounting, and data processing are theresponsibility of which corporate officer? The Corporate Controller.
The controller can be defined as the person who is generally responsible for overseeing the _____ of afirm. Accounting functions
The treasurer can be defined as the person who is generally responsible for overseeing the _____ of afirm. Financial planning
Capital budgeting is defined as the: Management of a firm’s long-term investments.
A firm’s capital structure is defined: As the combination of debt and equity used to finance the firm’s operations
Working capital management refers specifically to: The oversight of a firm’s current accounts
A sole proprietorship is best defined as a business owned by: A single individual who has unlimited liability for the firm’s debts.
A general partnership is best defined as a business owned by: One or more individuals who are each totally responsible for the debts of the entity
An entity wherein one or more owners may elect to actively manage the firm while other ownerschoose limited liability instead of management responsibility is called a: Limited partnership.
Bylaws are: The rules by which corporations govern themselves.
The agency problem is best defined as a conflict of interest between a firm’s: Stockholders and the firm’s managers.
The primary goal of financial management is defined as the: Maximization of the current value per share of the outstanding stock.
An agency problem is said to exist when there is a conflict of interest between _____ and _____. A principal; his or her agent
The primary market is defined as the market Wherein the original sale of securities by the issuer to the general public occurs.
The secondary market is the market wherein: Shareholders buy from and sell to other shareholders.
A dealer is a person who: Buys and sells for themselves, at their own risk.
The person generally directly responsible for overseeing the tax management, cost accounting,financial accounting, and data processing functions is the: Controller.
The person generally directly responsible for overseeing the cash and credit functions, financialplanning, and capital expenditures is the: Treasurer.
The process of planning and managing a firm’s long-term investments is called: Capital budgeting
The mixture of debt and equity used by a firm to finance its operations is called: Capital structure
The management of a firm’s short-term assets and liabilities is called: Working capital management.
Which one of the following correctly defines the chain of command in a typical corporateorganizational structure? The chief executive officer reports to the board of directors.
A business formed by two or more individuals who each have unlimited liability for business debts iscalled a General partnership
The division of profits and losses among the members of a partnership is formalized in the: Partnership agreement.
A business created as a distinct legal entity composed of one or more individuals or entities is calleda: Corporation.
The corporate document that sets forth the business purpose of a firm is the: Articles of incorporation
Capital structure decisions include which of the following? Determining the number of shares of stock to issue
The decision to issue debt rather than additional shares of stock is an example of: The capital structure decision
A conflict of interest between the stockholders and management of a firm is called: The agency problem
A stakeholder is: Any person or entity who potentially has a claim on the cash flows of the firm.
The original sale of securities by governments and corporations to the general public occurs inthe: Primary market.
When one shareholder sells stock directly to another the transaction is said to occur in the: Secondary market.
A market where dealers buy and sell securities for themselves, at their own risk, is called a(n): Dealer market.
A market where trading takes place directly between buyers and sellers is called a(n): Auction market
This of the following is an answer to “What are the duties of a financial manager?”I. Deciding how much interest to pay the holders of the corporation’s bonds.II. Deciding the mix of long-term debt and equity.III. Deciding which projects a firm should undertake.IV. Deciding how much short-term debt to use. II, III, and IV only
A financial manager is responsible for deciding whether or not new manufacturing equipment shouldbe purchased to replace existing equipment. The new equipment would reduce labour expenses andwould allow the firm to reduce its investment in inventory. Which of the financial management areaswould be involved in the decision process?I. Capital budgeting.II. Capital structure management.III. Working capital management. I and III only
According to the statement of financial position model of the firm, corporate finance may be thoughtof as the analysis of three primary subject areas. Which of the following correctly lists these areas? Capital budgeting, capital structure, net working capital.
Which of the following is NOT considered one of the basic questions of corporate finance? At what rate of interest should a firm borrow?
In the evaluation of cash flow in a capital budgeting decision, which of the following must beconsidered?I. The size of the cash flow.II. The timing of the cash flow.III. The risk of the cash flow. I, II, III
Which of the following combinations of attributes would make a capital expenditure project desirableto a financial manager?I. The project is worth more to the firm than the cost to acquire it.II. The value of the cash flow generated by the project exceeds the project’s cost.III. The project’s cash flows have acceptable levels of risk and size, but not timing. I and II only
The term capital structure describes: The mixture of debt and equity a firm uses to finance its operations.
A financial manager is responsible for determining the firm’s appropriate level of inventory. Which ofthe financial management areas addresses this decision?I. Capital budgeting.II. Capital structure management.III. Working capital management. III only
Which of the following statements is/are false concerning partnerships?I. Limited partners are responsible for all debts of the partnership.II. Limited partners generally do not manage the partnership.III. In a limited partnership, all partners share equally in the gains or losses. I only
Which of the following is an advantage of ownership of a corporation compared to that of a soleproprietorship? The corporation has an unlimited life.
Which of the following is a true statement concerning corporations? The life of the corporation is unlimited.
Sue Folker wants to start a new business decommissioning nuclear warheads and reactors. The workwill involve significant hazards, and Sue is concerned about protecting her personal wealth from anylosses the business might incur. If she is to be the majority owner of the business how should shestructure it? As a corporation
Limited liability may be a characteristic of each of the following form(s) of organization EXCEPT a________________. Sole proprietorship
Which of the following is a true statement concerning a general partnership?I. Partners are not responsible for the debts of the partnership.II. Partners generally do not manage the partnership.III. The income of a partnership is taxed at the partners’ income tax rate. III only
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Finance Flashcards

Personal Finance Final exam

Regarding older investors, which of the following holds true for most? They choose investments with less risks
A _________ is an employer-sponsored retirement account, and participating is one of the easiest ways to begin an investment program. 401(K) account
Which of the following is not one of the four components of the risk factor to be considered when evaluating investments? Stock risk
Which of the following would be considered speculative investments? Precious metals
When choosing an investment, you should consider risk. The four primary risk components are… Inflation, Interest rate, business failure, and market
A good rule of thumb is to limit installment payments to ___________ of your net (after-tax) income. 20%
A valid short-term investment goal is: Accumulating $3,000 in a savings account over the next 12 months.
If you invest $4,000 per year over the next 40 years of retirement, which of the following is correct? A high rate of return will give you the highest total and return
Which of the following risks deals with fluctuations in the economy from a period of rapid expansion followed by a period of recession? Market risk
Speculative investments include all of the following except: Savings accounts
Which of the following steps is not a factor to be considered before making your first investment? Save at least $10,000 to invest
Which of the following risks associated with preferred stocks or government or corporate bonds is a result of changes in rates in the economy? Interest rate risk
Which of the following steps be completed before making your first investment? Work to balance your budget
Which of the following risks deals with the possibility that bad management, unsuccessful products, or other factors will cause the business to be less profitable than originally anticipated? Business failure risk
Which of the following is not a true statement? Because investment goals deal with the future, it is effective to make long term goals
Which of the following statements about stock splits is correct? If a company has a 4-for-1 split, the new number of shares will be four times as many as before the split.
Megan decided to start investing in stocks. Which of the following should she do first? Research the corporations she is interested in as well as their industries.
A stock that typically sells for less than $5 per share (or in some cases, less than $1 per share) is called a(n) _______ stock. penny
Which of the following statements is not correct regarding preferred stock? The yield on preferred stocks is often lower than the yield on corporate bonds
Why does a company split its stock? The stock is trading at a high price, the company wants to bring the price inline with a theoretical ideal range
A stock issued by a stable corporation that generally attracts conservative investors is called a(n) __________ stock. Blue chips
Alberta owns 100 shares of stock of ABC Company, and Bobby owns 200 shares of the same stock. If ABC Company pays a $5 dividend to all stockholders with a record date of Friday, June 15, then Alberta will receive half as much as Bobby if they owned the stock two business days before the record date.
