-
web.groovymark@gmail.com
- December 23, 2024
Question 21
A company is evaluating a project with an initial investment of $300,000 and expects to generate cash inflows of $100,000 annually for the next 4 years. What is the project’s payback period?
- a) 3 years
- b) 4 years
- c) 2.5 years
- d) 3.5 years
Answer: a) 3 years
Explanation: The payback period is the time it takes to recover the initial investment. In this case, $100,000 per year for 3 years will recover the $300,000 investment.
Question 22
What is the main advantage of preferred stock compared to common stock?
- a) Preferred stockholders have voting rights
- b) Preferred stockholders receive dividends before common stockholders
- c) Preferred stockholders have a residual claim on assets
- d) Preferred stock can be issued without dilution of ownership
Answer: b) Preferred stockholders receive dividends before common stockholders
Explanation: Preferred stockholders have priority over common stockholders when it comes to dividend payments, but typically do not have voting rights.
Question 23
A company’s income statement shows Sales of $500,000, Cost of Goods Sold (COGS) of $300,000, and Operating Expenses of $100,000. What is the company’s gross profit?
- a) $100,000
- b) $200,000
- c) $300,000
- d) $400,000
Answer: b) $200,000
Explanation: Gross profit is calculated as Sales - COGS. In this case: $500,000 - $300,000 = $200,000.
Question 24
What is the main purpose of using derivatives in finance?
- a) To speculate on market movements
- b) To manage and hedge financial risks
- c) To generate higher returns than traditional investments
- d) To diversify a company’s assets
Answer: b) To manage and hedge financial risks
Explanation: Derivatives are financial instruments used primarily to hedge against risks such as fluctuations in interest rates, currency exchange rates, or commodity prices.
Question 25
Which of the following is a capital market instrument?
- a) Treasury Bills
- b) Certificates of Deposit
- c) Commercial Paper
- d) Corporate Bonds
Answer: d) Corporate Bonds
Explanation: Corporate bonds are long-term debt instruments traded in capital markets. Treasury Bills, CDs, and Commercial Paper are short-term instruments traded in money markets.
Question 26
Which of the following bonds has the lowest risk of default?
- a) Corporate Bonds
- b) Municipal Bonds
- c) High-Yield Bonds
- d) Treasury Bonds
Answer: d) Treasury Bonds
Explanation: Treasury bonds are issued by the U.S. government and are considered to have the lowest risk of default compared to corporate, municipal, or high-yield bonds.
Question 27
What does the term “free cash flow” refer to?
- a) The amount of cash available after all operating expenses have been paid
- b) Cash available for distribution to shareholders and creditors after all reinvestment needs have been met
- c) The cash generated by a company before taxes are deducted
- d) The cash inflows from a company’s operating activities
Answer: b) Cash available for distribution to shareholders and creditors after all reinvestment needs have been met
Explanation: Free cash flow is the cash left over after a company has funded its operating expenses and capital expenditures, available for distribution to investors.
Question 28
A company’s current assets are $50,000, and its current liabilities are $30,000. What is its current ratio?
- a) 1.5
- b) 1.67
- c) 2.0
- d) 2.5
Answer: b) 1.67
Explanation: The current ratio is calculated as Current Assets / Current Liabilities. In this case: $50,000 / $30,000 = 1.67.
Question 29
Which of the following is an unsystematic risk?
- a) Inflation
- b) Interest rate changes
- c) Government regulations
- d) A company’s CEO resigns
Answer: d) A company’s CEO resigns
Explanation: Unsystematic risk is company-specific, such as a CEO resignation, and can be diversified away. Systematic risks, like inflation and interest rates, affect the entire market.
Question 30
What is the primary purpose of a company’s cost of capital?
- a) To determine the risk-free rate
- b) To calculate the company’s liquidity
- c) To evaluate the minimum return required on investments
- d) To measure profitability
Answer: c) To evaluate the minimum return required on investments
Explanation: The cost of capital represents the minimum return a company must earn on its investments to satisfy both debt and equity investors.
