FIN 534 Midterm Exam Part 1& 2

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FIN 534MIDTERM EXAM_PART 1& 2PART 1Question 1Which of the following statements is CORRECT?AnswerThe New York Stock Exchange is an auction market with a physical location.Capital market transactions involve only the purchase and sale of equity securities, i.e., commonstocks.If an investor sells shares of stock through a broker, then this would be a primary markettransaction.Consumer automobile loans are evidenced by legal documents called "promissory notes," andthese individual notes are traded in the money market.While the distinctions are blurring as investment banks are today buying commercial banks, andvice versa, investment banks generally specialize in lending money, whereas commercial banksgenerally help companies raise capital from other parties.Question 2Which of the following statements is CORRECT?AnswerCapital market instruments include both long-term debt and common stocks.An example of a primary market transaction would be your uncle transferring 100 shares of Wal-Mart stock to you as a birthday gift.The NYSE does not exist as a physical location; rather, it represents a loose collection of dealerswho trade stocks electronically.If your uncle in New York sold 100 shares of Microsoft through his broker to an investor in LosAngeles, this would be a primary market transaction.While the two frequently perform similar functions, investment banks generally specialize inlending money, whereas commercial banks generally help companies raise large blocks ofcapital from investors.Question 3You recently sold 100 shares of your new company, XYZ Corporation, to your brother at afamily reunion. At the reunion your brother gave you a check for the stock and you gave yourbrother the stock certificates. Which of the following statements best describes this transaction?AnswerThis is an example of an exchange of physical assets.This is an example of a primary market transaction.This is an example of a direct transfer of capital.This is an example of a money market transaction.This is an example of a derivatives market transactionQuestion 4Which of the following statements is CORRECT?AnswerWhile the distinctions are blurring, investment banks generally specialize in lending money,whereas commercial banks generally help companies raise capital from other parties.A security whose value is derived from the price of some other "underlying" asset is called aliquid security.

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Money market mutual funds usually invest most of their money in a well-diversified portfolio ofliquid common stocks.Money markets are markets for common stocks and long-term debt.The NYSE operates as an auction market, whereas the Nasdaq is a dealer market.Question 5Money markets are markets forAnswerForeign stocks.Consumer automobile loans.U.S. stocks.Short-term debt securities.Long-term bonds.Question 6Which of the following could explain why a business might choose to operate as a corporationrather than as a sole proprietorship or a partnership?AnswerCorporations generally find it relatively difficult to raise large amounts of capital.Less of a corporation's income is generally subjected to taxes than would be true if the firm werea partnership.Corporate shareholders escape liability for the firm's debts, but this factor may be offset by thetax disadvantages of the corporate form of organization.Corporate investors are exposed to unlimited liability.Corporations generally face relatively few regulations.Question 7You recently sold 200 shares of Apple stock to your brother. The transfer was made through abroker, and the trade occurred on the NYSE. This is an example of:AnswerAn over-the-counter market transactionA futures market transaction.A primary market transaction.A secondary market transaction.A money market transaction.Question 8Which of the following statements is CORRECT?AnswerIf expected inflation increases, interest rates are likely to increase.If individuals in general increase the percentage of their income that they save, interest rates arelikely to increase.If companies have fewer good investment opportunities, interest rates are likely to increase.Interest rates on all debt securities tend to rise during recessions because recessions increase thepossibility of bankruptcy, hence the riskiness of all debt securities.Interest rates on long-term bonds are more volatile than rates on short-term debt securities like T-bills.Question 9Which of the following statements is CORRECT?Answer

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The maximum federal tax rate on personal income in 2010 was 50%.Since companies can deduct dividends paid but not interest paid, our tax system favors the use ofequity financing over debt financing, and this causes companies' debt ratios to be lower than theywould be if interest and dividends were both deductible.Interest paid to an individual is counted as income for tax purposes and taxed at the individual'sregular tax rate, which in 2010 could go up to 35%, but dividends received were taxed at amaximum rate of 15%.The maximum federal tax rate on corporate income in 2010 was 50%.Corporations obtain capital for use in their operations by borrowing and by raising equity capital,either by selling new common stock or by retaining earnings. The cost of debt capital is theinterest paid on the debt, and the cost of the equity is the dividends paid on the stock. Both ofthese costs are deductible from income when calculating income for tax purposes.Question 10Other things held constant, which of the following actions would increase the amount of cash ona company's balance sheet?AnswerThe company purchases a new piece of equipment.The company repurchases common stock.The company pays a dividend.The company issues new common stock.The company gives customers more time to pay their bills.Question 11Aubey Aircraft recently announced that its net income increased sharply from the previous year,yet its net cash flow from operations declined. Which of the following could explain thisperformance?AnswerThe company's operating income declined.The company's expenditures on fixed assets declined.The company's cost of goods sold increased.The company's depreciation and amortization expenses declined.The company's interest expense increased.Question 12Which of the following statements is CORRECT?AnswerThe primary difference between EVA and accounting net income is that when net income iscalculated, a deduction is made to account for the cost of common equity, whereas EVArepresents net income before deducting the cost of the equity capital the firm uses.MVA gives us an idea about how much value a firm's management has added during the lastyear.MVA stands for market value added, and it is defined as follows:MVA = (Shares outstanding)(Stock price) + Book value of common equity.EVA stands for economic value added, and it is defined as follows:EVA = EBIT(1-T)-(Investor-supplied op. capital) x (A-T cost of capital).EVA gives us an idea about how much value a firm's management has added over the firm's life.Question 13