A legal form that requests that stockholders transfer their voting rights to individual(s) is called a proxy
If you buy common stock, you may receive income from Possible increases in values from stock splits, dollar appreciation of stock value, and dividends
Which of the following is incorrect? A) Very little information is available about stocksB) Beginning investors sometimes worry that they won’t know what the information they find about stocks really meansC) Some investors do not know where to get the information they need to evaluate potential investmentsD) All of these statements are correct E) There is no substitute for researching a potential investment
Amanda wants to be part of the most basic form of ownership for a corporation. She should invest in common stock
All of the following statements are correct except… ***A) Dividends payments must be approved by the stockholders B) Dividends are paid out of profits C) Utility companies typically distributed a higher percentage of earnings than rapidly growing firms.D) Dividends are not mandatory E) A dividend can be a distribution of money, stock, or other property.
An investment that pays higher-than-average dividends is called a(n) _________ stock. Income
Since WWII, the average annual return for stocks has been almost… 10%
Distribution of money, stock, or other property that is paid to the stockholders of a company is called a… Dividend
How is an ETF similar to a closed-end fund? A) An investor can purchase as little as one share of a fund***B) All of these are correct C) Shares can be traded on a securities exchangeD) Shares can be traded in the over-the-counter market E) prices for shares are determined by supply and demand, the value of stocks and other investments contained in the funds’ portfolio, and by investor expectations.
Which of the following is not correct about the 12b-1 fee?
What percentage of all mutual funds are exchange traded funds? 13%
WHich of the following is a fund that invests in the stocks or securities contained in a specific stock or securities index? Exchange-traded fund
Which of the following types of stock funds invests in stock issued by companies expecting higher-than- average revenue and earning growth? Growth funds
The net asset value is calculated as… (Current market value of portfolio – Liabilities)/Number of shares outstanding.
A fee charged to defray the costs of advertising and marketing a mutual fund is called a _______ fee. 12b-1
Which of the following is correct for a closed-end fund? A)Investors are free to buy and sell shares ate the net asset valueB) It’s load cannot exceed 2%C)It is not traded on a securities exchange D)It is not actively managed by professional fund managers ***E) The price of its shares is determined by supply and demand, by the value of stocks in the portfolio ,and by investors expectations
Which type of fund has the prices determined by factors of supply and demand like the prices of a stock? Closed- end fund
The average upfront sales charge for the purchase of a no-load mutual fund is… 0%
Many exceptions exist, but the average load charge for mutual fund is… 3-5%
Many mutual funds charge a commission every time shares are purchased by investors. These are called Load funds
A load fund is allowed to collect a sales charge (commission) as high as _____ of the purchase price for investments. 8.5%
Whose shares are issued and redeemed by the investment company at the request of investors? Open-end fund
Which of the following types of stock funds invests in stock issued by companies with a big history of paying dividends? Equity income funds
When an employer promises to set aside a certain amount of money for each employee each year, it has set up a…. Money-purchase plan
When conducting a financial analysis for retirement planning, you should review… A) HousingB) other investmentsC) Assets***D) All of theseE) Life insurance
According to the text, which of the following will probably be your most valuable asset at retirement? House
All of th efollowing are examples of defined contribution plans except… A) Money-purchase planB) Stock- bonus planC) salary reduction planD) Profit-sharing plan***E) Defined-benefit plan
Which of the following is not a major source of retirement income? A) Public pension ***B) All of these are major sources of retirement C)Personal retirement plan D) Annuity E) Employer pension plan
an average older (65+) household spends most of its money on… Housing than on cash contributions, entertainment, and clothing combined
A salary-reduction plan is also known as… 401(K) plan
An employer’s contribution will vary according to the company’s profits in a… Profit- sharing plan
What steps should be taken in retirement planning? Conduct a financial analysis and estimate retirement living expenses.
When you retire, you will probably spend more money on…. Health insurance
When you retire, you will probably spend less money on… clothing
When conducting a financial analysis for retirement planning, Investments should be evaluated to determine whether their income can help cover living expenses
When thinking about retirement, which of the following is correct? The sooner you start saving, the better.
When an employer’s contribution is used to buy stock in the company for its employees, it has a Stock bonus plan
an average older (65+) household spends most of its money on Medical care
What is good advice for a potential investor in performing a financial analysis? Increase credit purchases and make installment payments in order to increase cash available for investing
What is a company that is growing rapidly in comparison to other companies in its field or the economy as a whole? Growth Company
Equity Financing money raised from within the firm, from operations or through the sale of ownership in the firm (stock or venture capital)
What are safe investments? Simple, agreement for future equity low return (small chance of losing money)
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Finance Flashcards

Personal Finance Exam 2

Closing Costs Expenses that borrowers pay when a mortgage loan is closed and they receive title to the purchased property Closing costs are like down payments: they represent money that you must come up with at the time you buy the houseClosing costs are made up of such items as loan application and loan organization fees, mortgage points, title search and insurance fees, attorneys’ fees, appraisal fees, etc.
Private Mortgage Insurance Policy that protects the mortgage lender from loss in the event the borrower defaults on the loan; typically required by lenders when the down payment is less than 20%
Fixed-Rate Mortgage Rate of interest and the monthly mortgage payment are fixedThe most common type of mortgage loan is the 30 year fixed-rate loan, although 10 and 15 year loans are becoming more popular as homeowners recognize the benefits of paying off their loan over a shorter period of time
Adjustable Rate Mortgage (ARM) Rate of interest is adjusted based on market interest rate movements; therefore the size of the monthly payment is adjusted based on market interest rate movements
Factors to consider when purchasing a vehicle that affect your finances Amount of down payment Size of the monthly loan paymentOperating costsType of vehicle Gas, diesel, or hybridNew or usedSize, body style, and featuresOther considerations:Trading in/selling, fuel economy, safety measures
Financial costs that you should consider when purchasing a home Down payment: Portion of the full purchase price provided by the purchaser when a house or other major asset is purchasedLoan to value ratio: Maximum percentage of the value of a property that the lender is willing to loanPrivate mortgage insurance (PMI): Policy that protects the mortgage lender from loss in the event the borrower defaults on the loan Closing costs: Expenses that borrowers pay when a mortgage loan is closed and they receive title to the purchased propertyProperty taxes: Levied by local governments on the assessed value of real estate for the purpose of Funding schools Law enforcement Local services Homeowner’s Insurance Required by mortgage lenders and covers the replacement value of a home and its contentMaintenance and operating expenses
Debt Safety Ratio Monthly consumer credit payments ____________________________________Monthly take-home pay
Monthly consumer credit payments should not exceed ____% of monthly net income 20%
Retail Credit Cards Issued by department stores and oil companies Preset credit limits
Bank Credit Cards A credit card issued by a bank or other financial institution that allows the holder to charge purchases at any establishment that accepts it
Revolving Line of Credit A type of open account credit offered by banks and other financial institutions that can be accessed by writing checks against demand deposit or specially designated credit line accounts
Should you use cash or borrow to make a purchase? Depends on the interest rate. Essentially, it all boils down to this: If it costs more to borrow the money than you can earn in interest, then withdraw the money from your savings to pay cash for the purchase; if not, you should probably take out a loan.
Liens Legal claim permitting the lender to liquidate the items serving as collateral to satisfy obligation
Consumer Loan Loans made for specific purposes using formally negotiated contracts that specify the borrowing terms and repayment
Installment Loan A loan that is repaid in a series of fixed, scheduled payments rather than a lump sum
Single-Payment Loans A loan made for a specified period, at the end of which payment is due in full
What are the advantages and disadvantages of leasing a car? Leasing is another way to pay for a car. You need to first look at the cost of leasing versus buying. Note the Financial Road sign in the chapter, “When Does it make Sense to Lease a Car?” The reasons are mostly not financial. If you plan to keep the car for 150,000 miles, buying will be better for you. Worksheet 5.1 gives a form for comparing the lease versus buy option.
