D076 - Finance Skills for Managers
Questions
A company called Bobby's Books is considering purchasing a new bookbinding machine. The company
calculates the hurdle rate of the project to be 9% and the IRR to be 11%. Should the company purchase
the bookbinding machine?
No, because the old bookbinding machine still works.
Yes, because the IRR exceeds the cost of capital.
No, because the hurdle rate is lower than the IRR.
Yes, because newer models of equipment are always profitable investments. - ✔✔✔Yes, because the
IRR exceeds the cost of capital.
Correct! When the IRR of a project is greater than the hurdle rate (the required rate of return, or cost of
capital), it indicates that the company should accept the project.
A company currently has a ratio of 1.5 but hopes to improve the ratio to 2 to align more with the
industry benchmark. To achieve this goal, costs were cut in production through an investment in
efficient equipment, and the company achieved a higher profit margin. If this continues, you are certain
that the firm will achieve its goal in two years. What is this an example of?
Trend analysis
Flexibility
Cross-sectional analysis
Progress measurement - ✔✔✔Progress measurement
Correct! You are comparing the company's ratio to the goal and checking how the company is
progressing toward the goal.
A company is trying to finance a project with a mortgage loan from a bank. The company's assessment
of the project indicates that the company may experience several years of loss until the project becomes
profitable. This means that the company might lose its ability to pay back the loan and the interest on
the mortgage. What action might the bank take to protect its interest?
Let the company manipulate accounting procedures.
Set a strict covenant that the company cannot easily achieve.
,Push the company to pay dividends to the shareholders.
Let the company take the mortgage loan because of its long partnership with the bank. - ✔✔✔Set a
strict covenant that the company cannot easily achieve.
Correct! By setting a strict covenant, there is a risk that the company may not meet its obligation, which
would deter the company from taking on risky projects.
A company that produces soap, shampoo, lotion, and other personal care products has recently taken a
hit due to a competitor's new product line. The company decides to reduce wages for its labor force to
save money while the company focuses on building up its reputation again, but the company's labor
force goes on strike to protest the pay cuts. What type of risk does the strike represent?
Non-diversifiable risk
Systematic risk
Market risk
Idiosyncratic risk - ✔✔✔Idiosyncratic risk
Correct! Idiosyncratic risk is the same as firm-specific risk. Since the strike will most likely affect only this
firm, it is a firm-specific risk.
A company's officers and board of directors are selling their stocks in the firm at higher prices due to
false accounting reports that made the stock seem more valuable than it truly was. Which ethical issue is
occurring in this situation?
Conflict between work and personal affairs
Pursuing individual interest over client interests
Agency problem due to conflicting interests
Maximizing shareholder value - ✔✔✔Agency problem due to conflicting interests
Correct! Accounting manipulation by management in pursuit of higher stock-related compensation is an
example of an agency problem.
A firm had sales of $100,000 this month. However, the firm received only $90,000 in cash from sales.
Why would the firm receive $10,000 less cash than its monthly sales?
,Because the firm did not make all sales on cash
Because the firm paid down $10,000 on a loan
Because the firm purchased inventory on credit this month
Because the firm paid cash for inventory purchased - ✔✔✔Because the firm did not make all sales on
cash
Correct! Some sales are made on credit rather than cash, and a portion of credit sales are collected in
the following months after the sales.
A firm has paid off its short-term loans more quickly in the past couple of years. What might this trend
indicate about the firm's financial ratios?
Its leverage ratio is decreasing.
Its activity ratio is increasing.
Its profitability ratio is decreasing.
Its liquidity ratio is increasing. - ✔✔✔Its liquidity ratio is increasing.
Correct! Liquidity is a measure of the ability of a firm to convert short-term assets into cash. Paying off
short-term loans quickly is an indication that a firm is quite liquid, so the firm's liquidity ratio would be
increasing.
A large corporation is looking to merge with another large corporation. Which financial institution can
help them do this?
Central bank
Pension fund
Investment bank
Private equity institution - ✔✔✔Investment bank
Correct! Investment banks facilitate complex financial deals, like mergers.
A local start-up company just hit its five-year anniversary and is planning an initial public offering
sometime this year. In order to issue public stock, which market will the company use?
, Dealer market
Primary market
Secondary market - ✔✔✔Primary market
Correct! When a company issues stock for the first time to raise capital, shares must initially be sold
through a primary market.
Futures and options market
About a year ago, the short-term Treasury bill had 1.54% interest and the long-term Treasury note had
2.54% interest. This week, the 1-year Treasury bill has an interest rate of 3.13%, while the 10-year
Treasury note has an interest rate of 2.28%. What does this information indicate about the future
economy?
It may indicate a decreasing unemployment rate along with higher wages.
It may reflect an expectation that the economy will grow in the future along with higher inflation.
It may indicate an economic downturn.
It may indicate that the economy is in a steady state. - ✔✔✔It may indicate an economic downturn.
Correct! Since the long-term Treasury interest rate is lower than the short-term rate, it has an inverted
yield curve, which may indicate an economic downturn.
An investor just purchased a bond for $973 that has a par value of $1,000. What type of bond is this?
A par bond
A preferred bond
A discount bond
A premium bond - ✔✔✔A discount bond
Correct! When the market price is less than the par price of a bond, you know that the YTM is currently
higher than the coupon rate of that particular bond, so it is being sold at a discount.
