1. A current ratio is presently 2 : 1 for a corporation that sells
sporting goods. Which of the following statements about
the ratio is correct?
A. The quick ratio is smaller than the current ratio.
B. The current ratio is unaffected by exchanging bonds
C. The current ratio is increased by purchasing a store with
cash, with potential to increase corporate sales.
D. The current ratio is unchanged by using cash to retire
2. Accountants suggest that assets should be valued at
B. the lower of market or cost.
D. the higher of market or cost.
3. If annual interest rates are 10 percent, which of the following values will be the lowest?
A. The future value of a $100 investment after 3 years
B. The future value of an investment after 4 years, if $100 is deposited annually
C. The present value of an investment that will be worth $100 after 2 years
D. The present value of an annuity that will pay $200 a year, at the end of each of the
next 4 years
4. If $800 is deposited in a savings account that pays an interest rate of 5 percent
annually, how much money will be in the account after 15 years?
A. $1,663 C. $384
B. $1,609 D. $238
5. Profitability ratios are used to measure
A. liquidity. C. performance.
B. leverage. D. turnover.
6. If the interest rate on an account is 8 percent annually, what is the present value of
$40,000 to be received 5 years from today?
A. $6,188 C. $22,073
B. $10,018 D. $27,223
7. Which of the following is calculated by adding total liabilities plus equity?
A. Total assets C. Inventory
B. Hidden assets D. Operating income
8. What is the future value of an ordinary annuity if you deposit $500 per year for the
next 10 years in an account that earns an interest rate of 13 percent annually?
A. $1,700 C. $9,210
B. $5,000 D. $14,990
9. At an interest rate of 20 percent compounded annually, how many years will it take for
an investment of $6,000 to grow to $10,000?
A. 1 year C. 5 years
B. 3 years D. 7 years
10. Which of the following types of ratio is used to measure activity?
A. A leverage ratio C. A profitability ratio
B. A turnover ratio D. A liquidity ratio
11. If you deposit $700 in an account today, and the money grows to $1,800 in 14 years,
what rate of annual interest have you earned?
A. 4 percent C. 10 percent
B. 7 percent D. 50 percent
12. Which of the following is considered to be a current liability?
B. Raw materials
C. Accounts payable
D. Short-term money market instruments
13. Which of the following would be the most likely cause of an increase in
A. The faster collection of accounts receivable
B. Lowered sales
C. An increase in the inventory level
D. A reduction in the price of the product
14. What is the future value of an ordinary annuity if you deposit $1,500 per year for the
next 5 years into an account that earns an interest rate of 5 percent annually?
A. $8,288 C. $6,322
B. $7,500 D. $1,914
15. Which of the following is calculated by subtracting the cost of goods sold and administrative
expense from net sales?
A. Operating income C. Total liabilities
B. Accounts receivable D. Inventory cost
16. If an account has an annual interest rate of 12 percent, what is the present value of
$1,000,000 to be received 10 years from today?
A. $3,105,848 C. $321,973
B. $789,633 D. $56,984
17. If an account currently has a value of $84,000 and earns an interest rate of 4 percent
annually, for how many years can you withdraw $10,000 from the account?
A. 8 C. 12
B. 10 D. 20
18. If you deposit $10,000 in an investment that yields 6 percent annually, how many
years will it take for your investment to double in value?
A. 12 years C. 18 years
B. 15 years D. 20 years
19. Discounting determines the worth of funds to be received in the future in terms of their
A. present value.
B. future value.
C. cost factor.
D. time factor.
20. If annual interest rates are 10 percent, which of the following values will be
A. The future value of an annuity after 4 years, if $100 is deposited annually
B. The future value of a $100 investment after 3 years
C. The present value of an investment that will be worth $100 after 2 years
D. The present value of an annuity that will pay $200 a year, at the end of each
of the next 4 years
1. A financial intermediary transfers
A. savings to households.
B. savings to borrowers.
C. stocks to brokers.
D. new stock issues to buyers.
2. If an individual buys stock on margin and its price rises,
A. must put up additional collateral.
B. must pay tax on the unrealized gain.
C. must pay interest on the borrowed funds.
D. may take delivery of the stock.
3. Which of the following best explains why commercial banks assume significant liabilities?
A. All commercial bank deposits are liabilities.
B. The loans commercial banks write can be risky.
C. Banks may pay too much interest on their deposits.
D. Banks may not charge enough interest on their loans to fund
operations and loan default risk.
