Chapter 3
Banks and Other Financial Institutions

TRUE-FALSE QUESTIONS

    1.    The structure of the modern banking system includes commercial banks, savings and loans, mutual savings banks, and credit unions.
 
    2.    An investment bank accepts deposits, makes loans, and issues checking accounts.
 
    3.    Commercial banks are aggressive and often assume large amounts of risk.
 
    4.    Part of the reason that the Banking Act of 1933 was passed was in response to the large numbers of bank failures.
 
    5.    Credit unions are cooperative nonprofit organizations that exist primarily to provide member depositors with consumer credit.
 
    6.    The National Banking Act of 1864 made it possible for banks to receive federal charters.
 
    7.    Today, reserve requirements imposed by the Federal Reserve apply only to member banks.
 
    8.    The principal assets of all depository institutions are cash, securities, and loans.
 
    9.    Savings and loans were first known as building societies.
 
    10.    Branch banks are those banking offices that are controlled by a single parent bank.
 
    11.    The bank holding company may not engage in direct banking activities.
 
    12.    Branch banking is permitted on an interstate basis by all state banks.
 
    13.    Nonbank financial conglomerates are large corporations that offer various financial services, such as mortgage insurance, real estate management, and consumer finance.
 
    14.    The main provisions of the Monetary Control Act of 1980 are deregulation and monetary control.
 
    15.    The Monetary Control Act prohibited the Federal Reserve from controlling thrift institutions.
 
    16.    Pension funds receive contributions from employees and/or their employers and invest the proceeds on behalf of the employees.
 
    17.    The Glass-Steagall Act was repealed with the passage of the Gramm-Leach-Bliley Act of 1999.
 
    18.    The Federal Reserve Act of 1913 created a system of central banks in the United States.
 
    19.    The prime rate of interest has been relatively stable during the past twenty-five years.
 
    20.    Primary capital consists of owners’ capital, preferred stock, debt convertible into common stock, and loan loss reserves.
 
    21.    International banking exists when banks operate in more than one country.
 
    22.    Major types of financial institutions in the U.S. include commercial banks, mutual funds, insurance companies, and pension funds.
 
    23.    Investment companies sell shares in their firms to individuals and invest the pooled proceeds in corporate and government securities.
 
    24.    Insurance companies sell shares in their firms to individuals and invest the pooled proceeds in corporate and government securities.
 
    25.    Investment banking firms sell shares in their firms to individuals and invest the pooled proceeds in corporate and government securities.
 
    26.    Mutual funds are open-end investment companies that can issue an unlimited number of shares to its investors and use the pooled proceeds to purchase corporate and government securities.
 
    27.    Insurance companies receive contributions from employees and/or their employers and invest the proceeds on behalf of the employees for use during their retirement years.
 
    28.    Pension funds receive contributions from employees and/or their employers and invest the proceeds on behalf of the employees for use during their retirement years.
 
    29.    Investment banking firms sell or market new securities issued by businesses to individual and institutional investors.
 
    30.    Investment banking firms assist individuals to purchase new or existing securities issues or to sell previously purchased securities.
 
    31.    Mortgage banking firms provide loans directly to consumers and businesses or aid individuals in obtaining financing of durable goods and homes.
 
    32.    Commercial banks provide loans directly to consumers and businesses or aid individuals in obtaining financing of durable goods and homes.
 
    33.    Commercial banks accept deposits and makes loans to individuals and businesses.
 
    34.    Investment banks accept deposits and makes loans to individuals and businesses.
 
    35.    The U.S. banking system as it exists today is relatively unchanged since just before the Civil War.
 
    36.    Credit unions are cooperative nonprofit organizations that exist primarily to provide member depositors with consumer credit.
 
    37.    Savings and loan associations are cooperative nonprofit organizations that exist primarily to provide member depositors with consumer credit.
 
    38.    The primary types of assets on a bank’s balance sheet include cash and deposits.
 
    39.    The primary types of assets on a bank’s balance sheet include cash, securities, and loans.
 
    40.    The primary type of liability on a bank’s balance sheet is deposits.
 
    41.    The effective rate of interest is generally lower on a standard loan than an otherwise equivalent discount loan.
 
    42.    Bank solvency reflects the ability to meet depositor withdrawals and to pay off other liabilities when due.
 
    43.    Bank solvency reflects the ability to keep the value of a bank’s assets greater than its liabilities.
 
    44.    Bank solvency is the likelihood that a bank will be unable to meet depositor withdrawal demands and other liabilities when due.
 
    45.    Credit risk is the likelihood that a bank will be unable to meet depositor withdrawal demands and other liabilities when due.
 
    46.    Credit risk is the chance of nonpayment or delayed payment of interest or principal.
 
    47.    Secondary reserves are vault cash and deposits held at other depository institutions and at Federal Reserve Banks.
 
    48.    Interest rate risk results from possible price fluctuations in fixed-rate debt instruments associated with changes in market interest rates.
 
    49.    The total capital ratio (TCR) can be computed as total capital divided by total assets times 100.
 
    50.    The Bretton Woods Agreement was an agreement between major central banks to adopt capital adequacy requirements for internationally involved banks.
 

MULTIPLE-CHOICE QUESTIONS

    1.    Which of the following institutions is not part of the modern banking system?
a.    credit unions
b.    savings and loan associations
c.    mutual funds
d.    mutual savings banks

 
    2.    The Bank of North America:
a.    was the first incorporated bank in the United States
b.    was patterned after the Central Bank of England
c.    was established to assist in financing the Civil War
d.    all the above
e.    none of the above

 
    3.    The notes of the Bank of North America
a.    served as a circulating medium of exchange
b.    loaned liberally to the government
c.    were redeemed in metallic coins upon demand
d.    all the above
e.    none of the above

 
    4.    Early chartered banks included:
a.    the Bank of North America
b.    the Bank of Massachusetts
c.    the Bank of New York
d.    All the above

 
    5.    Which of the following are not thrift institutions?
a.    credit unions
b.    savings and loan institutions
c.    commercial banks
d.    all the above

 
    6.    The National Banking Act of 1864 provided for:
a.    federally chartered banks
b.    the establishment of a system of central banks
c.    deregulation and monetary control
d.    the establishment of deposit insurance

 
    7.    The Depository Institutions Deregulation and Monetary Control Act:
a.    established a system of central banks
b.    has resulted in more competition among depository institutions
c.    increased federal deposit insurance from $40,000 to $80,000 for each account
d.    established minimum capital requirements for banks with federal charters

 
    8.    The Federal Deposit Insurance Corporation Improvement Act of 1991:
a.    transferred the reserves and functions of the Federal Savings and Loan Insurance Corporation to the FDIC
b.    required that failed banks be handled in such a way as to provide the lowest cost to the FDIC
c.    increased federal deposit insurance from $40,000 to $100,000 for each account
d.    extended federal deposit insurance to S&L depositors

 
    9.    The most basic functions of depository institutions are:
a.    safekeeping for depositors
b.    record keeping for depositors
c.    efficient and economical transfer of payments
d.    accepting deposits and granting loans

 
    10.    Which of the following is not an asset of depository institutions?
a.    cash
b.    unsecured loans
c.    time deposits
d.    U.S. government securities

 
    11.    The First Bank of the United States:
a.    is still in operation in Massachusetts
b.    transferred funds from region to region
c.    was unchartered
d.    all the above

 
    12.    Savings banks have nearly three quarters of their assets in the form of:
a.    securities
b.    cash
c.    unsecured loans
d.    real estate mortgages and mortgage-backed securities

 
    13.    The principal liabilities of all depository institutions are:
a.    certificates of deposits
b.    deposits
c.    loans
d.    all the above

 
    14.    The principal assets of savings banks are:
a.    securities
b.    vault cash and deposits at other banks
c.    real estate mortgages
d.    all the above

 
    15.    The first thrift institutions were:
a.    The First and Second Banks of the United States
b.    savings banks and Savings and Loans
c.    credit unions
d.    all the above

 
    16.    The Bank Holding Company Act of 1956:
a.    established uniform standards to evaluate the legality of bank holding company acquisitions
b.    allowed bank holding companies to acquire credit card companies
c.    defined a bank holding company as one which owns 25% or more of the voting
shares of each of two or more banks
d.    included all the above

 
    17.    Credit unions are:
a.    for profit organizations
b.    made up of individuals who possess common bonds of association
c.    institutions that derive funds from investment activities
d.    all the above

 
    18.    NOW accounts:
a.    are not subject to ceiling rates under Regulation Q
b.    enable depository institutions to compete effectively for funds that were flowing in large amounts to nonblank money market funds
c.    typically pay interest rates equal to that paid by money market funds
d.    all the above

 
    19.    The adequacy of capital for commercial banks as measured by regulatory authorities is:
a.    a composite of various asset risk categories
b.    a measure of investment success
c.    based on the total amount of deposits of a bank
d.    based on the ratio of federal government obligations to deposits

 
    20.    The interest rate charged by banks for short-term unsecured loans to their highest quality business customers is referred to as the:
a.    discount rate
b.    federal fund rate
c.    prime rate
d.    all the above

 
    21.    The Garn–St. Germain Depository Institutions Act, among other things:
a.    extended the Fed’s control to thrift institutions and to commercial banks that are not members of the Fed
b.    enabled depository institutions to issue money market accounts with no regulated interest rate ceiling
c.    was designed to assist the investment banking industry
d.    all the above

 
    22.    The Resolution Trust Corporation was brought into existence to:
a.    help savings and loan institutions invest funds in a wide range of higher yielding instruments
b.    authorize savings and loan institutions to issue a new money market account
with no regulated interest rate ceiling
c.    take over and liquidate the assets of failed savings and loan institutions
d.    all the above

 
    23.    The Federal Savings and Loan Insurance Corporation:
a.    has ceased operations and has been replaced by the FDIC in its insuring operations
b.    protects credit unions
c.    insures money market accounts
d.    is responsible for insuring deposits at savings banks

 

    24.    The First Bank of the United States ceased operations because:
a.    it was superseded by the Second Bank of the United States
b.    of the opposition of state banking interests
c.    its charter had expired and there was no provision for its renewal
d.    the need to provide financing for the Civil War was not supported by Congress

 
    25.    The Second Bank of the United States was created to:
a.    replace the First Bank of the United States
b.    appease political interests
c.    restore order to chaotic banking conditions
d.    all the above

 
    26.    During the colonial period in the nation’s history, banks depended on:
a.    their own issue of paper money
b.    foreign sources for their loanable funds
c.    deposits of foreign currency such as the Spanish dollar
d.    the investment of their own stockholders

 
    27.    There is more of a need for international banking because of:
a.    decreased international trade
b.    a stable exchange of goods and services among nations
c.    the large international trade deficit of the United States
d.    national savings and investment rates that dictate small flows of capital among nations

 
    28.    Which of the following statements is false?
a.    It is not possible for a bank to invest all of its funds in profitable loans or securities.
b.    All states now permit statewide branch banking.
c.    Regulation Q established interest rate ceilings on time and savings deposits.
d.    The depositors of a bank are creditors and hence have a claim that is superior to that of stockholders in the event of liquidation.

 
    29.    Which of the following statements is false?
a.    Thrift institutions are like commercial banks in that retained earnings and
certificates of deposits add to fund sources.
b.    The larger the volume of assets and deposits in relation to the capital contribution
of the stockholders, the larger the margin of safety for depositors.
c.    Capital funds include capital stock, surplus, and undivided profits.
d.    All the above statements are correct.

 
    30.    Which of the following statements is most correct?
a.    FDIC membership is required only for banks having national charter.
b.    The First Bank of the United States was the first incorporated bank created along modern banking lines.
c.    Secured loans represent the single most important activity of the commercial bank.
d.    All the above statements are false.

 
    31.    Which of the following statements is most correct?
a.    New capital adequacy standards were established for foreign banking offices in this country to achieve an 8% risk-based capital ratio by the end of 1992 in order to conform to domestic bank requirements.
b.    The proportion of branch banking offices has doubled since 1951.
c.    The National Banking Act provided that national banks could issue their own
paper money secured either by their own deposits or government bonds.
d.    All the above statements are equally correct.

 
    32.    Which of the following statements is most correct?
a.    The National Banking Act of 1894 has long lost any relationships to
modern bank regulation.
b.    The Federal Reserve System was created in large measure to force state
chartered banks into conformity with nationally chartered banks.
c.    “Wildcat banking” during the first half of the 1800s referred to risky banking practices by many state banks, such as excessive note issues, lack of adequate bank capital, and insufficient reserves against their notes and deposits.
d.    All the above statements are equally correct.

 
    33.    In 1989, the Financial Institution Reform, Recovery and Enforcement Act provided for all but which of the following?
a.    strengthening the federal deposit insurance programs
b.    the creation of the Resolution Trust Corporation
c.    enhanced enforcing powers
d.    stronger capital standards for thrift institutions

 
    34.    Capital notes:
a.    are subject to reserve requirements
b.    are assets of the banks that issue them
c.    are always subordinated to the claims of bank depositors
d.    reflect short-term borrowing on the part of the bank

 
    35.    The Depository Institutions Deregulation and Monetary Control Act of 1980 did not:
a.    eliminate all Regulation Q requirements
b.    allow all depository institutions to borrow from the Fed on the same basis
c.    increase federal deposit insurance
d.    amend the Home Owner’s Loan Act of 1993

 
    36.    The holding-company device to control two or more commercial banks:
a.    has diminished in importance in recent years
b.    has increased in importance in recent years
c.    is limited to state chartered banks
d.    is sometimes described as chain banking

 

    37.    One of the most significant advantages claimed by branch banking is:
a.    lower interest rates are usually available from branch bank
b.    convenience for customers
c.    banking operations are easier to regulate
d.    all the above

 


    38.    Legislation that permits depository institutions to compete with money market mutual funds on an equal basis with respect to interest rates offered to investors is the:
a.    Garn–St. Germain Depository Institutions Act
b.    National Banking Act
c.    Hunt Commission legislation
d.    Depository Institutions Deregulation and Monetary Control Act

 
    39.    The function of the capital accounts of a commercial bank is to:
a.    meet bank reserve requirements
b.    provide funds for real estate loans
c.    provide a cushion for possible bank losses
d.    support the purchase of bank buildings and equipment

 
    40.    The Federal Deposit Insurance Corporation:
a.    shares its operation with the Federal Reserve System by having the same
board of directors
b.    is owned by member banks of the Federal Reserve System
c.    provides strength for insured banks by partial ownership of their stock
d.    has as one of its board members the United States Comptroller of the Currency

 
    41.    Unit banking means:
a.    a bank may have only one full-service office
b.    the bank is owned by a unit trust
c.    all branch offices are controlled by a central unit
d.    none of the above

 
    42.    Limited branch banking:
a.    permits banks to located offices within a geographically defined distance
of the main office
b.    is controlled by the Federal Reserve system
c.    means that banks may only engage in certain limited activities
d.    none of the above

 
    43.    Statewide branch banking:
a.    is prohibited in all 50 states
b.    means that branch systems are less likely to fail than independent systems
c.    permits banks to located within a geographically defined distance of the main office
d.    none of the above

 
    44.    The principal assets of banks do not include:
a.    cash
b.    loans
c.    time deposits
d.    securities owned

 
    45.    Foreign banks in the United States:
a.    are prohibited in all 50 states
b.    need the approval of the Federal Reserve
c.    are not subject to federal examination
d.    none of the above

 
    46.    Capital notes:
a.    are the prime assets of commercial banks
b.    reflect long-term of a bank for purposes of bolstering the equity of the bank
c.    current investments of a bank
d.    none of the above

 
    47.    Which of the following would not be part of primary bank capital?
a.    bank premises
b.    common stock of the bank
c.    loan loss reserves
d.    perpetual preferred stock

 
    48.    Legislation that provided for the separation of commercial banking and investment banking activities in the United States is called
a.    Garn–St. Germain Depository Institutions Act
b.    Glass-Steagall Act
c.    Hunt Commission legislation
d.    Depository Institutions Deregulation and Monetary Control Act

 
    49.    The National Banking Act of 1864:
a.    established minimum capital requirements for federally chartered banks
b.    regulated loans with respect to safety and liquidity
c.    established minimum reserve requirements
d.    all of the above

 
    50.    The Monetary Control Act:
a.    extended the Fed’s control to thrift institutions and non-member commercial banks
b.    has resulted in more competition among depository institutions
c.    increased federal deposit insurance from $40,000 to $80,000 for each account
d.    established minimum capital requirements for banks with federal charters

 
    51.    The primary purpose of this Act was to aid the savings and loan industry
a.    Garn–St. Germain Depository Institutions Act
b.    Glass-Steagall Act
c.    Hunt Commission legislation
d.    Depository Institutions Deregulation and Monetary Control Act

 
    52.    In general, the effective rate of interest on a discount loan
a.    is lower than that on standard loan
b.    is higher than that on a standard loan
c.    is identical to that on a standard loan
d.    none of the above

 
    53.    Primary reserves
a.    include the cash assets of the firm under the heading “cash and balances due from depository institutions.
b.    are short term securities held by banks that are quickly converted into cash at little cost to the banks.
c.    reflects the bank’s ability to meet depositor withdrawals.
d.    reflects the bank’s ability to keep the value of a bank’s assets greater than its liabilities.

 
    54.    Reasons that banks become insolvent include all of the following EXCEPT:
a.    excessive credit risk
b.    interest rate risk
c.    insufficient collateral
d.    all of the above are correct

 
    55.    Our system of national banks:
a.    was designed to destroy state banking
b.    was an integral part of the Federal Reserve Act
c.    was replaced by Federal Reserve banking
d.    came into existence during the Civil War

 
    56.    Commercial banks obtain the bulk of their loanable funds from:
a.    depositors
b.    the issue of certificates of deposit
c.    sale of bank stock
d.    sale of subordinated debenture bonds

 
    57.    The likelihood that borrowers are ill and would not be able to make interest and principal payments is an example of:
a.    interest rate risk
b.    credit risk
c.    liquidity risk
d.    capital adequacy risk

 

    58.    Financial institutions include:
a.    banks
b.    pension funds
c.    insurance companies
d.    all of the above

 
    59.    Another name for an open-end investment company is a:
a.    brokerage firm
b.    finance company
c.    mutual fund
d.    investment bank

 
    60.    Major types of financial institutions include all of the following EXCEPT:
a.    commercial banks
b.    pension funds
c.    insurance companies
d.    brokerage firms

 
    61.    Major types of financial institutions include all of the following EXCEPT:
a.    commercial banks
b.    pension funds
c.    insurance companies
d.    all of the above are major financial institutions

 
    62.    An open-end investment company that can issue an unlimited number of its shares to investors and use the pooled proceeds to purchase corporate and government securities is called a (n)
a.    mutual fund
b.    pension fund
c.    insurance company
d.    brokerage firm

 
    63.    An organization that sells or markets new securities issued by businesses to individuals and institutional investors is called a (n)
a.    mutual fund
b.    investment bank
c.    insurance company
d.    brokerage firm

 
    64.    An organization that received contributions from employees and/or their employers and invests the proceeds on behalf of the employees for use during their retirement years is called a (n)
a.    mutual fund
b.    savings bank
c.    pension fund
d.    retirement fund

 
    65.    An organization that sells shares in their firms to individuals and others and invests the proceeds in corporate and government securities is called a (n)
a.    investment company
b.    investment bank
c.    insurance company
d.    brokerage firm

 
    66.    An organization that provides loans directly to consumers and businesses or aid individuals in obtaining financing for durable goods is called a (n)
a.    commercial bank
b.    investment bank
c.    savings and loan
d.    finance company

 
    67.    The _______________________ provided for separation of commercial banking and investment banking activities in the United States.
a.    Glass Steagall Act
b.    Gramm-Leach-Bliley Act
c.    Garn-Saint Germain Act
d.    Depository Institutions Deregulation and Monetary Control Act

 
    68.    The _______________________ was designed to reduce or eliminate interest rate limitations and increase access to various sources of funds available to banks and thrifts and expand the Federal Reserve’s control over thrifts and non-member banks.
a.    Glass Steagall Act
b.    Gramm-Leach-Bliley Act
c.    Garn-Saint Germain Act
d.    Depository Institutions Deregulation and Monetary Control Act

 
    69.    The _______________________ was designed mainly to assist the savings and loan industry.
a.    Glass Steagall Act
b.    Gramm-Leach-Bliley Act
c.    Garn-Saint Germain Act
d.    Depository Institutions Deregulation and Monetary Control Act

 
    70.    The three basic ways to clear a check through the U.S. banking system includes all of the following EXCEPT:
a.    through a Federal Reserve Bank
b.    through the U.S. Treasury Bank
c.    through a bank clearinghouse
d.    bank to bank

 
    71.    The _______________________ made it possible for banks to receive federal charters and provided a basis for national banking laws.
a.    Glass Steagall Act
b.    National Banking Act
c.    Garn-Saint Germain Act
d.    Federal Reserve Act

 
    72.    The _______________________ established the U.S. central banking system and increased the effectiveness of commercial banking in general.
a.    Glass Steagall Act
b.    National Banking Act
c.    Garn-Saint Germain Act
d.    Federal Reserve Act

 
    73.    The item on the liabilities and equity section of a bank’s balance sheet that represents the smallest proportion of bank’s assets is:
a.    deposits
b.    owner’s capital
c.    securities
d.    federal funds

 Level: Medium
 
    74.    The item on the liabilities and equity section of a bank’s balance sheet that represents the largest proportion of a typical bank’s assets is:
a.    deposits
b.    owner’s capital
c.    securities
d.    federal funds

 
    75.    The item on the assets side of a bank’s balance sheet that represents the largest proportion of bank assets is:
a.    deposits
b.    owner’s capital
c.    securities
d.    loans

 
    76.    __________________ is the process by which individual savings are accumulated in depository institutions and, in turn, lent or invested.
a.    Investing
b.    Financial intermediation
c.    The multiplier effect
d.    Lending
e.    none of the above

 
    77.    __________________ accept savings from individuals and then lend these pooled savings to businesses, governments, and individuals.
a.    Insurance companies
b.    Commercial finance companies
c.    Depository institutions
d.    Investment banks
e.    none of the above

 
    78.    __________________ accept savings from individuals and then lend these pooled savings to businesses, governments, and individuals.
a.    Insurance companies
b.    Commercial finance companies
c.    Government institutions
d.    Investment banks
e.    none of the above

 
    79.    __________________ collect premiums on insurance policies and employee/employer contributions from pension fund participants and provide retirement benefits and insurance against major financial losses.  
a.    Banks
b.    Contractual savings institutions
c.    Investment banking firms
d.    Brokerage firms
e.    none of the above

 
    80.    __________________ collect premiums on insurance policies and employee/employer contributions from pension fund participants and provide retirement benefits and insurance against major financial losses.  
a.    Banks
b.    Personal service firms
c.    Investment banking firms
d.    Brokerage firms
e.    none of the above

 
    81.    __________________ are the two important forms of contractual savings organizations.  
a.    Insurance companies and pension funds
b.    banks and insurance companies
c.    Investment banks and pension funds
d.    Pension funds and brokerage firms
e.    none of the above

 
    82.    __________________ are the two important forms of contractual savings organizations.  
a.    Insurance companies and brokerage firms
b.    banks and insurance companies
c.    Investment banks and pension funds
d.    Pension funds and brokerage firms
e.    none of the above

 
    83.    __________________ accept and invest individual savings and also facilitate the sale and transfer of securities between investors.     
a.    Securities firms
b.    Pension funds
c.    Asset management companies
d.    none of the above

 
    84.    Investment companies (mutual funds), investment banking firms, and brokerage firms are the primary types of ____________.   
a.    banks
b.    securities firms
c.    pension funds
d.    finance companies
e.    none of the above

 
    85.    _______________ provide loans directly to consumers and businesses and help borrowers obtain mortgage loans on real property.   
a.    banks
b.    securities firms
c.    pension funds
d.    finance firms
e.    none of the above

 
    86.    _______________ are non-commercial bank depository institutions that include savings banks and credit unions, which accumulate individual savings and lend primarily to other individuals.   
a.    Thrift institutions
b.    Securities firms
c.    Pension funds
d.    Finance firms
e.    none of the above

 
    87.    _______________ are non-commercial bank depository institutions that include savings banks and credit unions, which accumulate individual savings and lend primarily to other individuals.   
a.    Banks
b.    Securities firms
c.    Pension funds
d.    Finance companies
e.    none of the above

 
    88.    _______________ accept the savings of individuals and lend pooled savings to individuals primarily in the form of mortgage loans and operate almost entirely in New England , New York, and New Jersey, with most of their assets continuing to be invested in mortgage loans.   
a.    Commercial banks
b.    Thrift institutions
c.    Savings banks
d.    Credit unions
e.    none of the above

 
    89.    _______________ accept the savings of individuals and lend pooled savings to individuals primarily in the form of mortgage loans and operate almost entirely in New England , New York, and New Jersey, with most of their assets continuing to be invested in mortgage loans.   
a.    Commercial banks
b.    Thrift institutions
c.    Credit unions
d.    Finance companies
e.    none of the above

 
    90.    _______________ are cooperative nonprofit organizations that exist primarily to provide member depositors with consumer credit, including the financing of automobiles and the purchase of homes, and derive their funds almost entirely from the savings of their members.    
a.    Commercial banks
b.    Thrift institutions
c.    Savings banks
d.    Credit unions
e.    none of the above

 
    91.    _______________ are cooperative nonprofit organizations that exist primarily to provide member depositors with consumer credit, including the financing of automobiles and the purchase of homes, and derive their funds almost entirely from the savings of their members.    
a.    Commercial banks
b.    Thrift institutions
c.    Savings banks
d.    Brokerage firms
e.    none of the above

 
    92.    _______________ sell or market new securities issued by businesses to individual and institutional investors, whereas ______________ firms assist individuals who want to purchase new or existing securities issues or who want to sell previously purchased securities.     
a.    Brokerage firms, investment banks
b.    Investment banks, savings banks
c.    savings banks, investment banks
d.    Brokerage firms, savings banks
e.    none of the above

 
    93.    _______________ provide loans directly to consumers and businesses or aid individuals in obtaining financing of durable goods and homes, whereas ______________ originate mortgage loans on homes and other real property by bringing together borrowers and institutional investors.     
a.    thrift institutions, savings and loans
b.    thrift institutions, mortgage banking firms
c.    finance companies, savings and loans
d.    finance companies, mortgage banking firms
e.    none of the above

 
    94.    _______________ provide loans directly to consumers and businesses or aid individuals in obtaining financing of durable goods and homes, whereas ______________ originate mortgage loans on homes and other real property by bringing together borrowers and institutional investors.     
a.    thrift institutions, savings and loans
b.    thrift institutions, mortgage banking firms
c.    property brokers, savings and loans
d.    property brokers, mortgage banking firms
e.    none of the above

 
    95.    If $5,000 is borrowed on a discount basis and the rate is 10 percent, the annual percentage interest rate on this loan would be:     
a.    10%
b.    10.1%
c.    11%
d.    11.1%
e.    none of the above

 
    96.    The Equity Capital Ratio for a bank with owners’ equity of $3 million and total assets of $50 million would be:     
a.    3%
b.    6%
c.    2.83%
d.    5.66%
e.    none of the above

 
    97.    A(n) _______________ mortgage is a home loan made to a borrower with a relatively low credit score indicating the likelihood that loan payments might be missed when due.     
a.    adjustable rate
b.    subprime
c.    credit swap
d.    high performance
e.    none of the above

 
    98.    The process of ______________ which is the process of pooling and packaging mortgage loans into debt securities resulted in the creation of ______________.      
a.    securitization, pooled asset loans
b.    portfolio composition, mortgage backed securities
c.    issuing mortgage backed securities, securitization
d.    securitization, mortgage backed securities
e.    none of the above

 
    99.    The process of ______________ which is the process of pooling and packaging mortgage loans into debt securities resulted in the creation of ______________.      
a.    securitization, pooled asset loans
b.    portfolio composition, mortgage backed securities
c.    issuing mortgage backed securities, securitization
d.    specialization, mortgage backed securities
e.    none of the above

 
    100.    A ________ which is a security backed by mortgage-backed securities could be “sliced and diced” into different “tranches” are parts such that the different parts would appeal to different investors.     
a.    MPO
b.    CDO
c.    MDS
d.    MDO
e.    none of the above

Chapter 10
Bonds and Stocks: Characteristics and Valuation

TRUE-FALSE QUESTIONS

    1.    During periods of economic expansion, firms usually rely more on internal sources of funds.
 
    2.    Most of the annual funds raised from security issues come from corporate bond sales.
 
    3.    Long term business funds are obtained by issuing commercial paper and corporate bonds.
 
    4.    Private placements must be approved by the Securities and Exchange Commission (SEC).
 
    5.    Firms issue more bonds than equities.
 
    6.    A debt holder may force the firm to abide by the terms of the debt contract even if the result is reorganization or dissolution of the firm.
 
    7.    Bondholders have priority claims over equity holders to a firm’s assets and cash flows.
 
    8.    Bond covenants are the best way for bondholders to protect themselves against dubious management actions.
 
    9.    Bond issues of a single firm can have different bond ratings if their security provisions differ.
 
    10.    Mortgage bonds are secured by home mortgages.
 
    11.    The claims of collateralized bondholders are junior to the claims of debenture holders.
 
    12.    A convertible bond can be converted, at the issuing firm’s option, into a specific number of shares of the issuer’s common stock.
 
    13.    Callable bonds can be redeemed prior to maturity by the firm.
 
    14.    Eurodollar bonds are dollar-denominated bonds that are sold outside the United States.
 
    15.    Yankee bonds are U.S. dollar-denominated bonds that are issued in the United States by a foreign issuer.

 
    16.    Global bonds usually are denominated in U.S. dollars and have offering sizes that typically exceed $1 billion.

 
    17.    Preferred stock is an equity security that has a senior claim to the firm’s earnings and assets over bonds.
 
    18.    Callable preferred stock gives the corporation the right to retire the preferred stock at its option.
 
    19.    The higher the discount rate or yield to maturity, the lower the price of a bond.
 
    20.    The bond issuer does not necessarily know who is receiving interest payments on bearer bonds.
 
    21.    A bond with a coupon rate of 4% and a discount rate of 6% will pay $60 in interest each year.
 
    22.    A trustee represents the company to ensure that the covenants of the bond indenture are met.
 
    23.    Governmental agencies may not issue debenture bonds.
 
    24.    Corporate bonds are not as risky as common stocks; as a result, corporate bonds always lower returns to investors than do common stock.
 
    25.    The call price of a callable bond is typically equal to par value plus two years interest.
 
    26.    Zero coupon bonds are not suited for tax-exempt accounts such as IRAs or pension funds.
 
    27.    Inflation-protected Treasury notes have a principal value that changes in accordance with the consumer price index (CPI).