Briefly describe the various benefits of owning a home. Which one is most important to you? Which is least important? Major benefits of owning versus renting are:Tax shelter, that is, property taxes and mortgage interest are deductible for federal and state income tax, thus, these costs of ownership will reduce or “shelter” taxes on other income such as your salary. Costs of renting do not provide tax benefits.Inflation hedge, in general value of real estate increases over time. The major cost of ownership, mortgage interest, does not increase over time. Thus, the cost of ownership as a percent of the value of the house decreases over time. Within a certain time period, say a five year period, housing value may in fact decrease, but over longer period of time, the value will increase.
What does the loan-to-value ratio on a home represent? Is the down payment on a home related to its loan-to-value ratio? Explain. The loan-to-value ratio specifies the maximum percentage of the value of a property that the lender is willing to loan. For example, if the loan-to-value ratio is 80 percent, the buyer will have to come up with a down payment equal to the remaining 20 percent.
What are closing costs, and what items do they include? Who pays these costs, and when? Closing costs are all other expenses besides the down payment that borrowers ordinarily pay at the time a mortgage loan is closed and title to the purchased property is conveyed to them. The buyer typically pays the majority of the closing costs, although the seller may, by custom or contract, pay some of the costs. Closing costs are made up of such items as: (1) loan application fees, (2) loan origination fees, (3) points (if any), (4) title search and insurance, (5) attorneys’ fees, (6) appraisal fees, and (7) other miscellaneous fees for things like mortgage taxes, filing fees, inspections, credit reports, and so on.
Why is it advisable for the prospective home buyer to investigate property taxes? Because they’re local taxes levied to fund schools, law enforcement, and other local services, the level of property taxes differs from one community to another. In addition, within a given community, individual property taxes will vary according to the assessed value of the real estate—the larger and/or more expensive the home, the higher the property taxes, and vice versa. As a rule, annual property taxes vary from less than 0.5 percent to more than 2 percent of a home’s approximate market value. Thus, the property taxes on a $100,000 home could vary from about $500 to more than $2,000 a year, depending on location and geographic area.
What role does a real estate agent play in the purchase of a house? What is the benefit of the MLS? How is the real estate agent compensated, and by whom? Most home buyers rely on real estate agents because they’re professionals who are in daily contact with the housing market. Once you describe your needs to an agent, he or she can begin to search for appropriate properties. Your agent will also help you negotiate with the seller, obtain satisfactory financing, and, although not empowered to give explicit legal advice, prepare the real estate sales contract.Most real estate firms belong to a local Multiple Listing Service (MLS), a comprehensive listing, updated daily, of properties for sale in a given community or metropolitan area.Buyers should remember that agents typically are employed by sellers. Unless you’ve agreed to pay a fee to a sales agent to act as a buyer’s agent, a realtor’s primary responsibility, by law, is to sell listed properties at the highest possible prices. Agents are paid only if they make a sale, so some might pressure you to “sign now or miss the chance of a lifetime.”
Why should you investigate mortgage loans and prequalify for a mortgage early in the home-buying process? Prequalification can work to your advantage in several ways. You’ll know ahead of time the specific mortgage amount that you qualify for—subject, of course, to changes in rates and terms—and can focus your search on homes within an affordable price range. Prequalification also provides estimates of the required down payment and closing costs for different types of mortgages. It identifies in advance any problems, such as credit report errors, that might arise from your application and allows you time to correct them. Finally, prequalification enhances your bargaining power with the seller of a house you want by letting her or him know that the deal won’t fall through because you can’t afford the property or obtain suitable financing. And since you will have already gone through the mortgage application process, the time required to close the sale should be relatively short.
Briefly describe the two basic types of mortgage loans. Which has the lowest initial rate of interest? What is negative amortization, and which type of mortgage can experience it? Discuss the advantages and disadvantages of each mortgage type. The fixed-rate mortgage still accounts for a large portion of all home mortgages. Both the rate of interest and the monthly mortgage payment are fixed over the full term of the loan. The payments are fixed and there is no uncertainty with the loan.The adjustable-rate mortgage (ARM) provides that the rate of interest, and therefore the size of the monthly payment, is adjusted based on market interest rate movements. Typically the ARM will have lower rated than the fixed-rate mortgage, at least initially. The rates will change as the general interest rates vary at each adjustment date, generally every five years.Some ARMs are subject to negative amortization— an increase in the principal balance resulting from monthly loan payments that are lower than the amount of monthly interest being charged. In other words, you could end up with a larger mortgage balance on the next anniversary of your loan than on the previous one.
How can you use the debt safety ratio to determine whether your debt obligations are within reasonable limits? The easiest way to avoid repayment problems and ensure that your borrowing won’t place an undue strain on your monthly budget is to limit the use of credit to your ability to repay the debt! A useful credit guideline (and one widely used by lenders) is to make sure your monthly repayment burden doesn’t exceed 20 percent of your monthly take-home pay. Most experts, however, regard the 20 percent figure as the maximum debt burden and strongly recommend a debt safety ratio closer to 15 percent or 10 percent—perhaps even lower if you plan on applying for a new mortgage in the near future. Note that the monthly repayment burden here does include payments on your credit cards, but it excludes your monthly mortgage obligation.
What steps can you take to establish a good credit rating? Here are some things you can do to build a strong credit history:• Use credit only when you can afford it and only when the repayment schedule fits comfortably into the family budget—in short, don’t overextend yourself. • Fulfill all the terms of the credit.• Be consistent in making payments promptly.• Consult creditors immediately if you cannot meet payments as agreed.• Be truthful when applying for credit. Lies are not likely to go undetected.
Describe how revolving credit lines provide open account credit. Revolving lines of credit normally don’t involve the use of credit cards. Rather, they’re accessed by writing checks on regular checking accounts or specially designated credit line accounts. They are a form of open account credit and often represent a far better deal than credit cards, not only because they offer more credit but also because they can be a lot less expensive. The three major forms of open (non-credit card) credit are overdraft protection lines, unsecured personal lines of credit, and home equity credit lines.
Describe credit scoring and explain how it’s used (by lenders) in making a credit decision. Using the data provided by the credit applicant, along with any information obtained from the credit bureau, the store or bank must decide whether to grant credit. Very likely, some type of credit scoring scheme will be used to make the decision. An overall credit score is developed for you by assigning values to such factors as your annual income, whether you rent or own your home, number and types of credit cards you hold, level of your existing debts, whether you have savings accounts, and general credit references.The biggest provider of credit scores is, by far, Fair Isaac & Co.—the firm that produces the widely used FICO scores. Unlike some credit score providers, Fair Isaac uses only credit information in its calculations. There’s nothing in them about your age, marital status, salary, occupation, employment history, or where you live. Instead, FICO scores are derived from the following five major components, which are listed along with their respective weights: payment history (35 percent), amounts owed (30 percent), length of credit history (15 percent), new credit (10 percent), and types of credit used (10 percent). FICO scores, which are reported by all three of the major credit bureaus, range from a low of 300 to a max of 850.
Describe the basic operations and functions of a credit bureau. A credit bureau is a type of reporting agency that gathers and sells information about individual borrowers. If, as is often the case, the lender doesn’t know you personally, it must rely on a cost-effective way of verifying your employment and credit history. It would be far too expensive and time-consuming for individual creditors to confirm your credit application on their own, so they turn to credit bureaus that maintain fairly detailed credit files about you. Information in your file comes from one of three sources: creditors who subscribe to the bureau, other creditors who supply information at your request, and publicly recorded court documents (such as tax liens or bankruptcy records).