Question 31
If a company has an ROE of 12% and its retention ratio is 40%, what is the company’s sustainable growth rate?
- a) 4.8%
- b) 7.2%
- c) 10%
- d) 12%
Answer: b) 7.2%
Explanation: The sustainable growth rate is calculated as ROE × Retention Ratio. In this case: 12% × 40% = 4.8%.
Question 32
Which of the following is an example of a financing activity on the Statement of Cash Flows?
- a) Paying suppliers for inventory
- b) Paying dividends to shareholders
- c) Purchasing equipment
- d) Collecting cash from customers
Answer: b) Paying dividends to shareholders
Explanation: Financing activities include transactions with creditors and shareholders, such as paying dividends, issuing stock, or repaying debt.
Question 33
If a company’s sales increase by 10% and its operating leverage is 2, what will be the expected percentage increase in operating income?
- a) 5%
- b) 10%
- c) 15%
- d) 20%
Answer: d) 20%
Explanation: Operating leverage amplifies the effect of changes in sales on operating income. With an operating leverage of 2, a 10% increase in sales results in a 20% increase in operating income.
Question 34
A bond has a face value of $1,000, a coupon rate of 6%, and matures in 10 years. What is the total amount of interest the bondholder will receive over the bond’s life?
- a) $60
- b) $600
- c) $1,000
- d) $1,600
Answer: b) $600
Explanation: The annual interest payment is $1,000 × 6% = $60. Over 10 years, the bondholder will receive $60 × 10 = $600 in total interest.
Question 35
Which of the following is considered a short-term liquidity ratio?
- a) Debt-to-Equity Ratio
- b) Current Ratio
- c) Price-to-Earnings Ratio
- d) Return on Equity
Answer: c) Current ratio
Explanation: The current ratio compares a company’s current assets to its current liabilities, helping assess its ability to cover short-term obligations.
Question 36
If a company’s total debt is $400,000 and its total equity is $600,000, what is its debt-to-equity ratio?
- a) 0.5
- b) 0.67
- c) 1.0
- d) 1.5
Answer: b) 0.67
Explanation: The debt-to-equity ratio is calculated as Total Debt / Total Equity. In this case: $400,000 / $600,000 = 0.67.
Question 37
A company has a cost of debt of 6%, a cost of equity of 10%, and a tax rate of 30%. If the company has an equal amount of debt and equity, what is its WACC?
- a) 6.8%
- b) 7.0%
- c) 7.4%
- d) 8.0%
Answer: c) 7.4%
Explanation: WACC is calculated as (Weight of Debt × After-tax Cost of Debt) + (Weight of Equity × Cost of Equity). In this case, WACC = (0.5 × 6% × (1 - 0.30)) + (0.5 × 10%) = 7.4%.
Question 38
What does the Price-to-Earnings (P/E) ratio measure?
- a) The market value of a company’s assets
- b) The ratio of a company’s earnings to its debt
- c) The price investors are willing to pay for each dollar of a company’s earnings
- d) The price a company pays for each dollar of revenue
Answer: c) The price investors are willing to pay for each dollar of a company’s earnings
Explanation: The P/E ratio measures how much investors are willing to pay for each dollar of earnings, helping assess the valuation of a company’s stock.
Question 39
Which financial statement shows a company’s sources and uses of cash over a specific period?
- a) Income Statement
- b) Balance Sheet
- c) Statement of Retained Earnings
- d) Statement of Cash Flows
Answer: d) Statement of Cash Flows
Explanation: The statement of cash flows provides detailed information on cash inflows and outflows from operating, investing, and financing activities over a specific period.
Question 40
If a company issues new shares of stock, what effect does this have on the company’s equity?
- a) Equity decreases
- b) Equity remains the same
- c) Equity increases
- d) Equity is converted to debt
Answer: c) Equity increases
Explanation: Issuing new shares increases the company’s equity because it raises capital by selling ownership stakes in the company.