 
    28.    ADRs, or American Depository Receipts, which are traded on U.S. exchanges, represent shares of common stock that trade on foreign exchanges.

 
    29.    In general, research has shown that the performance of tracking stocks has exceeded that of parent company stocks.

 
    30.    A bond will sell at a discount if its required return or discount rate is greater than its coupon rate.

 
    31.    A bond will sell at a premium if its required return or discount rate is greater than its coupon rate.

 
    32.    Credit risk is another term for default risk.

 
    33.    Financial assets are claims against the income or assets of individuals, businesses, and governments.

 
    34.    Real assets are claims against the income or assets of individuals, businesses, and governments.

 
    35.    Most bonds currently issued in the United States today are registered bonds.

 
    36.    Most bonds currently issued in the United States today are bearer bonds.

 
    37.    The interest paid on bonds issued by corporations in the United States is tax deductible to the issuing corporation.

 
    38.    The dividends paid on stock issued by corporations in the United States are tax deductible to the issuing corporation.

 
    39.    The interest received by individuals on bonds issued by corporations in the United States is not tax deductible to the investor.

 

    40.    Bonds rated higher than BB+ by Standard & Poors and Fitch are considered to be investment grade issues.

 
    41.    Subordinate debentures are bonds whose claims are subordinate or junior to the claims of those holding debenture bonds.

 
    42.    Many callable bonds possess a call deferment period which is a specified period of time after the issue during which the bonds cannot be called.

 
    65.    Many convertible bonds possess a call deferment period which is a specified period of time after the issue during which the bonds cannot be called.

 
    43.    Many putable bonds possess a call deferment period which is a specified period of time after the issue during which the bonds cannot be called.

 
    44.    Global bonds are generally denominated in euros and are marketed globally.

 
    45.    Common stock possesses the highest claim on the assets and cash flow of the firm.

 
    46.    Common stock possesses the lowest claim on the assets and cash flow of the firm.

 
    47.    The par value of a common stock is an accounting and legal concept that bears no relationship to a firm’s stock price or book value.

 
    48.    The par value of a preferred stock is meaningful in that it is often used to determine the fixed annual dividend.

 
    49.    The par value of a common stock is meaningful in that it is often used to determine the fixed annual dividend.

 
    50.    Convertible preferred stock has a special provision that makes it possible to convert it to common stock of the corporation, generally at the stockholder’s option.

 


MULTIPLE-CHOICE QUESTIONS

    1.    Firms issue more equities than bonds for the following reason(s).
a.    it is cheaper to raise equity than to borrow
b.    bonds have a maturity date making them pricier
c.    both a and b are true
d.    none of the above are true

 
    2.    U.S. firms are continuing to raise more funds overseas include all of the following EXCEPT:
a.    it makes sense to raise funds in the county where a firm has a facility
b.    financing costs are sometimes lower overseas
c.    foreign underwriters often have more experience than U.S. underwriters
d.    issuers avoid the costly SEC approval process

 
    3.    Which type of bond is currently prohibited from being issued in the United States?
a.    bearer bonds
b.    unregulated debentures
c.    tax avoidance bonds
d.    income bonds

 
    4.    Preferred stock can have the following characteristic_______________?
a.    cumulative
b.    non-cumulative
c.    convertible
d.    all of the above

 
    5.    Private placements:
a.    are sold to the general public
b.    have expedited SEC scrutiny
c.    require public disclosure of the firm’s financial information
d.    none of the above

 

    6.    Which of the following is not an advantage of owning debt securities?
a.    high claim on cash flows of a firm
b.    highest return of corporate securities
c.    high claim on assets of in liquidation
d.    none of the above

 
    7.    A document which is administered by a trustee, and includes in great detail the various provisions of the loan agreement is called the:
a.    trust indenture
b.    debenture
c.    bond covenant
d.    bearer bond

 
    8.    All of the following represent bonds secured by real assets except a (n):
a.    closed-end mortgage bond
b.    equipment trust certificate
c.    debenture
d.    more than one of the above

 
    9.    A bond that can be changed into a specified number of shares of the issuer’s common stock is called a:
a.    retractable bond
b.    convertible bond
c.    callable bond
d.    collateralized bond

 
    10.    A bond that allows investors to force the issuer to redeem the bond prior to maturity is called a:
a.    convertible bond
b.    callable bond
c.    debenture bond
d.    putable bond

 
    11.    Dollar-denominated bonds that are issued in the United States by a foreign issuer are called:
a.    Eurodollar bonds
b.    foreign bonds
c.    Yankee bonds
d.    global bonds

 
    12.    Which of the following bonds may be secured by home mortgages?
a.    mortgage bonds
b.    collateralized mortgage obligations
c.    closed-end mortgage bonds
d.    open-end mortgage bonds

 
    13.    Which of the following types of bonds have the lowest risk?
a.    closed-end mortgage bond
b.    subordinated debenture
c.    open-end mortgage bond
d.    all the above would have the same risk

 
    14.    Which of the following types of stocks have the lowest risk to shareholders?
a.    common stock
b.    cumulative preferred stock
c.    non-cumulative preferred stock
d.    callable preferred stock

 
    15.    A bond’s value will be below its maturity value of $1,000 if it pays interest of $100 per year and investors require a rate of return of, all other things being equal:
a.    less than 10%
b.    exactly 10%
c.    higher than 10%
d.    either less than or greater than 10%

 
    16.    In actual practice, most corporate bonds pay interest:
a.    annually
b.    semi-annually
c.    quarterly
d.    monthly

 
    17.    Which of the following is considered to be the most risky?
a.    U.S. government bonds
b.    mortgage bonds
c.    corporate bonds
d.    common stocks

 
    18.    To determine risks of nondomestic bonds, a multinational corporation must consider all but which one of the following risks?
a.    political and economic risks
b.    seizure or expropriation of assets
c.    stabilized currencies
d.    foreign exchange controls and tax regulations

 
    19.    A firm’s stock is expected to pay a $3 annual dividend next year, the current stock price is $60, and the expected growth rate in dividends is 8%. Using the Gordon approach, what is the expected return?
a.    5%
b.    8%
c.    11%
d.    13%

 
    20.    A firm’s stock is expected to pay a $2 annual dividend next year, and the current $50 stock price is expected to rise to $53 over the next year. What is the expected return?
a.    8%
b.    10%
c.    12%
d.    15%

 
    21.    The constant dividend growth model assumes:
a.    a constant annual dividend
b.    a constant dividend growth rate for no more than the first 10 years
c.    that the discount rate must be greater than the dividend growth rate
d.    two of above are true assumptions

 
    22.    What is the value of GM which currently has a dividend of $2 and is growing at 7%? The investor’s required rate of return is 11%.
a.    $46
b.    $50
c.    $52
d.    none of the above

 
    23.    According to the Gordon dividend model, which of the following variables would not affect a stock’s price?
a.    the firm’s expected growth rate in dividends
b.    the number of shares outstanding
c.    the shareholder’s required return
d.    all the above affect stock price

 
    24.    AT&T 10-year, $1,000 par value bond is selling at $1,158.91. Interest on this bond is paid semianually. If the annual yield to maturity is 14%, what is the annual coupon rate of the AT&T bond?
a.    11%
b.    15%
c.    17%
d.    none of the above

 
    25.    Suppose a firm just issued a $1,000 par value convertible bond.  Its conversion ratio is 30 and the stock currently sells for $25 per share.  Would it make better financial sense to hold onto the bond or convert it?
a.    hold onto the bond
b.    convert the bond
c.    can’t tell from this information
d.    none of the above

 
    26.    Ameritech has just issued a $1,000 par value bond that will mature in 10 years. This bond pays interest of $45 every six months. If the annual yield to maturity of this bond is 8%, what is the price of the Ameritech bond if the market is in equilibrium?
a.    $991.50
b.    $1,067.96
c.    $1,112.82
d.    none of the above

 
    27.    Mary wants to purchase a 20-year bond that has a par value of $1,000 and makes semiannual interest payments of $40. If her required yield to maturity is 10%, how much should Mary be willing to pay for the bond?
a.    $902
b.    $925
c.    $1000
d.    none of the above

 
    28.    You are considering buying a 10-year, $1,000 par value bond issued by IBM. The coupon rate is 8% annually, with interest being paid semiannually. If you expect to earn a 10% rate of return on this bond, what is the maximum price you should be willing to pay for this IBM bond?
a.    $189.93
b.    $875.39
c.    $898.54
d.    $911.46

 
    29.    The last dividend on GTE stock was $4, and the expected growth rate is 10%. If you require a rate of return of 20%, what is the highest price you should be willing to pay for GTE stock?
a.    $40
b.    $42.50
c.    $44
d.    none of the above

 
    30.    You are trying to determine the fair price to pay for a share of Philip Morris. If you buy this stock, you plan to hold it for a year. At the end of the year, you expect to receive a dividend of $5.50 and to sell the stock for $154. The discount rate for Philip Morris stock is 16%. What should be the price of this stock?
a.    $99.80
b.    $137.50
c.    $144.22
d.    $151.66

 
    31.    Consolidated Edison has just paid an annual dividend of $3 per share. If the expected growth rate for Con Ed is 10%, and your required rate of return is 16%, how much are you willing to pay for this stock?
a.    $55
b.    $50
c.    $46.50
d.    none of the above

 
    32.    RJR Nabisco recently experienced a market reevaluation due to a number of tobacco lawsuits. The firm has a bond outstanding with 15 years to maturity, and a coupon rate of 8%, with interest being paid semiannually. The required yield to maturity has risen to 16%. What is the price of the RJR Nabisco bond?
a.    $1,000
b.    $804
c.    $767
d.    $550

 
    33.    Chrysler has a bond outstanding with eight years remaining to maturity, a coupon rate of 5%, and semiannual payments. If the market price of the Chrysler bond is $729.05, what is the yield to maturity?
a.    7%
b.    9%
c.    10%
d.    11%

 
    34.    Which of the following statements is most correct?
a.    A closed-end mortgage bond is one that allows the same assets to be used as security in future bond issues.
b.    Positive covenants in a trust indenture restrict or limit the actions the firm can take.
c.    Retractable bonds can be redeemed prior to maturity by the firm.
d.    Most of the annual funds raised from security issues come from corporate bond sales.

 
    35.    Which of the following statements is most correct?
a.    The par value of a common stock or preferred stock is not important.
b.    A convertible preferred stock gives the corporation the right to retire the preferred stock at its option.
c.    The U.S. security markets are the only public financial markets in which preferred stock can be sold.
d.    Similar to bonds, the fixed preferred stock dividend is a tax-deductible expense.

 
    36.    Which of the following statements is false?
a.    Preferred stock that is both cumulative and convertible is a popular financing choice for investors purchasing shares of stock in small firms with high growth potential.
b.    Bond issues of a single firm can have different bond ratings if their security provisions differ.
c.    Yankee bonds are dollar-denominated bonds that are sold outside the United States.
d.    All of the above statements are correct.

 
    37.    To accurately compare the rate of return on one investment with another, they should be:
a.    equal in size or dollar amount
b.    measured over different time periods
c.    measured over equal time periods
d.    held for more than one year

 
    38.    An unrated bond:
a.    is perceived as having lower than average risk
b.    are termed as “debentures”
c.    generally has a lower than rated bonds
d.    none of the above

 
    39.    The following factors may affect a bond rating:
a.    security provisions
b.    indenture provisions
c.    expected trends of industry operations
d.    all the above
e.    none of the above

 
    40.    Which of the following constitute default on a bond?
a.    nonpayment of par value
b.    nonpayment of coupon
c.    violation of the indenture
d.    all the above
e.    none of the above

     
    41.    Which of the following are not bond rating agencies?
a.    Standard and Poor’s
b.    Fitch’s
c.    Duff and Phelps
d.    all the above are rating agencies
e.    none of the above are rating agencies

 
    42.    Bond ratings are paid for by:
a.    the issuing firm
b.    the trustee
c.    the investment banker
d.    none of the above

 
    43.    A speculative (junk) bond issue as rated under Standard & Poor’s would be rated ______ or below:
a.    AA-
b.    BB+
c.    CCC
d.    CC

 
    44.    A (n) _____________ gives the bondholder a claim to specific assets (identified through serial numbers) such as railroad cars or airplanes.
a.    first mortgage bond
b.    equipment trust certificate
c.    inventory bond
d.    collateralized bond

 
    45.    The three types of risk faced by investors in domestic bonds include all of the following EXCEPT:
a.    political risk
b.    credit risk
c.    interest rate risk
d.    reinvestment rate risk

 
    46.    Which of the following bonds has the greatest interest rate risk?
a.    a 5 year, 10% coupon bond
b.    a 10 year, 10% coupon bond
c.    a 5 year, 5% coupon bond
d.    a 10 year, 5% coupon bond

 
    47.    An “r” bond rating means:
a.    the firm is too new to be rated
b.    the bond issue is subordinate to other bond issues of the firm
c.    the price volatility of the issue is expected to be especially high
d.    none of the above

 
    48.    An example of a collateralized bond is:
a.    a bond backed by credit card receivables
b.    a debenture
c.    a subordinated debenture
d.    all the above

 
    49.    If a bond with a par value of $500 and a call premium of 6% is called in before its maturity date, the firm would have to remit the following to the bondholders:
a.    $500
b.    $530
c.    $0
d.    none of the above

 
    50.    Putable bonds are sometimes referred to as:
a.    retractable bonds
b.    callable bonds
c.    convertible bonds
d.    none of the above

 
    51.    Eurodollar bonds are:
a.    denominated in Eurodollars
b.    extremely long-term obligations
c.    scrutinized by the SEC
d.    none of the above

 
    52.    A sinking fund:
a.    is a special fund set up to pay of the creditors of bankrupt firms
b.    requires specific approval by the firm’s the board of directors
c.    requires the issuer to retire a bond issue incrementally over time
d.    none of the above

 
    53.    The largest annual supply of external funds for business corporations comes from issuance of which one of the following sources?
a.    privately placed stocks
b.    bonds
c.    preferred stocks
d.    common stocks

 
    54.    The terms or covenants of a bond contract are set out in which of the following documents?
a.    debenture
b.    trust indenture
c.    mortgage
d.    negative pledge clause

 
    55.    Which of the following is not a rating category used when rating bonds?
a.    AAA
b.    BBB
c.    B
d.    D
e.    F

 
    56.    Which of the following bond types would describe unsecured obligations that depend on the general credit strength of the corporation?
a.    collateralized bonds
b.    mortgage bonds
c.    equipment trust certificates
d.    debenture bonds

 
    57.    Which of the following bonds can be redeemed prior to maturity by the firm?
a.    callable bonds
b.    convertible bonds  
c.    putable bonds
d.    retractable bonds

 
    58.    A bond’s value is the same as its principal amount when the coupon rate is:
a.    the same as the required rate of return
b.    higher than the required rate of return
c.    lower than the required rate of return  
d.    lower than the inflation rate

 
    59.    Which of the following risks would not be faced by investors in domestic bonds?
a.    credit (or default) risk
b.    interest rate risk
c.    reinvestment rate (or rollover) risk
d.    exchange rate risk

 
    60.    Which of the following is not a component of the Gordon (or constant dividend growth rate) model for valuing stocks?
a.    next year’s expected dividend
b.    a constant divided growth rate
c.    next year’s expected earnings
d.    a discount rate that reflects the riskiness of the stock

 
    61.    Bonds that have coupons that are literally clipped and presented, like a check, to the bank for payment, and where the bond issuer does not know who is receiving the coupon payments are called:
a.    registered bonds
b.    coupon bonds
c.    bearer bonds
d.    none of the above

 
    62.    An individual or organization that represents the bondholders to ensure the indenture’s provisions are respected by the bond issuer is called a (n):
a.    trust indenture
b.    trustee
c.    investment banker
d.    trust organization

 
    63.    __________________ assess both the collateral and underlying bonds as well as the ability of the issuer to make timely interest and principal payments.
a.    Bond covenants
b.    Bond indentures
c.    Bond ratings
d.    none of the above

 
    64.    According to Standard & Poors and Fitch, bonds rated ______ and below are considered to be speculative or “junk.”
a.    BBB+
b.    BB+
c.    B+
d.    CCC

 
    65.    A bond that does not permit future bond issues to be secured by any of the assets pledged as security to it is called a (n):
a.    first mortgage bond
b.    equipment trust certificate
c.    closed-end mortgage bond
d.    open-end mortgage bond

 
    66.    A bond that allows the same assets to be used as security in future issues is called a (n):
a.    first mortgage bond
b.    equipment trust certificate
c.    closed-end mortgage bond
d.    open-end mortgage bond

 
    67.    The risk of having a bond issuer request the bond back from the bondholder thus forcing the bondholder to reinvest the proceeds at a lower interest rate is called:
a.    call risk
b.    reinvestment rate risk
c.    interest rate risk
d.    none of the above

 
    68.    __________________ allows stock to be held in the name of a brokerage house.
a.    The Federal Reserve
b.    Street name
c.    The Securities Exchange Act of 1944
d.    none of the above

 
    69.    ___________________ has the lowest claim on the assets and cash flow of the firm.
a.    A bond
b.    A subordinated debenture
c.    Preferred stock
d.    Common stock

 
    70.    ___________________ is often called a hybrid security.
a.    A bond
b.    A subordinated debenture
c.    Preferred stock
d.    Common stock

 
    71.    When the market interest rate is the same as the coupon rate for a particular quality of bond, the bond will be priced:
a.    below its par value
b.    at its par value
c.    above its par value
d.    The bond price cannot be determined

 
    72.    When the market interest rate is above the coupon rate for a particular quality of bond, the bond will be priced:
a.    below its par value
b.     at its par value
c.    above its par value
d.    The bond price cannot be determined

 
    73.    When the market interest rate is below the coupon rate for a particular quality of bond, the bond will be priced:
a.    below its par value
b.    at its par value
c.    above its par value
d.    The bond price cannot be determined

 
    74.    When the market interest rate rises for a particular quality of bond, the price of the bond falls, which gives investors a new:
a.    coupon rate
b.    interest payment amount
c.    yield to maturity
d.    maturity

 
    75.    When the market interest rate rises above the coupon rate for a particular quality of bond, the “current yield:”
a.    will be below the coupon rate
b.    will be the same as the coupon rate
c.    will be above the coupon rate
d.     cannot be determined

 
    76.    When the market interest rate falls below the coupon rate for a particular quality of bond, the “current yield:”
a.    will be below the coupon rate
b.    will be the same as the coupon rate
c.    will be above the coupon rate
d.    cannot be determined

 
    77.    When the market interest rate rises above the coupon rate for a particular quality of bond and the bond price declines, the new expected yield is called the:
a.    coupon rate or yield
b.    current yield
c.    book value yield
d.    net present value yield

 
    78.    A current yield on a corporate bond is calculated as:
a.    coupon interest amount divided by par value
b.    coupon interest rate times the par value
c.    coupon interest amount divided by the current price
d.    coupon interest rate times the current price

 
    79.    Most firms that issue dividends try to maintain a consistent _________________.
a.    dividend per share
b.    dividend payout ratio
c.    both policies are frequently employed
d.    neither policy is frequently employed

 
    80.    A (n) ________________ is an extra dividend declared by the firm over and above its regular dividend payout.
a.    special dividend
b.    supplemental dividend
c.    extra-large dividend
d.    treasury dividend
e.    none of the above

 
    81.    A (n) ________________ is an extra dividend declared by the firm over and above its regular dividend payout.
a.    strong dividend
b.    supplemental dividend
c.    extra-large dividend
d.    treasury dividend
e.    none of the above

 
    82.    The _____________ policy states that dividends will vary based upon how much excess funds the firm has from year-to-year, whereas under a ________________ policy the firm pays a constant percentage of earnings as dividends, so as earnings rise and fall so does the dollar amount of dividends.
a.    constant payout ratio, residual dividend
b.    residual dividend, constant payout ratio
c.    constant dividend, variable payout ratio
d.    variable payout ratio, constant dividend
e.    none of the above

 
    83.    The _____________ policy states that dividends will vary based upon how much excess funds the firm has from year-to-year, whereas under a ________________ policy the firm pays a constant percentage of earnings as dividends, so as earnings rise and fall so does the dollar amount of dividends.
a.    constant payout ratio, regular dividend
b.    regular dividend, constant payout ratio
c.    constant dividend, variable payout ratio
d.    variable payout ratio, constant dividend
e.    none of the above

 
    84.    Several factors will be considered by the board of directors and management as they consider the level of dividend payout. Some of these factors include:
a.    the ability of the firm to generate cash to sustain the level of dividends.
b.    legal and contractual considerations
c.    growth opportunities
d.    cost of other financing sources
e.    all of the above

 
    85.    Several factors will be considered by the board of directors and management as they consider the level of dividend payout. Some of these factors include:
a.    the ability of the firm to generate cash to sustain the level of dividends.
b.    legal and contractual considerations
c.    growth opportunities
d.    all of the above
e.    none of the above

 
    86.    The effect of ______________ and _______________ on the value of a firm’s stock and the wealth of shareholders is zero.
a.    stock dividends, stock splits
b.    cash dividends, stock dividends
c.    cash dividends, stock splits
d.    all of the above
e.    none of the above

 
    87.    The effect of ______________ and _______________ on the value of a firm’s stock and the wealth of shareholders is zero.
a.    share repurchases, stock splits
b.    cash dividends, stock dividends
c.    cash dividends, stock splits
d.    stock dividends, share repurchases
e.    none of the above

 
    88.    The value of a share of stock currently selling for $100 after a 2 for 1 split is:
a.    $50
b.    $150
c.    $200
d.    $250
e.    none of the above

 
    89.    The value of a share of stock currently selling for $100 after a 5 for 1 split is:
a.    $50
b.    $150
c.    $200
d.    $250
e.    none of the above

 
    90.    The value of a share of stock currently selling for $100 after a 5 for 1 split is:
a.    $20
b.    $40
c.    $500
d.    $1000
e.    none of the above

 
    91.    The value of a share of stock currently selling for $100 after a 1 for 5 split is:
a.    $20
b.    $40
c.    $500
d.    $1000
e.    none of the above

 
    92.    The value of a share of stock currently selling for $50 after a 1 for 5 split is:
a.    $10
b.    $200
c.    $500
d.    $1000
e.    none of the above

 
    93.    Reasons for stock repurchases include all of the following EXCEPT:
a.    to acquire shares used in management stock option incentive programs, in which managers can purchase shares of stock at pre-specified prices.
b.    to use in stock-based acquisitions of other firms.
c.    the firm has the cash and sees its own stock as one of its most attractive investment alternatives.
d.    all of the above
e.    none of the above

 
    94.    Reasons for stock repurchases include all of the following EXCEPT:
a.    to sell off shares used in management stock option incentive programs, in which managers can purchase shares of stock at pre-specified prices.
b.    to use in stock-based sell-offs of other firms.
c.    the firm has too little cash and sees its own stock as one of its most attractive sales alternatives.
d.    all of the above
e.    none of the above

 
    95.    Reasons for stock repurchases include all of the following EXCEPT:
a.    to sell off shares used in management stock option incentive programs, in which managers can purchase shares of stock at pre-specified prices.
b.    to use in stock-based acquisitions of other firms.
c.    the firm has too little cash and sees its own stock as one of its most attractive sales alternatives.
d.    all of the above
e.    none of the above

 
    96.    Two sources of risk that investors in nondomestic securities face beyond those of domestic securities include:
a.    political risk
b.    exchange rate risk
c.    corruption risk
d.    two of the above
e.    all of the above

 
    97.    Two sources of risk that investors in nondomestic securities face beyond those of domestic securities include:
a.    purchasing power risk
b.    inflation rate risk
c.    corruption risk
d.    two of the above
e.    none of the above

 
    98.    The _____________ is the difference in return earned by investing in a longer term bond that has the same credit risk as a shorter-term bond.
a.    purchasing power spread
b.    credit risk premium
c.    horizon risk premium
d.    two of the above
e.    none of the above

 
    99.    The _____________ is the difference in return earned by investing in a longer term bond that has the same credit risk as a shorter-term bond.
a.    purchasing power spread
b.    credit risk premium
c.    yield slope premium
d.    two of the above
e.    none of the above

 
    100.    Most bonds pay coupon interest
a.    monthly
b.    quarterly
c.    semi-annually
d.    annually
e.    none of the above

 

1.Recently a former Halliburton employee was prevented from suing her employer due to an arbitration clause after what event happened to her in Iraq?
A. workplace accident
B. sexual assault
C. theft of funds
D. car accident

2.Arbitration is a method of ADR in which parties vest authority in a third-party neutral decision-maker who will hear their case and issue a decision, which is called a(n):
A. expert determination
B. tort reform
C. arbitration award
D. conciliation

3.International arbitration clauses are enforceable in most countries because of:
A. A WTO agreement
B. The influence the U.S. has over other countries.
C. The strong dominance of American companies in the global marketplace.
D. A United Nations treaty.

4.If passed, the Arbitration Fairness Act would not apply to:
A. Business to employee disputes
B. Business to franchisee disputes
C. Business to consumer disputes
D. Business to business disputes

5. When might a judge conduct a de novo review of an arbitration award?
A. Mandatory arbitration
B. Negotiated settlement
C. Mediation
D. Voluntary arbitration

6. Which of the following is a federal statute that requires parties that have entered into contracts with mandatory arbitration clauses to submit to arbitration to resolve disputes arising under such contracts?
A. The Federal Arbitration Act
B. Title VII of the Civil Rights Act
C. The Arbitration Fairness Act
D. The Uniform Arbitration Act

7. Which of the following is a drawback to negotiation as a form of ADR?
A. Involuntary participation
B. Lack of privacy
C. Expensive
D. No set rules

8. Compared to most other countries, the U.S. legal system is unique because:
A. Losers in lawsuits pay the winner's legal fees in all circumstances.
B. Litigants pay their own legal fees unless there is an agreement or statute at states otherwise.
C. Losers in lawsuits pay half the winner's legal fees in all circumstances.
D. Losers in lawsuits pay the winner's legal fees, unless the winner started the lawsuit.

9. In binding arbitration:
A. the parties may choose to resolve their dispute through litigation if the arbitration award is rejected by a party.
B. either party may reject the arbitration award and demand a trial instead.
C. parties involuntarily submit to the arbitration procedure.
D. the arbitration award is final.

10. In business, which method of ADR is more often used in disputes between employers and employees about topics such as workplace conditions, wrongful discharge, or advancement grievances?
A. Mediation
B. Minitrials
C. Negotiation
D. Arbitration

Chapter 13
Business Organization and Financial Data

TRUE-FALSE QUESTIONS

    1.    A business should begin with a vision or mission statement that is consistent with the planned overall strategy.
 
    2.    The goal of any firm should be the maximization of sales.
 
    3.    Shareholder wealth is the market value of a firm’s common stock.
 
    4.    The market value added measures the value created by the firm’s managers.
 
    5.    A close estimate of market value added (MVA) is the market value of equity less the book value of equity.
 
    6.    The success of a business in raising funds for operations depends upon the extent that profits can be produced from operations.
 
    7.    Managerial lines of authority, legal responsibility and the allocation of income and risk are directly related to the form the organization takes.
 
    8.    Proprietorships are the most widely used form although they are generally the smallest organizations in terms of assets.
 
    9.    A weakness for a proprietorship is that owner’s liability for debts of the firm is unlimited.
 
    10.    Profits from a proprietorship are taxed at the corporate income tax rates.
 
    11.    A partnership is a form of business organization when two or more people own a business operated for profit.
 
    12.    Partnership income is taxed at the partnership income tax rate.
 
    13.    Under partnership law, each partner has unlimited liability for all the debts of the firm.
 
    14.    Limited partners face liability limited to their investment in the firm, but they can participate in the operations of the firm.
 
    15.    The bylaws are the rules established to govern the corporation and include how the firm will be managed.
 
    16.    Limited partners must take an active role in the operations of the firm.
 
    17.    A limited liability company can have an unlimited number of shareholders, including other corporations.
 
    18.    Most of the limited liability company shareholders must take active roles in managing the company.
 
    19.    Poison pills are provisions in a corporate charter that make a corporate take-over more unattractive.
 
    20.    With generally accepted accounting practices, there is one “right way” of accounting for business transactions.
 
    21.    Most of accounting practice is based upon the cash concept.
 
    22.    A firm’s net income over some period is the same as its cash flow.
 
    23.    The balance sheet is a statement of a company’s financial position over an accounting period.
 
    24.    The net working capital of a firm would be cash and other assets that are expected to be converted into cash within a year.
 
    25.    The marginal tax rate is the rate paid on the last dollar of income.
 
    26.    A corporation is a legal entity created under federal law with an unending life and limited financial liability to its owners.
 
    27.    One of the important reasons corporations can accumulate large sums of capital is that they are allowed to sell capital stock.
 
    28.    Privately held corporations register shares with the Securities and Exchange Commission before selling them to shareholders.
 
    29.    If a corporation liquidates in bankruptcy, creditors may attach the personal assets of the owners of the company.
 
    30.    One advantage of the corporate form of organization is the ease with which ownership may be transferred.
 
    31.    An annual report contains descriptive information on operating and financial performance during the past year, a discussion of current and future business opportunities, and five year projected stock prices and shareholder returns.
 
    32.    Accounting is primarily concerned with matching revenues and expenses while finance focuses on identifying cash inflows and outflows.
 
    33.    Common-size financial statements express balance sheet and income statement numbers as a percent of sales.
 
    34.    Shareholder wealth may be defined as the price of a company’s stock times the number of shares outstanding.
 
    35.    Implicit agency costs do not have a direct expense associated with them, but they harm shareholders anyway.
 
    36.    The liability of all owners in both a limited liability company and a limited partnership is limited to the owners’ investment in the company.
 
    37.    The most desirable form of business organization from a liquidity standpoint is a corporation.
 
    38.    The most desirable form of business organization from a liquidity standpoint is a limited liability company.
 
    39.    The most desirable form of business organization in terms of ease of start-up is a proprietorship.
 
    40.    The most desirable form of business organization in terms of ease of start-up is a corporation.
 
    41.    The balance sheet equation or accounting identity can be written as: assets equal liabilities minus owners’ equity.
 
    42.    The balance sheet equation or accounting identity can be written as: assets equal liabilities plus owners’ equity.
 
    43.    The goal of the firm is the maximization of profits and market share.
 
    44.    Market value added can be written as: the market value of stock minus the market value of debt plus the book value of stock minus the book value of debt.
 
    45.    Market value added can be written as: the market value of stock plus the market value of debt minus the book value of stock minus the book value of debt.
 


    46.    Agency costs are the tangible and intangible expenses borne by shareholders because of the actual or potential self-serving actions of managers; and agency costs include explicit, out-of-pocket expenses.
 