Identify several different types of federally sponsored student loan programs. The federal government (and some state governments) have available several different types of subsidized educational loan programs. The federally sponsored programs are: • Stafford loans (Direct and Federal Family Education Loans—FFELs)• Perkins loans The Stafford and Perkins loans have the best terms and are the foundation of the government’s student loan program.• Parent Loans (PLUS) PLUS (which stands for Parent Loans for Undergraduate Students) loans are supplemental loans for undergraduate students who demonstrate a need but, for one reason or another, don’t qualify for Stafford or Perkins loans or need more aid than they’re receiving.See Exhibit 7.1, Federal Government Student Loan Programs at a Glance for a concise explanation of the loan programs.
List and briefly discuss the different factors to consider when shopping for a loan. How would you determine the total cost of the transaction? The major factors are:Finance Charges–What’s it going to cost me? That’s appropriate, because borrowers should know what they’ll have to pay to get the money The rate of interest, known as the APR (annual percentage rate), includes not only the basic cost of money but also any additional fees that might be required on the loan.Loan Maturity–Make sure that the size and number of payments will fit comfortably into your spending and savings plans. As a rule, the cost of credit increases with the length of the repayment period. Thus, to lower your cost, you should consider shortening the loan maturity—but only to the point where doing so won’t place an unnecessary strain on your cash flow.Total Cost of the Transaction–When comparison shopping for credit, always look at the total cost of both the price of the item purchased and the price of the credit. Retailers often manipulate both sticker prices and interest rates, so you really won’t know what kind of deal you’re getting until you look at the total cost of the transaction.Collateral–Make sure you know up front what collateral (if any) you’ll have to pledge on the loan and what you stand to lose if you default on your payments. Using collateral often makes sense–it may result in lower finance charges, perhaps half a percentage point or so.Other Loan ConsiderationsIn addition to following the guidelines just described, here are some questions that you should also ask. Can you choose a payment date that will be compatible with your spending patterns? Can you obtain the loan promptly and conveniently? What are the charges for late payments, and are they reasonable? Will you receive a refund on credit charges if you prepay your loan, or are there prepayment penalties? You should see to it that the consumer debt you undertake does, in fact, have the desired effects on your financial condition.
What is a lien, and when is it part of a consumer loan? Most single-payment loans are secured by certain specified assets. For collateral, lenders prefer items they feel are readily marketable at a price that’s high enough to cover the principal portion of the loan. The lenders don’t take physical possession of the collateral but instead file a lien, which is a legal claim that permits them to liquidate the collateral to satisfy the loan if the borrower defaults. The lien is filed in the county courthouse and is a matter of public record.
When might you request a loan rollover? An individual will borrow money using a single-payment loan and then discover that he or she is short of money when the loan comes due—after all, making one big loan payment can cause a real strain on one’s cash flow. Should this happen to you, don’t just let the payment go past due; instead, inform the lender in advance so that a partial payment, loan extension, or some other arrangement can be made. Under such circumstances, the lender will often agree to a loan rollover, in which case the original loan is paid off by taking out another loan. The lender will usually require that all the interest, and at least part of the principal, be paid at the time of the rollover.
Briefly describe the basic features of an installment loan. Installment loans differ from single-payment loans in that they require the borrower to repay the debt in a series of installment payments (usually monthly) over the life of the loan. Installment loans have long been one of the most popular forms of consumer credit. As a financing vehicle, there are few things that installment loans can’t do—which explains, in large part, why this form of consumer credit is so widely used. Most installment loans are secured with some kind of collateral—for example, the car or home entertainment center you purchased with the help of an installment loan usually serves as collateral on the loan. One rapidly growing segment of this market is installment loans secured by second mortgages referred to as home equity loans. Interest may be computed as simple and add-on interest to compute finance charges and monthly payments for installment loans.
When does it make more sense to pay cash for a big-ticket item than to borrow the money to finance the purchase? Essentially, it all boils down to this: If it costs more to borrow the money than you can earn in interest, then withdraw the money from your savings to pay cash for the purchase; if not, you should probably take out a loan.
Factors that affect your credit score Paying bills on time Knocking down your debt Avoid applying for multiple credit cards
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Finance Flashcards

Exam 1 Practice Questions

What are the three basic questions addressed by the study of finance? What long-term investments should the firm undertake?How should the firm raise money to fund these decisions?How can the firm best manage its cash flows as they arise in its day-to-day operations?
What are the three basic types of decisions addressed by the study of finance? Capital budgeting decisions, capital structure decisions, and working capital management decisions
TRUE/FALSEEven if you do not pursue a career in finance, you may find yourself working closely with finance managers. TRUE
TRUE/FALSEAs an individual you will be faced with numerous financial decisions throughout your life. Knowledge of financial principles will help you make the right decisions. TRUE
TRUE/FALSEFor those who plan to be entrepreneurs, managing company finances is crucial to the survival of the firm. TRUE
TRUE/FALSEFinancial management is a key component of other academic disciplines such as management, marketing, production, operations management, and accounting. TRUE
What are the three legal forms of business organizations? Corporation, sole proprietorship, and the partnership
TRUE/FALSEOne advantage of the sole proprietorship is that the survival of the firm does not depend upon just one person. FALSE
TRUE/FALSESources of funds for a sole proprietorship typically include personal savings, as well as raising fronds from a bank or personal loans from friends and family. TRUE
TRUE/FALSE Sole proprietorships are easy to set up with no paperwork required before the business can be opened. TRUE
TRUE/FALSE The sole proprietor is personally responsible for all debt of the sole proprietorship. TRUE
Which business partner actually runs the business and faces unlimited liability for the firm’s debt? general partner
This business partner is only liable up to the amount they personally invested. limited partner
TRUE/FALSECorporations have a greater ease in raising large sums of money than other forms of business organization. TRUE
TRUE/FALSEIn corporations, the life of the business is not tied to the status of the corporate owners. TRUE
TRUE/FALSEIn corporations, the owners’ liability is limited to the amount of their investment in the company. TRUE
TRUE/FALSEThe corporation is owned by the board of directors who share in the profits of and the liabilities of the company. FALSE
One attractive alternative to the corporation for a small business is the _________ because it combines the tax benefits of a partnership with the limited liability of a corporation. limited liability company
In a large corporation, the primary responsibility for overseeing the firm’s finance-related activities falls to the: Chief Financial Officer (CFO)
When managers have little or no ownership in the firm, they are less likely to work energetically for the company’s shareholders. We call this type of conflict a(n) ________. agency problem
What measures can be taken to help limit the agency problem? -Firms that fail to maximize shareholder wealth may be taken over and their management team replaced.-Compensation plans can be put in place to reward managers when they maximize shareholder wealth. -Financial markets play a key role in monitoring management. -The board of directors can actively monitor the actions of managers to keep pressure on them to act in the best interest of shareholders.