4. Which of the following best explains a potential disadvantage of leaving securities in
A. Securities held in street name become the property of the custodian and the
customer is only beneficiary of the securities.
B. Correspondence sent by securities issuers may not be forwarded to brokerage
clients who own securities held in street name.
C. Securities held in street name can’t be quickly purchased or sold.
D. In the event of class action suits against securities issuers, the custodian, not the
beneficial owner (customer), is the only party that may benefit from court orders.
5. Which of the following assets is the most liquid?
A. Money and antiques
B. Bonds and real estate
C. Savings accounts and checking accounts
D. Stocks and bonds
6. When investing in securities, an investor may place a limit order that
A. limits the amount of commissions.
B. specifies when the stock will be purchased.
C. establishes the exchange on which the security is to be bought or sold.
D. states a price at which the investor seeks to buy or sell the stock.
7. Terry buys 100 shares of XYZ stock on margin at $20 per share. If the margin requirement
is 45 percent, the interest rate is 10 percent, and he holds the security for 1
year, how much interest must he pay?
A. $2,000 C. $110
B. $200 D. $90
8. The reserves of commercial banks must be held against
A. the bank as equity. C. savings deposits.
B. losses. D. commercial loans.
9. Which of the following statements about specialists is correct?
A. A specialist stresses one type of investment.
B. A specialist buys only stock.
C. A specialist analyzes corporate securities.
D. A specialist makes a market in securities.
10. The term structure of interest rates involves the relationship between
A. risk and yields. C. term and yields.
B. yields and bond ratings. D. stock and bond yields.
11. A stock is currently selling for $36 a share. What is your gain/loss if you sell the stock
short and the price rises to $62?
A. You would lose $26 per share. C. You would gain $13 per share.
B. You would gain $26 per share. D. You would lose $6 per share.
12. Which of the following is indicated by an upward-sloping yield curve?
A. Lower prices for short-term maturity
B. Higher prices for long-term maturity
C. Lower interest rates for long-term maturity
D. Higher interest rates for long-term maturity
13. Which of these statements best describes the function of a preliminary prospectus?
A. A preliminary prospectus is the document that registers a new security issue with
the Securities and Exchange Commission (SEC) and on which the SEC bases its
approval or disapproval of the issue for the general investing public.
B. A preliminary prospectus informs the investing public about many of the terms of a
proposed new security offering.
C. A preliminary prospectus announces to the SEC and the investing public the terms
of a new public issue, including the issuer’s planned use of the proceeds of the sale
and the proposed price of the issue.
D. A preliminary prospectus, or “red herring,” serves to provide both valid information
about the proposed issue and conflicting information designed to confuse potential
purchasers of the issue.
14. Which of the following statements about pension plans is correct?
A. A pension plan that grants mortgage loans is an example of a
B. A pension plan that grants mortgage loans can’t suffer losses.
C. A pension plan that grants mortgage loans is called a savings and loan association.
D. A pension plan that grants mortgage loans isn’t an example of a
15. Money market mutual funds invest in
A. corporate bonds.
B. corporate stock.
C. federal government treasury bills.
D. federal government bonds.
16. Entering an order to sell stock at $17 when the bid is $18–$19 is an example of a
A. market order. C. margin payment.
B. short sale. D. limit order.
17. Which of the following statements about organized security markets is correct?
A. Organized security markets are examples of financial intermediaries.
B. Organized security markets transfer resources from savers to borrowers.
C. Organized security markets provide secondary markets.
D. Organized security markets aren’t subject to regulation.
18. The minimum margin requirement is established by
A. brokerage firms. C. the SEC.
B. Congress. D. the Federal Reserve.
19. If an investor sells short, then he or she
A. buys an odd lot of a security. C. anticipates a price increase.
B. sells securities from his or her portfolio. D. anticipates a price decrease.
20. Which of the following is a federally insured investment?
A. A savings account in a national commercial bank
B. A certificate of deposit in excess of $100,000
C. A life insurance policy
D. Commercial bank assets
1. What is the value of a common stock if the growth rate
is 8 percent, the most recent dividend was $2, and investors
require a 15 percent return on similar investments?
A. $25.78 C. $28.57
B. $27.34 D. $30.85
2. Which of the following preferred stock properties would
provide the best argument favoring purchase of preferred
stock by an investor?
A. When long-term bond yields decline, the value of preferred
stock can potentially rise.
B. Because preferred stock trading volume is lower than
common stock trading volume, preferred stock prices are
less volatile than common stock prices.
