Final Exam Word Problems

Which one of the following statements correctly applies to a sole proprietorship?

• The business entity has an unlimited life.

• The ownership can easily be transferred to another individual.

• The owner enjoys limited liability for the firm's debts.

• Debt financing is easy to arrange in the firm's name.

• Obtaining additional equity is dependent on the owner's personal finances.

Which one of the following actions best matches the primary goal of financial
management?

• increasing the size of the company by acquiring another firm in a different industry

• decreasing the variable costs while increasing the fixed costs per unit sold

• increasing the market value of the equity by improving the efficiency of operations

• decreasing the liquidity of the firm while increasing the long-term debt

• increasing the net working capital while maintaining the same level of sales

Net working capital is defined as:

• the depreciated book value of a firm's fixed assets.

• the value of a firm's current assets.

• available cash minus current liabilities.

• total assets minus total liabilities.

• current assets minus current liabilities.

Which one of the following statements is NOT correct?

• Highly liquid assets can be sold quickly at fair value.

• Financial leverage increases the potential return to the shareholders.

• The market value tends to provide a better guide to the actual worth of an asset than does
  the book value.

• On the balance sheet, assets are listed in descending order of liquidity.

• None of the above

Which one of the following statements is correct?

• high P/E ratio indicates a brighter future for the firm anticipated by the market.

• A M/B ratio lower than 1 could mean that the firm is not creating value for its
  stockholders.

• A high EPS is typically desirable for stockholders.
  

• All of the above.

Which one of the following statements is NOT correct?

• High profit margin is desirable, everything else is constant.

• Return for shareholder’s equity is the bottom line measure of performance in the
  accounting sense.

• Market to book value ratio indicates how aggressively the market valuates the firm.

• High P/E ratio indicates low growth potential for the firm.

Which one of the following statements regarding the assets performance over the last 100 years is not correct?

• Long-term government bonds underperformed long-term corporate bonds.

• the risk premium on stocks exceeded the risk premium on bonds

• U.S. Treasury bill had the lowest standard deviation of returns

• Annual nominal rate of return on U.S. Treasury bills have had a positive rate of return for
  every year in the period

• None of the above

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

• Major layoff by a regional manufacturer of power boats

• Increase in consumption created by a reduction in personal tax rates

• Surprise firing of a firm's chief financial officer

• Closure of a major retail chain of stores

• Product recall by one manufacturer.

The risk-free rate is 4.2 percent and the expected return on the market is 12.3 percent.
Stock A has a beta of 1.2 and an expected return of 13.1 percent. Stock B has a beta of
0.87 and an expected return of 11.4 percent. Are these stocks correctly priced? Why or
why not?

• No; Stock A is underpriced and stock B is overpriced.

• No; Stock A is overpriced and stock B is underpriced.

• No; Stock A is overpriced but stock B is correctly priced.

• No; Stock A is underpriced but stock B is correctly priced.

• Yes; Both stocks are correctly priced.

Answer explanation

Ri=Rf+(Rm-Rf)beta
rA = 0.042 + 1.2(0.123 - 0.042) = 13.92 percent required return >12.3 % of expected
return, not a good investment, overpriced.
rB = 0.042 + 0.87(0.123 - 0.042) = 11.25 percent required return<11.4% of expected
return, good investment, underpriced.
Stock A is overpriced because its expected return lies below the security market line.

Which one of the following statements is correct?

• Decreasing the interest rate increases the future value of a lump sum.

• Most annuities are annuity dues.

• Payments are made at the end of each payment period for ordinary annuities and at the
  beginning of each period for an annuity due.

• EAR is the effective or nominal annual interest rate.