Practice Questions for Midterm 1 - Version B
1. Trish Stratus wants to buy a new Cadillac when she graduates from Miami University
exactly four years from today. She knows the price of the Cadillac will be $45,000 at that
time. How much must she deposit today if the bank pays 15% APR compounded daily
(assume there are 365 days per year) in order to have exactly the $45,000 she needs four
years from today?
2. Britney Spears decides to start her own record label. She borrows $1,250,000 today from
Dr. Dre to buy the necessary equipment. She agrees to make monthly payments of
$109,169.48 (with the first payment exactly one month from today) to Dr. Dre for 6 years
to repay the loan. They agree on a rate of 8.75% APR with monthly compounding. What
is the Effective Annual Rate (EAR) on this loan?
3. You are going to deposit $175 in your bank account every six months (with the first
deposit being made six months from today) for the next 16 years. In other words, you will
make a total of 32 semiannual deposits. After that, you will make no more deposits into
the account. How much will you have in your account 18 years from today if you take no
money out of the account? Assume that the bank will pay you an interest rate of 7.50%
APR compounded semiannually for the whole 18 year period.
4. Which of the following statements is most correct regarding ratio analysis?
a) Many large firms operate different divisions in different industries, and this makes it hard to
develop a meaningful set of industry benchmarks for these types of firms.
b) Financial ratios should be interpreted with caution because there exists seasonal and
accounting differences that can reduce their comparability.
c) Financial ratios should be interpreted with caution because it may be difficult to say with
certainty what is a “good” value. For example, in the case of the current ratio, a “good” value
is neither high nor low.
d) Ratio analysis facilitates comparisons by standardizing numbers.
e) All of the statements above are correct.
5. Nine months ago you deposited $8,700 in an account that has paid an interest rate of
12.99% APR compounded quarterly. If you withdrew the funds today, how much would
6. You have started a business selling footballs to local schools. In the first month, you buy
75 footballs from the manufacturer for $1.76/ball and then sell them all for $9.50/ball to
local schools. If you make all cash sales and all credit purchases (90-day terms), what is
your net income and net cash flow for the first month? Assume you sell all 75 footballs.
Net Income Net Cash Flow
a) $713 $132
b) -$581 -$713
c) $845 $132
d) $581 $713
e) $713 $581
7. Many corporate bonds come with a call provision that gives the company the right to buy
the bonds back from the bondholder (the bondholders typically receive a call premium in
addition to the face value of the bond). All else constant, which of the following events
would make it more likely that a company would choose to call its outstanding callable
a) A reduction in market interest rates.
b) The company's bonds are downgraded from AA to BBB by Moody’s.
c) An increase in the call premium (i.e., the price paid to repurchase the bonds).
d) Answers (a) and (b) are correct.
e) Answers (a), (b), and (c) are correct.
10. The primary goal of a publicy-owned firm interested in serving its stockholders should be
a) maximize expected total corporate profit.
b) maximize expected earnings per share (EPS).
c) minimize the chances of losses.
d) maximize shareholder wealth.
e) maximize expected net income.
11. You have some extra money to invest and you are trying to choose between three-year
certificates of deposit being offered by two banks. Key Bank's three-year CD pays 8.75%
APR compounded daily (assume 365 days per year) and Fifth Third's three-year CD pays
8.85% APR compounded monthly. What is the EAR for each CD and what is your best
option if you wish to maximize your wealth?
Key Bank EAR Fifth-Third EAR Best Option
a) 8.75% 8.85% Fifth-Third
b) 9.22% 9.14% Key Bank
c) 9.20% 9.16% Key Bank
d) 9.14% 9.22% Fifth-Third
e) Not enough information is provided to answer this question.
12. Which of the following are not generally features of common equity (common stock)?
I. Voting rights
II. Fixed coupon rate
III. Limited liability
a) both I and III
b) III only
c) both I and II
d) II only
e) All of the above (I, II, and III) are generally features of common equity.
13. The E. Vedder Flannel Corporation had sales of $850,000 in 1999, and a spontaneous
liabilities to sales ratio of 0.075. For 2000, its sales are forecast to increase 15%, and its ratio
of spontaneous liabilities to sales is expected to rise to 0.10. The expected increase in its
level of spontaneous liabilities during 2000 is
14. Companies can issue different classes of common stock. Which of the following
statements concerning stock classes is most correct?
a) All common stocks fall into one of three classes: A, B, and C.
b) All common stock, regardless of class, must have voting rights.
c) All common stock, regardless of class, must have the same dividend privileges.
d) More than one of the above are correct.
e) None of the above are correct.