C. The yield differential between preferred stock and
bonds is smaller than would be expected on the basis
of risk differentials.
D. Preferred stockholders receive preferential treatment over
lower-class, common stockholders when the corporation
earns sufficient profit to pay creditors and shareholders.
3. If a company fails to meet the terms of indenture, the company is
A. bankrupt. C. profitable.
B. in default. D. in registration.
4. Which of the following is the best conclusion, given only the following information:
ZYX Corporation’s earnings after taxes have declined by 3.13% from the year earlier.
During the past three months, ZYX purchased from investors (retired) 7.5% of the
corporation’s outstanding preferred stock shares, which pay dividends at 5% of par.
A. ZYX Corporation’s net income decline is largely attributable to the expense it
incurred to purchase its preferred stock.
B. ZYX Corporation’s preferred stock purchase should enhance earnings after taxes next
year because it will earn 5% dividend income from its new preferred stock holdings.
C. ZYX Corporation’s purchase of preferred stock had no effect on the firm’s asset balance.
D. ZYX Corporation’s purchase of preferred stock improved its capacity to pay preferred
5. A 20-year $1,000 bond has a coupon of 8 percent. What would be the price if the
coupon is paid semiannually and comparable bonds yield 10 percent?
A. $1,000 C. $828
B. $895 D. $624
6. What is the value of a preferred stock that pays an annual dividend of $4 a share if
competitive yields are 5 percent?
A. $80 C. $40
B. $60 D. $20
7. Which of the following bonds is supported by collateral?
A. Convertible bonds C. Equipment trust certificates
B. Income bonds D. Debentures
8. If a perpetual preferred stock pays a dividend of $5 a year, and yields rise
from 10 percent to 12 percent, the price of the stock will
A. rise from $50 to $60. C. rise from $41.67 to $50.
B. fall from $50 to $41.67. D. fall from $60 to $50.
9. Interest is exempt from federal income taxation on
A. equipment trust certificates.
B. zero coupon bonds.
C. federal bonds such as savings bonds.
D. state of Florida bonds.
10. A 30-year $1,000 bond has an annual coupon of 6 percent. What would be the current
yield if the bond sells for $622?
A. 9.6 percent C. 5.6 percent
B. 6 percent D. 5 percent
11. Dividends come at the expense of
A. interest. C. liabilities.
B. retained earnings. D. stock.
12. A 10-year $1,000 bond has a coupon of 9 percent. What would be the price if the
coupon is paid annually and comparable bonds yield 10 percent?
A. $1,900 C. $1,000
B. $1,159 D. $938
13. An increase in investors’ required return will cause the value of a common stock to
A. rise. C. remain unchanged.
B. fall. D. remain stable or rise slightly.
14. If investors require a rate of return of 8 percent, what is the value of a perpetual
preferred stock that pays a fixed dividend of $2?
A. $16 C. $32
B. $25 D. $50
15. A $1,000 bond has an annual coupon of 5 percent and a price of $692. Find the
number of years to maturity if comparable bonds yield 10 percent.
A. 5 years C. 20 years
B. 10 years D. 30 years
16. A common stock costs $40.50, the current dividend is $1.50, and the growth in the
value of the shares and the dividend is 8 percent. What is the annual rate of return
on an investment in this stock?
A. 4.5 percent C. 10 percent
B. 8 percent D. 12 percent
17. Preferred stock and bonds are similar because
A. they both have voting power.
B. interest and dividend payments are legal obligations.
C. neither interest nor dividends are tax deductible.
D. both may be subject to a call option.
18. What is the value of a $100 par preferred stock that must be retired after 10 years if it
pays a dividend of $5 annually and the investor requires a 6 percent rate of return?
A. $92 C. $110
B. $100 D. $122
19. A perpetual preferred stock pays a fixed dividend of $9 and sells for $100. What is the
stock’s rate of return?
A. 6.5 percent C. 11 percent
B. 9 percent D. 12.5 percent
20. The value of common stock depends on the
A. price of the stock.
B. retirement date.
C. present value of cash flows.
D. coupon rate.
1. A firm’s sales increase by 50 percent and inventory was
$100,000. According to the percent of sales method of
forecasting, what will the new inventory be?
A. $100,000 C. $150,000
B. $120,000 D. $175,000
2. If a firm produces 50,000 widgets and sells each unit for $20.50,
what is the total revenue generated by this production?
A. $10,250 C. $1,025,000
B. $100,250 D. $10,250,000
3. If investors want to limit financial risk and maximize their
control of the business, which of the following forms of
business would they prefer?