    47.    Agency costs are the tangible and intangible revenues generated by shareholders because of the actual or potential selfless actions of managers; and agency costs include explicit, out-of-pocket expenses.
 
    48.    Two basic tools that can be used to reduce the consequences of managers making self-serving decisions include offering managers stock options and offering managers restricted stock.
 
    49.    The Sarbanes-Oxley Act of 2002 was passed by the U.S. Congress in response several accounting scandals.
 
    50.    The Sarbanes-Oxley Act of 2002 was passed by the U.S. Congress in response several political scandals.
 


MULTIPLE-CHOICE QUESTIONS

    1.    Of the following forms of organization, which businesses are the greatest in numbers?
a.    proprietorships
b.    partnerships
c.    corporations
d.    limited partnerships

 
    2.    Of the following forms of business organization, which have stockholders with limited liability?
a.    proprietorships
b.    partnerships
c.    corporations
d.    limited partnerships

 
    3.    Computation of a firm’s market value added (MVA) includes all of the components EXCEPT:
a.    market value of equity
b.    market value of debt
c.    book value of equity
d.    book value of debt
e.  all of the above are included

 
    4.    Of the following forms of business organization, which have the advantage of limited liability but no stockholders?
a.    proprietorships
b.    partnerships
c.    corporations
d.    limited partnerships

 
    5.    Which one of the following is not a basic function of financial management?
a.    financial planning and analysis
b.    acquiring other business firms
c.    asset management
d.    raising of funds

 
    6.    The current liabilities of a business may include:
a.    notes payable
b.    accounts receivable
c.    prepaid expenses
d.    depreciation reserves

 
    7.    For a given accounting period, which of the following is likely to represent primarily variable costs?
a.    cost of goods sold
b.    general and administrative expenses
c.    depreciation expense
d.    interest expense

 
    8.    The actual disbursement of cash is recorded in which of the following financial statements?
a.    income statement
b.    balance sheet
c.    statement of cash flows
d.    cash transactions statement

 
    9.    Information about which accounting principles were used by the firm are included in the:
a.    balance sheet
b.    footnotes
c.    management discussion on annual report
d.    none of the above

 
    10.    A limited liability company (LLC):
a.    must register with the SEC to sell securities to the public
b.    is an ongoing entity, even if one of the owners leaves
c.    has a limited number of shareholders
d.    all the above
e.    none of the above

 
    11.    Which form of business organization has a basic weakness of reaching a capital limit?
a.    proprietorship
b.    partnership
c.    limited partnership
d.    all of the above

 
    12.    Corporate stockholders:
a.    cannot have limited liability
b.    cannot easily transfer ownership
c.    cannot be subject to taxes on dividends
d.    can limit their liability to the amount of their investment

 
    13.    Nestle, IBM, and Coca-Cola are examples of:
a.    U.S. corporations
b.    corporations with mainly domestic revenues
c.    “stateless” corporations
d.    multinational corporations based in the U.S.

 
    14.    The average tax rate on a corporation with $75,000 in income and a tax liability of $15,000 is:
a.    15%
b.    20%
c.    25%
d.    39%

 
    15.    The term ___________ conveys a relationship of equality between the assets of the business and the sources of funds for their acquisition.
a.    statement of cash flows
b.    cash transactions statement
c.    income statement
d.    balance sheet

 
    16.    The notes receivable of a firm may be:
a.    loans to other businesses
b.    loans to employees
c.    loans to the CEO
d.    all of the above

 
    17.    The accrued liabilities of a firm are:
a.    retained earnings from past years
b.    reflect the prepayment of certain expenses
c.    owners’ equity in the firm
d.    amounts owed but not yet due

 
    18.    If a firm issues 10,000 shares of common stock with a par value of $5 and for a sales price of $15, what amount would be recorded in the paid-in capital account?
a.    $10,000
b.    $15,000
c.    $50,000
d.    $100,000

 
    19.    What would be recorded in the common stock account on the balance sheet if 20,000 shares are issued at a par value of $2 and the market value is $5?
a.    $20,000
b.    $40,000
c.    $30,000
d.    $60,000

 
    20.    A limited partnership is comprised of:
a.    only limited partners
b.    only general partners
c.    both general and limited partners
d.    both partners and proprietors

 
    21.    Which of the following business organizations limit the liability of some or all of their owners to the extent of their investment in the company?
a.    proprietorships and partnerships
b.    corporations and proprietorships
c.    limited partnerships and proprietorships
d.    corporations and limited partnerships

 
    22.    Which of the following business organizations do not limit the liability of some or all of their owners to the extent of their investment in the company?
a.    proprietorships and partnerships
b.    corporations and proprietorships
c.    limited partnerships and proprietorships
d.    corporations and limited partnerships

 
    23.    A business organization that receives the limited liability of a corporation but is taxed as a proprietorship or partnership is called a:
a.    limited proprietorship
b.    limited partnership
c.    limited corporation
d.    S corporation

 
    24.    Which of the following are considered to be major financial management functions?
a.    financial planning and analysis
b.    asset management
c.    raising funds
d.    all of the above

 
    25.    Which one of the following balance sheet accounts would not be considered to be a current liability?
a.    account payable
b.    bank notes payable
c.    accrued liabilities
d.    mortgage debt

 
    26.    Which of the following accounts is usually part of the owners’ equity for a corporation?
a.    common stock
b.    paid-in-capital
c.    retained earnings
d.    all of the above

 
    27.    Which of the following are required to file annual reports with the Securities and Exchange Commission?
a.    proprietorships
b.    partnerships
c.    public corporations
d.    all the above

 
    28.    Which of the following are included in an annual report?
a.    balance sheet
b.    income statement
c.    statement of cash flows
d.    all of the above
e.    none of the above

 
    29.    The three main sections of the statement of cash flows include all of the following EXCEPT:
a.    cash from saving
b.    cash from investments
c.    cash from operations
d.    cash from financing
e.    all are included

 
    30.    Net income is:
a.    equal to cash flow
b.    profits remaining after income taxes are paid
c.    unavailable to the owners of the business
d.    none of the above

 
    31.    Which of the following statements is false?
a.    Working capital represents assets needed to carry out the normal
operations of the business.
b.    Current liabilities that reflect amounts owed but not yet due on the date
of the balance sheet are called accruals.
c.    Because of accrual accounting, a firm’s net income over some period
is not necessarily the same as its cash flows.
d.    All the above statements are correct.

 
    32.    Current liabilities would not include:
a.    accounts payable
b.    notes payable
c.    bonds
d.    accruals

 
    33.    Owners’ equity may include:
a.    common stock
b.    retained earnings
c.    surplus account
d.    all the above
e.    none of the above

 
    34.    Which of the following would not be included on the balance sheet?
a.    dividends paid
b.    retained earnings
c.    surplus account
d.    common stock

 
    35.    Which of the following would not be considered an asset?
a.    cash
b.    accounts receivable
c.    equipment
d.    accounts payable

 
    36.    Which of the following would not be a source of funds?
a.    decrease in an equity account
b.    increase in a liability account
c.    decrease in an asset account
d.    all the above are sources of funds

 
    37.    Which of the following would not be a use of funds?
a.    increase in an asset account
b.    decrease in a liability account
c.    decrease in an equity account
d.    all the above are uses of funds

 
    38.    Shareholder wealth would be:
a.    assets plus liabilities
b.    assets minus liabilities
c.    common stock price times number of shares outstanding
d.    none of the above

 
    39.    Market value added would equal:
a.    assets plus liabilities
b.    assets minus liabilities
c.    common stock price times number of shares outstanding
d.    none of the above

 
    40.    Agency costs are:
a.    the costs of hiring managers
b.    assets minus liabilities
c.    common stock price times number of shares outstanding
d.    none of the above

     
    41.    Agency costs may include:
a.    costs of auditing financial statements
b.    liability insurance for board of directors
c.    management perks
d.    all the above
e.    none of the above

 
    42.    Implicit agency costs:
a.    may harm shareholders
b.    do not have a direct expense associated with them
c.    may include restrictive covenants
d.    all the above
e.    none of the above

 
    43.    Cash flows from financing activities might include:
a.    increase in notes payable
b.    increase in accounts payable
c.    depreciation
d.    all the above
e.    none of the above

 
    44.    Cash flows from operating activities might include:
a.    net income
b.    increase in notes payable
c.    dividend payment
d.    all the above
e.    none of the above

 
    45.    Top finance officers in a corporation may include:
a.    treasurer
b.    chief financial officer
c.    controller
d.    all the above
e.    none of the above

 
    46.    The depreciation method currently used for tax purposes today is called the:
a.    accelerated cost recovery system (ACRS)
b.    straight line method (SLM)
c.    modified accelerated cost recovery system (MACRS)
d.    double digit balance (DDB)
e.    none of the above

 
    47.    The goal of a business should be:
a.    maximization of the owners’ wealth
b.    maximization of accounting profit
c.    maximization of sales
d.    maximization of assets

 
    48.    Which of the following is not considered to be one of the three major forms of business ownership in the United States?
a.    proprietorship
b.    partnership
c.    public limited company
d.    corporation

 
    49.    Under which one of the following business organizations do the owners have unlimited liability for all debts of the firm?
a.    partnership
b.    limited partnership
c.    corporation
d.    subchapter S corporation

 
    50.    The corporate form of organization is recognized in many countries. Which one of the following does not designate a corporation?
a.    Inc.
b.    PLC
c.    AG
d.    SEC

 
    51.    For corporations, the principal-agent relationship usually refers to the relationship between:
a.    buyers-sellers
b.    owners-managers
c.    manager-customer
d.    owner-bankers

 
    52.    Which one of the following alternatives is commonly used to reduce agency problems as they relate to corporate control?
a.    stock options
b.    higher salaries
c.    larger perquisites (“perks”)
d.    less restrictive accountability requirements

 
    53.    Generally accepted accounting principles are formulated by the:
a.    Securities and Exchange Commission
b.    Financial Accounting Standards Board
c.    Federal Trade Commission
d.    General Accounting Office

 
    54.    Which one of the following financial statements conveys a relationship of equality between assets and liabilities plus owners’ equity?
a.    income statement
b.    statement of cash flows
c.    balance sheet
d.    statement of retained earnings

 
    55.    All of the following forms of organization are taxed at the owners’ personal tax rate EXCEPT:
a.    proprietorship
b.    LLC
c.    subchapter S corporation
d.    partnership
e.    all of the above assess taxes at the owners’ personal rate

 
    56.    Which of the following forms of organization has an unlimited life?
a.    proprietorship
b.    LLC
c.    subchapter S corporation
d.    corporation
e.    two of the above have an unlimited life

 
    57.    The financial statement that provides a snapshot view of the financial condition of a business at a point in time is the:
a.    balance sheet
b.    income statement
c.    statement of cash flows
d.    statement of retained earnings
e.    two of the above

 
    58.    Which of the following is a source of cash?
a.    an increase in an asset account
b.    a decrease in an asset account
c.    a decrease in a liability account
d.    a decrease in an equity account
e.    none of the above

 
    59.    Which of the following is a use of cash?
a.    an increase in an asset account
b.    a decrease in an asset account
c.    an increase in a liability account
d.    an increase in an equity account
e.    none of the above

 
    60.    A statement that expresses the income statement items as a percent of total sales is called:
a.    a percentage of sales income statement
b.    a cross-sectional income statement
c.    a common size income statement
d.    a ratio based income statement
e.    none of the above

 
    61.    The rule-setting body, which authorizes generally accepted accounting principles is:
a.    GAAP
b.    FASB
c.    SEC
d.    Federal Reserve System
e.    none of the above

 
    62.    Accounting practices and procedures used to prepare financial statements are called:
a.    GAAP
b.    FASB
c.    SEC
d.    Federal Reserve System
e.    none of the above

 
    63.    The U.S. federal government body that regulates the sale and listing of securities on U.S. financial markets is the:
a.    IRS
b.    FRS
c.    SEC
d.    FBI
e.    none of the above

 
    64.    Financial statements that must be included in the annual report include the:
a.    income statement
b.    balance sheet
c.    statement of cash flows
d.    all of the above
e.    none of the above

 
    65.    Financial statements that must be included in the annual report include all of the following EXCEPT:
a.    the income statement
b.    the balance sheet
c.    the statement of cash flows
d.    the cash budget
e.    all of the above must be included

 
    66.    On the balance sheet, total assets minus net fixed assets equals:
a.    current assets
b.    current liabilities
c.    gross fixed assets
d.    total assets
e.    none of the above

 
    67.    On the income statement, gross profit is defined as:
a.    operating profits minus operating expenses
b.    gross profit minus operating expenses
c.    sales revenue minus cost of goods sold
d.    sales revenue minus operating expenses
e.    none of the above

 
    68.    On the income statement, gross profit is defined as:
a.    operating profits minus operating expenses
b.    gross profit minus operating expenses
c.    sales revenue minus total expenses
d.    sales revenue minus operating expenses
e.    none of the above

 
    69.    On the income statement, operating profit is defined as:
a.    operating profits minus operating expenses
b.    gross profit minus operating expenses
c.    sales revenue minus cost of goods sold
d.    sales revenue minus operating expenses
e.    none of the above

 
    70.    On the income statement, gross profit is defined as:
a.    operating profits minus operating expenses
b.    gross profit minus cost of goods sold
c.    sales revenue minus cost of goods sold
d.    sales revenue minus operating expenses
e.    none of the above

 
    71.    On the income statement, net profit after tax is defined as:
a.    operating profit minus operating expenses
b.    operating profit minus cost of goods sold
c.    operating profit minus interest
d.    operating profit minus interest minus taxes
e.    none of the above

 
    72.    On the income statement, net profit after tax is defined as:
a.    operating profit minus operating expenses
b.    operating profit minus cost of goods sold
c.    operating profit minus interest
d.    operating profit minus total expenses
e.    none of the above

 
    73.    All of the following accounts are considered to be current assets on the balance sheet except:
a.    cash
b.    accruals
c.    accounts receivable
d.    inventory
e.    none of the above

 
    74.    All of the following accounts are considered to be current assets on the balance sheet except:
a.    cash
b.    short-term investments or marketable securities
c.    accounts receivable
d.    inventory
e.    all of the above are current assets

 
    75.    All of the following accounts are considered to be fixed assets on the balance sheet except:
a.    buildings
b.    equipment
c.    plant
d.    machinery
e.    all of the above are fixed assets

 
    76.    All of the following accounts are considered to be fixed assets on the balance sheet except:
a.    buildings
b.    equipment
c.    marketable securities
d.    machinery
e.    all of the above are fixed assets

 
    77.    All of the following accounts are considered to be current liabilities on the balance sheet except:
a.    accounts receivable
b.    accounts payable
c.    accruals
d.    notes payable
e.    all of the above are current liabilities

 
    78.    All of the following accounts are considered to be current liabilities on the balance sheet except:
a.    taxes payable
b.    accounts payable
c.    accruals
d.    notes payable
e.    all of the above are current liabilities

 
    79.    On the balance sheet, retained earnings represents
a.    net profits for the current year
b.    net profits for the current year minus preferred stock dividends
c.    cash reinvested in fixed assets to support growth
d.    the cumulative total of earnings reinvested in the firm.
e.    none of the above

 
    80.    On the balance sheet, retained earnings represents
a.    net profits for the current year
b.    net profits for the current year minus preferred stock dividends
c.    cash reinvested in fixed assets to support growth
d.    the total of earnings reinvested in the firm for the current year
e.    none of the above

 
    81.    The statement of retained earnings includes all of the following accounts within the statement except:
a.    interest expense
b.    net profits after taxes
c.    preferred stock dividends
d.    common stock dividends
e.    all of the above are included

 
    82.    The statement of retained earnings includes all of the following accounts within the statement except:
a.    interest expense
b.    net profits after taxes
c.    preferred stock dividends
d.    stock repurchases
e.    all of the above are included

 
    83.    In the statement of cash flows, retained earnings are reported as two separate line items, which are __________ and ___________.
a.    revenues and expenses
b.    assets and liabilities
c.    depreciation and amortization
d.    net profits and dividends
e.    none of the above

 
    84.    In the statement of cash flows, retained earnings are reported as two separate line items, which are __________ and ___________.
a.    revenues and expenses
b.    assets and liabilities
c.    depreciation and amortization
d.    net profits and taxes
e.    none of the above

 
    85.    Suppose Ningbo Steel had sales revenue of $10,000 sales revenue, cost of goods sold of $5,000, operating expenses of $3000, interest expense of $1,000, a tax rate of 20%, and 1,000 shares of common stock outstanding.  Based on this information, net profit after tax was:
a.    $1,200
b.    $1,000
c.    $800
d.    $400
e.    none of the above

 
    86.    Suppose Ningbo Steel had sales revenue of $10,000 sales revenue, cost of goods sold of $5,000, operating expenses of $3000, interest expense of $1,000, a tax rate of 20%, and 1,000 shares of common stock outstanding.  Based on this information, net profit after tax was:
a.    $1,500
b.    $1,000
c.    $500
d.    $0
e.    none of the above

 
    87.    Suppose Ningbo Steel had sales revenue of $10,000 sales revenue, cost of goods sold of $5,000, operating expenses of $3000, interest expense of $1,000, a tax rate of 20%, and 1,000 shares of common stock outstanding.  Based on this information, earnings per share was:
a.    $1.20
b.    $1.00
c.    $0.80
d.    $0.40
e.    none of the above

 
    88.    Suppose Ningbo Steel had sales revenue of $10,000 sales revenue, cost of goods sold of $5,000, operating expenses of $3000, interest expense of $1,000, a tax rate of 20%, and 1,000 shares of common stock outstanding.  Based on this information, earnings per share was:
a.    $2.00
b.    $1.00
c.    $0.50
d.    $0.0
e.    none of the above

 
    89.    Paid-in-capital in excess of par represents:
a.    the net proceeds from the original sale of stock
b.    the proceeds in excess of par value from the original sale of stock
c.    the current market value of the stock
d.    the current book value of the stock
e.    none of the above

 
    90.    Paid-in-capital in excess of par represents:
a.    the net proceeds from the original sale of stock
b.    the proceeds from resale of treasury stock
c.    the current market value of the stock
d.    the current book value of the stock
e.    none of the above

 
    91.    Ningbo Steel had year end 2010 and 2011 retained earnings balances of $5,000,000 and $6,000,000 respectively.  The firm paid $100,000 of dividends in 2011.  Based on this information, Ningbo Steel’s net profit after taxes in 2011 was:
a.    $100,000
b.    $900,000
c.    $1,000,000
d.    $1,100,000
e.    none of the above

 
    92.    Ningbo Steel had year end 2010 and 2011 retained earnings balances of $5,000,000 and $6,000,000 respectively.  The firm paid $100,000 of dividends in 2011.  Based on this information, Ningbo Steel’s net profit after taxes in 2011 was:
a.    $100,000
b.    $900,000
c.    $1,000,000
d.    $1,200,000
e.    none of the above

 
    93.    The _______________ established the Public Company Accounting Oversight Board (PCAOB).
a.    Smoot-Hawley Act
b.    Sarbanes-Oxley Act
c.    Gram-Harkins Act
d.    McKean-Obama Act
e.    none of the above

 
    94.    The _______________ established the Public Company Accounting Oversight Board (PCAOB).
a.    Smoot-Hawley Act
b.    Sarbanes-Oakley Act
c.    Gram-Harkins Act
d.    McKean-Obama Act
e.    none of the above

 
    95.    The 2002 Sarbanes-Oxley Act was designed to:
a.    limit the compensation that could be paid to CEOs.
b.    eliminate the many disclosure and conflict of interest problems of corporations
c.    provide uniform international accounting standards
d.    two of the above
e.    none of the above

 
    96.    The 2002 Sarbanes-Oxley Act was designed to:
a.    limit the compensation that could be paid to CEOs.
b.    exacerbate the many disclosure and conflict of interest problems of corporations
c.    provide uniform international accounting standards
d.    two of the above
e.    none of the above

 
    97.    The Public Company Accounting Oversight Board (PCAOB) is
a.    a not-for-profit corporation that oversees auditors of public corporations
b.    a not-for-profit corporation that oversees managers of public corporations
c.    a for-profit corporation that oversees auditors of public corporations
d.    a for-profit corporation that oversees managers of public corporations
e.    none of the above

 
    98.    The Public Company Accounting Oversight Board (PCAOB) is
a.    a not-for-profit corporation that oversees managers of public corporations
b.    a not-for-profit corporation that oversees CEOs of public corporations
c.    a for-profit corporation that oversees managers of public corporations
d.    a for-profit corporation that oversees CEOs of public corporations
e.    none of the above

 
    99.    The agency problem may result from a manager's concerns about any of the following except
a.    job security
b.    personal wealth
c.    corporate goals
d.    company provided perquisites
e.    none of the above

 
    100.    The agency problem may result from a manager's concerns about any of the following except
a.    job security
b.    personal wealth
c.    embezzlement
d.    company provided perquisites
e.    none of the above

 

Chapter 17
Capital Budgeting Analysis

TRUE-FALSE QUESTIONS

    1.    Capital budgeting is the process of identifying, evaluating, and implementing a firm’s investment opportunities.
 
    2.    The typical capital budgeting project involves a large up-front cash outlay, followed by a series of smaller net cash outflows.
 
    3.    A capital budgeting project’s cash flows, including the total up-front cost of the project, are typically known with certainty before the project starts.
 
    4.    Capital budgeting decisions can only involve mutually exclusive projects.
 
    5.    The net present value of an investment is the present value of a project’s future cash inflows minus its initial cost.
 
    6.    The majority of capital budgeting projects are short-lived projects.
 
    7.    Information generation develops three types of data: internal financial data, external economic and political data, and non-financial data.
 
    8.    The profitability index is the least preferable method to use to evaluate capital budgeting projects because it does not take the time value of money into account.
 
    9.    To maximize shareholder wealth, a financial manager needs to find capital budgeting projects that have positive net present values.
 
    10.    The internal rate of return is the return that caused the net present value to be zero.
 
    11.    The net present value and internal rate of return methods will always agree on whether a project enhances or harms shareholder wealth.
 
    12.    The profitability index is the ratio between the some of the cash flows and the projects’ cost.
 
    13.    Whenever the net present value of a project is positive, the profitability index is greater or equal to 1.0.
 
    14.    The net present value, internal rate of return and payback period methods always agree on which project would enhance shareholder wealth and which would diminish it.
 
    15.    Independent projects are not in direct competition with one another.
 
    16.    The identification stage in capital budgeting involves finding potential capital investment opportunities and identifying whether a project involves a replacement decision and/or revenue expansion.
 
    17.    A sunk cost is a project-related expense that is dependent upon whether or not the project is undertaken.
 
    18.    Estimates of revenues and costs should take the business unit view, rather than the corporate view.
 
    19.    The selection stage involves applying the appropriate capital budgeting techniques to help make a final decision.
 
    20.    The depreciation tax shield equals the amount of the depreciation expense multiplied by the firm’s tax rate.
 
    21.    A higher-risk project needs to be evaluated using a lower required rate of return.
 
    22.    Expansion projects involving new areas and product lines are usually associated with greater cash inflow uncertainty.
 
    23.    One weakness of the payback period method is that all cash flows beyond the payback period are ignored.
 
    24.    Nonfinancial information plays no part in capital budgeting.
 
    25.    The stand-alone principle focuses on the project’s own cash flows, uncontaminated by cash flows from the firm’s other activities.
 
    26.    Projects with negative net present values will lead to a decrease in the value of the firm.
 
    27.    The internal rate of return measures the return on the project’s initial cost.
 
    28.    The profitability index is calculated by subtracting the net investment from the present value of the cash flows.
 
    29.    The profitability index measures the present value of benefits received for each dollar invested.
 
    30.    Projects favored using payback techniques will be ranked the same using net present value.
 

    31.    Sound capital budgeting decisions require a variety of information including internal financial data, external economic and political data, and non-financial data.
 
    32.    Payback explicitly considers the time value of money.
 
    33.    A firm’s cost of capital is discount rate used in the evaluation of capital budgeting projects using payback and IRR.
 
    34.    A firm’s cost of capital is discount rate used in the evaluation of capital budgeting projects using NPV and IRR.
 
    35.    A firm’s cost of capital represents a firm’s weighted average cost of financing.
 
    36.    A positive NPV suggests that a project produces sufficient cash flows to cover not only its initial cost, but also all financing costs.
 
    37.    A NPV profile shows how NPV varies given alternative IRRs.
 
    38.    The profitability index is also sometimes referred to as the benefit/cost ratio.
 
    39.    The stand alone principle suggests that a project must be viewed separately from the rest of the firm.
 
    40.    Incremental cash flows represents a project’s cash flows summed together with the firm’s other cash flows to get a total firm view of the project.
 
    41.    Enhancement occurs when a project robs cash flow from the firm’s existing line of business.
 
    42.    Cannibalization occurs when a project robs cash flow from the firm’s existing line of business.
 
    43.    The risk-adjusted discount rate (RADR) is the risk adjustment factor that represents the percent of estimated cash inflows that investors would be satisfied to receive for certain rather than the cash inflows that are possible for each year.
 
    44.    The higher the risk of a project, the higher its risk-adjusted discount rate and thus the lower the net present value for a given stream of cash inflows.
 
    45.    Mutually exclusive projects are projects that are not in direct competition with one another.
 
    46.    In a capital budgeting context, a project’s required rate of return is called the yield to maturity.
 
    47.    A net present value profile is a useful tool for evaluating the sensitivity of a project’s NPV to changes in required return.
 
    48.    When applied to the analysis of independent projects, NPV and IRR never provide conflicting results.
 
    49.    Sunk costs are relevant in capital budgeting analysis and should be considered in calculating a project’s initial investment.
 
    50.    Opportunity costs reflect the cost of passing up the next best alternative and are irrelevant in capital budgeting analysis.
 

MULTIPLE-CHOICE QUESTIONS

    1.    Two years ago, a company spent $450,000 on a consulting study that focused on the technology of the firm’s operations. Now it appears that technology is noncompliant with existing regulations. New technology must replace the old project. The $450,000 would represent:
a.    an opportunity cost
b.    an operating expenditure
c.    a sunk cost
d.    none of the above

 
    2.    Your company owns land in a busy shopping district. If the chair of the company’s board of directors thinks they can build a plant on that land and that the land will incur no additional cost, the chair fails to take into account:
a.    capital expenditures
b.    opportunity costs
c.    sunk costs
d.    depreciation

 
    3.    The process of allocating funds among competing investment opportunities is referred to as:
a.    capital expenditures
b.    initial cash flow analysis
c.    long-term forecasting
d.    capital budgeting

 
    4.    Which of the following is true of sunk costs?
a.    not included in initial cash flow
b.    similar to opportunity costs
c.    often combined with terminal cash flow
d.    deciding factor in most project decisions

 
    5.    Only one of the following features is characteristic of a payback period. Identify this feature.
a.    uses discounting
b.    ignores cash flows beyond the payback period
c.    equivalent to net present value
d.    considers time value of money

 
    6.    Which of the following is the best expression of the net preset value (NPV) acceptance criterion?
a.    positive cash flows total greater than negative flows
b.    number of positive cash flows exceeds negative
c.    payback within one third the life of the project
d.    NPV is greater than or equal to zero

 
    7.    Internal rate of return (IRR) and net present value (NPV) methods:
a.    generally arrive at the same accept/reject decisions
b.    are less sophisticated than the payback period
c.    cannot make use of the same cash flows
d.    can be substituted for by the payback period

 
    8.    The time required for the cumulative cash flows from a project to equal zero is called the:
a.    profitability index
b.    cash flow time frame
c.    project life
d.    payback period

 
    9.    In calculation of a payback period, what use is made of cash flows occurring after the end of the payback period?
a.    They are ignored.
b.    They are discounted back to time zero.
c.    They are included in the accept/reject decision.
d.    They are normally canceled by initial negative cash flows.

 
    10.    The method that calculates the ratio of the present value of the positive cash flows of a project to the absolute value of the present value of the negative cash flows is called the:
a.    internal rate of return
b.    profitability index
c.    net present value
d.    payback period

 
    11.    Of the four options listed below and encountered in project evaluation, which one is most likely to make a project seem less attractive?
a.    underestimating negative cash flows
b.    overestimating positive cash flows
c.    using a higher cost of capital
d.    ignoring the time value of money

 
    12.    The internal rate of return concept is best explained by which of the following?
a.    rate where NPV is equal to zero
b.    point where initial investment has been returned
c.    marginal cost of capital
d.    average book value

 
    13.    The payback period concept is best explained by which of the following?
a.    marginal cost of capital
b.    point where initial investment has been returned
c.    rate where NPV is equal to zero
d.    accounting rate of return

 
    14.    Which one of the following best explains the impact on a firm that accepts a project with a negative NPV?
a.    negative cash flows
b.    decrease in the value of the firm
c.    high marginal cost of capital
d.    low initial returns

 
    15.    When considering the time value of money, which of the following four methods of project evaluation would appear to be the least satisfactory?
a.    internal rate of return
b.    profitability index
c.    net present value
d.    payback period method

 
    16.    With independent projects, NPV and IRR provide identical accept/reject decisions. If, however, you have two mutually exclusive projects to evaluate, the most accurate thing you could say about the eventual results is that:
a.    NPV and IRR may give conflicting results
b.    NPV and IRR never give the same result
c.    NPV and IRR always give the same result
d.    IRR is more lenient in accepting

 
    17.    As a rule, independent projects are accepted if the internal rate of return is greater than or equal to:
a.    1.0
b.    zero
c.    marginal cost of capital
d.    expected rate of return

 
    18.    When a project’s net present value exceeds zero, then:
a.    the project should be accepted
b.    the project will be acceptable using the payback period method
c.    the IRR should be calculated to ensure that the project’s IRR exceeds the cost of capital
d.    both a and c are true

 
    19.    If a project has a positive net present value, then the profitability index is:
a.    greater than one
b.    less than one
c.    equal to one
d.    cannot tell from this information

 
    20.    The after-tax cash flows without the project are referred to as:
a.    the net investment
b.    incremental cash flows
c.    the base case
d.    none of the above

 
    21.    The stand-alone principle means that:
a.    projects should not be evaluated against one another
b.    projects must operate independently of the firm’s other projects
c.    analysts should focus on the project’s cash flows, uncontaminated by cash flows from the firm’s other activities
d.    none of the above

 
    22.    All of the following are considered stages in the capital budgeting process EXCEPT:
a.    development
b.    identification
c.    implementation
d.    selection
e.    all are included

 
    23.    All of the following are considered stages in the capital budgeting process EXCEPT:
a.    invention
b.    development
c.    implementation
d.    selection
e.    all are included

 
    24.    A firm is evaluating a proposal which has an initial investment of $50,000 and has cash flows of $15,000 per year for five years.  The payback of the project is:
a.    1.5 years
b.    2 years
c.    3.3 years
d.    4 years
e.    none of the above

 
    25.    A firm is evaluating a proposal which has an initial investment of $50,000 and has cash flows of $15,000 per year for five years.  If the firm’s required return or cost of capital is 10%, the NPV of the project is:
a.    $5,000
b.    $6,862
c.    -$5,000
d.    -$6,862
e.    none of the above

 
    26.    A firm is evaluating a proposal which has an initial investment of $50,000 and has cash flows of $15,000 per year for five years.  If the firm’s required return or cost of capital is 15%, should it accept the project using the IRR as a decision criteria?
a.    yes
b.    no
c.    can’t tell
d.    none of the above

 
    27.    When the net present value is negative, the internal rate of return is __________ the cost of capital.
a.    greater than
b.    greater than or equal to
c.    less than
d.    equal to
e.    none of the above

 
    28.    All of the groups of cash flows from the firm’s statement of cash flows are also used in the analysis of project cash flows EXCEPT:
a.    cash flow from financing
b.    cash flow from investment
c.    cash flow from operations
d.    all are included

 
    29.    Two or more projects that perform the same function are said to be:
a.    mutually exclusive projects
b.    independent projects
c.    joint projects
d.    none of the above

 
    30.    The capital-budgeting process starts with which one of the following stages:
a.    development
b.    identification
c.    implementation
d.    selection

 
    31.    Which one of the following capital-budgeting evaluation techniques is based on finding a discount rate which causes the net present value to be zero?
a.    net present value
b.    internal rate of return
c.    profitability index
d.    payback

 
    32.    The relevant cash flows of a project do not include which one of the following?
a.    incremental after-tax cash flows
b.    cannibalization effects
c.    opportunity costs
d.    sunk costs

 
    33.    What is the payback period for Sweetbay Supermarket’s new project if its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash flows of $1,800,000 in year 1, $1,900,000 in year 2, $700,000 in year 3 and $1,800,000 in year 4?
a.    4.33 years
b.    3.33 years
c.    2.33 years
d.    none of the above

 
    34.    Which of the following statements is false?
a.    If the payback period is greater than the maximum acceptable payback period, accept the project.
b.    If the payback period is less than the maximum acceptable payback period, reject the project.
c.    If the payback period is greater than the maximum acceptable payback period, reject the project.
d.    two of the above are false.