15. Which of the following statements are true?
a) The process of comparing a financial ratio with itself over a period of time is called peer
b) If a particular ratio is declining over time, it must be a sign of poor decision making by
c) Ratio analysis involves a comparison of the relationships between financial statement
accounts so as to analyze the financial position and strength of a firm.
d) Variations in accounting methods among firms can invalidate financial comparisons between
e) More than one of the above answers is true.
16. You deposit $82 into the First National Bank of Beverly Hills today, which pays an
interest rate of 6% APR compounded semiannually. How many years will it take to have
your money grow to exactly $500? Round all fractional years up. For example, 7.04
years should be rounded up to 8 years.
a) 62 years
b) 7 years
c) 25 years
d) 35 years
e) 31 years
17. You are the owner of a small business which has the following balance sheet:
Current Assets $5,000 Accounts Payable $1,000
Net Fixed Assets 10,000 Accruals 1,000
Long-term Debt 5,000
Common Equity 8,000
Total Assets $15,000 Total Liab. & Equity $15,000
No change in asset efficiency is expected, and the sales/assets and sales/spontaneous liabilities
ratios will remain constant. Next year you expect sales to increase by 50 percent. You also
expect to retain $2,000 of next year’s earnings within the firm. Assume that accounts payable
and accruals are spontaneous liabilities. What is next year’s external financing requirement?
a) No additional funds are required.
18. McMahon Corporation recently announced that its net income was higher than last year.
However, analysts estimate that the company's net cash flow decreased. What factors
could explain this discrepancy?
a) The company's interest expense increased.
b) The company had a decrease in its noncash revenues
c) The company's depreciation expense decreased.
d) Answers (a) and (b) are correct.
e) Answers (b) and (c) are correct.
19. A local bank is offering an effective annual rate (EAR) of 10%. You know that this bank
uses a monthly compounding period but you do not know the APR they offer. If you
deposit $800 today in the bank, how much will you have in 2.5 years?
e) Cannot be calculated.
20. You have decided to buy a new car exactly five years from today that will cost $45,000 at
that time. To buy this car, you intend to place $15,000 into a bank account exactly one
year from today. Assume that your bank compounds interest quarterly. What is the
minimum annual percentage rate (APR) that you must earn on your money so that you
can buy your new car in five years as planned?
21. M. Foley Inc.’s operating income (EBIT) is $85,000. The company's tax rate is 28
percent, and its operating cash flow (OCF) is $65,200. The company's interest expense is
$15,000. What is the company's net cash flow? (Assume that depreciation is the only
non-cash item in the firm's financial statements.)
e) Not enough information is given to find this firm’s net cash flow.
22. Which of the following statements is most correct concerning percent of sales
a) One of the key steps in the development of pro forma financial statements is to identify those
assets and liabilities that increase spontaneously with net income.
b) The first, and most critical, step in constructing a set of pro forma financial statements is
establishing the sales forecast.
c) Pro forma financial statements are used primarily to assess a firm’s historical performance.
d) All balance sheet accounts are tied directly to sales.
e) All of the above are correct.
23. A(n) _____________ is always secured only by the reputation of the issuing firm; that is,
no specific pledge of property is made.
a) junk bond
b) straight bond
d) zero coupon bond
24. Company A has sales of $1,000, assets of $500, and a debt ratio of 30 percent, and an
ROE of 15 percent. Company B has the same sales, assets, and net income, but its ROE
is 30 percent. What is B’s debt ratio (debt/assets)? (Hint: Begin by looking at the Du
Net cash flow = Net income + depreciation expense
Operating cash flow = (Operating income) x (1 – tax rate) + Depreciation expense
EAR = (1 + r/m)m - 1
FV = PV X (1 + r/m)t
PV = FV / (1 + r/m)t
ln 1/ t
t , r PV 1 m
ln (1 r / m)
1 1/(1 r / m)t (1 r / m)t 1
PV of annuity $ PMT FV of Annuity$ PMT
PMT , PMT
1 1/(1 r / m)t (1 r / m)t 1
PMTt 1 PMTt 1
PV of perpetuityt PV of a growing perpetuity PVt
net profit after taxes sales assets
ROE DUPONT IDENTITY
sales assets stockholders ' equity