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True or False

1. In general, the role of the financial manager is to plan for the acquisition and use of funds so as to maximize the value of the firm.

2. The disadvantages associated with a proprietorship are similar to those under a partnership. One exception to this is due to the formal nature of the partnership agreement and the commitment of the partners personal assets. As a result, partnerships do not have difficulty raising large amounts of capital.

3. The current ratio and inventory turnover ratio measure the liquidity of a firm. The current ratio measures the relation of a firms current assets to its current liabilities and the inventory turnover ratio measures how rapidly a firm turns its inventory back into a quick asset or cash.

4. Selling new stock is an equity transaction; it does not affect any asset or liability account and therefore, does not appear on the statement of cash flows.

5. Financial asset markets deal with stocks, bonds, mortgages, and other claims on real assets with respect to the distribution of future cash flows.

6. The existence of financial intermediaries greatly increases the efficiency of financial markets because, without them, savers would have to provide funds directly to borrowers, which would be a much costlier process.

7. Of all the techniques used in finance, the least important is the concept of the time value of money.

8. The difference between an ordinary annuity and an annuity due is that each of the payments of the annuity due earns interest for one additional year (period).

9. The nominal rate of interest is defined as the sum of the nominal risk-free rate of return and the expected inflation rate.

10. An investor with a six-year investment horizon believes that interest rates are determined only by expectations about future interest rates, (i.e. this investor believes in the expectations theory). This investor should expect to earn the same rate of return over the 6-year time horizon if he or she buys a 6-year bond or a 3-year bond now and another 3-year bond three years from now (ignore transaction costs).

11. There is an inverse relationship between bond ratings and the required return on a bond. The required return is lowest for AAA rated bonds, and required returns increase as the ratings get lower (worse).

12. Although common stock represents a riskier investment to an individual than do bonds, in the sense of exposing the firm to the risk of bankruptcy, bonds represent a riskier method of financing to a corporation than does common stock.

13. The book value per share is computed by taking the sum of common stock, additional paid in capital, and retained earnings and dividing the number by the number of shares outstanding.

14. When management controls more than 50% of the shares of the firm, they must be concerned with the potential of a proxy fights than can lead to takeovers of the firm and the replacement of management.

15. Assume Stock A has a standard deviation of 0.21 while Stock B has a standard deviation of 0.10. If both Stock A and Stock B must be held in isolation, and if investors are risk averse, we can conclude that Stock A will have a greater required return. However, if the assets could be held in portfolios, it is conceivable that the required return could be higher on the low standard deviation stock.

Multiple Choice (2 points per question):

16. The primary goal of a financial manager should be to __________.

a. minimize operating costs

b. minimize interest payments

c. minimize tax payments

d. maximize operating income each year

e. maximize the value of the firms stock

17. Which of the following statements about the corporate form of business organization is incorrect?

a. The corporation is the easiest form of business organization to establish.

b. In the United States, corporations generate a significantly greater percentage of total annual sales than either partnerships or proprietorships.

c. Corporations generally are larger than either partnerships or proprietorships.

d. One of the most important features of the corporate form of business organization is that stockholders have limited liability.

e. None of the above.

18. Other things held constant, if a firm holds cash balances in excess of their optimal level in a non-interest bearing account, this will tend to lower the firms

a. Profit margin.

b. Total asset turnover.

c. Return on equity.

d. All of the above.

e. Answers b and c above.

19. Bubbles Soap Corporation has a quick ratio of 1.0 and a current ratio of 2.0 implying that

a. the value of current assets is equal to the value of inventory.