 
    35.    What is the IRR for the following project if its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash flows of ($1,800,000) in year 1, $2,900,000 in year 2, $2,700,000 in year 3, and $2,300,000 in year 4?
a.    5.83%
b.    9.67%
c.    11.44%
d.    none of the above

 
    36.    What is the NPV for the following project if its cost of capital is 12% and its initial after-tax cost is $5,000,000 and it is expected to provide after-tax operating cash flows of $1,800,000 in year 1, $1,900,000 in year 2, $1,700,000 in year 3, and ($1,300,000) in year 4?
a.    ($1,494,336)
b.    $1,494,336
c.    greater than zero
d.    two of the above

 

    37.    When the net present value for a project is negative, the internal rater of return is _________ the cost of capital.
a.    greater than
b.    greater than or equal to
c.    less than
d.    equal to

 
    38.    The ________ is the discount rate that equates the present value of the cash inflows with the initial investment.
a.    payback period
b.    average rate of return
c.    cost of capital
d.    internal rate of return

 
    39.    The final step in the capital budgeting process is
a.    implementation
b.    selection
c.    follow-up
d.    development

 
    40.    The first step in the capital budgeting process is
a.    implementation
b.    selection
c.    follow-up
d.    identification

 
    41.    All of the following statements are correct EXCEPT:
a.    Capital budgeting analysis is a framework for evaluating all business decisions; it is not only a tool for the “financial” types.
b.    Proper analysis will identify relevant cash flows and an appropriate discount rate to reflect the risk of the strategy and will compare the benefits and costs of the project by considering the time value of money.
c.    Whether the investment is one in a business strategy, building a new warehouse, seeking fuel efficient methods of doing business, upgrading information technology systems, or investing in human resources, we should try to quantify the benefits and cost of these choices in order to evaluate them properly.
d.    To achieve success over time, a firm’s managers must identify and invest in projects that provide positive net present values to maximize shareholder wealth.
e.    all of the above statements are correct

 
    42.    Which of the following statements is correct?
a.    Capital budgeting analysis is not a framework for evaluating all business decisions; it is only a tool for the “financial” types.
b.    Proper analysis will identify irrelevant cash flows and an appropriate discount rate to reflect the risk of the strategy and will compare the benefits and costs of the project without considering the time value of money.
c.    Whether the investment is one in a business strategy, building a new warehouse, seeking fuel efficient methods of doing business, upgrading information technology systems, or investing in human resources, we should not try to quantify the benefits and cost of these choices in order to evaluate them properly.
d.    To achieve success over time, a firm’s managers must identify and invest in projects that provide positive net present values to maximize shareholder wealth.
e.    all of the above statements are correct

 
    43.    All of the following statements are correct EXCEPT:
a.    Capital budgeting analysis is a framework for evaluating all business decisions; it is not only a tool for the “financial” types.
b.    Proper analysis will identify relevant cash flows and an appropriate discount rate to reflect the risk of the strategy and will compare the benefits and costs of the project by considering the time value of money.
c.    Whether the investment is one in a business strategy, building a new warehouse, seeking fuel efficient methods of doing business, upgrading information technology systems, or investing in human resources, we should not try to quantify the benefits and cost of these choices in order to evaluate them properly.
d.    To achieve success over time, a firm’s managers must identify and invest in projects that provide positive net present values to maximize shareholder wealth.
e.    all of the above statements are correct

 
    44.    Which of the following statements is correct?
a.    Capital budgeting analysis is not a framework for evaluating all business decisions; it is only a tool for the “financial” types.
b.    Proper analysis will identify irrelevant cash flows and an appropriate discount rate to reflect the risk of the strategy and will compare the benefits and costs of the project without considering the time value of money.
c.    Whether the investment is one in a business strategy, building a new warehouse, seeking fuel efficient methods of doing business, upgrading information technology systems, or investing in human resources, we should not try to quantify the benefits and cost of these choices in order to evaluate them properly.
d.    To achieve success over time, a firm’s managers must identify and invest in projects that provide higher than average profits to maximize shareholder wealth.
e.    none of the above statements are correct

 
    45.    Capital budgeting is
a.    the process of identifying, evaluating, and implementing a firm’s investment opportunities.
b.    the process of identifying, evaluating, and implementing a firm’s objectives.
c.    the process of identifying, evaluating, and implementing a firm’s strategic plans.
d.    the process of identifying, evaluating, and implementing a firm’s financing requirements.
e.    all of the above statements are correct

 
    46.    Capital budgeting is
a.    the process of identifying, evaluating, and implementing a firm’s working capital requirements.
b.    the process of identifying, evaluating, and implementing a firm’s management objectives.
c.    the process of identifying, evaluating, and implementing a firm’s strategic plans.
d.    the process of identifying, evaluating, and implementing a firm’s financing requirements.
e.    none of the above statements are correct

 

    47.    All of the following statements are correct except:
a.    Capital budgeting is the process of identifying, evaluating, and implementing a firm’s investment opportunities.
b.    Capital budgeting seeks to identify projects that will enhance a firm’s competitive advantage and by so doing increase shareholders’ wealth.
c.    By its nature, capital budgeting involves long-term projects, although capital budgeting techniques also can be applied to working capital decisions
d.    Capital budgeting projects usually require large initial investments and may involve acquiring or constructing plant and equipment.
e.    all of the above statements are correct

 
    48.    All of the following statements are correct except:
a.    Capital budgeting is the process of identifying, evaluating, and implementing a firm’s investment opportunities.
b.    Capital budgeting seeks to identify projects that will enhance a firm’s competitive advantage and by so doing increase shareholders’ wealth.
c.    By its nature, capital budgeting involves long-term projects, although capital budgeting techniques also can be applied to working capital decisions
d.    Capital budgeting projects usually require small initial investments and may involve acquiring or constructing plant and equipment.
e.    all of the above statements are correct

 
    49.    Which of the following statements is correct?
a.    Capital budgeting is the process of identifying, evaluating, and implementing a firm’s investment opportunities.
b.    Capital budgeting seeks to identify projects that will reduce a firm’s competitive advantage and by so doing decrease shareholders’ wealth.
c.    By its nature, capital budgeting involves short-term projects.
d.    Capital budgeting projects usually require small initial investments and may involve acquiring or constructing plant and equipment.
e.    none of the above statements are correct

 

    50.    Which of the following statements is correct?
a.    Capital budgeting is the process of identifying, evaluating, and implementing a firm’s financing strategies.
b.    Capital budgeting seeks to identify projects that will reduce a firm’s competitive advantage and by so doing decrease shareholders’ wealth.
c.    By its nature, capital budgeting involves short-term projects.
d.    Capital budgeting projects usually require small initial investments and may involve acquiring or constructing plant and equipment.
e.    none of the above statements are correct

 

    51.    Which of the following statements is correct?
a.    The typical capital budgeting project involves a small upfront cash outlay, followed by a series of smaller cash inflows and outflows, but the project’s cash flows, including the total upfront cost of the project, are not known with certainty before the project starts.
b.    The typical capital budgeting project involves a large upfront cash outlay, followed by a series of larger cash inflows and outflows, but the project’s cash flows, including the total upfront cost of the project, are not known with certainty before the project starts.
c.    The typical capital budgeting project involves a large upfront cash outlay, followed by a series of smaller cash inflows and outflows, but the project’s cash flows, including the total upfront cost of the project, are not known with certainty before the project starts.
d.    The typical capital budgeting project involves a large upfront cash outlay, followed by a series of smaller cash inflows and outflows, and the project’s cash flows, including the total upfront cost of the project, are known with certainty before the project starts.
e.    none of the above statements are correct

 

    52.    Which of the following statements is correct?
a.    The typical capital budgeting project involves a small upfront cash outlay, followed by a series of smaller cash inflows and outflows, but the project’s cash flows, including the total upfront cost of the project, are not known with certainty before the project starts.
b.    The typical capital budgeting project involves a large upfront cash outlay, followed by a series of larger cash inflows and outflows, but the project’s cash flows, including the total upfront cost of the project, are not known with certainty before the project starts.
c.    The atypical capital budgeting project involves a large upfront cash outlay, followed by a series of smaller cash inflows and outflows, but the project’s cash flows, including the total upfront cost of the project, are not known with certainty before the project starts.
d.    The typical capital budgeting project involves a large upfront cash outlay, followed by a series of smaller cash inflows and outflows, and the project’s cash flows, including the total upfront cost of the project, are known with certainty before the project starts.
e.    none of the above statements are correct

 

    53.    In the case of mutually exclusive projects:
a.    the financial manager is responsible for choosing the average of these alternatives since only one can be chosen; selecting one project requires the selection of the other.
b.    they are to be evaluated based on their expected effect on shareholder wealth; all such projects that enhance shareholder wealth should be included in the firm’s capital budget.
c.    the financial manager is responsible for choosing the best of these alternatives since only one can be chosen; selecting one project precludes the other from being undertaken.
d.    they are to be evaluated based on their past effect on shareholder wealth; all such projects that enhance shareholder wealth should be included in the firm’s capital budget.
e.    none of the above statements are correct

 

    54.    In the case of mutually exclusive projects:
a.    the financial manager is responsible for choosing the average of these alternatives since only one can be chosen; selecting one project requires the selection of the other.
b.    they are to be evaluated based on their expected effect on shareholder wealth; all such projects that enhance shareholder wealth should be included in the firm’s capital budget.
c.    the financial manager is responsible for choosing the top three of these alternatives since only three can be chosen.
d.    they are to be evaluated based on their past effect on shareholder wealth; all such projects that enhance shareholder wealth should be included in the firm’s capital budget.
e.    none of the above statements are correct

 
    55.    In the case of independent projects:
a.    the financial manager is responsible for choosing the average of these alternatives since only one can be chosen; selecting one project requires the selection of the other.
b.    they are to be evaluated based on their expected effect on shareholder wealth; all such projects that enhance shareholder wealth should be included in the firm’s capital budget.
c.    the financial manager is responsible for choosing the best of these alternatives since only one can be chosen; selecting one project precludes the other from being undertaken.
d.    they are to be evaluated based on their past effect on shareholder wealth; all such projects that enhance shareholder wealth should be included in the firm’s capital budget.
e.    none of the above statements are correct

 
    56.    In the case of independent projects:
a.    the financial manager is responsible for choosing the average of these alternatives since only one can be chosen; selecting one project requires the selection of the other.
b.    they are to be evaluated based on their expected effect on net income; all such projects that enhance net income should be included in the firm’s capital budget.
c.    the financial manager is responsible for choosing the best of these alternatives since only one can be chosen; selecting one project precludes the other from being undertaken.
d.    they are to be evaluated based on their past effect on shareholder wealth; all such projects that enhance shareholder wealth should be included in the firm’s capital budget.
e.    none of the above statements are correct

 
    57.    An examination of a firm’s opportunities, strengths, threats and weaknesses is often referred to by the following acronym:
a.    WOTS.
b.    OSTW.
c.    SWOT.
d.    TWOS.
e.    none of the above statements are correct

 

    58.    An examination of a firm’s opportunities, strengths, threats and weaknesses is often referred to by the following acronym:
a.    WOTS.
b.    OSTW.
c.    STOW.
d.    TWOS.
e.    none of the above statements are correct

 
    59.    The corporate planning tool that develops project plans that fit well with the firm’s plans is often referred to by the following acronym:
a.    MOGS.
b.    SMOG.
c.    OMGS.
d.    GOMS.
e.    none of the above statements are correct

 

    60.    The corporate planning tool that develops project plans that fit well with the firm’s plans is often referred to by the following acronym:
a.    MOSG.
b.    SMOG.
c.    OMGS.
d.    GOMS.
e.    none of the above statements are correct

 
    61.    The corporate planning tool that develops project plans that fit well with the firm’s plans is often referred to by the following acronym:
a.    SWOT.
b.    MOGS.
c.    STOW.
d.    GOMS.
e.    none of the above statements are correct

 
    62.    The corporate planning tool that develops project plans that fit well with the firm’s plans is often referred to by the following acronym:
a.    SWOT.
b.    MOSG.
c.    STOW.
d.    GOMS.
e.    none of the above statements are correct

 

    63.    Any positive economic profit or positive net present value must arise from
a.    market imperfections or inefficiencies such as a monopoly situation.
b.    cost-saving projects that allow the firm to reduce costs below the current level such as economies of scale and access to distribution channels.
c.    government contracts or preferences.
d.    two of the above are correct.
e.    all of the above statements are correct

 

    64.    Any positive economic profit or positive net present value must arise from
a.    a perfectly competitive market situation.
b.    cost-producing projects that allow the firm to increase costs above the current level such as economies of scale and access to distribution channels.
c.    government contracts or preferences.
d.    two of the above are correct.
e.    none of the above statements are correct

 

    65.    Any positive economic profit or positive net present value may arise from
a.    market imperfections or inefficiencies such as a monopoly situation.
b.    economies of scale.
c.    product differentiation.
d.    government policy.
e.    all of the above statements are correct

 
    66.    Positive NPV projects may originate from cost saving projects such as those that
a.    create economies of scale.
b.    create product differentiation.
c.    generate absolute cost advantages.
d.    exploit advantages in distribution channels.
e.    all of the above statements are correct

 
    67.    Positive NPV projects may originate from cost saving projects such as those that
a.    reduce economies of scale.
b.    create product differentiation.
c.    reduce absolute cost advantages.
d.    fail to exploit advantages in distribution channels.
e.    none of the above statements are correct

 

    68.    Positive NPV projects may originate from cost saving projects such as those that
a.    reduce economies of scale.
b.    reduce product differentiation.
c.    reduce absolute cost advantages.
d.    fail to exploit advantages in distribution channels.
e.    none of the above statements are correct

 
    69.    The capital budgeting process consists of all of the following stages except:
a.    follow-up.
b.    selection.
c.    implementation.
d.    Development.
e.    all of the above

 
    70.    The capital budgeting process consists of all of the following stages except:
a.    follow-up.
b.    selection.
c.    refurbishing.
d.    development.
e.    all of the above are included

 
    71.    Stages of the capital budgeting include all of the following except:
a.    follow-up.
b.    selection.
c.    identification.
d.    development.
e.    all of the above are included

 
    72.    The stage in the capital budgeting process that involves finding potential capital investment opportunities and determining whether a project involves a replacement decision and/or revenue expansion is called the _____________ stage.
a.    follow-up.
b.    selection.
c.    identification.
d.    development.
e.    none of the above are included

 

    73.    The stage in the capital budgeting process that requires estimating relevant cash inflows and outflows and discussing the pros and cons of each project is called the _____________ stage.
a.    follow-up.
b.    selection.
c.    identification.
d.    development.
e.    none of the above are included

 

    74.    The stage in the capital budgeting process that involves applying the appropriate capital budgeting techniques to help make a final accept or reject decision is called the _____________ stage.
a.    follow-up.
b.    selection.
c.    identification.
d.    development.
e.    none of the above are included

 

    75.    The stage in the capital budgeting process in which projects that are accepted must be executed in a timely fashion is called the _____________ stage.
a.    follow-up.
b.    selection.
c.    identification.
d.    implementation.
e.    none of the above are included

 

    76.    The stage in the capital budgeting process in which implemented projects are periodically reviewed is called the _____________ stage.
a.    follow-up.
b.    selection.
c.    identification.
d.    implementation.
e.    none of the above are included

 
    77.    Unlike other corporations undertaking the capital budgeting process, ___________ need to consider possible added political and economic risks such as the possibility of seizure of assets, unstable currencies, foreign exchange controls and foreign tax regulations.
a.    MOGs.
b.    MNCs.
c.    SWOTs.
d.    LTDs.
e.    none of the above

 

    78.    Unlike other corporations undertaking the capital budgeting process, ___________ need to consider possible added political and economic risks such as the possibility of seizure of assets, unstable currencies, foreign exchange controls and foreign tax regulations.
a.    MOGs.
b.    INCs.
c.    SWOTs.
d.    LTDs.
e.    none of the above

 

    79.    Examples of external economic data required for project analysis include all of the following except:
a.    business cycle stages.
b.    inflation trends
c.    labor-management relations
d.    exchange rate trends
e.    all of the above are included

 

    80.    Examples of external economic data required for project analysis include all of the following except:
a.    business cycle stages
b.    inflation trends
c.    taxes
d.    exchange rate trends
e.    all of the above are included

 



    81.    Examples of internal financial data required for project analysis include all of the following except:
a.    investment costs
b.    business cycle stages
c.    financing costs
d.    transportation costs
e.    all of the above are included

 

    82.    Examples of internal financial data required for project analysis include all of the following except:
a.    investment costs
b.    estimates of revenues, costs, and cash flows
c.    financing costs
d.    transportation costs
e.    all of the above are included

 

    83.    Examples of non-financial data required for project analysis include all of the following except:
a.    distribution channels
b.    quantity and quality of labor force in different locations
c.    labor-management relations
d.    status of technological change in the industry
e.    all of the above are included

 

    84.    Examples of non-financial data required for project analysis include all of the following except:
a.    financing costs
b.    quantity and quality of labor force in different locations
c.    labor-management relations
d.    status of technological change in the industry
e.    all of the above are included

 
    85.    Shanghai Shipping is considering investing in a project that requires an after-tax initial investment of 156 million and is expected to produce after-tax cash inflows of $40 million for each of the next five years.  The firm’s cost of capital is 10%.  Based on this information, the NPV of the project is _________ million and the firm should _________ the project.
a.    $151.63; accept
b.    -$151.63, reject
c.    $4.37, accept
d.    -$4.37, reject
e.    none of the above

 

    86.    Shanghai Shipping is considering investing in a project that requires an after-tax initial investment of 156 million and is expected to produce after-tax cash inflows of $40 million for each of the next five years.  The firm’s cost of capital is 8%.  Based on this information, the NPV of the project is _________ million and the firm should _________ the project.
a.    $3.7; accept
b.    -$3.7, reject
c.    $159.37, accept
d.    -$159.37, reject
e.    none of the above

 
    87.    Shanghai Shipping is considering investing in a project that requires an after-tax initial investment of 156 million and is expected to produce after-tax cash inflows of $40 million for each of the next five years.  The firm’s cost of capital is 10%.  Based on this information, the IRR of the project is _________ percent and the firm should _________ the project.
a.    9.9; accept
b.    -9.9, reject
c.    8.9, accept
d.    -8.9, reject
e.    none of the above

 


    88.    Shanghai Shipping is considering investing in a project that requires an after-tax initial investment of 156 million and is expected to produce after-tax cash inflows of $40 million for each of the next five years.  The firm’s cost of capital is 8%.  Based on this information, the IRR of the project is _________ percent and the firm should _________ the project.
a.    9.9; accept
b.    -9.9, reject
c.    8.9, accept
d.    -8.9, reject
e.    none of the above

 
    89.    The IRR
a.    shows the graphical relationship between a project’s NPV and cost of capital.
b.    is the return that causes the NPV to be zero.
c.    is the return that causes the NPV to be positive.
d.    measures the firm and project’s required rate of return.
e.    none of the above

 
    90.    The IRR
a.    shows the graphical relationship between a project’s NPV and cost of capital.
b.    is the return that causes the NPV to be negative.
c.    is the return that causes the NPV to be positive.
d.    measures the firm and project’s required rate of return.
e.    none of the above

 
    91.    All of the following statements are correct except:
a.    The NPV and IRR methods will always agree on whether a project enhances or harms shareholder wealth.
b.    If a project has a positive NPV, its IRR will always be greater than the cost of capital.
c.    If a project has a negative NPV, its IRR will always be less than the cost of capital.
d.    There is never a conflict between NPV and IRR in the case of mutually exclusive projects.
e.    all of the above are correct

 
    92.    All of the following statements are correct except:
a.    The NPV and IRR methods will always agree on whether a project enhances or harms shareholder wealth.
b.    If a project has a positive NPV, its IRR will always be greater than the cost of capital.
c.    If a project has a negative NPV, its IRR will always be less than the cost of capital.
d.    There is always a conflict between NPV and IRR in the case of mutually exclusive projects.
e.    all of the above are correct

 
    93.    All of the following statements are correct except:
a.    The NPV and IRR methods will only sometimes agree on whether a project enhances or harms shareholder wealth.
b.    If a project has a positive NPV, its IRR will always be less than the cost of capital.
c.    If a project has a negative NPV, its IRR will always be greater than the cost of capital.
d.    There is always a conflict between NPV and IRR in the case of mutually exclusive projects.
e.    none of the above are correct

 
    94.    All of the following statements are correct except:
a.    The NPV and IRR methods will always agree on whether a project enhances or harms shareholder wealth.
b.    If a project has a positive NPV, its IRR will always be greater than the cost of capital.
c.    If a project has a negative NPV, its IRR will always be less than the cost of capital.
d.    There is sometimes a conflict between NPV and IRR in the case of mutually exclusive projects.
e.    all of the above are correct

 
    95.    All of the following statements are correct except:
a.    MIRR solves some of the problems presented by IRR in that MIRR rankings of mutually exclusive projects with comparably-sized initial investments will agree with the NPV rankings of those projects.
b.    MIRR always gives a single  c.    MIRR is most useful in the case of mutually exclusive investments and in cases where project cash flows change sign more than once.
d.    MIRR is always less than the regular IRR if the cost of capital is less than the regular IRR.
e.    all of the above are correct

 
    96.    All of the following statements are correct except:
a.    MIRR solves some of the problems presented by IRR in that MIRR rankings of mutually exclusive projects with comparably-sized initial investments will agree with the NPV rankings of those projects.
b.    MIRR always gives a single  c.    MIRR is most useful in the case of mutually exclusive investments and in cases where project cash flows change sign more than once.
d.    MIRR is always greater than the regular IRR if the cost of capital is less than the regular IRR.
e.    all of the above are correct

 
    97.    All of the following statements are correct except:
a.    MIRR solves all of the problems presented by IRR and will always provide the same recommendation as the NPV.
b.    MIRR never gives a single  c.    MIRR is least useful in the case of mutually exclusive investments and in cases where project cash flows change sign more than once.
d.    MIRR is always greater than the regular IRR if the cost of capital is less than the regular IRR.
e.    none of the above are correct

 
    98.    The ratio between the present value of a project’s cash inflows and the present value of its initial investment is called the:
a.    MIRR.
b.    IRR.
c.    PI.
d.    NPV.
e.    none of the above are correct

 
    99.    The ratio between the present value of a project’s cash inflows and the present value of its initial investment is called the:
a.    MIRR.
b.    IRR.
c.    PM.
d.    NPV.
e.    none of the above are correct

 
    100.    Reasons NPV, IRR, MIRR, and PI will sometimes disagree in the case of mutually exclusive investments include all of the following except:
a.    different cash flow patterns.
b.    different time horizons.
c.    different sizes.
d.    different locations.
e.    all of the above are correct

 

Chapter 18
Capital Structure and the Cost of Capital

TRUE-FALSE QUESTIONS

    1.    The firm’s capital structure is the mix of debt and equity used to finance its assets.
  
    2.    The firm’s optimum debt/equity mix maximizes the firm’s cost of capital, which in turn will help the firm to maximize shareholder wealth.
  
    3.    Firm value is calculated by adding expected cash flow to the firm’s cost of capital under each capital structure.
  
    4.    Similar to the net present value method, there is a formula to determine the proportions of debt and equity a firm should use to finance its assets.
  
    5.    EBIT/EPS analysis allows managers to see how different capital structures affect the earnings levels of their firms.
  
    6.    EBIT/EPS analysis shows the ranges of EBIT where a firm may prefer one capital structure over another.
  
    7.    A firm’s financial risk is measured by its variability in EBIT over time.
  
    8.    Operating leverage affects the top portion of a firm’s income statement whereas financial leverage affects the bottom half of the income statement.
  
    9.    The degree of financial leverage measures the sensitivity of earnings per share to changes in EBIT.
  
    10.    The degree of financial leverage may be measured by taking the firm’s earnings before interest and taxes and dividing by earnings before taxes.
  
    11.    The degree of combined leverage is the percentage change in earnings per share that results from a one percent change in EBIT.
  
    12.    A firm’s degree of combined leverage is the product of its degree of operating leverage and its degree of financial leverage
  
    13.    When the interest expense is zero, the percentage change in earnings per share will be the same as the percentage change in EBIT.
  
    14.    Corporate investors can exempt all preferred dividend income from income taxes.
  
    15.    Some classes of common equity may have superior voting rights.
  
    16.    One advantage of preferred is that it increases a firm’s equity without diluting the ownership and control of the common shareholders.
  
    17.    The cost of debt represents the minimum acceptable rate of return to a firm on a project of average risk.
  
    18.    There is no opportunity cost associated with retained earnings.
  
    19.    The minimum required rate of return is a weighted average of the firm’s cost of various sources of capital.
  
    20.    A non-optimal capital structure may lead to higher financing costs.
  
    21.    Leverage does not affect EPS for most firms.
  
    22.    A greater percentage of European multinational firms use weighted average costs of capital as their project discount rates than U.S. firms.
  
    23.    Financial theory favors the method using the market values of the firm’s debt and equity to compare target and actual weights.
  
    24.    The greater the total fixed operating costs of a firm, the greater the degree of operating leverage and the greater the degree of combined leverage.
  
    25.    A firm’s business risk is measured by its variability in EBIT over time.
  
    26.    Operating leverage is affected by such items as rental payments, contractual employee salaries, and general and administrative overhead expenses.
  
    27.    The degree of financial leverage measures the sensitivity of earnings per share to sales.
  
    28.    Business risk is measured by the degree of financial leverage.
  
    29.    Financial risk affects the bottom half of the income statement.
  
    30.    The degree of combined leverage is measured by adding the degree of operating leverage and degree of financial leverage.
  
    31.    The firm’s optimum debt/equity mix minimizes the firm’s cost of capital, which in turn will help the firm to maximize shareholder wealth.
  
    32.    The ratio of long-term debt to GDP for non-financial U.S. corporations declined drastically during the late 1990s.
  
    33.    The ratio of debt to stock market equity has generally been highest for the smallest of U.S. firms.
  
    34.    The ratio of debt to stock market equity has generally been lowest for the largest of U.S. firms.
  
    35.    The minimum acceptable rate of return for a project is the return that generates sufficient cash flow to pay investors their expected return.
  
    36.    The required return, the cost of capital, and the discount rate are actually three distinctively different concepts.
  
    37.    The cost of capital may be estimated from the historical cost of raising debt and equity capital.
  
    38.    The firm’s unadjusted cost of debt financing equals the yield to maturity on new debt issues.
  
    39.    The internal growth rate measures how quickly a firm can increase its asset base over the next year without raising outside funds.
  
    40.    The sustainable growth rate measures how quickly a firm can increase its asset base over the next year without raising outside funds.
  
    41.    The sustainable growth rate measures how quickly a firm can grow when it uses both internal equity and debt financing to keep its capital structure constant over time.
  
    42.    The internal growth rate measures how quickly a firm can grow when it uses both internal equity and debt financing to keep its capital structure constant over time.
  

    43.    For any firm’s given growth strategy, its dividend decision directly affects its capital structure decision.
  
    44.    The EPS/EBIT indifference level represents the level of EBIT at which the firm would be indifferent between two different capital structures because they both result in the same level of EPS.
  
    45.    The EPS/EBIT indifference level represents the level of Assets at which the firm would be indifferent between two different capital structures because they both result in the same level of EPS.
  
    46.    The pecking order hypothesis implies that firm’s have no optimal debt/equity ratios.

  
    47.    Because the cost of capital is used to evaluate future investment proposals, it is important to flotation costs because such costs would be incurred if a firm were to raise new capital to fund proposed projects.

  
    48.    In estimating the cost of equity, the rate of return on U.S. Treasury bills is often used as a proxy for the risk free rate of return.

  
    49.    The weighted average cost of capital represents the maximum required rate of return on a capital-budgeting project and is found by multiplying the cost of each capital structure component by its appropriate weight and summing the terms.

  
    50.    The weighted average cost of capital represents the minimum required rate of return on a capital-budgeting project and is found by multiplying the cost of each capital structure component by its appropriate weight and summing the terms.