______________ was passed to directly confront concerns about both agency and ethical issues. The Sarbanes-Oxley Act of 2002 (SOX)
TRUE/FALSERegarding SOX, senior executives are no longer held responsible for the accuracy and completeness of the firm’s financial reports if an accounting firm declares the reports acceptable according to established accounting procedures. FALSE
TRUE/FALSESOX holds corporate advisors who have access to or influence on company decisions, legally accountable for instances of misconduct. TRUE
TRUE/FALSEThe purpose of SOX is to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the security laws. TRUE
TRUE/FALSEWhile the goal of SOX is to provide greater protection against accounting fraud and financial misconduct, the demanding reporting requirements of SOX are quite costly and may inhibit firms from listing on U.S. stock markets. TRUE
There are 4 basic principles of finance. Which principle correctly describes the following statement: “A dollar today is worth more than a dollar received in the future. Conversely, a dollar received in the future is worth less than a dollar received today”? Principle 1: Money has a time value
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Finance Flashcards

FINANCE CHPT 1

In most corporations, the CFO ranks under the CEO. TRUE
The Chairman of the Board must also be the CEO. FALSE
The board of directors is the highest ranking body in a corporation, and the chairman of the board is the highest ranking individual. The CEO generally works under the board and its chairman, and the board generally has the authority to remove the CEO under certain conditions. The CEO, however, cannot remove the board, but he or she can endeavor to have the board voted out and a new board voted in should a conflict arise. It is possible for a person to simultaneously serve as CEO and chairman of the board, though many corporate control experts believe it is bad to vest both offices in the same person. TRUE
Partnerships and proprietorships generally have a tax advantage over corporations. TRUE
A disadvantage of the corporate form of organization is that corporate stockholders are more exposed to personal liabilities in the event of bankruptcy than are investors in a typical partnership. FALSE
An advantage of the corporate form of organization is that corporations are generally less highly regulated than proprietorships and partnerships. FALSE
Some partners in a partnership may have different rights, privileges, and responsibilities than other partners. TRUE
One advantage of the corporate form of organization is that it avoids double taxation. FALSE
It is generally harder to transfer one’s ownership interest in a partnership than in a corporation. TRUE
One danger of starting a proprietorship is that you may be exposed to personal liability if the business goes bankrupt. This problem would be avoided if you formed a corporation to operate the business. TRUE
If a corporation elects to be taxed as an S corporation, then it can avoid the corporate tax. However, its stockholders will have to pay personal taxes on the firm’s net income. TRUE
If a corporation elects to be taxed as an S corporation, then both it and its stockholders can avoid all Federal taxes. This provision was put into the Federal Tax Code in order to encourage the formation of small businesses. FALSE
It is generally less expensive to form a corporation than a proprietorship because, with a proprietorship, extensive legal documents are required. FALSE
The more capital a firm is likely to require, the greater the probability that it will be organized as a corporation. TRUE
One disadvantage of forming a corporation rather than a partnership is that this makes it more difficult for the firm’s investors to transfer their ownership interests. FALSE
Organizing as a corporation makes it easier for the firm to raise capital. This is because corporations’ stockholders are not subject to personal liabilities if the firm goes bankrupt and also because it is easier to transfer shares of stock than partnership interests. TRUE
In order to maximize its shareholders’ value, a firm’s management must attempt to maximize the expected EPS. FALSE
In order to maximize its shareholders’ value, a firm’s management must attempt to maximize the stock price on a specific target date. FALSE
In order to maximize its shareholders’ value, a firm’s management must attempt to maximize the stock price in the long run, or the stock’s “intrinsic value.” TRUE
If management operates in a manner designed to maximize the firm’s expected profits for the current year, this will also maximize the stockholders’ wealth as of the current year. FALSE
Globalization of business has been facilitated by improvements in information technology. TRUE
As a result of financial scandals occurring during the past decade, there has been a strong push to improve business ethics. TRUE
There are many types of unethical business behavior. One example is where executives provide information that they know is incorrect to banks and to stockholders. It is illegal to provide such information to banks, but it is not illegal to provide it to stockholders because they are the owners of the firm, not outsiders. FALSE
A stock’s market price would equal its intrinsic value if all investors had all the information that is available about the stock. In this case the stock’s market price would equal its intrinsic value. TRUE
If a stock’s market price is above its intrinsic value, then the stock can be thought of as being undervalued, and it would be a good buy. FALSE
If a stock’s intrinsic value is greater than its market price, then the stock is overvalued and should be sold FALSE
For a stock to be in equilibrium as the book defines it, its market price should exceed its intrinsic value. FALSE
The term “marginal investor” means an investor who is active in the market and would tend to buy a stock if its price fell and sell it if it rose, barring any new information coming out about the stock. It is the “marginal investor” who determines the actual stock price. TRUE
If a lower level person in a firm does something illegal, like “cooking the books” to understate costs and thereby increase profits above the correct profits because he or she was told to do so by a superior, the lower level person cannot be prosecuted but the superior can be prosecuted. FALSE
If someone deliberately understates costs and thereby increases profits, this can cause the price of the stock to rise above its intrinsic value. The stock price will probably fall in the future. Also, those who participated in the fraud can be prosecuted, and the firm itself can be penalized. TRUE
Managers always attempt to maximize the long-run value of their firms’ stocks, or the stocks’ intrinsic values. This is exactly what stockholders desire. Thus, conflicts between stockholders and managers are not possible. However, there can be conflicts between stockholders and bondholders. FALSE
A hostile takeover is said to occur when another corporation or group of investors gains voting control over a firm and replaces the old managers. If the old managers were managing the firm inefficiently, then hostile takeovers can improve the economy. However, hostile takeovers are controversial, and legislative actions have been taken to make them more difficult to undertake. TRUE
If a firm’s board of directors wants to maximize value for its stockholders in general (as opposed to some specific stockholders), it should design an executive compensation system whose goal is to maximize the stock’s intrinsic value rather than the stock’s current market price. TRUE
Which of the following statements is CORRECT?a. One of the disadvantages of incorporating your business is that you could become subject to the firm’s liabilities in the event of bankruptcy.b. Proprietorships are subject to more regulations than corporations.c. In any partnership, every partner has the same rights, privileges, and liability exposure as every other partner.d. Corporations of all types are subject to the corporate income tax.e. Proprietorships and partnerships generally have a tax advantage over corporations A
Which of the following statements is CORRECT?a. One of the advantages of the corporate form of organization is that it avoids double taxation.b. It is easier to transfer one’s ownership interest in a partnership than in a corporation.c. One of the disadvantages of a proprietorship is that the proprietor is exposed to unlimited liability.d. One of the advantages of a corporation from a social standpoint is that every stockholder has equal voting rights, i.e., “one person, one vote.”e. Corporations of all types are subject to the corporate income tax. C
Which of the following statements is CORRECT?a. One advantage of forming a corporation is that equity investors are usually exposed to less liability than they would be in a partnership.b. Corporations face fewer regulations than proprietorships.c. One disadvantage of operating a business as a proprietor is that the firm is subject to double taxation, because taxes are levied at both the firm level and the owner level.d. It is generally less expensive to form a corporation than a proprietorship because, with a proprietorship, extensive legal documents are required.e. If a partnership goes bankrupt, each partner is exposed to liabilities only up to the amount of his or her investment in the business. A
Relaxant Inc. operates as a partnership. Now the partners have decided to convert the business into a corporation. Which of the following statements is CORRECT?a. Relaxant’s shareholders (the ex-partners) will now be exposed to less liability.b. The company will probably be subject to fewer regulations and required disclosures.c. Assuming the firm is profitable, none of its income will be subject to federal income taxes.d. The firm’s investors will be exposed to less liability, but they will find it more difficult to transfer their ownership.e. The firm will find it more difficult to raise additional capital to support its growth. A
Which of the following statements is CORRECT?a. Corporations generally face fewer regulations than proprietorships.b. Corporate shareholders are exposed to unlimited liability.c. It is usually easier to transfer ownership in a corporation than in a partnership.d. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation.e. There is a tax disadvantage to incorporation, and there is no way any corporation can escape this disadvantage, even if it is very small. C
Which of the following could explain why a business might choose to operate as a corporation rather than as a proprietorship or a partnership?a. Corporations generally face fewer regulations.b. Less of a corporation’s income is generally subject to federal taxes.c. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation.d. Corporate investors are exposed to unlimited liability.e. Corporations generally find it easier to raise large amounts of capital. E
The primary operating goal of a publicly-owned firm interested in serving its stockholders should be toa. Maximize its expected total corporate income.b. Maximize its expected EPS.c. Minimize the chances of losses.d. Maximize the stock price per share over the long run, which is the stock’s intrinsic value.e. Maximize the stock price on a specific target date. D
