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Principles of Finance

Mid Term Exam 1, Spring 2010


School of Business
United International University
Time: 1 hour 15 mins.

Name:________________________________________ Section:______ ID:_________________________


Instructions:
1. Answer the multiple choice questions in the question paper by circling the correct answer.
2. Answer the short questions in the answer script.
3. Use the answer script for rough work.
4. Calculators are allowed.

Part A: Choose the correct answer (20 x 1 = 20 marks)


1. In a ________, none of the owners are offered the protection of limited liability.
(a) limited liability company
(b) sole proprietorship
(c) corporation
(d) partnership
2. Which of the following is a true statement concerning corporations?
(a) It is difficult to transfer ownership of corporate shares
(b) When dividends are paid, corporate profits are taxed once
(c) The corporation has limited liability for business debts
(d) The life of the corporation is unlimited
(e) The equity money that can be raised by the corporation is limited to the current shareholders' personal wealth
3. Which of the following is equivalent to the "balance sheet identity?"
(a) Total assets plus equity equals total liabilities
(b) Total assets minus total liabilities equals equity
(c) Total assets minus long-term debt equals equity
(d) Total liabilities minus equity equals total assets
(e) Total liabilities plus total assets equals equity
4. Accounts payable are a component of
(a) equity
(b) long-term liabilities
(c) current assets
(d) net working capital
5. Which of the following is generally considered to have the highest degree of liquidity?
(a) Accounts receivable
(b) Long-term debt
(c) A patent or trademark
(d) Inventory
(e) Net fixed assets
6. Earnings per share is equal to
(a) net income divided by the par value of common stock
(b) operating income multiplied by number of common shares outstanding
(c) net income divided by the total number of common shares outstanding
(d) gross income multiplied by the par value of common stock
(e) net income divided by total stockholders' equity
7. Direct comparison of the financial statements of two firms in the same general industry may be difficult if
I. the size of the two firms' operations are different
II. the firms have identical product lines and operations
III. the firms' financial statements are prepared using different fiscal year-ends
(a) I only
(b) III only
(c) I and II only
(d) I, II, and III
(e) I and III only
8. Which of the following is NOT incorporated into calculation of the Du Pont identity?
(a) Profit margin
(b) Total asset turnover
(c) Equity multiplier
(d) Return on assets
(e) Receivables turnover
9. The quick ratio
(a) can be computed by using all short term liabilities except deferred taxes
(b)will always be larger than the current ratio
(c) incorporates all current assets except inventory
(d) excludes only the cash account from current assets in its computation
(e) considers only those assets and liabilities with a life of one year or less
10. All else unchanged, which of the following occurs when a firm buys inventory with cash?
(a) The quick ratio declines but the current ratio remains unchanged
(b) The quick ratio goes up if it was lower than 1 before the change
(c) The current ratio goes down if it was lower than 1 before the change
(d) The current ratio goes down if it was greater than 1 before the change
(e) The quick ratio goes up if it was greater than 1 before the change
11. Golf Inc. and Golfanatics Corp. are close competitors. Last year, both had the same level of cost of goods sold, but Golf
Inc. turned its inventory 5 times during the year while Golfanatics turned its inventory every 65 days. If the objective is to
keep inventory as low as possible (on average), which of the following is true?
(a) Golf Inc. did a better job since since its inventory turnover was lower
(b) Golf Inc. did a better job since its days sales in inventory was lower
(c) Golfanatics did a better job since its days sales in inventory was lower
(d) Golfanatics did a better job since its inventory turnover was lower
(e) Golf Inc. did a better job since its level of inventory was lower
12. In 3 years you are to receive $5,000. If the interest rate were to suddenly increase, the present value of that future
amount to you would
(a) fall.
(b) rise.
(c) remain unchanged.
(d) cannot be determined without more information.
13. The purpose of financial markets is to:
(a) increase the price of common stocks.
(b) lower the yield on bonds.
(c) allocate savings efficiently.
(d) control inflation.
14. Which of the following enjoys limited liability?
(a) A general partnership.
(b) A corporation.
(c) A sole proprietorship.
(d) None of the above.
15. "Shareholder wealth" in a firm is represented by:
(a) the number of people employed in the firm.
(b) the book value of the firm's assets less the book value of its liabilities.
(c) the amount of salary paid to its employees.
(d) the market price per share of the firm's common stock.
16. The market price of a share of common stock is determined by:
(a) the board of directors of the firm.
(b) the stock exchange on which the stock is listed.
(c) the president of the company.
(d) individuals buying and selling the stock.
17. The Du Pont Approach breaks down the earning power on shareholders' book value (ROE) as follows: ROE = ____.
(a) Net profit margin × Total asset turnover × Equity multiplier
(b) Total asset turnover × Gross profit margin × Debt ratio
(c) Total asset turnover × Net profit margin
(d) Total asset turnover × Gross profit margin × Equity multiplier

18. Which of the following statements is TRUE? (Assume that the yearly cash flows are identical for both annuities )
(a) The present value of an annuity due is greater than the present value of an ordinary annuity.
(b) The present value of an ordinary annuity is greater than the present value of an annuity due.
(c) The future value of an ordinary annuity is greater than the future value of an annuity due.
(d) Both B and C are correct.