  

MULTIPLE-CHOICE QUESTIONS

    1.    Which of the following is not used in the weighted average cost of capital equation?
a.    cost of retained earnings
b.    weight of debt
c.    corporate income tax rate
d.    marginal tax rate

  
    2.    Of the components shown below, which is least likely to be of value in calculating the cost of preferred stock?
a.    flotation costs per share
b.    book value of a preferred share
c.    dividends per share
d.    initial market price per share

  
    3.    In calculating the cost of new common stock using the constant dividend growth model, it is important that the __________ are subtracted from the price of the stock.
a.    flotation costs
b.    par value
c.    cost of retained earnings
d.    proceeds of the sale

  
    4.    When retained earnings are used up and new common stock is issued, we know that the cost of:
a.    equity has increased
b.    equity has dropped
c.    equity is unaffected
d.    both common and preferred stock are affected

  
    5.    Flotation costs include:
a.    cost of printing shares
b.    legal and accounting costs
c.    investment banker fees
d.    all the above

  
    6.    Smith Company has a degree of operating leverage of 5, while Johnson Company has a degree of operating leverage of 2.  Supplied with this knowledge, pick the response below that is most typical of Johnson Company.
a.    high fixed costs
b.    conservative
c.    large commitment to plant facilities
d.    greater sales.

  
    7.    A company experienced a 12 % increase in earnings before interest and taxes and a 3 % increase in sales. What is the degree of operating leverage for this company?
a.    36
b.    6
c.    4
d.    none of the above

  
    8.    The degree of combined leverage shows us to what degree a percentage change in sales will cause a percentage change in:
a.    earnings before interest and taxes
b.    earnings after tax
c.    earnings per share
d.    gross profit

  
    9.    Which of the following is a correct way to calculate degree of combined leverage?
a.    divide DFL by DOL
b.    multiply DOL by DFL
c.    divide DOL by DFL
d.    add DOL and DFL

  
    10.    What should be the relation between the target capital structure for a firm and the firm’s optimum capital structure?
a.    Target and optimum capital structures should be the same.
b.    Target capital structure is more conservative overall.
c.    Target capital structure contains more debt.
d.    Target capital structure excludes preferred stock.

  
    11.    Given the conflict between risk and return, the purpose of capital structure management is to find the debt level:
a.    that will always be kept below the equity level
b.    where the price of company stock is maximized
c.    that most adequately supports corporate goals
d.    that is equal in dollar value to the equity level

  
    12.    Which of the following is not an influence affecting a firm’s capital structure choices?
a.    corporate control
b.    maturity matching
c.    timing
d.    all the above

  
    13.    As a general rule, the capital structure that maximizes stock price also:
a.    minimizes the weighted average cost of capital
b.    maximizes the weighted average cost of capital
c.    minimizes the required rate of return on equity
d.    maximizes the cost of debt

  
    14.    A decrease in the debt ratio will normally have no effect on:
a.    financial risk
b.    business risk
c.    total risk
d.    systematic risk

  
    15.    The firm’s target capital structure is consistent with which of the following?
a.    minimum risk
b.    maximum earnings per share
c.    minimum weighted average cost of capital
d.    minimum cost of equity

  
    16.    Which of the following phrases make the statement false?  As a firm increases its operating leverage for a given quantity of output, this:
a.    decreases its financial leverage
b.    changes its operating cost structure
c.    increases its business risk
d.    increases the variability on earnings per share

  
    17.    As a general rule, the capital structure that:
a.    minimizes the cost of equity also maximizes the stock price
b.    maximizes the stock price also minimizes the weighted average cost of capital
c.    minimizes the cost of debt also maximizes the expected earnings per share
d.    none of the above is a true statement

  
    18.    Which of the following statements is most correct?
a.    All component costs in a firm’s weighted average cost of capital must reflect after-tax costs, but the only component that requires an adjustment for taxes is the cost of new common stock.
b.    An increase in the corporate tax rate would lower the weighted average cost of capital for the firm, other things held constant.
c.    The cost of debt is equal to one minus the marginal tax rate multiplied by the coupon rate on outstanding debt.
d.    All the above statements are equally true.

  
    19.    Which of the following statements is most correct?
a.    The degree of combined leverage measures the sensitivity of earnings per share in EBIT.
b.    A firm’s business risk is measured by its variability in earnings per share over time.
c.    A firm’s degree of combined leverage is the product of its degree of operating leverage and its degree of financial leverage.
d.    All the above statements are false.

  
    20.    Which of the following statements is false?
a.    Combined leverage is the effect on earnings produced by the operating and financial leverage.
b.    There is strong empirical evidence that firms adjust their degrees of operating leverage and degrees of financial leverage to match some standard degree of combined leverage.
c.    Financial risk is the additional risk, above business risk, resulting from substituting debt into the capital structure.
d.    All the above statements are true.

  
    21.    A company with a DCL of 12 and a DFL of 2 has a DOL of?
a.    24
b.    14
c.    6
d.    cannot tell from this information

  
    22.    Which of the following statements is false?
a.    Other factors being constant, higher fixed costs mean a higher operating leverage.
b.    Corporate bonds and notes provide no voting rights.
c.    The cost of debt is the minimum acceptable rate of return to a firm on a project of average risk.
d.    All of the above statements are true.

  
    23.    A firm with a DOL of 2, and no preferred stock, and no long-term debt will have a DCL of:
a.    0
b.    2
c.    1
d.    cannot tell from this information

  
    24.    A high degree of financial leverage means that a small change in sales will result in:
a.    a small change in earnings per share
b.    a large change in earnings per share
c.    no change in earnings per share
d.    none of the above

  
    25.    A decrease in contractual managers’ salaries will result in:
a.    an increase in the degree of financial leverage
b.    a decrease in the degree of financial leverage
c.    no change in the degree of financial leverage

  
    26.    A decrease in contractual managers’ salaries will result in:
a.    an increase in the degree of combined leverage
b.    a decrease in the degree of combined leverage
c.    no change in the degree of combined leverage
d.    none of the above

  
    27.    Which of the following securities have voting rights?
a.    convertible bond
b.    preferred stock
c.    common stock
d.    all the above

  
    28.    The cost of debt:
a.    is typically higher than the cost of preferred stock
b.    must be adjusted to an after-tax cost
c.    is higher than the cost of retained earnings
d.    is the lowest component cost because corporations can deduct 70 percent of the interest expense

  
    29.    The cost of retained earnings is:
a.    the cheapest component cost
b.    zero because the firm does not have to pay interest or dividend to itself
c.    always less than the cost of new common stock
d.    typically cheaper than the cost of preferred stock

  
    30.    The initial impact of increasing the use of debt is to:
a.    lower the cost of capital
b.    lower the weight of the debt component
c.    increase the cost of capital
d.    lower the cost of retained earnings

  
    31.    Other factors being constant, higher fixed operating costs mean:
a.    higher financial leverage
b.    higher operating leverage
c.    lower combined leverage
d.    the degree of financial leverage is equal to 1.0

  
    32.    Other factors being constant, higher fixed financial costs mean:
a.    higher financial leverage
b.    higher operating leverage
c.    lower combined leverage
d.    the degree of financial leverage is equal to 1.0

  
    33.    A firm’s business risk is affected by:
a.    business cycle
b.    the firm’s operating leverage
c.    competitive pressures
d.    all the above

  
    34.    If a firm has current earnings per share of $2 and a degree of combined leverage of 4, a 10% increase in sales would result in earnings per share of:
a.    $2.80
b.    $8
c.    $2.20
d.    cannot tell from this information

  
    35.    If a firm has current earnings per share of $2 and a degree of financial leverage of 4, a 10% increase in sales would result in earnings per share of:
a.    $2.80
b.    $8
c.    $2.20
d.    cannot tell from this information

  
    36.    If a firm has current earnings per share of $2 and a degree of operating leverage of 4, a 10% increase in sales would result in earnings per share of:
a.    $2.80
b.    $8
c.    $2.20
d.    cannot tell from this information

  
    37.    If a firm has current earnings before interest and taxes of $100,000 and interest expense of $10,000, its degree of financial leverage would be:
a.    10
b.    1.11
c.    .10
d.    cannot tell from this information

  
    38.    If firms select the proportion of debt in their capital structures in order to balance the benefits of tax-deducible interest payments with opportunity costs, this would support the notion of:
a.    the static trade-off hypothesis
b.    pecking order theory
c.    efficient markets hypothesis
d.    none of the above

  
    39.    The cost of capital for retained earnings:
a.    cannot be determined
b.    may be determined by more than method
c.    is greater than the cost of capital for common stock
d.    none of the above

  
    40.    Using the constant dividend growth model, which of the following components not be considered?
a.    current stock price
b.    dividend growth rate
c.    risk-free rate
d.    all the above are considered in the constant dividend growth model

  
    41.    If a firm has total long-term capital of $1,000,000, preferred stock of $500,000, preferred dividends of $10 and preferred stock price of $100, the weighted cost of capital is:
a.    50%
b.    10%
c.    5%
d.    cannot tell from this information

  
    42.    The after-tax cost of debt for a firm in the 35% tax bracket with a before-tax cost of debt of 6% is:
a.    6%
b.    2.1%
c.    3.9%
d.    cannot tell from this information

  
    43.    Finance theory favors the use of ____________ value weights in the calculation of the weighted average cost of capital.
a.    book
b.    future
c.    market
d.    none of the above

  
    44.    All of the following components are needed to calculate the internal growth rate except:
a.    return on assets
b.    retention rate
c.    return on equity
d.    all are needed

  
    45.    All of the following components are needed to calculate the sustainable growth rate except:
a.    return on assets
b.    retention rate
c.    return on equity
d.    all are needed

  
    46.    The internal and sustainable growth rate relationships suggest that there are three measurable influences on growth.  These include all of the following except:
a.    asset policy
b.    dividend policy
c.    profitability
d.    the firm’s capital structure

  
    47.    The hypotheses that states that firm’s try to time the market by issuing stocks when stock prices are high and repurchasing shares when prices are low is called:
a.    the market theory hypothesis
b.    the market timing hypothesis
c.    the market value hypothesis
d.    the market pricing hypothesis

  
    48.    A firm’s mix of debt and equity defines the firm’s:
a.    capital structure
b.    working capital
c.    net working capital
d.    degree of operating leverage

  
    49.    A firm’s business risk is measured by the variability in which one of the following over time:
a.    net sales
b.    total assets
c.    operating income (EBIT)
d.    net income

  
    50.    The degree of financial leverage measures the sensitivity of __________ to changes in __________.
a.    net sales, EBIT
b.    EBIT, net sales
c.    EBIT, EPS
d.    EPS, EBIT

  
    51.    A firm’s degree of combined leverage can be measured as degree of operating leverage __________ the degree of financial leverage:
a.    plus
b.    minus
c.    times
d.    divided by

  
    52.    Which of the following affects a firm’s choice of capital structures?
a.    flexibility
b.    timing
c.    corporate control
d.    all of the above

  
    53.    Which of the following is a different concept from the other three?
a.    required rate of return
b.    cost of capital
c.    discount rate
d.    net profit margin

  
    54.    Which of the following costs must be adjusted to an after-tax cost?
a.    cost of debt
b.    cost of preferred stock
c.    cost of common stock
d.    cost of retained earnings

  
    55.    The estimate of how quickly a firm may grow by maintaining a constant mix of debt and equity is called:
a.    the retention growth rate
b.    dividend growth rate
c.    sustainable growth rate
d.    the internal growth rate

  
    56.    All of the following statements are correct except:
a.    The firm’s optimum debt/equity mix minimizes the firm’s cost of capital, which in turn helps the firm to maximize shareholder wealth
b.    A firm’s mix of debt and equity used to finance its assets defines the firm’s capital structure.
c.    A nonoptimal capital structure with either too much or too little debt leads to higher financing costs, and the firm will likely reject some capital budgeting projects that could have increased shareholder wealth with an optimal financing mix.
d.    A project’s NPV represents the increase in shareholders’ wealth from undertaking a project; thus, a lower weighted average cost of capital gives higher project net present values and results in higher levels of shareholder wealth.
e.    All of the above statements are correct.

  
    57.    All of the following statements are correct except:
a.    The firm’s optimum debt/equity mix maximizes the firm’s cost of capital, which in turn helps the firm to maximize shareholder wealth
b.    A firm’s mix of debt and equity used to finance its assets defines the firm’s capital structure.
c.    A nonoptimal capital structure with either too much or too little debt leads to higher financing costs, and the firm will likely reject some capital budgeting projects that could have increased shareholder wealth with an optimal financing mix.
d.    A project’s NPV represents the increase in shareholders’ wealth from undertaking a project; thus, a lower weighted average cost of capital gives higher project net present values and results in higher levels of shareholder wealth.
e.    All of the above statements are correct.

  
    58.    All of the following statements are correct except:
a.    The firm’s optimum debt/equity mix maximizes the firm’s cost of capital, which in turn helps the firm to maximize shareholder wealth
b.    A firm’s mix of debt and equity used to finance its assets defines the firm’s working capital structure.
c.    A nonoptimal capital structure with either too much or too little debt leads to lower financing costs, and the firm will likely reject some capital budgeting projects that could have increased shareholder wealth with an optimal financing mix.
d.    A project’s NPV represents the decrease in shareholders’ wealth from undertaking a project; thus, a lower weighted average cost of capital gives higher project net present values and results in higher levels of shareholder wealth.
e.    None of the above statements are correct.

  
    59.    Corporate debt as a percentage of GDP grew from around ______ in 1970 to nearly ______ in 2007.
a.    35%; 50%
b.    40%; 55%
c.    45%; 60%
d.    50%; 60%

  

    60.    All of the following statements are correct except:
a.    Venture capitalists usually are members of partnerships that consist of a few general partners.
b.    The typical venture capital partnership manages between $50 million and $100 million in assets.
c.    It is common to organize a venture capital fund as a limited partnership in which the venture capitalist is the general partner and the other investors are limited investors.
d.    At the end of a fund’s life, cash and securities are distributed to the investors.
e.    All of the above statements are correct.

  
    61.    All of the following statements are correct except:
a.    Venture capitalists usually are members of partnerships that consist of thousands of general partners.
b.    The typical venture capital partnership manages between $50 billion and $100 billion in assets.
c.    It is common to organize a venture capital fund as a publicly listed corporation.
d.    At the end of a fund’s life, cash and securities are typically donated to charitable causes.
e.    None of the above statements are correct.

  
    62.    All of the following statements are correct except:
a.    Venture capitalists usually are members of partnerships that consist of a few general partners.
b.    The typical venture capital partnership manages between $50 million and $100 million in assets.
c.    It is common to organize a venture capital fund as publicly listed corporations.
d.    At the end of a fund’s life, cash and securities are distributed to the investors.
e.    All of the above statements are correct.

  
    63.    All of the following statements are correct except:
a.    Relevant cash flows are incremental after-tax cash flows, which must be discounted using an incremental after-tax cost of capital.
b.    The firm’s relevant cost of capital is computed from after-tax financing costs.
c.    A project’s incremental cash flows must be discounted at a cost of capital that represents the incremental or marginal cost to the firm of financing the project, that is, the cost of raising one additional dollar of capital.
d.    In estimating the cost of capital, the firm’s analysts need to evaluate investors’ expected returns under likely market conditions and then use these expected returns to compute the firm’s marginal future cost of raising funds.
e.    All of the above statements are correct.

  
    64.    All of the following statements are correct except:
a.    Relevant cash flows are incremental before-tax cash flows, which must be discounted using an incremental after-tax cost of capital.
b.    The firm’s relevant cost of capital is computed from after-tax financing costs.
c.    A project’s incremental cash flows must be discounted at a cost of capital that represents the incremental or marginal cost to the firm of financing the project, that is, the cost of raising one additional dollar of capital.
d.    In estimating the cost of capital, the firm’s analysts need to evaluate investors’ expected returns under likely market conditions and then use these expected returns to compute the firm’s marginal future cost of raising funds.
e.    All of the above statements are correct.

  
    65.    All of the following statements are correct except:
a.    Relevant cash flows are incremental before-tax cash flows, which must be discounted using an incremental after-tax cost of capital.
b.    The firm’s relevant cost of capital is computed from before-tax financing costs.
c.    A project’s incremental cash flows must be discounted at a cost of capital that represents the historical cost to the firm of financing the project.
d.    In estimating the cost of capital, the firm’s analysts need to evaluate investors’ historical returns under past market conditions and then use these past returns to compute the firm’s cost of raising funds.
e.    None of the above statements are correct.

  
    66.    All of the following methods can be used to estimate the cost of debt except:
a.    If the firm targets an “A” rating (or any other bond rating), a review of the yields to maturity on A-rated bonds in Standard & Poor’s Bond Guide can provide an estimate of the firm’s current borrowing costs.
b.    The firm can solicit the advice of investment bankers on the cost of issuing new debt.
c.    If the firm has debt currently trading, it can use public market prices and yields to estimate its current cost of debt.
d.    A firm can seek long-term debt financing from a bank or a consortium of banks; preliminary discussions with the bankers will indicate a ballpark interest rate the firm can expect to pay on its borrowing.
e.    All of the above statements are correct.

  
    67.    All of the following methods can be used to estimate the cost of debt except:
a.    If the firm targets an “A” rating (or any other bond rating), a review of the yields to maturity on A-rated bonds in Standard & Poor’s Bond Guide can provide an estimate of the firm’s current borrowing costs.
b.    The firm can solicit the advice of personal financial planners on the cost of issuing new debt.
c.    If the firm has debt currently trading, it can use public market prices and yields to estimate its current cost of debt.
d.    A firm can seek long-term debt financing from a bank or a consortium of banks; preliminary discussions with the bankers will indicate a ballpark interest rate the firm can expect to pay on its borrowing.
e.    All of the above statements are correct.

  
    68.    All of the following methods can be used to estimate the cost of debt except:
a.    If the firm targets an “A” rating (or any other bond rating), a review of the yields to maturity on A-rated bonds in the business section of the local newspaper can provide an estimate of the firm’s current borrowing costs.
b.    The firm can solicit the advice of personal financial planners on the cost of issuing new debt.
c.    If the firm has debt currently trading, it can send a survey to current owners of its bonds to find out what rate the firm should offer.
d.    A firm can seek long-term debt financing from a wealthy individual; preliminary discussions with the individual will indicate a ballpark interest rate the firm can expect to pay on its borrowing.
e.    None of the above statements are correct.

  
    69.    All of the following methods can be used to estimate the cost of equity except:
a.    Unlike debt and preferred stock, cash flows from common equity are not fixed or known beforehand and their risk is harder to evaluate.
b.    Firms have two sources of common equity, retained earnings and new stock issues, and thus two costs of common equity.
c.    From the shareholders’ perspective, the opportunity cost of retained earnings is the return the shareholders could earn by investing the funds in assets whose risk is similar to that of the firm.
d.    If the firm cannot invest its retained earnings to achieve a sufficient risk-adjusted return, shareholders would be better off receiving 100 percent of its net income as dividends.
e.    All of the above statements are correct.

  
    70.    All of the following methods can be used to estimate the cost of equity except:
a.    Like debt and preferred stock, cash flows from common equity are fixed.
b.    Firms have two sources of common equity, retained earnings and new stock issues, and thus two costs of common equity.
c.    From the shareholders’ perspective, the opportunity cost of retained earnings is the return the shareholders could earn by investing the funds in assets whose risk is similar to that of the firm.
d.    If the firm cannot invest its retained earnings to achieve a sufficient risk-adjusted return, shareholders would be better off receiving 100 percent of its net income as dividends.
e.    All of the above statements are correct.

  
    71.    All of the following methods can be used to estimate the cost of equity except:
a.    Like debt and preferred stock, cash flows from common equity are fixed.
b.    Firms have two sources of common equity, retained earnings and new stock issues, but only one single cost of common equity.
c.    From the shareholders’ perspective, the opportunity cost of retained earnings is the return the shareholders could earn by investing the funds in long-term treasury securities.
d.    If the firm cannot invest its retained earnings to achieve a sufficient risk-adjusted return, shareholders would be better off receiving additional shares of stock.
e.    None of the above statements are correct.

  
    72.    All of the following statements regarding capital structure weights in the WACC equation are correct except:
a.    The weights represent a specific intended financing mix.
b.    These target weights represent a mix of debt and equity that the firm will try to achieve or maintain over the planning horizon.
c.    As much as possible, the target weights should reflect the combination of debt and equity that management believes will minimize the firm’s weighted average cost of capital.
d.    The firm should make an effort over time to move toward and maintain its target capital structure mix of debt and equity.
e.    All of the above statements are correct.

  
    73.    All of the following statements regarding capital structure weights in the WACC equation are correct except:
a.    The weights represent a specific intended financing mix.
b.    These target weights represent a mix of debt and equity that the firm will try to achieve or maintain over the planning horizon.
c.    As much as possible, the target weights should reflect the combination of debt and equity that management believes will maximize the firm’s weighted average cost of capital.
d.    The firm should make an effort over time to move toward and maintain its target capital structure mix of debt and equity.
e.    All of the above statements are correct.

  
    74.    All of the following statements regarding capital structure weights in the WACC equation are correct except:
a.    The weights represent a firm’s most recent financing mix.
b.    These target weights represent a mix of debt and equity that the firm will try to achieve or maintain for a period of at least 5 years.
c.    As much as possible, the target weights should reflect the combination of debt and equity that management believes will maximize the firm’s weighted average cost of capital.
d.    The firm should make an effort over time to move toward and maintain its target capital structure mix of current liabilities, debt and equity.
e.    All of the above statements are correct.

  
    75.    All of the following statements are correct except:
a.    The internal growth rate measures how quickly a firm can increase its asset base over the next year without raising outside funds.
b.    The retention rate represents the proportion of every $1 of earnings per share that is retained by the firm; in other words, it is equal to one minus the dividend payout ratio.
c.    The sustainable growth rate measures how quickly the firm can grow when it uses both internal equity and debt financing to keep its capital structure constant over time.
d.    The internal and sustainable growth rate relationships suggest that there are three measurable influences on growth: dividend policy (as reflected in the retention rate), profitability (as measured by ROA), and the firm’s capital structure (as measured by the equity multiplier).
e.    All of the above statements are correct.

  
    76.    All of the following statements are correct except:
a.    The internal growth rate measures how quickly a firm can increase its asset base over the next year without raising outside funds.
b.    The retention rate represents the proportion of every $1 of earnings per share that is retained by the firm; in other words, it is equal to one minus the dividend payout ratio.
c.    The sustainable growth rate measures how quickly the firm can grow when it uses only debt financing to keep its capital structure constant over time.
d.    The internal and sustainable growth rate relationships suggest that there are three measurable influences on growth: dividend policy (as reflected in the retention rate), profitability (as measured by ROA), and the firm’s capital structure (as measured by the equity multiplier).
e.    All of the above statements are correct.

  
    77.    All of the following statements are correct except:
a.    The internal growth rate measures how quickly a firm can increase its asset base over the next year using outside funds.
b.    The retention rate represents the proportion of every $1 of earnings per share that is retained by the firm; in other words, it is equal to one plus the dividend payout ratio.
c.    The sustainable growth rate measures how quickly the firm can grow when it uses only debt financing to keep its capital structure constant over time.
d.    The internal and sustainable growth rate relationships suggest that there are three measurable influences on growth: working capital policy, total asset turnover, and the firm’s borrowing rate.
e.    None of the above statements are correct.

  
    78.    All of the following statements are correct except:
a.    EBIT/EPS analysis allows managers to see how different capital structures affect the earnings and risk levels of their firms.
b.    EBIT/EPS analysis shows the graphical relationship between a firm’s operating earnings, or earnings before interest and taxes (EBIT), and earnings per share (EPS).
c.    EBIT/EPS analysis suggests that at some EBIT level, a firm will be indifferent between the two capital structures, inasmuch as they result in the same earnings per share.
d.    EBIT/eps analysis shows the ranges of EBIT where a firm may prefer one capital structure over another so that the firm may decide to increase or decrease its financial leverage depending on whether its expected EBIT is above or below the indifference EBIT level.
e.    All of the above statements are correct.

  
    79.    All of the following statements are correct except:
a.    EBIT/EPS analysis allows managers to see how the same capital structure affects the earnings and risk levels of their firms..
b.    EBIT/EPS analysis shows the graphical relationship between a firm’s after tax net income and earnings per share (EPS).
c.    EBIT/EPS analysis suggests that at some EBIT level, a firm will be indifferent between the two capital structures, inasmuch as they result in the different earnings per share.
d.    EBIT/EPS analysis shows the ranges of sales where a firm may prefer one capital structure over another so that the firm may decide to increase or decrease its financial leverage depending on whether its expected Sales is above or below the indifference EPS level.
e.    None of the above statements are correct.

  
    80.    All of the following statements are correct except:
a.    EBIT/EPS analysis allows managers to see how the same capital structures affect the earnings and risk levels of their firms.
b.    EBIT/EPS analysis shows the graphical relationship between a firm’s operating earnings, or earnings before interest and taxes (EBIT), and earnings per share (EPS).
c.    EBIT/EPS analysis suggests that at some EBIT level, a firm will be indifferent between the two capital structures, inasmuch as they result in the same earnings per share.
d.    EBIT/eps analysis shows the ranges of EBIT where a firm may prefer one capital structure over another so that the firm may decide to increase or decrease its financial leverage depending on whether its expected EBIT is above or below the indifference EBIT level.
e.    All of the above statements are correct.

  
    81.    All of the following statements are correct except:
a.    A firm’s business risk is measured by its variability in EBIT over time and is affected by several factors, including the business cycle, competitive pressures, and the firm’s operating leverage or its level of fixed operating costs.
b.    The degree of financial leverage measures the sensitivity of earnings per share to changes in EBIT.
c.    The degree of combined leverage is the percentage change in earnings per share that results from a 1 percent change in sales volume.
d.    The degree of combined leverage is simply the product of its degree of operating leverage and its degree of financial leverage.
e.    All of the above statements are correct.

  
    82.    All of the following statements are correct except:
a.    A firm’s business risk is measured by its variability in EBIT over time and is affected by several factors, including the business cycle, competitive pressures, and the firm’s operating leverage or its level of fixed operating costs.
b.    The degree of financial leverage measures the sensitivity of earnings per share to changes in EBIT.
c.    The degree of combined leverage is the percentage change in gross profit that results from a 1 percent change in sales volume.
d.    The degree of combined leverage is simply the product of its degree of operating leverage and its degree of financial leverage.
e.    All of the above statements are correct.

  
    83.    All of the following statements are correct except:
a.    A firm’s business risk is measured by its variability in EPS over time and is affected by several factors, including the business cycle, competitive pressures, and the firm’s operating leverage or its level of fixed operating costs.
b.    The degree of financial leverage measures the sensitivity of earnings per share to changes in interest expense.
c.    The degree of combined leverage is the percentage change in gross profit that results from a 1 percent change in sales volume.
d.    The degree of combined leverage is simply the product of its degree of operating leverage and its retention rate.
e.    None of the above statements are correct.

  
    84.    All of the following statements are correct except:
a.    The tax deductibility of debt becomes less important to firms with large nondebt tax shields such as foreign tax credits granted by the U.S. government to firms that pay taxes to foreign governments.
b.    As the debt/total asset ratio rises, or as earnings become more volatile, the firm will face higher borrowing costs, driven upward by bond investors requiring higher yields to compensate for additional risk.
c.    The static tradeoff hypothesis states that firms will balance the advantages of debt (its lower cost and tax-deductibility of interest) with its disadvantages (greater possibility of bankruptcy and the value of explicit and implicit bankruptcy costs).
d.    Agency costs reduce the optimal level of debt financing for a firm below the level that would be appropriate if agency costs were zero.
e.    All of the above statements are correct.

  
    85.    All of the following statements are correct except:
a.    The tax deductibility of debt becomes less important to firms with large nondebt tax shields such as foreign tax credits granted by the U.S. government to firms that pay taxes to foreign governments.
b.    As the debt/total asset ratio falls, or as earnings become less volatile, the firm will face higher borrowing costs, driven upward by bond investors requiring higher yields to compensate for additional risk.
c.    The static tradeoff hypothesis states that firms will balance the advantages of debt (its lower cost and tax-deductibility of interest) with its disadvantages (greater possibility of bankruptcy and the value of explicit and implicit bankruptcy costs).
d.    Agency costs reduce the optimal level of debt financing for a firm below the level that would be appropriate if agency costs were zero.
e.    All of the above statements are correct.

  
    86.    All of the following statements are correct except:
a.    The tax deductibility of debt becomes more important to firms with large nondebt tax shields such as foreign tax credits granted by the U.S. government to firms that pay taxes to foreign governments.
b.    As the debt/total asset ratio falls, or as earnings become less volatile, the firm will face higher borrowing costs, driven upward by bond investors requiring higher yields to compensate for additional risk.
c.    The static tradeoff hypothesis states that firms will balance the advantages of equity (its lower cost and tax-deductibility of dividends) with its disadvantages (greater possibility of bankruptcy and the value of explicit and implicit bankruptcy costs).
d.    Agency costs increase the optimal level of debt financing for a firm above the level that would be appropriate if agency costs were zero.
e.    None of the above statements are correct.

  
    87.    All of the following statements are correct except:
a.    The pecking order hypothesis is a theory that states managers prefer to use additions to retained earnings to finance the firm, then debt, and (as a final resort) new equity.
b.    The market timing hypothesis states that firms try to time the equity market by issuing stock when their stock prices are high and repurchasing shares when stock values are low.
c.    The static tradeoff hypothesis states that firms will balance the advantages of debt (its lower cost and tax-deductibility of interest) with its disadvantages (greater possibility of bankruptcy and the value of explicit and implicit bankruptcy costs).
d.    Agency costs reduce the optimal level of debt financing for a firm below the level that would be appropriate if agency costs were zero.
e.    All of the above statements are correct.

  
    88.    All of the following statements are correct except:
a.    The pecking order hypothesis is a theory that states managers prefer to use new debt to finance the firm, then retained earnings, and (as a final resort) new equity.
b.    The market timing hypothesis states that firms try to time the equity market by issuing stock when their stock prices are high and repurchasing shares when stock values are low.
c.    The static tradeoff hypothesis states that firms will balance the advantages of debt (its lower cost and tax-deductibility of interest) with its disadvantages (greater possibility of bankruptcy and the value of explicit and implicit bankruptcy costs).
d.    Agency costs reduce the optimal level of debt financing for a firm below the level that would be appropriate if agency costs were zero.
e.    All of the above statements are correct.

  
    89.    All of the following statements are correct except:
a.    The pecking order hypothesis is a theory that states managers prefer to use new debt to finance the firm, then retained earnings, and (as a final resort) new equity.
b.    The market timing hypothesis states that firms try to time the equity market by issuing stock when their stock prices are low and repurchasing shares when stock values are high.
c.    The static tradeoff hypothesis states that firms will balance the advantages of equity (its lower cost and tax-deductibility of interest) with its disadvantages (greater possibility of bankruptcy and the value of explicit and implicit bankruptcy costs).
d.    Agency costs increase the optimal level of debt financing for a firm above the level that would be appropriate if agency costs were zero.
e.    None of the above statements are correct.