Which of the following statements is CORRECT?a. In most corporations, the CFO ranks above the CEO.b. By law in most states, the chairman of the board must also be the CEO.c. The board of directors is the highest ranking body in a corporation, and the chairman of the board is the highest ranking individual. The CEO generally works under the board and its chairman, and the board generally has the authority to remove the CEO under certain conditions. The CEO, however, cannot remove the board, but he or she can endeavor to have the board voted out and a new board voted in should a conflict arise. It is possible for a person to simultaneously serve as CEO and chairman of the board, though many corporate control experts believe it is bad to vest both offices in the same person.d. The CFO generally reports to the firm’s chief accounting officer, who is normally the controller.e. The CFO is responsible for raising capital and for making sure that capital expenditures are desirable, but he or she is not responsible for the validity of the financial statements, as the controller and the auditors have that responsibility. C
Which of the following statements is CORRECT?a. One drawback of forming a corporation is that it generally subjects the firm to additional regulations.b. One drawback of forming a corporation is that it subjects the firm’s investors to increased personal liabilities.c. One drawback of forming a corporation is that it makes it more difficult for the firm to raise capital.d. One advantage of forming a corporation is that it subjects the firm’s investors to fewer taxes.e. One disadvantage of forming a corporation is that it is more difficult for the firm’s investors to transfer their ownership interests. A
Which of the following statements is CORRECT?a. If a corporation elects to be taxed as an S corporation, then both it and its stockholders can avoid all Federal taxes. This provision was put into the Federal Tax Code in order to encourage the formation of small businesses.b. The more capital a firm is likely to require, the smaller the probability that it will be organized as a corporation.c. It is generally easier to transfer one’s ownership interest in a partnership than in a corporation.d. One danger of starting a proprietorship is that you may be exposed to personal liability if the business goes bankrupt. This problem would be avoided if you formed a corporation to operate the business.e. Corporate shareholders are exposed to unlimited liability, but this factor is offset by the tax advantages of incorporation. D
Which of the following statements is CORRECT?a. Due to limited liability, unlimited lives, and ease of ownership transfer, the vast majority of U.S. businesses (in terms of number of businesses) are organized as corporations.b. Most businesses (by number and total dollar sales) are organized as proprietorships or partnerships because it is easier to set up and operate one of these forms rather than as a corporation. However, if the business gets very large, it becomes advantageous to convert to a corporation, primarily because corporations have important tax advantages over proprietorships and partnerships.c. Due to legal considerations related to ownership transfers and limited liability, which affect the ability to attract capital, most business (measured by dollar sales) is conducted by corporations in spite of large corporations’ less favorable tax treatment.d. Large corporations are taxed more favorably than proprietorships.e. Corporate stockholders are exposed to unlimited liability. C
Which of the following statements is CORRECT?a. A hostile takeover is the main method of transferring ownership interest in a corporation.b. A corporation is a legal entity created by a state, and it has a life and existence that is separate from the lives and existence of its owners and managers.c. Unlimited liability and limited life are two key advantages of the corporate form over other forms of business organization.d. Limited liability is an advantage of the corporate form of organization to its owners (stockholders), but corporations have more trouble raising money in financial markets because of the complexity of this form of organization.e. Although the stockholders of the corporation are insulated by limited legal liability, the legal status of the corporation does not protect the firm’s managers in the same way, i.e., bondholders can sue the firm’s managers if the firm defaults on its debt. B
Which of the following statements is CORRECT?a. In a typical partnership, liability for other partners’ misdeeds is limited to the amount of a particular partner’s investment in the business.b. In a limited partnership, the limited partners have voting control, while the general partner has operating control over the business, and the limited partners are individually responsible, on a pro rata basis, for the firm’s debts in the event of bankruptcy.c. A slow-growth company, with little need for new capital, would be more likely to organize as a corporation than would a faster growing company.d. Partnerships have more difficulty attracting large amounts of capital than corporations because of such factors as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and selling) of partnership interests.e. A major disadvantage of a partnership relative to a corporation is the fact that federal income taxes must be paid by the partners rather than by the firm itself. D
The primary operating goal of a publicly-owned firm trying to best serve its stockholders should be toa. Maximize managers’ own interests, which are by definition consistent with maximizing shareholders’ wealth.b. Maximize the firm’s expected EPS, which must also maximize the firm’s price per share.c. Minimize the firm’s risks because most stockholders dislike risk. In turn, this will maximize the firm’s stock price.d. Use a well-structured managerial compensation package to reduce conflicts that may exist between stockholders and managers. e. Since it is impossible to measure a stock’s intrinsic value, the text states that it is better for managers to attempt to maximize the current stock price than its intrinsic value. D
Which of the following statements is CORRECT?a. If a lower level person in a firm does something illegal, like “cooking the books” to understate costs and thereby artificially increase profits because he or she was ordered to do so by a superior, the lower level person cannot be prosecuted but the superior can be prosecuted.b. There are many types of unethical business behavior. One example is where executives provide information that they know is incorrect to outsiders. It is illegal to provide such information to federally regulated banks, but it is not illegal to provide it to stockholders because they are the owners of the firm.c. If someone deliberately understates costs and thereby causes reported profits to increase, this can cause the price of the stock to rise above its intrinsic value. The stock will probably fall in the future. Both those who participated in the fraud and the firm itself can be prosecuted.d. Ethical behavior is not influenced by training and auditing procedures. People are either ethical or they are not, and this is what determines ethical behavior in business. C
With which of the following statements would most people in business agree?a. A corporation’s short-run profits will almost always increase if the firm takes actions that the government has determined are in the best interests of the nation.b. Firms and government agencies almost always agree with one another regarding the restrictions that should be placed on hiring and firing employees.c. “Whistle blowers,” because of the courage it takes to blow the whistle, are generally promoted more rapidly than other employees.d. It is not useful for large corporations to develop a formal set of rules defining ethical and unethical behavior.e. Although people’s moral characters are probably developed before they are admitted to a business school, it is still useful for business schools to cover ethics, if only to give students an idea about the adverse consequences of unethical behavior to themselves, their firms, and the nation. E
Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and bondholders?a. Compensating managers with stock options.b. Financing risky projects with additional debt.c. The threat of hostile takeovers.d. The use of covenants in bond agreements that limit the firm’s use of additional debt and constrain managers’ actions.e. Abolishing the Security and Exchange Commission. D
Which of the following actions would be most likely to reduce potential conflicts between stockholders and bondholders?a. Including restrictive covenants in the company’s bond indenture (which is the contract between the company and its bondholders).b. Compensating managers with more stock options and less cash income.c. The passage of laws that make it harder for hostile takeovers to succeed.d. A government regulation that banned the use of convertible bonds.e. The firm begins to use only long-term debt, e.g., debt that matures in 30 years or more, rather than debt that matures in less than one year. A
Which of the following actions would be most likely to reduce potential conflicts of interest between stockholders and managers?a. Pay managers large cash salaries and give them no stock options.b. Change the corporation’s formal documents to make it easier for outside investors to acquire a controlling interest in the firm through a hostile takeover.c. Beef up the restrictive covenants in the firm’s debt agreements.d. Eliminate a requirement that members of the board of directors must hold a high percentage of their personal wealth in the firm’s stock.e. For a firm that compensates managers with stock options, reduce the time before options are vested, i.e., the time before options can be exercised and the shares that are received can be sold. B
Which of the following actions would be likely to reduce potential conflicts of interest between stockholders and managers?a. Congress passes a law that severely restricts hostile takeovers.b. A firm’s compensation system is changed so that managers receive larger cash salaries but fewer long-term options to buy stock.c. The company changes the way executive stock options are handled, with all options vesting after 2 years rather than having 20% of the options awarded vest every 2 years over a 10-year period.d. The company’s outside auditing firm is given a lucrative year-by-year consulting contract with the company.e. The composition of the board of directors is changed from all inside directors to all outside directors, and the directors are compensated with stock rather than cash. E
Which of the following mechanisms would be most likely to help motivate managers to act in the best interests of shareholders?a. Decrease the use of restrictive covenants in bond agreements.b. Take actions that reduce the possibility of a hostile takeover.c. Elect a board of directors that allows managers greater freedom of action.d. Increase the proportion of executive compensation that comes from stock options and reduce the proportion that is paid as cash salaries.e. Eliminate a requirement that members of the board of directors have a substantial investment in the firm’s stock. D