19. The difference between equities and debt securities is


(a) Equities pay interest and debt securities pay dividends.
(b) Equities represent ownership in a corporation and debt represents a contractual liability of the corporation.
(c) Holders of equity securities get paid before holders of debt securities in the event of a bankruptcy.
(d) Equities are short term and debt securities are long term.

20. Study the time line and accompanying 5-period cash-flow pattern below.
0 1 2 3 4 5 6 Time line
|--------|--------|--------|--------|--------|--------|
$10 $10 $10 $10 $10 Cash flows
A B
The present value of the 5-period annuity shown above as of Point A is the present value of a 5-period
______________ , whereas the future value of the same annuity as of Point B is the future value of a 5-period
______________ .
(a) ordinary annuity; ordinary annuity.
(b) ordinary annuity; annuity due.
(c) annuity due; annuity due.
(d) annuity due; ordinary annuity.

Part B: Solve the following problems and select the correct answer. (10 x 2 = 20 marks)

1. Kanji Company had sales last year of $245 million. If its average collection period was 36 days, its accounts receivable
balance is closest to _____. (Assume a 365-day year.)
(a) $26.1 million
(b) $23.7 million
(c) $7.4 million
(d) $18.7 million
2. Krisle and Kringle's debt-to-total assets (D/TA) ratio is .4. What is its debt-to-equity (D/E) ratio?
(a) .2
(b) .6
(c) .667
(d) .333
3. You expect to deposit the following cash flows at the end of years 1 through 5, $1,000; $4,000; $9,000; $5,000; and
$2,000 respectively. What is the future account value at the end of year 6 if you can earn 10% compounded annually?
(a) $15,633.62
(b) $21,000.00
(c) $25,178.10
(d) $27,695.91

4. What is the future value of $25,000 received today if it is invested at 6.5% compounded annually for six years?
(a) 17,133.35
(b) 27,476.42
(c) 36,478.56
(d) 39,521.75
(e) 41,374.89
5. You want to put some money away for your child's college education. College will cost $65,000 in 18 years. You can earn
8% compounded annually. How much do you need to invest today?
(a) 16,266.19
(b) 15,258.17
(c) 13,690.82
(d) 11,763.07
(e) 9,828.18
6. A 5-year ordinary annuity has periodic cash flows of $100 each year. If the interest rate is 8 percent, the present value of
this annuity is closest to which of the following?
(a) $331.20
(b) $399.30
(c) $431.24
(d) $486.65
(e) $586.70
7. In 1889, Vincent Van Gogh's painting "Sunflowers" sold for $125. One hundred years later it sold for $36 million. Had
the painting been purchased by your great-grandfather and passed on to you, how much would your average annually
compounded rate of return have been?
(a) 9.11%
(b) 10.09%
(c) 11.88%
(d) 11.99%
(e) 13.40%
8. What's the future value of $2,000 after 3 years if the nominal interest rate is 8% compounded monthly?
(a) 2,854.13
(b) 2,491.45
(c) 2,324.89
(d) 2,011.87
(e) 2,540.47
9. You need $2,000 to buy a new stereo for your car. If you have $800 to invest at 5% compounded annually, how long will
you have to wait to buy the stereo?
(a) 18.7 years
(b) 15.75 years
(c) 14.58 years
(d) 8.42 years
(e) 6.58 years
10. Calculate the Quick Ratio given that Current Assets = $1757, Inventory = $645. and Current Liabilities = $878.
(a) 0.9
(b) 1.27
(c) 1.78
(d) 2.15

Part C: Short questions (5 x 2 = 10 marks)

1. In financial markets, who are the providers of funds and who are the users? Name some benefits of financial markets.

2. Income Statement data for Green Corp and Red Corp. are presented below.
Green Corp Red Corp
Sales $750,000 $600,000
Cost of goods sold 450,000 390,000
Operating expenses 180,000 138,000
Income tax expense 36,000 21,000
Net income 84,000 51,000

Instructions
Prepare a a vertical analysis for the two companies and comment on their relative profitability.

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