  
    90.    All of the following statements are correct except:
a.    The pecking order hypothesis is a theory that states managers prefer to use new debt to finance the firm, then retained earnings, and (as a final resort) new equity.
b.    The market timing hypothesis states that firms try to time the equity market by issuing stock when their stock prices are high and repurchasing shares when stock values are low.
c.    The static tradeoff hypothesis states that firms will balance the advantages of debt (its lower cost and tax-deductibility of interest) with its disadvantages (greater possibility of bankruptcy and the value of explicit and implicit bankruptcy costs).
d.    Agency costs reduce the optimal level of debt financing for a firm below the level that would be appropriate if agency costs were zero.
e.    All of the above statements are correct.

  
    91.    If a firm pays out 30% of its earnings as dividends and has averaged a 20 percent return on assets, how quickly can the firm grow without needing to secure outside funding sources?
a.    6.4%.
b.    10.2%.
c.    16.3%.
d.    20.0%.
e.    none of the above.

  
    92.    If a firm pays out 30% of its earnings as dividends and has averaged a 20 percent return on assets, how quickly can the firm grow without needing to secure outside funding sources?
a.    6.4%.
b.    10.2%.
c.    14.3%.
d.    20.0%.
e.    none of the above.

  
    93.    If a firm pays out 30% of its earnings as dividends and has averaged a 20 percent return on equity, how quickly can the firm grow while maintaining a constant debt to equity mix?
a.    6.4%.
b.    10.2%.
c.    16.3%.
d.    20.0%.
e.    none of the above.

  
    94.    If a firm pays out 30% of its earnings as dividends and has averaged a 20 percent return on equity, how quickly can the firm grow while maintaining a constant debt to equity mix?
a.    6.4%.
b.    10.2%.
c.    14.3%.
d.    20.0%.
e.    none of the above.

  
    95.    Ningbo Shipping has issued preferred stock at its $125 per share par value. The stock will pay a $15 annual dividend. The cost of issuing and selling the stock was $4 per share. The cost of Ningbo Shipping preferred stock is:
a.    7.2%.
b.    12.0%.
c.    12.4%.
d.    15%.
e.    none of the above.

  
    96.    Ningbo Shipping, which has an average tax rate of 40 percent, would like to estimate the after-tax cost of debt for a 15-year, 12 percent, $1,000 par value bond, selling at $950.  Based on this information, the after-tax cost of debt is:
a.    7.7%.
b.    12.0%.
c.    12.8%.
d.    15%.
e.    none of the above.

  
    97.    Ningbo Shipping has common stock with a market price of $25 per share and an expected dividend of $2 per share at the end of the coming year. The growth rate in dividends has been 5 percent and this growth is expected to continue indefinitely. Based on this information, the cost of the firm's common stock equity is
a.    5%.
b.    8%.
c.    10%.
d.    13%.
e.    none of the above.

  
    98.    What is Ningbo Shipping’s WACC if it’s after tax cost of debt is 3.5%, it’s cost of retained earnings is 14%, and the firm’s market value of debt is $40 million while the market value of  its equity is $60 million?
a.    9.8%.
b.    3.5%.
c.    11.8%.
d.    14.7%.
e.    none of the above.

  
    99.    What is Ningbo Shipping’s WACC if it’s after tax cost of debt is 3.5%, it’s cost of retained earnings is 14%, and the firm’s market value of debt is $40 million while the market value of  its equity is $60 million?
a.    1.8%.
b.    3.5%.
c.    11.8%.
d.    14.7%.
e.    none of the above.

  
    100.    Ningbo Shipping has determined it can issue preferred stock at $115 per share par value. The stock will pay a $12 annual dividend. The cost of issuing and selling the stock is $3 per share. The cost of the preferred stock is
a.    6.4%.
b.    9.4%.
c.    10.7%.
d.    14.7%.
e.    none of the above.

  

Chapter 4
Federal Reserve System

TRUE-FALSE QUESTIONS

    1.    The National Banking Act provides that national banks can issue their own notes only against U.S. government bonds that the banks held on deposit with large city banks.
 
    2.    Because of the National Banking Act, the volume of national bank notes depends on the government bond market rather than the seasonal or cyclical needs of the nation for currency.
 
    3.    The United States was one of the earliest major-industrial nations to adopt a permanent system of central banking.
 
    4.    A central bank is a Federal government agency that facilitates operation of the financial system and regulates growth of the money supply.
 
    5.    Although a central bank does not necessarily operate for profit, it generally deals directly with the public.
 
    6.    A central bank is required to hold reserves, and it has stockholders and a board of directors.
 
    7.    The Federal Reserve Advisory Council provides advice and general information to the Secretary of the Treasury.
 
    8.    The Federal Reserve System replaced the system that existed under the National Banking Act.
 
    9.    The Federal Reserve Act of 1913 provided that all national and state-chartered banks were to become members of the Fed.
 
    10.    The Reserve Banks are private institutions owned by many member banks of the Fed.
 
    11.    All commercial banks are members of the Fed.
 
    12.    Open market operations involve the buying and selling of U.S. government securities.
 
    13.    In addition to the 12 Reserve Banks, 25 branch banks have been established.
 
    14.    The Fed Board of Governors is composed of seven members who are appointed for a term of 12 years.
 
    15.    The only bank asset that can be counted as reserve is deposits with the Reserve Banks.
 
    16.    The closer to the required minimum the banking system maintains its reserves, the tighter the control the Fed has over the money creation process through its other instruments.
 
    17.    The ability to change reserve requirement is a powerful tool the Fed uses frequently.
 
    18.    Banks are required by the Fed to hold reserves equal to a part of their deposits as part of the fractional reserve system of the U.S. banking system.
 
    19.    If excess reserves are near zero, then a reduction of reserves will cause the system to loosen credit.
 
    20.    The Fed lending rate to depository institutions was consistently lower than the bank prime lending rate during the 1977–1994 period.
 
    21.    Although not provided for in the original organization of the Fed, open market operations have become the most important and effective means of monetary control.
 
    22.    The Federal Reserve has no power to regulate the overseas activities of member banks and bank holding companies.
 
T    23.    Total deposits can be contracted by holding the amount of reserves constant but raising the reserve requirement.
 
    24.    The money supply can be contracted by holding the amount of reserves constant but raising the reserve requirement.
 
    25.    The Fed prefers to change reserve requirements rather than to use open market operations.
 
    26.    When reserves are added to the banking system, depository institutions may expand their lending but are not forced to do so.
 
    27.    Banks with large transaction account balances hold the same percentage of reserves as all other banks.
 
    28.    Member banks of the Federal Reserve System may not borrow from the Fed.

 
    29.    A major weakness of the banking system under the National Banking Acts was that the money supply could not be easily expanded or contracted to meet changing seasonal needs and/or changes in economic activity.

 
    30.    The United States was one of the last major industrial nations to adopt a permanent system of central banking.

 
    31.    The Federated Requirement System (Fed) is the central bank of the United States and is responsible for setting monetary policy and regulating the banking system.

 
    32.    The Federal Reserve act required that ALL national banks were to become members of the Fed.

 
    33.    Paul Volcker was chairman of the Fed prior to the appointment of Alan Greenspan.

 
    34.    Open market operations are similar to discount operations in that they increase or decrease bank reserves at the initiative of the Fed.

 
    35.    Empirical evidence shows that in countries where central banks are relatively independent from their governments, there has been higher inflation and lower economic growth rates than in countries where central banks are closely tied to their governments.

 
    36.    The essential requirements of a well-functioning financial system include an efficient national payments system, a flexible money supply, and a lending/borrowing mechanism to help alleviate liquidity problems when they arise.

 
    37.    A central bank is a federal government agency that facilitates the operation of the financial system and regulates money supply growth.

 
    38.    The Federal Open Market Committee directs open market operations by buying and selling government securities which are the primary instruments of exercising monetary policy.

 
    39.    The seven members of the Federal Reserve Board of Governors are responsible for the establishment of monetary policy.

 
    40.    Federal Reserve actions that stimulate or repress the level of prices or economic activity are called dynamic actions.

 
    41.    Federal Reserve actions that stimulate or repress the level of prices or economic activity are called defensive activities.

 
    42.    Federal Reserve actions that meet the credit needs of individuals and institutions, clearing checks, and supporting depository institutions are called accommodative activities.

 
    43.    The minimum amount of total reserves that depository institutions must hold are called fractional reserves.

 
    44.    The three primary means that the Fed can use to exercise monetary policy includes closed market operations, stabilizing reserve requirements, and freeing the Federal discount rate.

 
    45.    Since the late 1970s, the Federal Discount Rate has generally exceeded the Prime Interest Rate by a few percentage points.

 
    46.    Since the late 1970s, the Federal Discount Rate has generally been below the Prime Interest Rate by a few percentage points.

 
    47.    The Fed would be practicing contractionary monetary policy if, through open market operations, it is a net seller of government securities.

 
    48.    The Fed would be practicing contractionary monetary policy if it caused a decrease in market interest rates.

 
    49.    The Consumer Credit Protection Act requires that lenders clearly explain consumer credit costs and prohibited them from charging overly high-priced credit transactions.

 
    50.    Regulation Z requires that lenders clearly explain consumer credit costs and prohibited them from charging overly high-priced credit transactions.

 
MULTIPLE-CHOICE QUESTIONS

    1.    Under the authority of the Federal Reserve Act of 1913:
a.    all national and state-chartered banks must become members of the Fed
b.    only national banks were permitted to become members of the Fed
c.    state-chartered banks were permitted to withdraw from membership with the Fed
d.    a system of deposit insurance was created

 
    2.    Under the authority of the Federal Reserve Act of 1913:
a.    member banks were required to purchase capital stock in the Federal Reserve Banks of their district
b.    member banks may not borrow from the Fed
c.    a formal open-market committee arrangement was established
d.    national banks were permitted to become members of the Fed if they could show evidence of satisfactory financial condition

 
    3.    The primary function of the Federal Reserve System is to:
a.    issue currency to member banks
b.    regulate the growth of the money supply
c.    serve as a fiscal agent for the U.S. government
d.    regulate and conduct bank examinations

 
    4.    The members of the board of directors of each Federal Reserve bank are:
a.    appointed by the Board of Governors of the Federal Reserve System
b.    elected by the member banks
c.    chosen by the Board of Governors and by the member banks
d.    appointed by the President of the United States with the advice and consent of the Senate

 
    5.    Each member of the Fed Board of Governors is appointed for a term of:
a.    8 years
b.    12 years
c.    14 years
d.    none of the above

 
    6.    The members of the Fed Board of Governors are:
a.    elected by the member banks
b.    appointed by the President of the United States with the advice and consent of the Senate
c.    appointed by the Secretary of the Treasury
d.    appointed by each of the Federal Reserve banks
e.    none of the above

 
    7.    One of the major weaknesses of the banking system before the Federal Reserve System was set up was:
a.    the arrangement for holding reserves
b.    the lack of a deposit insurance system
c.    a lack of currency and coin
d.    an inadequate supply of government bonds

 
    8.    Before the Federal Reserve System was created, a large part of the reserves of commercial banks was:
a.    in the form of state and federal government bonds
b.    deposited with the United States Treasury
c.    held as deposits with large city banks
d.    held as cash in their vaults

 
    9.    The National Banking Act provided that:
a.    national banks could issue their own notes only against U.S. government bonds the banks held on deposit with the Treasury
b.    national banks could issue their own notes only against cash held in their vaults
c.    national banks could issue their own notes only against U.S. government bonds the banks held on deposit with the Federal Reserve Bank
d.    none of the above

 
    10.    The United States created its system of central banking:
a.    earlier than such banks were established in other industrial nations
b.    later than such banks were established in other industrial nations
c.    to facilitate branch banking
d.    to facilitate international exchange operations

 
    11.    Member banks of the Federal Reserve System:
a.    must maintain all reserves with their Federal Reserve Bank
b.    may include deposits held at large city banks as legal reserves
c.    maintain levels of reserves based on the size of the city in which they are located
d.    are permitted to count vault cash as part of their reserves

 
    12.    A central bank does not:
a.    deal directly with the public
b.    necessarily operate for a profit
c.    have stockholders because it is a non-profit organization
d.    hold reserve requirements

 
    13.    Under the Federal Reserve Act of 1913, the number of Federal Reserve districts established is:
a.    8
b.    10
c.    12
d.    25

 
    14.    For which of the following are member banks prohibited from borrowing at the Fed’s discount window?
a.    funds to meet reserve requirements
b.    funds to meet depositor withdrawal demands
c.    to meet business loan demands
d.    all the above are permitted
e.    none of the above are permitted

 
    15.    The discount rate is:
a.    the rate charged a bank’s best customers
b.    the rate paid by large business with good credit
c.    the rate a bank must pay to borrow from the Fed
d.    none of the above

 
    16.    Which of the following statements would be false? The discount rate is
a.    an instrument of monetary policy
b.    frequently used as a tool of fiscal policy
c.    regarded as a fine-tuning mechanism
d.    all the above are true

 
    17.    Open market operations:
a.    are used infrequently
b.    are a prime source of income for the U.S. economy
c.    are used by the Fed to alter bank reserves
d.    none of the above

 
    18.    Each Federal Reserve Bank has a president and first vice-president who are appointed by:
a.    the Board of Governors
b.    the President of the United States
c.    the President of the United States with the advice and consent of the Senate
d.    its board of directors

 

    19.    The Board of Governors:
a.    is elected by the member banks
b.    is appointed by the Senate
c.    has seven members appointed for 14-year terms
d.    has seven members appointed for a term of 12 years

 
    20.    The Federal Reserve System exercises its most direct control of the money supply:
a.    by the issuance of Federal Reserve notes
b.    through reserve requirements
c.    by setting the discount rates on loans to depository institutions
d.    through open market operations

 
    21.    The principal examining activity of the Federal Reserve System is directed to:
a.    all state-chartered banks
b.    state-chartered member banks
c.    all national banks
d.    foreign banks operating in the United States

 
    22.    The Federal Reserve Banks are owned by:
a.    commercial banks
b.    the U.S. Treasury
c.    national member banks of the Federal Reserve System
d.    member banks of the Federal Reserve System

 
    23.    All Federal Reserve Banks have:
a.    check clearance facilities
b.    branch banks
c.    directors who are elected for 14-year terms
d.    directors who are appointed by the President of the United States

 
    24.    In addition to the clearing of checks through Federal Reserve Banks, the Fed accommodates check clearing through:
a.    check clearinghouses it sponsors in major cities
b.    its branches and a group of regional check-processing centers
c.    electronic transfers of funds
d.    the United Postal Service

 
    25.    The Federal Reserve is empowered to encourage depository institutions to help meet the needs of communities for housing and other purposes:
a.    through the Community Reinvestment Act
b.    through the Truth in Lending Act
c.    by a provision of the Fair Housing Act
d.    by strictly enforcing usury laws setting maximum interest rates

 
    26.    Bank holding companies are supervised and examined by:
a.    the Comptroller of the Currency
b.    the FDIC
c.    the Federal Reserve
d.    internal auditors only

 
    27.    The Federal Open Market Committee:
a.    is comprised of members of the Federal Reserve board and representatives of all Federal Reserve Banks
b.    came into being at the time the Federal Reserve System was created
c.    is made up of the presidents of the 12 Federal Reserve Banks
d.    was created under a provision of the Banking Act of 1935

 
    28.    The effect of an increase of required reserves by the Fed is:
a.    a decrease in loanable funds of depository institutions
b.    a decrease in interest rates
c.    usually an increase in vault cash
d.    to stimulate activity in the home construction field

 
    29.    The Federal Open Market Committee:
a.    typically buys and sells long-term corporate bonds
b.    is the most powerful and flexible monetary policy tool of the Fed
c.    works out of Washington D.C.
d.    deals with most of the commercial banks of the nation

 
    30.    It is generally agreed by the public that the Federal Reserve System:
a.    should not engage in international exchange controls
b.    carries out its functions reasonably well
c.    is distrusted by business as well as by banking interests
d.    should be under the control of the U.S. Treasury

 
    31.    The Federal Reserve Banks now hold reserves for:
a.    branches of foreign banks
b.    only commercial banks, savings and loan associations, and credit unions
c.    all of the reserve requirements of member banks
d.    all of the reserve requirements of all depository institutions

 
a    32.    When the Federal Reserve System was created, it was thought that its most important influence over monetary conditions would be:
a.    lending to banks to bolster their reserve positions
b.    open market operations
c.    the issuance of Federal Reserve notes
d.    the changing of reserve requirements

 
    33.    The Fed shares its depository examining functions with:
a.    the Federal Savings and Loan Insurance Corporation
b.    the FDIC, Comptroller of the Currency, and state agencies
c.    only the Comptroller of the Currency
d.    National Credit Union administration and the FDIC

 
    34.    The accommodative activities of the Federal Reserve System are:
a.    clearing checks
b.    meeting the credit needs of individuals and institutions
c.    supporting depository institutions
d.    all of the above

 
    35.    Eligible paper that the borrowing institution can sell to the Reserve Bank includes:
a.    common stock
b.    corporate bonds
c.    U.S. government bonds
d.    all of the above

 
    36.    The purpose of Regulation Z is to:
a.    make consumers aware of the costs of alternative forms of credit
b.    prohibit garnishment
c.    encourage depository institutions to help meet the credit needs of their communities for housing and other purposes
d.    regulate the overseas activities of member banks of the Federal Reserve System

 
    37.    The Truth in Lending Act:
a.    prohibits discrimination in the granting of credit on the basis of sex, race, color, and religion
b.    limits liability on lost or stolen credit cards
c.    prohibits unfair or deceptive acts or practices on the part of banks
d.    requires prompt correction of errors on a revolving charge account

 
    38.    The dynamic actions of the Federal Reserve System:
a.    contribute to the smooth everyday functioning of the economy
b.    are designed to meet the credit needs of individuals and institutions
c.    support depositories and other institutions
d.    stimulate or repress the level of prices or economic activity

 
    39.    The Federal Open Market Committee:
a.    is made up of the presidents of the 12 Federal Reserve Banks
b.    consists of the seven members of the Board of Governors of the Fed, plus five presidents of Reserve Banks
c.    is appointed by the Chairman of the Federal Reserve System
d.    none of the above

 
    40.    The payment mechanism of the Reserve Bank includes:
a.    processing and clearing checks
b.    issuing currency and coins
c.    wire transfers
d.    all the above

 
    41.    The National Banking Acts of 1863 and 1864 were:
a.    totally eliminated under the Federal Reserve Act of 1913
b.    were modified to permit greater flexibility of operations under the Federal Reserve Act of 1913
c.    were unaffected by the Federal Reserve Act of 1913
d.    none of the above

 
    42.    The Board of Governors of the Federal Reserve System:
a.    consists of 7 appointed members
b.    sets reserve requirements
c.    approves discount rates as part of monetary policy
d.    all the above
e.    none of the above

 
    43.    The Board of Governors of the Federal Reserve System:
a.    oversee the supervision and regulation of member banks and bank holding companies
b.    regulates reserve balance requirements for depository institutions
c.    oversees the collection and clearance of checks for depository institutions
d.    all the above
e.    none of the above

 
    44.    The Federal Open Market committee:
a.    establishes and administers protective consumer finance regulations
b.    furnishes currencies
c.    handles U.S. government debt and cash balances
d.    all the above
e.    none of the above

 
    45.    State-chartered banks:
a.    automatically receive membership in the Federal Reserve System
b.    are prohibited from membership in the Federal Reserve System
c.    may be permitted to join the Federal Reserve system, given a satisfactory financial condition
d.    none of the above

 
    46.    Members of the Federal Reserve System may include:
a.    commercial banks with a national charter
b.    credit unions
c.    savings and loan institutions
d.    all the above
e.    none of the above

 
    47.    The chairman of the Federal Reserve System:
a.    is appointed by the Secretary of the Treasury
b.    serves a life term
c.    is the president of the New York Federal Reserve Bank
d.    none of the above

 
    48.    Three essential needs of a well-operating financial system include all of the following EXCEPT:
a.    an efficient national payments system
b.    an elastic or flexible money supply
c.    a bank insurance system
d.    a lending/borrowing mechanism

 
    49.    Which monetary policy tool does the Fed use most infrequently?
a.    changing reserve requirements
b.    changing the discount rate
c.    open market operations
d.    none of the above

 
    50.    One significant feature of DIDMCA was that it:
a.    expanded the ability of the Fed to influence unemployment rates
b.    expanded Fed control over the reserve requirements of non-member banks
c.    created the FDIC
d.    none of the above

 
    51.    During the past several years:
a.    the discount rate has been lower than the prime rate
b.    the discount rate has been higher than the prime rate
c.    the discount rate has been unrelated to the prime rate
d.    none of the above

 
    52.    The Fed has legal responsibility for administering:
a.    the Bank Holding Company Act of 1956
b.    the Bank Merger Act of 1960
c.    the Change in Bank Control Act of 1978
d.    all of the above

 
    53.    A central bank serves the nation:
a.    as a source of consumer credit when otherwise not available
b.    by regulating money supply growth
c.    as a secondary source of funds for home financing
d.    as the strong right arm of the U.S. Treasury

 
    54.     The capital stock of each Federal Reserve Bank:
a.    is owned by the Board of Governors of the Fed
b.    can be used in an emergency to provide funds for the Fed
c.    is owned by members of the individual Federal Reserve Banks
d.    has been reserved for purchase of the U.S. Treasury

 
    55.     Which of the following statements is true when describing Federal Reserve Banks?
a.    they are located in each of the 50 states
b.    every Federal Reserve Bank has at least one branch
c.    they have been moved from city to city as the U.S. developed
d.    two Federal Reserve Banks are located in the same state

 
    56.    The Federal Reserve System consists of all of the following components EXCEPT:
a.    Federal Reserve District Banks
b.    Board of Governors
c.    Federal Open Market Committee
d.    all of the above

 
    57.    The Federal Reserve System consists of all of the following components EXCEPT:
a.    Monetary Policy Committee
b.    Board of Governors
c.    Federal Open Market Committee
d.    all of the above

 
    58.    The seven-member board of the Federal Reserve that sets monetary policy is called
a.    the Federal Reserve Open Market Committee
b.    the Federal Reserve Board of Governors
c.    the Federal Reserve Advisory Committee
d.    none of the above

 
    59.    Federal Reserve actions that offset unexpected monetary developments and contribute to the smooth everyday functioning of the economy are called
a.    defensive actions
b.    dynamic actions
c.    accommodative actions
d.    none of the above

 
    60.    The basic policy instruments that the Fed uses to execute monetary policy include all of the following EXCEPT
a.    changing reserve requirements
b.    changing the discount rate
c.    conducting open market operations
d.    all of the above are monetary policy instruments

 
    61.    The basic policy instruments that the Fed uses to execute monetary policy include all of the following EXCEPT
a.    changing reserve requirements
b.    changing the discount rate
c.    conducting closed market operations
d.    all of the above are monetary policy instruments

 
    62.    The percentage of deposits that must be held as reserves is called
a.    the bank reserve percentage
b.    the required reserve ratio
c.    the excess reserve ratio
d.    the fractional reserve percentage

 
    63.    The interest rate that a bank must pay to borrow from its regional federal reserve bank is called
a.    the National Discount Rate
b.    the Prime Rate
c.    the Federal Discount Rate
d.    none of the above

 
    64.    The most used monetary policy instrument used by the Fed is
a.    open market operations
b.    changing the discount rate
c.    changing the reserve requirement
d.    none of the above

 
    65.    The least used monetary policy instrument used by the Fed is
a.    open market operations
b.    changing the discount rate
c.    changing the reserve requirement
d.    none of the above

 
    66.    ____________________________ requires disclosure of the finance charge and the annual percentage rate of credit along with certain other costs and terms to permit consumers to compare the prices of credit from differing sources.
a.    Truth in Lending Act
b.    Equal Credit Opportunity Act
c.    Federal Trade Commission Improvement Act
d.    Fair Credit Billing Act

 
    67.    ____________________________ sets up a procedure for the prompt correction of errors on a revolving charge account and prevents damage to credit ratings while a dispute is being settled.
a.    Truth in Lending Act
b.    Equal Credit Opportunity Act
c.    Federal Trade Commission Improvement Act
d.    Fair Credit Billing Act

 
    68.    ____________________________ prohibits discrimination in the granting of credit on the basis of sex, marital status, race, color, religion, national origin, age, or receipt of public assistance.
a.    Truth in Lending Act
b.    Equal Credit Opportunity Act
c.    Federal Trade Commission Improvement Act
d.    Fair Credit Billing Act

 
    69.    ____________________________ authorizes the Federal Reserve Board to unfair or deceptive acts or practices on the part of banks and to issue regulations to prohibit them.
a.    Truth in Lending Act
b.    Equal Credit Opportunity Act
c.    Federal Trade Commission Improvement Act
d.    Fair Credit Billing Act

 
a    70.    The ____________________________ conducts monetary policy for the twelve European countries that adopted the euro as their common currency.
a.    European Central Bank
b.    Switzerland Central Bank
c.    London Central Bank
d.    British National Bank

 
    71.    Currently, the Chairman of the Federal Reserve is ________________________.
a.    Paul Volker
b.    Alan Greenspan
c.    Ben Bernanke
d.    None of the above

 
    72.    In response to the 2007 - 2009 financial crisis, the Fed’s prime credit rate, which was 6.25 percent at the end of 2006, was lowered to _____ percent by the end of 2008 and was maintained at that level through 2009.
a.    0.0
b.    0.5
c.    1.0
d.    1.5
e.    none of the above

 
    73.    The five components of the Federal Reserve System include:
a.    Member banks, Federal Reserve District Banks, Board of Governors, Federal Open Market Committee, Adlib Committees.
b.    Nonmember banks, Federal Reserve District Banks, Board of Governors, Federal Open Market Committee, Advisory committees.
c.    Member banks, Federal Reserve District Banks, Board of Governors, Federal Open Market Committee, Advisory committees.
d.    Member banks, Federal Reserve District Banks, Board of Governors, Federal Closed Market Committee, Advisory committees.
e.    none of the above

 
    74.    The five components of the Federal Reserve System include:
a.    Member banks, Federal Reserve District Banks, Board of Governors, Federal Open Market Committee, Adlib Committees.
b.    Nonmember banks, Federal Reserve District Banks, Board of Governors, Federal Open Market Committee, Advisory committees.
c.    Member banks, Federal Reserve District Banks, Board of Presidents, Federal Open Market Committee, Advisory committees.
d.    Member banks, Federal Reserve District Banks, Board of Governors, Federal Closed Market Committee, Advisory committees.
e.    none of the above

 
    75.    Approximately __________ of the nation’s commercial banks are members of the Fed.
a.    three-fourths
b.    two-thirds.
c.    one-third.
d.    one-half.
e.    none of the above

 
    76.    __________ directors of the Federal Reserve are appointed by the Board of Governors of the Federal Reserve System and may not be stockholders, directors, or employees of existing banks.
a.    Class A
b.    Class B
c.    Class C
d.    Class D

 
    77.    Although it enjoys substantial independence in its operations, the appointive power of the president and the ability of Congress to alter its structure make the ______________ a dependent political structure and one of the most powerful monetary organizations in the world.
a.    Board of Governors (BOG)
b.    Board of Directors (BOD)
c.    Governing Body (GOB)
d.    Financial Governors (FOG)
e.    none of the above

 
    78.    Although it enjoys substantial independence in its operations, the appointive power of the president and the ability of Congress to alter its structure make the ______________ a dependent political structure and one of the most powerful monetary organizations in the world.
a.    Presidential Appointment Board (PAB)
b.    Board of Directors (BOD)
c.    Governing Body (GOB)
d.    Financial Governors (FOG)
e.    none of the above

 
    79.    The Board of Governors of the Federal Reserve establishes monetary policy by:
a.    setting reserve requirements, altering the prime rate, and through federal open market operations.
b.    setting reserve requirements, altering the discount rate, and through federal open market operations.
c.    setting reserve requirements, altering the discount rate, and through international currency transactions.
d.    setting bank profitability ratios, altering the discount rate, and through federal open market operations.
e.    none of the above

 
    80.    The Board of Governors of the Federal Reserve establishes monetary policy by:
a.    setting reserve requirements, altering the prime rate, and through federal open market operations.
b.    setting loan to value ratios, altering the discount rate, and through federal open market operations.
c.    setting reserve requirements, altering the discount rate, and through international currency transactions.
d.    setting bank profitability ratios, altering the discount rate, and through federal open market operations.
e.    none of the above

 
    81.    Which of the following is not a method by which the Federal Reserve establishes monetary policy?
a.    setting reserve requirements,
b.    altering the discount rate,
c.    through federal open market operations,
d.    setting bank profitability ratios,
e.    none of the above

 
    82.    Which of the following is a method by which the Federal Reserve establishes monetary policy?
a.    setting reserve requirements,
b.    altering the discount rate,
c.    through federal open market operations,
d.    all of the above methods are used.
e.    none of the above

 
    83.    The Board of Governors publishes ________________, which carries articles of current interest and offers a convenient source of the statistics compiled by the Fed.
a.    the Federal Reserve Magazine
b.    the Federal Reserve Bulletin
c.    the Federal Reserve Journal
d.    the Federal Reserve News
e.    none of the above

 
    84.    The Board of Governors publishes ________________, which carries articles of current interest and offers a convenient source of the statistics compiled by the Fed.
a.    the Federal Reserve Magazine
b.    the Federal Reserve Weekly
c.    the Federal Reserve Journal
d.    the Federal Reserve News
e.    none of the above

 
    85.    History generally supports the contention that under the guidance of Paul Volcker, a (n) ____________ Fed policy brought down the double-digit inflation of the 1970s and the early 1980s, and the Federal Open Market Committee consistently responded to his leadership.
a.    loosening of
b.    restrictive
c.    expansionary
d.    two of the above
e.    none of the above

 
e    86.    History generally supports the contention that under the guidance of Paul Volcker, a (n) ____________ Fed policy brought down the double-digit inflation of the 1970s and the early 1980s, and the Federal Open Market Committee consistently responded to his leadership.
a.    loosening of
b.    easing of
c.    expansionary
d.    two of the above
e.    none of the above

 
    87.    Alan Greenspan’s tenure as chair of the Fed Board was generally characterized by:
a.    real economic decline in the U.S. economy, interest rates that declined to historic lows, and stock prices that reached all-time highs.
b.    real economic growth in the U.S. economy, interest rates that rose to historic highs, and stock prices that reached all-time highs.
c.    real economic growth in the U.S. economy, interest rates that declined to historic lows, and stock prices that reached all-time lows.
d.    real economic growth in the U.S. economy, interest rates that declined to historic lows, and stock prices that reached all-time highs.
e.    none of the above

 
    88.    Today the responsibilities of the Fed may be described as:
a.    those relating to monetary policy, to supervision and regulation, and to services provided for depository institutions and the government.
b.    those relating to fiscal policy, to supervision and regulation, and to services provided for depository institutions and the government.
c.    those relating to monetary policy, to deregulation, and to services provided for depository institutions and the government.
d.    those relating to monetary policy, to supervision and regulation, and to services provided for homeowners and the government.
e.    none of the above