Which of the following actions would be likely to encourage a firm’s managers to make decisions that are in the best interests of shareholders?a. The percentage of executive compensation that comes in the form of cash is increased and the percentage coming from long-term stock options is reduced.b. The state legislature passes a law that makes it more difficult to successfully complete a hostile takeover.c. The percentage of the firm’s stock that is held by institutional investors such as mutual funds, pension funds, and hedge funds rather than by small individual investors rises from 10% to 80%.d. The firm’s founder, who is also president and chairman of the board, sells 90% of her shares.e. The firm’s board of directors gives the firm’s managers greater freedom to take whatever actions they think best without obtaining board approval. C
Which of the following statements is CORRECT?a. One of the ways in which firms can mitigate or reduce potential conflicts between bondholders and stockholders is by increasing the amount of debt in the firm’s capital structure.b. The threat of takeover generally increases potential conflicts between stockholders and managers.c. Managerial compensation plans cannot be used to reduce potential conflicts between stockholders and managers.d. The threat of takeovers tends to reduce potential conflicts between stockholders and managers.e. The creation of the Securities and Exchange Commission (SEC) has eliminated conflicts between managers and stockholders. D
Which of the following statements is CORRECT?a. Corporations are taxed more favorably than proprietorships.b. Corporations have unlimited liability.c. Because of their size, large corporations face fewer regulations than smaller corporations and proprietorships.d. Reducing the threat of corporate takeover increases the likelihood that managers will act in shareholders’ interests.e. Bond covenants are designed to protect bondholders and to reduce potential conflicts between stockholders and bondholders. E
Which of the following statements is CORRECT?a. A good goal for a firm’s management is the maximization of expected EPS.b. Most business in the U.S. is conducted by corporations, and corporations’ popularity results primarily from their favorable tax treatment.c. Conflicts can exist between stockholders and managers, but potential conflicts are reduced by the possibility of hostile takeovers.d. Corporations and partnerships have an advantage over proprietorships because a proprietor is exposed to unlimited liability, but the liability of all investors in the other types of businesses is more limited.e. For a stock to be in equilibrium, its intrinsic value must be greater than the actual market price. C
Which of the following statements is CORRECT?a. One disadvantage of organizing a business as a corporation rather than a partnership is that the equity investors in a corporation are exposed to unlimited liability.b. Using restrictive covenants in debt agreements is an effective way to reduce conflicts between stockholders and managers.c. Managers generally welcome hostile takeovers since the “raider” generally offers a price for the stock that is higher than the price before the takeover action started.d. The managers of established, stable companies sometimes attempt to get their state legislatures to impose rules that make it more difficult for raiders to succeed with hostile takeovers.e. The managers of established, stable companies sometimes attempt to get their state legislatures to remove rules that make it more difficult for raiders to succeed with hostile takeovers. D
Which of the following statements is CORRECT?a. Well designed bond covenants are useful for reducing potential conflicts between stockholders and managers.b. The bid price in a hostile takeover is generally above the price before the takeover attempt is announced, because otherwise there would be no incentive for the stockholders to sell to the hostile bidder and the takeover attempt would probably fail.c. Stockholders in general would be better off if managers never disclosed favorable events and therefore caused the price of the firm’s stock to sell at a price below its intrinsic value.d. Takeovers are most likely to be attempted if the target firm’s stock price is above its intrinsic value.e. The efficiency of the U.S. economy would probably be increased if hostile takeovers were absolutely forbidden. B
Which of the following statements is CORRECT?a. Hostile takeovers are most likely to occur when a firm’s stock is selling below its intrinsic value as a result of poor management.b. The efficiency of the U.S. economy would probably be increased if hostile takeovers were absolutely forbidden.c. Hostile takeovers are most likely to occur when a firm’s stock sells at a price above its intrinsic value because its management has been issuing overly optimistic statements about its likely future performance. d. In general, it is more in bondholders’ interests than stockholders’ interests for a firm to shift its investment focus away from safe, stable investments and into risky investments, especially those that primarily involve research and development.e. Stockholders in general would be better off if managers never disclosed favorable events and therefore caused the price of the firm’s stock to sell at a price below its intrinsic value. A
Which of the following statements is CORRECT?a. One disadvantage of operating as a corporation rather than as a partnership is that corporate shareholders are exposed to more personal liability than are partners.b. Relative to proprietorships, corporations generally face fewer regulations, and they also find it easier to raise capital.c. There is no good reason to expect a firm’s stockholders and bondholders to react differently to the types of assets in which it invests.d. Stockholders should generally be happier than bondholders to have managers invest in risky projects with high potential returns as opposed to safe projects with lower expected returns.e. Bondholders should generally be happier than stockholders to have managers invest in risky projects with high potential returns as opposed to safe projects with lower expected returns. D
Which of the following statements is CORRECT?a. Because bankruptcy requires that corporate bondholders be paid in full before stockholders receive anything, bondholders generally prefer to see corporate managers invest in high risk/high return projects rather than low risk/low return projects.b. Since bondholders receive fixed payments, they do not share in the gains if risky projects turn out to be highly successful. However, they do share in the losses if risky projects fail and drive the firm into bankruptcy. Therefore, bondholders generally prefer to see corporate managers invest in low risk/low return projects rather than high risk/high return projects.c. One advantage of operating a business as a corporation is that stockholders can deduct their pro rata share of the taxes the firm pays, thereby eliminating the double taxation investors would face in a partnership.d. One drawback of forming a corporation is that you lose the limited liability that you would otherwise receive as a proprietor B
Which of the following statements is CORRECT?a. Corporations face few regulations and more favorable tax treatment than do proprietorships and partnerships.b. Managers who face the threat of hostile takeovers are less likely to pursue policies that maximize shareholder value compared to managers who do not face the threat of hostile takeovers.c. Bond covenants are an effective way to resolve conflicts between shareholders and managers.d. Because of their simplified organization, it is easier for proprietors and partnerships to raise large amounts of outside capital than it is for corporations.e. One advantage to forming a corporation is that the owners of the firm have limited liability. E
what is finance the system that includes the circulation of money, the granitic of credit, the making of investments, and the provision of baking facilities. 4
finance is divided into what three areas? 1. financial management2. capital markets3. investments pg 4
financial management called corporate finance, focuses on decisions relating to how much and what types of assets to acquire, how to raise the capital needed to purchase assets, and how to run the firm so as to maximize its value. pg 4
capital markets relate to the markets where interest rates, along with stock and bond prices, are determined. pg 4
investments relate to decisions concerning stocks and bonds and include a number of activities:1. security analysis2. portfolio theory3. market analysis. pg 4
CFO COO CEO pg 5
Sarbanes-Oxley Act law passed by congress that requires the CEO and CFO to certify that their firm’s financial statements are accurate. pg 5
finance versus economics and accounting pg 6
defined contribution pension plans where each year the company puts a specified amount of money into an account that belongs to the employee. pg 6
The basics of financial management are the same for all businesses, large or small, regardless of how they are organized. pg 6 still a firms legal structure affects its operations and thus should be recognized
four main forms of business organizations 1. proprietorships2. partnerships3. corporations4. limited liability companies (LLCs) and limited liability partnerships (LLPs)pg. 6
in terms of numbers, most businesses are proprietorships. however, based on the dollar value of sales, more than 80% of all business is done by corporations. because corporations conduct the most business and because most successful businesses eventually convert to corporations. pg 7
proprietorship an incorporated business owned by one individual. pg 7businesses are frequently started as proprietorships and then converted to corporations when their growth results in the disadvantages outweighing the advantages
advantages of proprietorship 1. they are easy and inexpensive to form2. they are subject to few government regulations3. they are subject to lower income taxes than are corporations
limitation to proprietors 1. proprietors have unlimited personal liability for the business’ debts, so you can lose more than the amount of money you put into the company2. the life of the business is limited to the life of the individual who created it, and to bring in new equity, investors require a change in the structure of the business3. because of the first two points, proprietorships have difficulty obtaining large sums of capital; hence, proprietorships are used primarily for small businesses.pg 7
partnership an incorporated business owned by two or more persons. pg 7
advantages and disadvantages to partnership pg 7
corporation is a legal entity created by a state, and it is separate and distinct from its owners and managers, having unlimited life, easy transferability of ownership, and limited liability. pg 7 look to grow shareholders wealth
advantages of corporation -unlimited life-easy transfer or ownership-limited liability-ease of raising capital
disadvantages of corporations -double taxation-cost of setup and report filing
two types of investors those who look at short run (1 yr)or long term (growth investor, warren buffet)
a major drawback to corporations is taxes. most corporations’ earnings are subject to double taxation.