A. A sole proprietorship C. An S corporation
B. A limited partnership D. A corporation
4. Break-even analysis is concerned with the relationship between
A. financial leverage and risk. C. debt and equity.
B. total costs and revenues. D. dividends and retained earnings.
5. A union contract suggests that labor costs may be
A. variable. C. a noncash expense.
B. fixed. D. undetermined.
6. A product sells for $5 per unit. If fixed costs are $1,000 and variable costs are $2 per
unit, what is the degree of operating leverage at 2,000 units?
A. 0.83 C. 1.2
B. 1.0 D. 2.0
7. Which of the following situations would provide corporate management with the
strongest rationale to carry forward current-year losses?
A. Management projects taxable income to remain unchanged over the next five years.
B. Early in his first term this year, the President of the United States initiated legislation
and signed into law a significant increase in income tax rates.
C. Management projects pre-tax losses over the next two years, and possibly even
four years into the future.
D. Congress just passed a very popular bill that reduces marginal federal income
8. Which of these situations offers the best rationale for organizing a business as a
A. You’re an entrepreneur and you want two others’ expertise, former business
partners, to help execute your business plan.
B. You want your small new business, which is operating out of your garage, to pay
you and your partner (your spouse) dividends for which income tax will only be
paid by you or your business, not both.
C. Management needs to raise money through a stock offering, but does not want to
relinquish control of the business to stockholders.
D. Management rejects the idea of personally assuming liability for the business.
9. Airlines have a high degree of operating leverage because of
A. a large investment in fixed assets.
B. small fixed expenses.
C. insufficient government regulation.
D. a large use of debt financing.
10. Currently, a firm’s accounts payable is 5 percent of sales. If the level of sales is anticipated
to increase from $10,000 to $20,000, what is the level of accounts payable
forecasted by the percent of sales method?
A. $250 C. $750
B. $500 D. $1,000
11. Which of the following statements about fixed costs is correct?
A. Fixed costs don’t change with the level of output.
B. Fixed costs don’t change with the size of the firm.
C. Fixed costs are greater than variable costs.
D. Fixed costs are paid before variable costs.
12. If ABC, Inc. has $650,000 in sales and $230,000 in expenses, what are the firm’s
earnings before interest and taxes (EBIT)?
A. $850,000 C. $420,000
B. $650,000 D. $325,000
13. Which of the following is an advantage of the sole proprietorship?
A. Ease of formation C. Limited liability
B. Joint ownership D. Ease of transfer of ownership
14. A product sells for $2 per unit. If fixed costs are $200 and variable costs are $1 per
unit, what is the break-even level of output?
A. 200 units C. 100 units
B. 150 units D. 50 units
15. Which of the following tends to vary spontaneously with changes in the level of sales?
A. Long-term debt C. Plant
B. Accounts payable D. Paid-in capital
16. If Sam’s Diner has an EBIT of $350,000, what are the diner’s net earnings after paying
$50,000 in taxes and $34,000 in interest?
A. $434,000 C. $311,000
B. $334,000 D. $266,000
17. Which of the following is usually a variable expense?
A. Salaries C. Wages
B. Rent D. Insurance premiums
18. If a firm substitutes fixed for variable costs, which of the following will occur?
A. The use of financial leverage will be increased.
B. The degree of operating leverage will be increased.
C. The break-even level of output will be reduced.
D. The profits will always be higher.
19. Which of the following events would be most likely to increase the quantity breakeven
point, assuming other factors remain constant?
A. Reduced marketplace competition enables LMN Corporation to raise its selling
price for finance textbooks.
B. The pressure has subsided: The property owner, who rents space to your
small manufacturing plant, has agreed to blacktop the employee and customer
C. The city council has finally been persuaded: Your taxi business will pay lower water
and sewer rates.
D. XYZ Corp agrees to increase its sales-commissions paid to employees by 12 percent.
20. Which of the following is an advantage of a corporation?
A. Permanence C. Elimination of double taxation
B. Ease of formation D. Dilution of ownership
1. Which of the following statements best explains why a rising
ratio of debt-to-total assets increases the cost of debt?
A. As the ratio increases, creditors require higher interest
rates to compensate them for higher default risk.
B. As total assets decline in relation to a stable debt level,
C. As debt increases, the contribution of more expensive
equity financing decreases.