 
    89.    Today the responsibilities of the Fed may be described as:
a.    those relating to monetary and fiscal policy, to supervision and regulation, and to services provided for depository institutions and the government.
b.    those relating to fiscal policy, to supervision and regulation, and to services provided for depository institutions and the government.
c.    those relating to monetary policy, to deregulation, and to services provided for depository institutions and the government.
d.    those relating to monetary policy, to supervision and regulation, and to services provided for homeowners and the government.
e.    none of the above

 
    90.    The banking system of the United States is a ___________ reserve system because banks are required by the Fed to hold reserves equal to a specified percentage of their deposits.
a.    required
b.    fractional
c.    proportional
d.    multiplicative
e.    none of the above

 
    91.    Because depository institutions earn no interest on reserves:
a.    profit maximizing behavior motivates them to lend out excess reserves to the fullest extent consistent with their liquidity requirements; and when interest rates are high, this motivation is especially strong.
b.    profit maximizing behavior motivates them to lend out excess reserves to the fullest extent consistent with their liquidity requirements; and when interest rates are low, this motivation is especially strong.
c.    profit maximizing behavior motivates them to retain excess reserves to the fullest extent consistent with their liquidity requirements; and when interest rates are low, this motivation is especially strong.
d.    profit maximizing behavior motivates them to retain excess reserves to the fullest extent consistent with their liquidity requirements; and when interest rates are high, this motivation is especially strong.
e.    none of the above

 
    92.    Because depository institutions earn no interest on reserves:
a.    profit maximizing behavior motivates them to retain excess reserves to the fullest extent consistent with their liquidity requirements; and when reserve requirements are low, this motivation is especially strong.
b.    profit maximizing behavior motivates them to lend out excess reserves to the fullest extent consistent with their liquidity requirements; and when interest rates are low, this motivation is especially strong.
c.    profit maximizing behavior motivates them to retain excess reserves to the fullest extent consistent with their liquidity requirements; and when interest rates are low, this motivation is especially strong.
d.    profit maximizing behavior motivates them to retain excess reserves to the fullest extent consistent with their liquidity requirements; and when interest rates are high, this motivation is especially strong.
e.    none of the above

 
    93.    __________________ become the most important and effective means of monetary and credit control.
a.    Changing reserve requirements has
b.    Changing the discount rate has
c.    Open market operations has
d.    Changing the Treasury bill rate has
e.    none of the above

 
    94.    Which of the following statements is most correct?
a.    Open-market operations always lead to an immediate increase in the volume of lending; this is especially true when bonds are sold to restrict deposit growth.
b.    Open-market operations don’t always lead to an immediate change in the volume of deposits; this is especially true when bonds are purchased to expand deposit growth.
c.    Open-market operations always lead to an immediate change in the volume of deposits; this is especially true when bonds are sold to restrict deposit growth.
d.    Open-market operations don’t always lead to an immediate change in the volume of deposits; this is especially true when bonds are sold to restrict deposit growth.
e.    none of the above

 
    95.    Which of the following statements is most correct?
a.    Open-market operations always lead to an immediate increase in the volume of lending; this is especially true when bonds are sold to restrict deposit growth.
b.    Open-market operations don’t always lead to an immediate change in the volume of deposits; this is especially true when bonds are purchased to expand deposit growth.
c.    Open-market operations always lead to an immediate change in the volume of deposits; this is especially true when bonds are sold to restrict deposit growth.
d.    Increasing reserve requirements always leads to an immediate increase in the volume of lending; this is especially true when bonds are sold to restrict deposit growth.
e.    none of the above

 
    96.    The __________________, passed in 1968, requires the clear explanation of consumer credit costs and garnishment procedures (taking wages or property by legal means) and prohibits overly high-priced credit transactions.
a.    Consumer Credit Expansion Act
b.    Credit Growth Act
c.    Consumer Credit Protection Act
d.    Consumer Safety Act
e.    none of the above

 
    97.    A (n) ____________________ is necessary for the monetary system to carry out the financial function of transferring money, which in turn is a requirement for an effective financial system.
a.    internet banking system
b.    electronic data transfer system
c.    wire transfer system
d.    efficient payments mechanism
e.    none of the above

 
    98.    The central bank in the United Kingdom is the:
a.    Bank of Britain
b.    British Fed
c.    British Bank
d.    Bank of England
e.    none of the above

 
    99.    The ___________________ conducts monetary policy for the twelve European countries that formed the European Monetary Union and adopted the euro as their common currency at the beginning of 1999.
a.    Bank of England
b.    European Central Bank
c.    Bank of Europe
d.    Bank of Switzerland
e.    none of the above

 
    100.    The two routes of check clearance include the _____________ settlement, in which the transaction takes place entirely within a single Federal Reserve district, and the _____________ settlement, in which there are relationships between banks of two Federal Reserve districts.
a.    interdistrict, intradistrict
b.    intradistrict, interdistrict
c.    Fed wire, District wire
d.    District wire, Fed wire
e.    none of the above

Question 36        2 / 2 points
Which account below is not a subdivision of owner's equity?

A)    Expenses

B)    Revenues


C)    Liabilities

D)    Drawing
Question 37        2 / 2 points
In recording an accounting transaction in a double-entry system

A)    there must always be entries made on both sides of the accounting equation.

B)    there must only be two accounts affected by any transaction.

C)    the number of debit accounts must equal the number of credit accounts.


D)    the amount of the debits must equal the amount of the credits.
Question 38        2 / 2 points
In the first month of operations for Widget Industries, the total of the debit entries to the cash account amounted to $8,000 ($4,000 investment by the owner and revenues of $4,000). The total of the credit entries to the cash account amounted to $5,000 (purchase of equipment $2,000 and payment of expenses $3,000). At the end of the month, the cash account has a(n)


A)    $3,000 debit balance.

B)    $3,000 credit balance.

C)    $2,000 credit balance.

D)    $2,000 debit balance.
Question 39        2 / 2 points
A debit is not the normal balance for which account listed below?

A)    Drawing

B)    Accounts Receivable

C)    Cash


D)    Service Revenue
Question 40        2 / 2 points
The partnership form of business organization


A)    is a common form of organization for service-type businesses.

B)    has limited liability.

C)    is a separate legal entity.

D)    enjoys an unlimited life.
Question 41        2 / 2 points
An account consists of


A)    a title, a debit side, and a credit side.

B)    a title, a left side, and a debit balance.

C)    a title, a right side, and a debit balance.

D)    a title, a debit balance, and a credit balance.
Question 42        2 / 2 points
On June 1, 2010 Quang Le buys a copier machine for his business and finances this purchase with cash and a note. When journalizing this transaction, he will

A)    use two journal entries.

B)    list the credit entries first, which is proper form for this type of transaction.

C)    make a simple entry.


D)    make a compound entry.
Question 43        2 / 2 points
Which of the following techniques are not used by accountants to interpret and report financial information?

A)    Ratios.

B)    Graphs.

C)    Charts.


D)    Special memos for each class of external users.
Question 44        2 / 2 points
Owner's equity can be described as

A)    debtor claim on total assets.

B)    benefactor's claim on total assets.


C)    ownership claim on total assets.

D)    creditorship claim on total assets.
Question 45        2 / 2 points
Which of the following would not be considered an external user of accounting data for the GHI Company?

A)    Customers.

B)    Creditors.

C)    Internal Revenue Service Agent.


D)    Management.
Question 46        2 / 2 points
At January 31, 2010, the balance in Bota Inc.'s supplies account was $250. During February, Bota purchased supplies of $300 and used supplies of $400. At the end of February, the balance in the supplies account should be

A)    $250 debit.

B)    $350 credit.

C)    $950 debit.


D)    $150 debit.
Question 47        2 / 2 points
Root Company provided consulting services and billed the client $2,500. As a result of this event,

A)    assets remained unchanged.

B)    assets increased by $2,500.

C)    owner's equity increased by $2,500.


D)    Both b and c.
Question 48        2 / 2 points
Auditing is

A)    conducted by the Securities and Exchange Commission to ensure that registered financial statements are presented fairly.

B)    a part of accounting that involves only recording of economic events.

C)    an area of accounting that involves such activities as cost accounting, budgeting, and accounting information systems.


D)    the examination of financial statements by a CPA in order to express an opinion on their fairness.
Question 49        2 / 2 points
At October 1, Smithson Enterprises reported owner's equity of $35,000. During October, the owner made additional investments of $5,000 and the company posted a net loss of $3,000. If owner's equity at October 31 totals $35,000, what amount of owner drawings were made during the month?

A)    $5,000

B)    $3,000


C)    $2,000

D)    $0
Question 50        2 / 2 points
On January 14, Ericsson Industries purchased supplies of $500 on account. The entry to record the purchase will include

A)    a debit to Accounts Receivable and a credit to Supplies.


B)    a debit to Supplies and a credit to Accounts Payable.

C)    a debit to Supplies and a credit to Cash.

D)    a debit to Supplies Expense and a credit to Accounts Receivable.

Question 19        2 / 2 points
Sources of increases to owner's equity are

A)    purchases of merchandise.

B)    expenses.

C)    withdrawals by the owner.


D)    additional investments by owners.
Question 20        2 / 2 points
If total liabilities decreased by $25,000 and owner's equity increased by $5,000 during a period of time, then total assets must change by what amount and direction during that same period?

A)    $20,000 increase

B)    $30,000 increase

C)    $25,000 increase


D)    $20,000 decrease
Question 21        2 / 2 points
A balance sheet shows

A)    revenues, expenses, and drawings.

B)    expenses, drawings, and owner's equity.

C)    revenues, liabilities, and owner's equity.


D)    assets, liabilities, and owner's equity.
Question 22        2 / 2 points
Benito Company began the year with owner's equity of $175,000. During the year, the company recorded revenues of $250,000, expenses of $190,000, and had owner drawings of $20,000. What was Benito's owner's equity at the end of the year?


A)    $215,000.

B)    $405,000.

C)    $255,000.

D)    $235,000.
Question 23        2 / 2 points
At October 1, Smithson Enterprises reported owner's equity of $35,000. During October, no additional investments were made and the company posted a net loss of $3,000. If owner's equity at October 31 totals $32,000, what amount of owner drawings were made during the month?

A)    $1,000


B)    $0

C)    $7,000

D)    $3,000
Question 24        2 / 2 points
The private sector organization involved in developing accounting principles is the

A)    Feasible Accounting Standards Body.


B)    Financial Accounting Standards Board.

C)    Financial Accounting Studies Board.

D)    Financial Auditors' Standards Body.
Question 25        2 / 2 points
The accounting equation for Gudgeyes Enterprises is as follows:
Assets         Liabilities         Owner's Equity
$120,000    =    $60,000    +    $60,000

If Gudgeyes purchases office equipment on account for $12,000, the accounting equation will change to
Assets         Liabilities         Owner's Equity


A)    $120,000    =    $60,000    +    $60,000


B)    $132,000    =    $60,000    +    $72,000



C)    $132,000    =    $72,000    +    $60,000


D)    $132,000    =    $66,000    +    $66,000

Question 26        2 / 2 points
If a company has overdrawn its bank balance, then

A)    its cash account will show a debit balance.


B)    its cash account will show a credit balance.

C)    it cannot be detected by observing the balance of the cash account.

D)    the cash account debits will exceed the cash account credits.
Question 27        2 / 2 points
The left side of an account is

A)    a description of the account.


B)    the debit side.

C)    the balance of the account.

D)    blank.
Question 28        2 / 2 points
An awareness of the normal balances of accounts would help you spot which of the following as an error in recording?

A)    A credit balance in a revenue account


B)    A credit balance in an expense account

C)    A debit balance in the drawing account

D)    A credit balance in a liabilities account
Question 29        0 / 2 points
When an owner makes a withdrawal


A)    the drawing account will be decreased with a debit.

B)    the capital account will be directly increased with a debit.

C)    the drawing account will be increased with a credit.


D)    it doesn't have to be cash, it could be another asset.
Question 30        2 / 2 points
Which of the following statements is not true?

A)    Expenses are a negative factor in the computation of net income.

B)    Expenses have normal debit balances.


C)    Expenses increase owner's equity.

D)    Expenses decrease owner's equity.
Question 31        2 / 2 points
As of June 30, 2010, Dallas Company has assets of $100,000 and owner's equity of $5,000. What are the liabilities for Dallas Company as of June 30, 2010?

A)    $100,000

B)    $90,000

C)    $85,000


D)    $95,000
Question 32        2 / 2 points
Owner's equity is best depicted by the following:

A)    Liabilities + Assets.


B)    Assets – Liabilities.

C)    Residual equity + Assets.

D)    Assets = Liabilities.
Question 33        2 / 2 points
A basic assumption of accounting that requires activities of an entity be kept separate from the activities of its owner is referred to as the

A)    corporate form of ownership.

B)    stand alone concept.


C)    economic entity assumption.

D)    monetary unit assumption.
Question 34        2 / 2 points
Stahl Consulting started the year with total assets of $20,000 and total liabilities of $5,000. During the year, the business recorded $16,000 in catering revenues and $8,000 in expenses. Stahl made an additional investment of $3,000 and withdrew cash of $5,000 during the year.The owner's equity at the end of the year was

A)    $2,000.

B)    $18,000.

C)    $8,000.


D)    $21,000.
Question 35        2 / 2 points
If an individual asset is increased, then

A)    there must be an equal decrease in a specific liability.


B)    there must be an equal decrease in another asset.

C)    there must be an equal decrease in owner's equity.

D)    none of these is possible.

Question 32        2 / 2 points
For accounting purposes, postdated checks (checks payable in the future) are considered to be


A)    accounts receivable.

B)    money orders.

C)    petty cash.

D)    cash.
Question 33        2 / 2 points
An alternative name for Bad Debts Expense is

A)    Deadbeat Expense.

B)    Credit Loss Expense.


C)    Uncollectible Accounts Expense.

D)    Collection Expense.
Question 34        2 / 2 points
If a petty cash fund is established in the amount of $200, and contains $120 in cash and $85 in receipts for disbursements when it is replenished, the journal entry to record replenishment should include credits to the following accounts

A)    Petty Cash, $80.

B)    Cash, $80.

C)    Petty Cash, $85.


D)    Cash, $80; Cash Over and Short, $5.
Question 35        2 / 2 points
Which of the following receivables would not be classified as an "other receivable"?


A)    Notes receivable

B)    Advance to an employee

C)    Interest receivable

D)    Refundable income tax
Question 36        2 / 2 points
Entries in a sales journal are

A)    never posted.

B)    posted only to accounts in an accounts receivable subsidiary ledger.


C)    posted to accounts in an accounts receivable subsidiary ledger and to accounts in the general ledger.

D)    posted only to accounts in the general ledger.
Question 37        2 / 2 points
A system of internal control

A)    is infallible.


B)    can be rendered ineffective by employee collusion.

C)    invariably will have costs exceeding benefits.

D)    is premised on the concept of absolute assurance.
Question 38        2 / 2 points
The maturity value of a $30,000, 8%, 3-month note receivable is

A)    $30,240.

B)    $30,200.

C)    $32,400.


D)    $30,600.
Question 39        2 / 2 points
A subsidiary ledger is

A)    a group of accounts used by branches and subsidiaries of a corporate business.

B)    used in place of the general ledger if the general ledger is destroyed or stolen.

C)    used to post excess transactions if a general ledger account becomes full during an accounting period.


D)    a group of accounts with a common characteristic that provides detailed information about a control account in the general ledger.
Question 40        2 / 2 points
The sale of receivables by a business

A)    is generally the major revenue item on its income statement.


B)    can be a quick way to generate cash for operating needs.

C)    is an indication that the business is owned by a factor.

D)    indicates that the business is in financial difficulty.
Question 41        2 / 2 points
In 2010, Garrison Company had net credit sales of $1,125,000. On January 1, 2010, Allowance for Doubtful Accounts had a credit balance of $27,000. During 2010, $45,000 of uncollectible accounts receivable were written off. Past experience indicates that the allowance should be 10% of the balance in receivables (percentage of receivables basis). If the accounts receivable balance at December 31 was $300,000, what is the required adjustment to the Allowance for Doubtful Accounts at December 31, 2010?

A)    $30,000

B)    $112,500


C)    $48,000

D)    $45,000
Question 42        2 / 2 points
The allowance method of accounting for uncollectible accounts is required if

A)    the company charges interest on accounts receivable.

B)    the company makes any credit sales.

C)    the company is a retailer.


D)    bad debts are significant in amount.
Question 43        2 / 2 points
Short-term notes receivables


A)    use the same estimations and computations as accounts receivable to determine cash realizable value.

B)    present the same valuation problems as long-term notes receivables.

C)    have a related allowance account called Allowance for Doubtful Notes Receivable.

D)    are reported at their gross realizable value.
Question 44        2 / 2 points
Rainey Company wrote checks totaling $8,540 during October and $9,325 during November. $8,120 of these checks cleared the bank in October, and $9,110 cleared the bank in November. What was the amount of outstanding checks on November 30?


A)    $635

B)    $115

C)    $990

D)    $305
Question 45        2 / 2 points
Tayler Company wrote checks totaling $17,080 during October and $18,650 during November. $16,240 of these checks cleared the bank in October, and $18,220 cleared the bank in November. What was the amount of outstanding checks on November 30?

A)    $230

B)    $610


C)    $1,270

D)    $1,980
Question 46        2 / 2 points
The entry to replenish a petty cash fund includes a credit to

A)    Postage Expense.

B)    Petty Cash.

C)    Freight-in.


D)    Cash.
Question 47        2 / 2 points
In 2010, Freeze Company had credit sales of $900,000 and granted sales discounts of $18,000. On January 1, 2010, Allowance for Doubtful Accounts had a credit balance of $22,500. During 2010, $37,500 of uncollectible accounts receivable were written off. Past experience indicates that 3% of net credit sales become uncollectible. What should be the adjusted balance of Allowance for Doubtful Accounts at December 31, 2010?


A)    $11,460

B)    $49,500

C)    $26,460

D)    $12,000
Question 48        2 / 2 points
A customer charges a treadmill at Mike's Sport Shop. The price is $2,000 and the financing charge is 9% per annum if the bill is not paid in 30 days. The customer fails to pay the bill within 30 days and a finance charge is added to the customer's account.

The accounts affected by the journal entry made by Mike's Sport Shop to record the finance charge are

A)    Accounts Receivable
Interest Payable

B)    Accounts Receivable
Cash


C)    Cash
Finance Receivable


D)    Accounts Receivable
Interest Revenue
Question 49        2 / 2 points
Interest is usually associated with

A)    accounts receivable.

B)    doubtful accounts.


C)    notes receivable.

D)    bad debts.
Question 50        2 / 2 points
Richmond's Wholesale uses a sales journal. An entry in this journal represents a


A)    debit to Accounts Receivable; credit to Sales.

B)    debit to Cash; credit to Sales.

C)    debit to Accounts Payable; credit to Sales Returns and Allowances.

D)    debit to Sales Discounts; credit to Cash.

Question 17        2 / 2 points
A petty cash fund is generally established in order to

A)    pay employees' wages.


B)    pay relatively small expenditures.

C)    make loans internally to employees.

D)    pay for all merchandise purchased on account.
Question 18        2 / 2 points
On February 1, 2010, Janssen Company sells merchandise on account to Nicholson Company for $5,000. The entry to record this transaction by Janssen Company is

A)    Notes Receivable          5,000
Accounts Receivable               5,000

B)    Sales          5,000
Accounts Payable               5,000

C)    Cash          5,000
Sales               5,000


D)    Accounts Receivable          5,000
Sales               5,000
Question 19        2 / 2 points
A subsidiary ledger frees the general ledger from details of

A)    internal transactions.

B)    external transactions.


C)    individual balances.

D)    the control account.
Question 20        2 / 2 points
If a check correctly written and paid by the bank for $428 is incorrectly recorded on the company's books for $482, the appropriate treatment on the bank reconciliation would be to

A)    add $54 to the bank's balance.


B)    add $54 to the book's balance.

C)    deduct $54 from the bank's balance.

D)    deduct $428 from the book's balance.
Question 21        2 / 2 points
On January 15, 2010, Raymond Company received a two-month, 9%, $5,000 note from William Pentel for the settlement of his open account. The entry by Raymond Company on January 15, 2010 would include a:


A)    debit of $5,000 to Notes Receivable.

B)    debit of $5,075 to Notes Receivable.

C)    credit of $5,000 to Notes Receivable.

D)    credit of $5,075 to Accounts Receivable.
Question 22        2 / 2 points
A debit balance in Cash Over and Short is reported as a

A)    miscellaneous asset.


B)    miscellaneous expense.

C)    miscellaneous revenue.

D)    contra asset.
Question 23        2 / 2 points
Trade accounts receivable are valued and reported on the balance sheet

A)    in the investment section.

B)    only if they are not past due.


C)    at net realizable value.

D)    at gross amounts less sales returns and allowances.
Question 24        2 / 2 points
On a bank reconciliation, deposits in transit are


A)    added to the bank balance.

B)    deducted from the book balance.

C)    added to the book balance.

D)    deducted from the bank balance.
Question 25        2 / 2 points
Which one of the following items would not be considered cash?

A)    Currency

B)    Coins

C)    Money orders


D)    Postdated checks
Question 26        2 / 2 points
The balance of Allowance for Doubtful Accounts prior to making the adjusting entry to record estimated uncollectible accounts

A)    is relevant when using the percentage of sales basis.

B)    will never show a debit balance at this stage in the accounting cycle.


C)    is relevant when using the percentage of receivables basis.

D)    is relevant to both bases of adjusting for uncollectible accounts.
Question 27        2 / 2 points
The existing balance in Allowance for Doubtful Accounts is considered in computing bad debts expense in the

A)    direct write-off method.

B)    percentage of sales basis.


C)    percentage of receivables basis.

D)    percentage of receivables and percentage of sales basis.
Question 28        2 / 2 points
Checks received through the mail should

A)    be "rung up" on a cash register immediately.

B)    be sent to the accounts receivable subsidiary ledger clerk for immediate posting to the customer's account.

C)    be cashed at the bank as soon as possible.


D)    immediately be endorsed "For Deposit Only."
Question 29        2 / 2 points
Using the percentage of receivables method for recording bad debts expense, estimated uncollectible accounts are $25,000. If the balance of the Allowance for Doubtful Accounts is $8,000 debit before adjustment, what is the amount of bad debts expense for that period?

A)    $8,000

B)    $25,000

C)    $17,000


D)    $33,000
Question 30        2 / 2 points
An example of poor internal control is

A)    The accountant should not have physical custody of the asset nor access to it.

B)    The custodian of an asset should not maintain or have access to the accounting records.


C)    One person should be responsible for handling related transactions.

D)    A salesperson makes the sale, and a different person ships the goods.
Question 31        2 / 2 points
Klosterman Corporation's unadjusted trial balance includes the following balances (assume normal balances):
Accounts Receivable    $746,000
Allowance for Doubtful Accounts    14,200
Bad debts are estimated to be 6% of outstanding receivables. What amount of bad debts expense will the company record?

A)    $29,708

B)    $44,760


C)    $30,560

D)    $45,612

question set
Question 1        2 / 2 points
Transactions in a journal are initially recorded in

A)    account number order.

B)    alphabetical order.


C)    chronological order.

D)    dollar amount order.
Question 2        2 / 2 points
The final step in the recording process is to

A)    prepare a trial balance.

B)    analyze each transaction.


C)    transfer journal information to ledger accounts.

D)    enter the transaction in a journal.
Question 3        2 / 2 points
Owner's capital at the end of the period is equal to

A)    net income.


B)    owner's capital at the beginning of the period plus net income minus drawings.

C)    owner's capital at the beginning of the period plus net income minus liabilities.

D)    assets plus liabilities.
Question 4        2 / 2 points
The Duce Company has five plants nationwide that cost $100 million. The current market value of the plants is $500 million. The plants will be recorded and reported as assets at

A)    $400 million.

B)    $600 million.

C)    $500 million.


D)    $100 million.
Question 5        2 / 2 points
All of the following are advantages cost has over other valuations except that it

A)    can be objectively measured.

B)    can be verified.

C)    is reliable.


D)    is relevant.
Question 6        2 / 2 points
At October 1, 2010, Padilla Industries had an accounts payable balance of $30,000. During the month, the company made purchases on account of $25,000 and made payments on account of $40,000. At October 31, 2010, the accounts payable balance is


A)    $15,000.

B)    $40,000.

C)    $30,000.

D)    $10,000.
Question 7        2 / 2 points
The proprietorship form of business organization


A)    represents the largest number of businesses in the United States.

B)    must have at least three owners in most states.

C)    combines the records of the business with the personal records of the owner.

D)    is characterized by a legal distinction between the business as an economic unit and the owner.
Question 8        2 / 2 points
A journal is not useful for

A)    providing a record of transactions.

B)    locating and preventing errors.

C)    disclosing in one place the complete effect of a transaction.


D)    preparing financial statements.
Question 9        2 / 2 points
At September 1, 2010, Crews Co. reported owner's equity of $136,000. During the month, Crews generated revenues of $20,000, incurred expenses of $12,000, purchased equipment for $5,000 and withdrew cash of $2,000. What is the amount of owner's equity at September 30, 2010?


A)    $142,000

B)    $137,000

C)    $136,000

D)    $8,000
Question 10        2 / 2 points
Which of the following events is not a business transaction?

A)    Incurred utility expenses for the month.

B)    Investment of cash by the owner.


C)    Hired employees.

D)    Earned revenue for services provided.
Question 11        2 / 2 points
Liabilities of a company are owed to

A)    debtors.

B)    benefactors.


C)    creditors.

D)    underwriters.
Question 12        2 / 2 points
Which of the following is an external user of accounting information?

A)    Finance directors.


B)    Labor unions.

C)    Company officers.

D)    Managers.
Question 13        2 / 2 points
Metzger Company compiled the following financial information as of December 31, 2010:
Revenues    $140,000
Metzger, Capital (1/1/10)    70,000
Equipment    40,000
Expenses    125,000
Cash    35,000
Metzger, Drawings    10,000
Supplies    5,000
Accounts payable    20,000
Accounts receivable    15,000

Metzger's assets on December 31, 2010 are

A)    $80,000.

B)    $235,000.


C)    $95,000.

D)    $170,000.
Question 14        2 / 2 points
Carla's Computer Repair Shop started the year with total assets of $270,000 and total liabilities of $180,000. During the year, the business recorded $450,000 in computer repair revenues, $255,000 in expenses, and Carla withdrew $45,000. Carla's Capital balance changed by what amount from the beginning of the year to the end of the year?

A)    $90,000.


B)    $150,000.

C)    $45,000.

D)    $195,000.
Question 15        2 / 2 points
In recording business transactions, evidence that an accounting transaction has taken place is obtained from


A)    business documents.

B)    the public relations department.

C)    the Internal Revenue Service.

D)    the SEC.
Question 16        2 / 2 points
Which of the following events cannot be quantified into dollars and cents and recorded as an accounting transaction?

A)    The sale of store equipment.

B)    The purchase of a new computer.

C)    Payment of income taxes.


D)    The appointment of a new CPA firm to perform an audit.
Question 17        0 / 2 points
Rusthe Company showed the following balances at the end of its first year:
Cash    $ 7,000
Prepaid insurance    700
Accounts receivable    3,500
Accounts payable    2,800
Notes payable    4,200
Denton, Capital    1,400
Denton, Drawing    700
Revenues    21,000
Expenses    17,500

What did Rusthe Company show as total credits on its trial balance?

A)    $30,100


B)    $29,400

C)    $30,800


D)    $28,700
Question 18        2 / 2 points
If total liabilities increased by $15,000 and owner's equity increased by $5,000 during a period of time, then total assets must change by what amount and direction during that same period?

A)    $20,000 decrease


B)    $20,000 increase

C)    $30,000 increase

D)    $25,000 increase

Question 17        2 / 2 points
A business pays weekly salaries of $20,000 on Friday for a five-day week ending on that day. The adjusting entry necessary at the end of the fiscal period ending on a Thursday is

A)    debit Salaries Payable, $16,000; credit Cash, $16,000.

B)    debit Salaries Expense, $4,000; credit Salaries Payable, $4,000.

C)    debit Salaries Expense, $16,000; credit Cash, $16,000.


D)    debit Salaries Expense, $16,000; credit Salaries Payable, $16,000.
Question 18        2 / 2 points
An error has occurred in the closing entry process if

A)    the owner's capital account is credited for the amount of net income.

B)    revenue and expense accounts have zero balances.

C)    the owner's drawing account is closed to the owner's capital account.


D)    the balance sheet accounts have zero balances.
Question 19        2 / 2 points
Accumulated Depreciation is

A)    an expense account.

B)    an owner's equity account.

C)    a liability account.


D)    a contra asset account.
Question 20        2 / 2 points
A post-closing trial balance is prepared

A)    after closing entries have been journalized but before the entries are posted.

B)    before closing entries have been journalized but after the entries are posted.


C)    after closing entries have been journalized and posted.

D)    before closing entries have been journalized and posted.
Question 21        2 / 2 points
The income statement for the month of June, 2010 of Ramirez Enterprises contains the following information:
Revenues              $7,000
Expenses:                                        
Wages Expense    $2,000     
Rent Expense    1,000          
Supplies Expense    300               
Advertising Expense    200                    
Insurance Expense        100                         
Total expenses         3,600
Net income    $3,400                              

After the revenue and expense accounts have been closed, the balance in Income Summary will be


A)    a credit balance of $3,400.

B)    $0.

C)    a debit balance of $3,400.

D)    a credit balance of $7,000.
Question 22        2 / 2 points
The difference between the cost of a depreciable asset and its related accumulated depreciation is referred to as the

A)    market value of the asset.

B)    blue book value of the asset.


C)    book value of the asset.

D)    depreciated difference of the asset.
Question 23        2 / 2 points
Each of the following accounts is closed to Income Summary except

A)    Expenses.

B)    All of these are closed to Income Summary.

C)    Revenues.


D)    Owner's Drawing.
Question 24        2 / 2 points
Can financial statements be prepared directly from the adjusted trial balance?

A)    They can because that is the only reason that an adjusted trial balance is prepared.

B)    They cannot. The general ledger must be used.

C)    No, the adjusted trial balance merely proves the equality of the total debit and total credit balances in the ledger after adjustments are posted. It has no other purpose.