S corporations a special designation that allows small businesses that meet qualifications to be taxed as if they were a proprietorship or a partnership rather than a corporation. pg 8
limited liability company a popular type of organization that is a hybrid between a partnership and a corporation pg 8
limited liability partnership similar to an LLC but used for professional firms in the files of accounting, law, and architecture. It provides personal asset protection from business debts and liabilities but is taxed as a partnership. pg 8`
LLCs/LLPs were created by lawyers and are structured in different ways by state when deciding on its form organization, a firm must trade off the advantages of incorporation agains possibly higher tax burden,.
advantages of corporations pg 8 -limited liability reduces the risks borne by investors; and other things held constant, the lower the firm’s risk, the higher its value-a firm’s value is dependent on its growth opportunities, which are dependent on its ability to attract capital. because corporations can attract capital more easily than other types of businesses, they are better able to take advantage of growth opportunities.-the value of an asset also depends on its liquidity, which means the time and effort it takes to sell the asset for cash at a fair market value. Because the stock of a corporation is easier to transfer to a potential buyer than is an interest in a proprietorship or partnership, and because more investors are willing to invest in stocks than in partnerships (with their potential unlimited liability), a corporate investment is relatively liquid. This too enhances the value of a corporation.
The main goal for a corporation create value for investors. 9
investors like higher expected cash flows, but they dislike risk: so the larger the expected cash flows and the lower the perceived risk, the higher the stock’s price. 9
intrinsic value an estimate of a stock’s “true” value based on accurate risk and return data. the intrinsic value can be estimated but not measured precisely. 10
market price the stock value based on perceived but possibly incorrect information as seen by the marginal investor. 10
marginal investor an investor whose views determine the actual stock price. 10
equilibrium the situation in which the actual market price equals the intrinsic value, so investors are indifferent between buying and selling a stock. 10
intrinsic values are estimates; and different analysts with different data and different views about the future form different estimates of stock’s intrinsic value estimating intrinsic values is what security analysis is all about and is what distinguishes successful from unsuccessful investors. 10
management’s goal should be to take actions designed to maximize the firm’s intrinsic value, not its current market price. that maximizing the intrinsic value will maximize the average price over the long run, but not necessarily the current price at each point in time. 11
consequences of having a short-run focus 11 huge bonuses for engaging in risky transactions that generated short-term profits. 12
stockholder manager conflicts 12managers’ personal goals may compete with shareholder wealth maximization. in particular, managers might be more interested in maximizing their own wealth than their stockholders’ wealth effective executive compensatiomn plans motivate managers to act in their stockholders’ best interests. useful motivational tools inclue 1. reasonable compensation packages. 2. firing managers who don’t perform well. and threat of hostile takeovers. pg13
compensation packages should be sufficient to attract and retain able managers, but they should not go beyond what is needed. 13
direct stockholder intervention 13 the majority of stock is owned by institutional investors such as insurance companies, pension funds, hedge funds,a nd mutual funds, and private equity groups are ready and able to step in and take over underperforming firms. 13`
corporate raiders individuals who target corporations for takeover because they are undervalued. 15
hostile takeover the acquisition of a company over the opposition of its management. 15
managers should try to maximize their stock’s intrinsic value and then communicate effectively with stockholders. that will cause the intrinsic value to be high and the actual stock price to remain close to the intrinsic value over time 15 stockholder debtholder conflicts 15
conflicts can also arise between stockholders and debtholders. debtholders, which include the company’s bankers and its bonholders, generally receive fixed payments regardless of how well the company does, while stockholders do better when the company does better. 15
shareholder wealth maximization the primary goal for managers of publicly owned companies implies that decisions should be made to maximize the long-run value of the firm’s common stock.17
most managers understand that maximizing shareholder value does not mean that they are free to ignore the larger interests of society. 17 business ethics pg 19. most firms today have strong written codes of ethical behavior; companies also conduct training programs to ensure that employees understand proper behavior in different situations.
consequences of unethical behavior. 20 how should employees deal with unethical behavior. 21
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Finance Flashcards

Fundamentals of Business Finance Chapter 6

The appropriate measure for risk according to the capital asset pricing model is: beta.
Which of the following types of risk is diversifiable? Unsystematic, or company-unique risk.
Of the following different types of securities, which is typically considered most risky? Common stocks of small companies
SeeBreeze Incorporated has a beta of 1.0. If the expected return on the market is 15%, what is the expected return on SeeBreeze Incorporated’s stock? 15%
Portfolio risk is typically measured by ________ while the risk of a single investment is measured by ________. beta; standard deviation
The capital asset pricing model: provides a risk-return trade off in which risk is measured in terms of beta.
What is diversifying among different kinds of assets known as? Asset allocation
Investment A has an expected return of 15% per year, while investment B has an expected return of 12% per year. A rational investor will choose investment A if A and B are of equal risk.
Stock A has a beta of 1.2 and a standard deviation of returns of 18%. Stock B has a beta of 1.8 and a standard deviation of returns of 18%. If the market risk premium increases, then the required return on stock B will increase more than the required return on stock A.
Billings, Inc. common stock has a beta of 1.2. If the expected risk free return is 4% and the expected market risk premium is 9%, what is the expected return on Billing’s stock? 14.8%
The risk-free rate of interest is 4% and the market risk premium is 9%. Howard Corporation has a beta of 2.0, and last year generated a return of 16% with a standard deviation of returns of 27%. The required return on Howard Corporation stock is: 22%.
Assume that an investment is forecasted to produce the following returns: a 10% probability of a $1,400 return; a 50% probability of a $6,600 return; and a 40% probability of a $10,500 return. What is the expected amount of return this investment will produce? $7,640
Your stock portfolio has two stocks with the following proportions:Stock A – 20% of the investment; Beta for stock A = 1.4Stock B – 80% of the investment; Beta for stokc B = 0.9What is the beta of the portfolio? 1.00
Which of the following is the slope of the security market line? the market risk premium
Beginning with an investment in one company’s securities, as we add securities of other companies to our portfolio, which type of risk declines? Unsystematic risk
Which of the following measures the average relationship between a stock’s returns and the market’s returns? Beta coefficient
The beta of ABC Co. stock is the slope of: The characteristic line for a plot of ABC Co. returns against the returns of the market portfolio for the same period.
Collectibles Corp. has a beta of 2.5 and a standard deviation of returns of 20%. The return on the market portfolio is 15% and the risk free rate is 4%. What is the risk premium on the market? 11%
You purchased 1,000 shares of K.C Inc. common stock one year ago for $50 per share. You received a dividend of $2 per share today and decide to take your profits by selling at $54.50 per share. What is your holding period return? 13.0%
Assume that an investment is forecasted to produce the following returns: a 20% probability of a 12% return; a 50% probability of a 16% return; and a 30% probability of a 19% return. What is the standard deviation of return for this investment? 2.43%
You have a portfolio of two stocks with the following investment proportions and betas:Stock A = 30% of the portfolio investment; Beta of stock A = 1.8Stock B = 70% of the portfolio investment; Beta of stock B = 1.1What is the portfolio beta? 1.31