D. If debt remains constant while the ratio increases,
rising assets must be finance with more expensive
2. The flotation costs of issuing new securities
A. decrease the cost of capital.
B. encourage the retention of earnings.
C. encourage external financing.
D. don’t affect the cost of capital.
3. If the net present values of two mutually exclusive investments are positive, a firm
A. both investments.
B. neither investment.
C. the investment with the higher present value.
D. the investment with the higher net present value.
4. Which of the following statements about the cost of debt is correct?
A. The cost of debt is equal to the firm’s interest rate.
B. The cost of debt is greater than the cost of equity.
C. The cost of debt is less than the cost of equity.
D. The cost of debt is greater than the cost of preferred stock.
5. The internal rate of return and net present value methods of capital budgeting assume
that the cash flows are reinvested at the
A. cost of capital.
B. internal rate of return.
C. cost of capital for IRR and the internal rate of return for NPV.
D. cost of capital for NPV and the internal rate of return for IRR.
6. The optimal capital structure involves
A. minimizing the cost of all funds.
B. maximizing the cost of all funds.
C. minimizing the weighted average of the cost of funds.
D. maximizing the weighted average of the cost of funds.
Use the information in the following table to answer Questions 7, 8, 9, 10, and 11.
Coupon rate = 7 percent Marginal tax rate = 35 percent
Average tax rate = 32 percent Common stock dividend (D0) = $6
Price of common stock = $80 Preferred stock dividend = $4
Price of preferred stock = $50 Growth rate of common stock
dividend = 6 percent
Bond yield risk premium = 7
Risk-free rate of return = 6
Return on the market = 12 percent Beta = 1.2
7. According to the information provided in the table, what is the cost of debt?
A. 2.45 percent C. 6.25 percent
B. 4.55 percent D. 7.0 percent
8. According to the information in the table, what is the cost of preferred stock?
A. 8 percent C. 10 percent
B. 9 percent D. 12 percent
9. According to the information in the table, what is the cost of equity using the capital
asset pricing model (CAPM)?
A. 12 percent C. 13.95 percent
B. 13.2 percent D. 14.4 percent
10. According to the information in the table, what is the cost of equity using the bond
yield plus risk premium method?
A. 12 percent C. 13.95 percent
B. 13.2 percent D. 14 percent
11. According to the information in the table, what is the cost of equity using the expected
A. 12 percent C. 13.95 percent
B. 13.2 percent D. 14.4 percent
12. A firm should make an investment if the present value of the cash inflows on the
A. less than zero.
B. greater than zero.
C. less than the cost of the investment.
D. greater than the cost of the investment.
13. Which of the following statements about retained earnings is correct?
A. Retained earnings have no cost.
B. Retained earnings are the firm’s cheapest source of funds.
C. Retained earnings have the same cost as new shares of stock.
D. Retained earnings are cheaper than the cost of new shares.
Use the following information to complete Questions 14, 15, 16, and 17.
A firm has two investment opportunities. Each investment costs $2,000, and the firm’s cost
of capital is 8 percent. The cash flows of each investment are shown in the following table:
Cash Flow of
Cash Flow of
Year 1 $1,800 $900
Year 2 $600 $900
Year 3 $500 $900
Year 4 $400 $900
14. According to the information in the table, the NPV for Investment A is
A. $871. C. $2,871.
B. $1,300. D. $3,300.
15. According to the information in the table, the NPV for Investment B is
A. $980. C. $2,980.
B. $1,600. D. $3,600.
16. Based on the information in the table, if the investments are mutually exclusive,
the firm should select
A. neither investment.
B. both investments.
C. the higher-NPV investment.
D. the higher-payback investment.
17. Based on the information in the table, if the investments are independent, the firm
A. the higher IRR investment.
B. all investments with an IRR that’s greater than 8 percent.
C. all investments with an IRR that’s less than 8 percent.
D. only one investment if the IRR is greater than 8 percent.
18. A firm should reject an investment if the internal rate of return (IRR) on the investment is
A. greater than the cost of capital. C. greater than the interest rate.
B. less than the cost of capital. D. less than the interest rate.
19. The net present value of an investment will be higher if
A. the cost of capital is higher.
B. there’s no salvage value.
C. the cost of the investment is lower.
D. a firm uses straight-line depreciation.
20. Which of the following statements about the marginal cost of capital is correct?
A. The marginal cost of capital is a firm’s cost of debt and equity finance.
B. The marginal cost of capital is constant once the optimal capital structure
C. The marginal cost of capital declines as flotation costs alter equity financing.
D. The marginal cost of capital refers to the cost of additional funds.