D)    Yes, adjusting entries have been recorded in the general journal and posted to the ledger accounts.
Question 25        2 / 2 points
The following information is for Benton Office Supplies:

Benton Office Supplies
Balance Sheet
December 31, 2010

Cash    $ 65,000         Accounts Payable    $ 60,000
Prepaid Insurance    30,000         Salaries Payable    10,000
Accounts Receivable    50,000         Mortage Payable      90,000
Inventory    70,000         Total Liabilities    $160,000
Land held for investment    75,000          
Land    90,000          
Building    $100,000              Common Stock    $120,000
Less Accumulated              Retained Earnings    250,000
Depreciation    (20,000)    80,000         Total stockholder's equity    $370,000
Trademark       70,000         Total Liabilities and
Total Assets    $530,000         Stockholders' Equity    $530,000

The total dollar amount of assets to be classified as current assets is


A)    $215,000.

B)    $180,000.

C)    $290,000.

D)    $145,000.
Question 26        2 / 2 points
As prepaid expenses expire with the passage of time, the correct adjusting entry will be a

A)    debit to an expense account and a credit to an expense account.

B)    debit to an asset account and a credit to an expense account.

C)    debit to an asset account and a credit to an asset account.


D)    debit to an expense account and a credit to an asset account.
Question 27        2 / 2 points
The revenue recognition principle dictates that revenue should be recognized in the accounting records

A)    in the period that income taxes are paid.

B)    when cash is received.


C)    when it is earned.

D)    at the end of the month.
Question 28        2 / 2 points
Office Equipment is classified in the balance sheet as

A)    an intangible asset.


B)    property, plant, and equipment.

C)    a current asset.

D)    a long-term investment.
Question 29        2 / 2 points
The net income (or loss) for the period

A)    is found by computing the difference between the trial balance totals and the adjusted trial balance totals.

B)    cannot be found on the worksheet.


C)    is found by computing the difference between the income statement columns of the worksheet.

D)    is found by computing the difference between the income statement credit column and the balance sheet credit column on the worksheet.
Question 30        2 / 2 points
Which of the following steps in the accounting cycle may be performed most frequently?

A)    Prepare a post-closing trial balance

B)    Journalize closing entries

C)    Post closing entries


D)    Prepare a trial balance
Question 31        2 / 2 points
A liability—revenue relationship exists with

A)    accrued expense adjusting entries.


B)    unearned revenue adjusting entries.

C)    prepaid expense adjusting entries.

D)    accrued revenue adjusting entries.

Question 32        2 / 2 points
Sherman Air Charter signed a four-month note payable in the amount of $8,000 on September 1. The note requires interest at an annual rate of 9%. The amount of interest to be accrued at the end of September is

A)    $720.

B)    $240.

C)    $80.


D)    $60.
Question 33        2 / 2 points
A company spends $10 million dollars for an office building. Over what period should the cost be written off?

A)    When the $10 million is expended in cash

B)    All in the first year

C)    After $10 million in revenue is earned


D)    Over the useful life of the building
Question 34        2 / 2 points
If the total debits exceed total credits in the balance sheet columns of the worksheet, owner's equity

A)    is in error because a mistake has occurred.

B)    will not be affected.

C)    will decrease because a net loss has occurred.


D)    will increase because net income has occurred.
Question 35        2 / 2 points
Employees at Julian Corporation are paid $5,000 cash every Friday for working Monday through Friday. The calendar year accounting period ends on Wednesday, December 31. How much salary expense should be recorded two days later on January 2?


A)    $2,000

B)    $3,000

C)    $5,000

D)    None, matching requires the weekly salary to be accrued on December 31.
Question 36        2 / 2 points
Speedy Clean Laundry purchased $6,500 worth of laundry supplies on June 2 and recorded the purchase as an asset. On June 30, an inventory of the laundry supplies indicated only $2,000 on hand. The adjusting entry that should be made by the company on June 30 is


A)    Debit Laundry Supplies Expense, $4,500; Credit Laundry Supplies, $4,500.

B)    Debit Laundry Supplies Expense, $2,000; Credit Laundry Supplies, $2,000.

C)    Debit Laundry Supplies, $2,000; Credit Laundry Supplies Expense, $2,000.

D)    Debit Laundry Supplies, $4,500; Credit Laundry Supplies Expense, $4,500.
Question 37        2 / 2 points
A new accountant working for Unitas Company records $800 Depreciation Expense on store equipment as follows:
Dr.    Depreciation Expense              800     
Cr.         Cash              800
The effect of this entry is to

A)    understate the book value of the depreciable assets as of December 31.

B)    adjust the accounts to their proper amounts on December 31.

C)    understate total assets on the balance sheet as of December 31.


D)    overstate the book value of the depreciable assets at December 31.
Question 38        2 / 2 points
The income statement and balance sheet columns of Reed Company's worksheet reflect the following totals:
Income Statement    Balance Sheet
Dr.    Cr.    Dr.    Cr.
Totals    $58,000    $48,000    $34,000    $44,000

The net income (or loss) for the period is

A)    not determinable.

B)    $48,000 income.


C)    $10,000 loss.

D)    $10,000 income.
Question 39        2 / 2 points
All of the following statements about the post-closing trial balance are correct except it

A)    provides evidence that the journalizing and posting of closing entries have been properly completed.


B)    proves that all transactions have been recorded.

C)    shows that the accounting equation is in balance.

D)    contains only permanent accounts.
Question 40        2 / 2 points
The following information is for Benton Office Supplies:
Benton Office Supplies
Balance Sheet
December 31, 2010

Cash    $ 65,000         Accounts Payable    $ 60,000
Prepaid Insurance    30,000         Salaries Payable    10,000
Accounts Receivable    50,000         Mortage Payable      90,000
Inventory    70,000         Total Liabilities    $160,000
Land held for investment    75,000          
Land    90,000          
Building    $100,000              Common Stock    $120,000
Less Accumulated              Retained Earnings    250,000
Depreciation    (20,000)    80,000         Total stockholder's equity    $370,000
Trademark       70,000         Total Liabilities and
Total Assets    $530,000         Stockholders' Equity    $530,000

The total dollar amount of assets to be classified as investments is

A)    $180,000.

B)    $150,000.

C)    $0.


D)    $75,000.
Question 41        2 / 2 points
Joyce's Gifts signs a three-month note payable to help finance increases in inventory for the Christmas shopping season. The note is signed on November 1 in the amount of $50,000 with annual interest of 12%. What is the adjusting entry to be made on December 31 for the interest expense accrued to that date, if no entries have been made previously for the interest?


A)    Interest Expense         1,000     
Interest Payable         1,000


B)    Interest Expense         1,500     
Interest Payable         1,500


C)    Interest Expense         1,000     
Note Payable         1,000


D)    Interest Expense         1,000     
Cash         1,000

Question 42        2 / 2 points
The following items are taken from the financial statements of Dinkel Company for the year ending December 31, 2010:
Accounts payable    $ 18,000
Accounts receivable    11,000
Accumulated depreciation – equipment    28,000
Advertising expense    21,000
Cash    15,000
Dinkel, Capital (1/1/10)    102,000
Dinkel, Drawing    14,000
Depreciation expense    12,000
Insurance expense    3,000
Note payable, due 6/30/11    70,000
Prepaid insurance (12-month policy)    6,000
Rent expense    17,000
Salaries expense    32,000
Service revenue    133,000
Supplies    4,000
Supplies expense    6,000
Equipment    210,000

What is the balance that would be reported for owner's equity at December 31, 2010?


A)    $130,000

B)    $158,000

C)    $144,000

D)    $102,000
Question 43        2 / 2 points
Southwestern City College sold season tickets for the 2010 football season for $160,000. A total of 8 games will be played during September, October and November. In September, three games were played. The adjusting journal entry at September 30


A)    will include a debit to Unearned Ticket Revenue and a credit to Ticket Revenue for $60,000.

B)    is not required. No adjusting entries will be made until the end of the season in November.

C)    will include a debit to Ticket Revenue and a credit to Unearned Ticket Revenue for $53,333.

D)    will include a debit to Cash and a credit to Ticket Revenue for $40,000.
Question 44        2 / 2 points
An accounting time period that is one year in length, but does not begin on January 1, is referred to as

A)    a reporting period.

B)    an interim period.


C)    a fiscal year.

D)    the time period assumption.
Question 45        2 / 2 points
Which of the following reflect the balances of prepayment accounts prior to adjustment?

A)    Balance sheet accounts are understated and income statement accounts are understated.


B)    Balance sheet accounts are overstated and income statement accounts are understated.

C)    Balance sheet accounts are overstated and income statement accounts are overstated.

D)    Balance sheet accounts are understated and income statement accounts are overstated.
Question 46        2 / 2 points
Monthly and quarterly time periods are called

A)    fiscal periods.


B)    interim periods.

C)    quarterly periods.

D)    calendar periods.
Question 47        2 / 2 points
Farr Company paid the weekly payroll on January 2 by debiting Wages Expense for $45,000. The accountant preparing the payroll entry overlooked the fact that Wages Expense of $27,000 had been accrued at year end on December 31. The correcting entry is


A)    Wages Payable         27,000     
Wages Expense         27,000


B)    Wages Payable         27,000     
Cash         27,000


C)    Cash         27,000     
Wages Expense         27,000


D)    Cash         18,000     
Wages Expense         18,000

Question 48        2 / 2 points
Which of the following would not be classified a long-term liability?


A)    Current maturities of long-term debt

B)    Bonds payable

C)    Lease liabilities

D)    Mortgage payable
Question 49        2 / 2 points
Closing entries are made


A)    in order to transfer net income (or loss) and owner's drawing to the owner's capital account.

B)    so that all assets, liabilities, and owner's capital accounts will have zero balances when the next accounting period starts.

C)    so that financial statements can be prepared.

D)    in order to terminate the business as an operating entity.
Question 50        2 / 2 points
Henry-K Company purchased a computer system for $3,600 on January 1, 2010. The company expects to use the computer system for 3 years. It has no salvage value. Monthly depreciation expense on the asset is

A)    $3,600.

B)    $1,200.

C)    $0.


D)    $100.

question set
Question 1        2 / 2 points
If Income Summary has a credit balance after revenues and expenses have been closed into it, the closing entry for Income Summary will include a

A)    debit to the owner's drawing account.

B)    credit to the owner's drawing account.


C)    credit to the owner's capital account.

D)    debit to the owner's capital account.
Question 2        2 / 2 points
The first item listed under current liabilities is usually

A)    taxes payable.


B)    notes payable.

C)    accounts payable.

D)    salaries payable.
Question 3        2 / 2 points
Intangible assets include each of the following except

A)    goodwill.

B)    patents.

C)    copyrights.


D)    land improvements.
Question 4        2 / 2 points
A candy factory's employees work overtime to finish an order that is sold on February 28. The office sends a statement to the customer in early March and payment is received by mid-March. The overtime wages should be expensed in


A)    February.

B)    the period when the workers receive their checks.

C)    March.

D)    either in February or March depending on when the pay period ends.
Question 5        2 / 2 points
RAS Corporation issued a one-year, 12%, $200,000 note on August 31, 2010. Interest expense for the year ended December 31, 2010 was

A)    $24,000.

B)    $10,000.


C)    $8,000.

D)    $6,000.
Question 6        2 / 2 points
The income statement for the month of June, 2010 of Ramirez Enterprises contains the following information:
Revenues              $7,000
Expenses:                                        
Wages Expense    $2,000     
Rent Expense    1,000          
Supplies Expense    300               
Advertising Expense    200                    
Insurance Expense        100                         
Total expenses         3,600
Net income    $3,400                              

The entry to close Income Summary to Ramirez, Capital includes

A)    credits to Expenses totalling $3,600.

B)    a credit to Income Summary for $3,400


C)    a credit to Ramirez, Capital for $3,400.

D)    a debit to Revenue for $7,000.
Question 7        2 / 2 points
The following information is for Benton Office Supplies:
Benton Office Supplies
Balance Sheet
December 31, 2010

Cash    $ 65,000         Accounts Payable    $ 60,000
Prepaid Insurance    30,000         Salaries Payable    10,000
Accounts Receivable    50,000         Mortage Payable      90,000
Inventory    70,000         Total Liabilities    $160,000
Land held for investment    75,000          
Land    90,000          
Building    $100,000              Common Stock    $120,000
Less Accumulated              Retained Earnings    250,000
Depreciation    (20,000)    80,000         Total stockholder's equity    $370,000
Trademark       70,000         Total Liabilities and
Total Assets    $530,000         Stockholders' Equity    $530,000

The total dollar amount of liabilities to be classified as current liabilities is

A)    $160,000.


B)    $70,000.

C)    $150,000.

D)    $60,000.
Question 8        2 / 2 points
A worksheet can be thought of as a(n)

A)    permanent accounting record.

B)    part of the general ledger.


C)    optional device used by accountants.

D)    part of the journal.
Question 9        2 / 2 points
Y-B-2 Inc. pays its rent of $120,000 annually on January 1. If the February 28 monthly adjusting entry for prepaid rent is omitted, which of the following will be true?


A)    Assets will be overstated by $10,000 and net income and owner's equity will be overstated by $10,000.

B)    Failure to make the adjustment does not affect the February financial statements.

C)    Expenses will be overstated by $10,000 and net income and owner's equity will be understated by $10,000.

D)    Assets will be overstated by $20,000 and net income and owner's equity will be understated by $20,000.
Question 10        2 / 2 points
Daly Investments purchased an 18-month insurance policy on May 31, 2010 for $3,600. The December 31, 2010 balance sheet would report Prepaid Insurance of


A)    $2,200.

B)    $0 because Prepaid Insurance is reported on the Income Statement.

C)    $3,600.

D)    $1,400.
Question 11        2 / 2 points
An adjusting entry


A)    affects a balance sheet account and an income statement account.

B)    affects two income statement accounts.

C)    affects two balance sheet accounts.

D)    is always a compound entry.
Question 12        2 / 2 points
The following items are taken from the financial statements of Dinkel Company for the year ending December 31, 2010:
Accounts payable    $ 18,000
Accounts receivable    11,000
Accumulated depreciation – equipment    28,000
Advertising expense    21,000
Cash    15,000
Dinkel, Capital (1/1/10)    102,000
Dinkel, Drawing    14,000
Depreciation expense    12,000
Insurance expense    3,000
Note payable, due 6/30/11    70,000
Prepaid insurance (12-month policy)    6,000
Rent expense    17,000
Salaries expense    32,000
Service revenue    133,000
Supplies    4,000
Supplies expense    6,000
Equipment    210,000

What is the company's net income for the year ending December 31, 2010?

A)    $28,000

B)    $12,000

C)    $133,000


D)    $42,000
Question 13        2 / 2 points
The balance in the income summary account before it is closed will be equal to

A)    the beginning balance in the owner's capital account.


B)    the net income or loss on the income statement.

C)    the ending balance in the owner's capital account.

D)    zero.
Question 14        2 / 2 points
The relationship between current assets and current liabilities is important in evaluating a company's

A)    accounting cycle.

B)    profitability.


C)    liquidity.

D)    market value.
Question 15        2 / 2 points
Which one of the following is an optional step in the accounting cycle of a business enterprise?

A)    Post to the ledger accounts

B)    Prepare a trial balance

C)    Analyze business transactions


D)    Prepare a worksheet
Question 16        2 / 2 points
In order to close the owner's drawing account, the

A)    owner's capital account should be credited.

B)    income summary account should be credited.


C)    owner's capital account should be debited.

D)    income summary account should be debited.

Question 32        2 / 2 points
An error in the physical count of goods on hand at the end of a period resulted in a $10,000 overstatement of the ending inventory. The effect of this error in the current period is
Cost of Goods Sold    Net Income


A)    Overstated    Overstated


B)    Overstated    Understated


C)    Understated    Understated



D)    Understated    Overstated

Question 33        2 / 2 points
Julian Junkets has the following inventory information.
July    1         Beginning Inventory    10 units at $90
5         Purchases    60 units at $84
14         Sale    40 units
21         Purchases    30 units at $87
30         Sale    28 units

Assuming that a perpetual inventory system is used, what is the ending inventory (rounded) under the average-cost method?

A)    $2,772

B)    $2,406

C)    $2,784


D)    $2,750
Question 34        2 / 2 points
Two companies report the same cost of goods available for sale but each employs a different inventory costing method. If the price of goods has increased during the period, then the company using


A)    FIFO will have the highest ending inventory.

B)    LIFO will have the lowest cost of goods sold.

C)    LIFO will have the highest ending inventory.

D)    FIFO will have the highest cost of good sold.
Question 35        2 / 2 points
The managers of Mayo Company receive performance bonuses based on the net income of the firm. Which inventory costing method are they likely to favor in periods of declining prices?

A)    Average Cost

B)    Physical inventory method

C)    FIFO


D)    LIFO
Question 36        2 / 2 points
A merchandising company using a perpetual system will make

A)    one less adjusting entry than a service company does.

B)    different types of adjusting entries compared to a service company.


C)    one more adjusting entry than a service company does.

D)    the same number of adjusting entries as a service company does.
Question 37        2 / 2 points
Kershaw Bookstore had 500 units on hand at January 1, costing $18 each. Purchases and sales during the month of January were as follows:
Date         Purchases         Sales
Jan.     14              375 @ $28
17         250 @ $20
25         250 @ $22
29         250 @ $32

Kershaw does not maintain perpetual inventory records. According to a physical count, 375 units were on hand at January 31.

The cost of the inventory at January 31, under the FIFO method is:


A)    $8,000.

B)    $1,000.

C)    $6,750.

D)    $7,750.
Question 38        2 / 2 points
Which of the following is not a true statement about a multiple-step income statement?

A)    There is a section for cost of goods sold.

B)    Operating expenses are similar for merchandising and service enterprises.

C)    There may be a section for nonoperating activities.


D)    There may be a section for operating assets.
Question 39        2 / 2 points
Unitech has the following inventory information.
July    1         Beginning Inventory    20 units at $19    $   380
7         Purchases    70 units at $20    1,400
22         Purchases    10 units at $22        220
$2,000

A physical count of merchandise inventory on July 31 reveals that there are 30 units on hand. Using the LIFO inventory method, the amount allocated to cost of goods sold for July is

A)    $580.

B)    $1,380.

C)    $620.


D)    $1,420.
Question 40        2 / 2 points
Birk Company sells merchandise on account for $2,000 to Kiner Company with credit terms of 2/10, n/30. Kiner Company returns $400 of merchandise that was damaged, along with a check to settle the account within the discount period. What is the amount of the check?


A)    $1,568

B)    $1,960

C)    $1,600

D)    $1,968
Question 41        2 / 2 points
Under the LCM approach, the market value is defined as

A)    selling price.

B)    LIFO cost.


C)    current replacement cost.

D)    FIFO cost.
Question 42        2 / 2 points
Julian Junkets has the following inventory information.
July    1         Beginning Inventory    10 units at $90
5         Purchases    60 units at $84
14         Sale    40 units
21         Purchases    30 units at $87
30         Sale    28 units

Assuming that a perpetual inventory system is used, what is the ending inventory on a LIFO basis?

A)    $2,748

B)    $2,772


C)    $2,754

D)    $5,796
Question 43        2 / 2 points
Which of the following accounts has a normal credit balance?

A)    Purchases

B)    Freight-in

C)    Sales Returns and Allowances


D)    Purchase Discounts
Question 44        0 / 2 points
Julian Junkets has the following inventory information.
July    1         Beginning Inventory    10 units at $90
5         Purchases    60 units at $84
14         Sale    40 units
21         Purchases    30 units at $87
30         Sale    28 units

Assuming that a perpetual inventory system is used, what is the ending inventory on a FIFO basis?

A)    $2,754

B)    $5,796


C)    $2,748


D)    $2,778
Question 45        2 / 2 points
Selection of an inventory costing method by management does not usually depend on

A)    tax effects.


B)    the fiscal year end.

C)    income statement effects.

D)    balance sheet effects.
Question 46        2 / 2 points
If a company is given credit terms of 2/10, n/30, it should

A)    recognize that the supplier is desperate for cash and withhold payment until the end of the credit period while negotiating a lower sales price.

B)    hold off paying the bill until the end of the credit period, while investing the money at 10% annual interest during this time.


C)    pay within the discount period and recognize a savings.

D)    pay within the credit period but don't take the trouble to invest the cash while waiting to pay the bill.
Question 47        2 / 2 points
Which of the following would not be classified as a contra account?

A)    Sales Returns and Allowances

B)    Accumulated Depreciation

C)    Sales Discounts


D)    Sales
Question 48        2 / 2 points
A merchandising company using a perpetual system may record an adjusting entry by

A)    debiting Income Summary.

B)    crediting Income Summary.

C)    debiting Sales.


D)    debiting Cost of Goods Sold.
Question 49        2 / 2 points
The following information was available for Hoover Company at December 31, 2010: beginning inventory $90,000; ending inventory $70,000; cost of goods sold $660,000; and sales $900,000. Hoover's inventory turnover ratio in 2010 was

A)    9.4 times.


B)    8.3 times.

C)    7.3 times.

D)    6.0 times.
Question 50        2 / 2 points
Holliday Company's inventory records show the following data:
Units    Unit Cost
Inventory, January 1              5,000    $9.00
Purchases:          June 18    4,500    8.00
November 8    3,000    7.00

A physical inventory on December 31 shows 2,000 units on hand. Holliday sells the units for $12 each. The company has an effective tax rate of 20%. Holliday uses the periodic inventory method. What is the cost of goods available for sale?

A)    $21,000

B)    $45,000

C)    $36,000


D)    $102,000

Question 17        2 / 2 points
A company purchased inventory as follows:
200 units at $10
300 units at $12
The average unit cost for inventory is

A)    $12.00.

B)    $10.00.


C)    $11.20.

D)    $11.00.
Question 18        2 / 2 points
A sales discount does not

A)    reduce the amount of cash received from a credit sale.


B)    increase an operating expense account.

C)    increase a contra-revenue account.

D)    provide the purchaser with a cash saving.
Question 19        2 / 2 points
Hicks Company purchased merchandise from Beyer Company with freight terms of FOB shipping point. The freight costs will be paid by the

A)    seller.


B)    buyer.

C)    transportation company.

D)    buyer and the seller.
Question 20        2 / 2 points
If a customer agrees to retain merchandise that is defective because the seller is willing to reduce the selling price, this transaction is known as a sales

A)    contra asset.


B)    allowance.

C)    discount.

D)    return.
Question 21        2 / 2 points
As a result of a thorough physical inventory, Hastings Company determined that it had inventory worth $270,000 at December 31, 2010. This count did not take into consideration the following facts: Carlin Consignment store currently has goods worth $52,000 on its sales floor that belong to Hastings but are being sold on consignment by Carlin. The selling price of these goods is $75,000. Hastings purchased $20,000 of goods that were shipped on December 27. FOB destination, that will be received by Hastings on January 3. Determine the correct amount of inventory that Hastings should report.

A)    $342,000.


B)    $322,000.

C)    $345,000.

D)    $290,000.
Question 22        2 / 2 points
A company just starting in business purchased three merchandise inventory items at the following prices. First purchase $80; Second purchase $95; Third purchase $85. If the company sold two units for a total of $240 and used FIFO costing, the gross profit for the period would be

A)    $50.


B)    $65.

C)    $75.

D)    $60.
Question 23        2 / 2 points
Cole Company has sales revenue of $39,000, cost of goods sold of $24,000 and operating expenses of $9,000 for the year ended December 31. Cole's gross profit is

A)    $30,000.


B)    $15,000.

C)    $0.

D)    $6,000.
Question 24        2 / 2 points
Rasner Co. returned defective goods costing $3,000 to Markum Company on March 19, for credit. The goods were purchased April 10, on credit, terms 3/10, n/30. The entry by Rasner Co. on April 19, in receiving full credit is:

A)    Accounts Payable              3,000     
Purchase Discounts         90
Merchandise Inventory         2,910


B)    Accounts Payable              3,000     
Merchandise Inventory         90
Cash         2,910



C)    Accounts Payable              3,000     
Merchandise Inventory         3,000


D)    Accounts Payable         3,000     
Merchandise Inventory    90     
Cash         3,090

Question 25        2 / 2 points
In periods of rising prices, the inventory method which results in the inventory value on the balance sheet that is closest to current cost is the

A)    tax method.


B)    FIFO method.

C)    average-cost method.

D)    LIFO method.
Question 26        2 / 2 points
Colletti Company recorded the following data:
Units                      Unit
Date    Received    Sold    On Hand    Cost
1/1 Inventory      600    $2.00
1/8 Purchased    900         1,500    2.20
1/12 Sold    1,200         300

The weighted average unit cost of the inventory at January 31 is:

A)    $2.20.

B)    $2.00.

C)    $2.10.


D)    $2.12.
Question 27        2 / 2 points
If a company has net sales of $500,000 and cost of goods sold of $350,000, the gross profit percentage is

A)    100%.

B)    15%.

C)    70%.


D)    30%.
Question 28        2 / 2 points
On November 2, 2010, Griffey Company has cash sales of $4,200 from merchandise having a cost of $3,000. The entries to record the day's cash sales will include:

A)    a $4,200 debit to Accounts Receivable.

B)    a $4,200 credit to Cash.


C)    a $3,000 credit to Merchandise Inventory.

D)    a $3,000 credit to Cost of Goods Sold.
Question 29        2 / 2 points
Disclosures about inventory should include each of the following except the

A)    basis of accounting.

B)    costing method.

C)    major inventory classifications.


D)    quantity of inventory.
Question 30        2 / 2 points
Inventoriable costs include all of the following except the


A)    costs of the purchasing and warehousing departments.

B)    cost of the beginning inventory.

C)    freight costs incurred when buying inventory.

D)    cost of goods purchased.
Question 31        2 / 2 points
Holliday Company's inventory records show the following data:
Units    Unit Cost
Inventory, January 1         5,000    $9.00
Purchases:          June 18    4,500    8.00
November 8    3,000    7.00

A physical inventory on December 31 shows 2,000 units on hand. Holliday sells the units for $12 each. The company has an effective tax rate of 20%. Holliday uses the periodic inventory method. If the company uses FIFO, what is the gross profit for the period?

A)    $10,000

B)    $21,000


C)    $38,000

D)    $2,000

question set
Question 1        2 / 2 points
When goods are returned that relate to a prior cash sale,

A)    Accounts Receivable will be credited.

B)    Sales Returns and Allowances will be credited.


C)    the cash account will be credited.

D)    the Sales Returns and Allowances account should not be used.
Question 2        2 / 2 points
All of the following items would be reported as other expenses and losses except

A)    loss from employees' strikes.

B)    interest expense.


C)    freight-out.

D)    casualty losses.
Question 3        2 / 2 points
Graham Company uses a periodic inventory system. Details for the inventory account for the month of January, 2010 are as follows:
Units    Per unit price    Total
Balance, 1/1/10    200    $5.00    $1,000
Purchase, 1/15/10    100    5.30    530
Purchase, 1/28/10    100    5.50    550

An end of the month (1/31/10) inventory showed that 120 units were on hand. If the company uses FIFO and sells the units for $10 each, what is the gross profit for the month?

A)    $3,000

B)    $2,800

C)    $1,424


D)    $1,376
Question 4        2 / 2 points
When a seller grants credit for returned goods, the account that is credited is


A)    Accounts Receivable.

B)    Sales Returns and Allowances.

C)    Sales.

D)    Merchandise Inventory.
Question 5        2 / 2 points
Which one of the following transactions is recorded with the same entry in a perpetual and a periodic inventory system?


A)    Cash received on account with a discount

B)    Sale of merchandise on credit

C)    Payment of freight costs on a purchase

D)    Return of merchandise sold
Question 6        2 / 2 points
During August, 2010, Joe's Supply Store generated revenues of $30,000. The company's expenses were as follows: cost of goods sold of $12,000 and operating expenses of $2,000. The company also had rent revenue of $500 and a gain on the sale of a delivery truck of $1,000.

Joe's nonoperating income (loss) for the month of August, 2010 is

A)    $500.

B)    $1,000.

C)    $0.


D)    $1,500.
Question 7        2 / 2 points
Net purchases plus freight-in determines


A)    cost of goods purchased.

B)    cost of goods available for sale.

C)    total goods available for sale.

D)    cost of goods sold.
Question 8        2 / 2 points
Maxwell Company's financial information is presented below.
Sales    $     ????      Cost of Goods Sold    270,000
Sales Returns and Allowances    30,000      Gross Profit    ????
Net Sales    450,000     

The missing amounts above are:
Sales         Gross Profit


A)    $420,000     $210,000

B)    $480,000     $210,000

C)    $420,000     $180,000


D)    $480,000     $180,000
Question 9        2 / 2 points
In a period of inflation, the cost flow method that results in the lowest income taxes is the

A)    gross profit method.


B)    LIFO method.

C)    FIFO method.

D)    average-cost method.
Question 10        2 / 2 points
Merchandise inventory is

A)    often reported as a miscellaneous expense on the income statement.


B)    reported as a current asset on the balance sheet.

C)    reported under the classification of Property, Plant, and Equipment on the balance sheet.

D)    generally valued at the price for which the goods can be sold.
Question 11        2 / 2 points
Unitech has the following inventory information.
July    1         Beginning Inventory    20 units at $19    $   380
7         Purchases    70 units at $20    1,400
22         Purchases    10 units at $22        220
$2,000

A physical count of merchandise inventory on July 31 reveals that there are 30 units on hand. Using the FIFO inventory method, the amount allocated to cost of goods sold for July is


A)    $1,380.

B)    $620.

C)    $580.

D)    $1,420.
Question 12        2 / 2 points
The cost flow method that often parallels the actual physical flow of merchandise is the

A)    average-cost method.


B)    FIFO method.

C)    LIFO method.

D)    gross profit method.
Question 13        2 / 2 points
A credit memorandum is used as documentation for a journal entry that requires a debit to

A)    Cash and a credit to Sales Returns and Allowances.

B)    Sales and a credit to Cash.


C)    Sales Returns and Allowances and a credit to Accounts Receivable.

D)    Accounts Receivable and a credit to a contra-revenue account.
Question 14        2 / 2 points
Murray's Fashions sold merchandise for $38,000 cash during the month of July. Returns that month totaled $800. If the company's gross profit rate is 40%, Murray's will report monthly net sales revenue and cost of goods sold of


A)    $37,200 and $22,320.

B)    $38,000 and $22,800.

C)    $37,200 and $14,880.

D)    $38,000 and $22,320.
Question 15        2 / 2 points
The accountant at Paige Company is figuring out the difference in income taxes the company will pay depending on the choice of either FIFO or LIFO as an inventory costing method. The tax rate is 30% and the FIFO method will result in income before taxes of $5,460. The LIFO method will result in income before taxes of $4,935. What is the difference in tax that would be paid between the two methods?


A)    $158.

B)    $525.

C)    $225.

D)    Cannot be determined from the information provided.
Question 16        2 / 2 points
Which of the following expressions is incorrect?

A)    Net income + operating expenses = gross profit

B)    Sales – cost of goods sold – operating expenses = net income

C)    Gross profit – operating expenses = net income


D)    Operating expenses – cost of goods sold = gross profit