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Which of the following statements is CORRECT?AnswerAll corporations other than non-profit corporations are subject to corporate income taxes, whichare 15% for the lowest amounts of income and 35% for the highest amounts of income.The income of certain small corporations that qualify under the Tax Code is completely exemptfrom corporate income taxes. Thus, the federal government receives no tax revenue from thesebusinesses.All businesses, regardless of their legal form of organization, are taxed under the Business TaxProvisions of the Internal Revenue Code.Small businesses that qualify under the Tax Code can elect not to pay corporate taxes, but thentheir owners must report their pro rata shares of the firm's income as personal income and paytaxes on that income.Congress recently changed the tax laws to make dividend income received by individuals exemptfrom income taxes. Prior to the enactment of that law, corporate income was subject to doubletaxation, where the firm was first taxed on the income and stockholders were taxed again on theincome when it was paid to them as dividends.Question 14Which of the following factors could explain why Regal Industrial Fixtures had a negative netcash flow last year, even though the cash on its balance sheet increased?AnswerThe company repurchased 20% of its common stock.The company sold a new issue of bonds.The company made a large investment in new plant and equipment.The company paid a large dividend.The company had high amortization expenses.Question 15Which of the following statements is CORRECT?AnswerThe statement of cash needs tells us how much cash the firm will require during some futureperiod, generally a month or a year.The four most important financial statements provided in the annual report are the balance sheet,income statement, cash budget, and the statement of stockholders' equity.The balance sheet gives us a picture of the firm's financial position at a point in time.The income statement gives us a picture of the firm's financial position at a point in time.The statement of cash flows tells us how much cash the firm has in the form of currency anddemand deposits.Question 16Which of the following statements is CORRECT?AnswerNet cash flow (NCF) is defined as follows:NCF = Net income-Depreciation and Amortization.Changes in working capital have no effect on free cash flow.Free cash flow (FCF) is defined as follows:FCF = EBIT(1-T)+ Depreciation and Amortization

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-Capital expenditures required to sustain operations-Required changes in net operating working capital.Free cash flow (FCF) is defined as follows:FCF = EBIT(1-T)+ Depreciation and Amortization + Capital expenditures.Net cash flow is the same as free cash flow (FCF).Question 17Analysts following Armstrong Products recently noted that the company's operating net cashflow increased over the prior year, yet cash as reported on the balance sheet decreased. Which ofthe following factors could explain this situation?AnswerThe company issued new long-term debt.The company cut its dividend.The company made a large investment in a profitable new plant.The company sold a division and received cash in return.The company issued new common stock.Question 18If a bank loan officer were considering a company's request for a loan, which of the followingstatements would you consider to be CORRECT?AnswerOther things held constant, the lower the current ratio, the lower the interest rate the bank wouldcharge the firm.The lower the company's EBITDA coverage ratio, other things held constant, the lower theinterest rate the bank would charge the firm.Other things held constant, the higher the debt ratio, the lower the interest rate the bank wouldcharge the firm.Other things held constant, the lower the debt ratio, the lower the interest rate the bank wouldcharge the firm.The lower the company's TIE ratio, other things held constant, the lower the interest rate thebank would charge the firm.Question 19Which of the following statements is CORRECT?AnswerIf a firm has the highest price/earnings ratio of any firm in its industry, then, other things heldconstant, this suggests that the board of directors should fire the president.If a firm has the highest market/book ratio of any firm in its industry, then, other things heldconstant, this suggests that the board of directors should fire the president.Other things held constant, the higher a firm's expected future growth rate, the lower its P/E ratiois likely to be.The higher the market/book ratio, then, other things held constant, the higher one would expectto find the Market Value Added (MVA).If a firm has a history of high Economic Value Added (EVA) numbers each year, and if investorsexpect this situation to continue, then its market/book ratio and MVA are both likely to be belowaverage.Question 20A firm wants to strengthen its financial position. Which of the following actions would increaseits current ratio?

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