Questions
A company called Bobby's Books is considering purchasing a new bookbinding machine. The company
calculates the hurdle rate of the project to be 9% and the IRR to be 11%. Should the company purchase
the bookbinding machine?
No, because the old bookbinding machine still works.
Yes, because the IRR exceeds the cost of capital.
No, because the hurdle rate is lower than the IRR.
Yes, because newer models of equipment are always profitable investments. - ✔✔✔Yes, because the
IRR exceeds the cost of capital.
Correct! When the IRR of a project is greater than the hurdle rate (the required rate of return, or cost of
capital), it indicates that the company should accept the project.
A company currently has a ratio of 1.5 but hopes to improve the ratio to 2 to align more with the
industry benchmark. To achieve this goal, costs were cut in production through an investment in
efficient equipment, and the company achieved a higher profit margin. If this continues, you are certain
that the firm will achieve its goal in two years. What is this an example of?
Trend analysis
Flexibility
Cross-sectional analysis
Progress measurement - ✔✔✔Progress measurement
Correct! You are comparing the company's ratio to the goal and checking how the company is
progressing toward the goal.
A company is trying to finance a project with a mortgage loan from a bank. The company's assessment
of the project indicates that the company may experience several years of loss until the project becomes
profitable. This means that the company might lose its ability to pay back the loan and the interest on
the mortgage. What action might the bank take to protect its interest?
Let the company manipulate accounting procedures.
Set a strict covenant that the company cannot easily achieve.
,Push the company to pay dividends to the shareholders.
Let the company take the mortgage loan because of its long partnership with the bank. - ✔✔✔Set a
strict covenant that the company cannot easily achieve.
Correct! By setting a strict covenant, there is a risk that the company may not meet its obligation, which
would deter the company from taking on risky projects.
A company that produces soap, shampoo, lotion, and other personal care products has recently taken a
hit due to a competitor's new product line. The company decides to reduce wages for its labor force to
save money while the company focuses on building up its reputation again, but the company's labor
force goes on strike to protest the pay cuts. What type of risk does the strike represent?
Non-diversifiable risk
Systematic risk
Market risk
Idiosyncratic risk - ✔✔✔Idiosyncratic risk
Correct! Idiosyncratic risk is the same as firm-specific risk. Since the strike will most likely affect only this
firm, it is a firm-specific risk.
A company's officers and board of directors are selling their stocks in the firm at higher prices due to
false accounting reports that made the stock seem more valuable than it truly was. Which ethical issue is
occurring in this situation?
Conflict between work and personal affairs
Pursuing individual interest over client interests
Agency problem due to conflicting interests
Maximizing shareholder value - ✔✔✔Agency problem due to conflicting interests
Correct! Accounting manipulation by management in pursuit of higher stock-related compensation is an
example of an agency problem.
A firm had sales of $100,000 this month. However, the firm received only $90,000 in cash from sales.
Why would the firm receive $10,000 less cash than its monthly sales?
,Because the firm did not make all sales on cash
Because the firm paid down $10,000 on a loan
Because the firm purchased inventory on credit this month
Because the firm paid cash for inventory purchased - ✔✔✔Because the firm did not make all sales on
cash
Correct! Some sales are made on credit rather than cash, and a portion of credit sales are collected in
the following months after the sales.
A firm has paid off its short-term loans more quickly in the past couple of years. What might this trend
indicate about the firm's financial ratios?
Its leverage ratio is decreasing.
Its activity ratio is increasing.
Its profitability ratio is decreasing.
Its liquidity ratio is increasing. - ✔✔✔Its liquidity ratio is increasing.
Correct! Liquidity is a measure of the ability of a firm to convert short-term assets into cash. Paying off
short-term loans quickly is an indication that a firm is quite liquid, so the firm's liquidity ratio would be
increasing.
A large corporation is looking to merge with another large corporation. Which financial institution can
help them do this?
Central bank
Pension fund
Investment bank
Private equity institution - ✔✔✔Investment bank
Correct! Investment banks facilitate complex financial deals, like mergers.
A local start-up company just hit its five-year anniversary and is planning an initial public offering
sometime this year. In order to issue public stock, which market will the company use?
, Dealer market
Primary market
Secondary market - ✔✔✔Primary market
Correct! When a company issues stock for the first time to raise capital, shares must initially be sold
through a primary market.
Futures and options market
About a year ago, the short-term Treasury bill had 1.54% interest and the long-term Treasury note had
2.54% interest. This week, the 1-year Treasury bill has an interest rate of 3.13%, while the 10-year
Treasury note has an interest rate of 2.28%. What does this information indicate about the future
economy?
It may indicate a decreasing unemployment rate along with higher wages.
It may reflect an expectation that the economy will grow in the future along with higher inflation.
It may indicate an economic downturn.
It may indicate that the economy is in a steady state. - ✔✔✔It may indicate an economic downturn.
Correct! Since the long-term Treasury interest rate is lower than the short-term rate, it has an inverted
yield curve, which may indicate an economic downturn.
An investor just purchased a bond for $973 that has a par value of $1,000. What type of bond is this?
A par bond
A preferred bond
A discount bond
A premium bond - ✔✔✔A discount bond
Correct! When the market price is less than the par price of a bond, you know that the YTM is currently
higher than the coupon rate of that particular bond, so it is being sold at a discount.
