Finance — Additional Practice — Part 1: 39 MCQs with Explanations

Markup is the amount by which the selling price exceeds the cost of inventory, expressed either in absolute terms or as a percentage of cost.

Financial analysts draw on accounting data to value securities, judge credit and model performance, so their use is broader than that of accountants or auditors, who work within the reporting and verification cycle.

Yield to maturity is the discount rate that equates a bond's price with its future cash flows, which is precisely the definition of the bond's internal rate of return.

Over trading means carrying too little working capital for the volume of trade, so a low inventory turnover is not a symptom. Cash shortage, a low current ratio and a high inventory turnover all are.

Discounting a single future amount divides the cash flow by one plus the rate raised to the number of periods, which is option A written as CF1 divided by (1 + r) to the power n.

Cash flow is the item analysts extract most insistently from the statements, because profit is an accrual figure while cash shows whether the firm can actually meet its obligations.

Asset-management (activity) ratios measure how intensively assets are used, such as inventory and receivables turnover. The capital intensity ratio is a market-value comparison, not an activity ratio.

A bond rating is an independent assessment of the issuer's creditworthiness by a rating agency. Issuers, not holders, pay for the rating, and the agency consults the issuer directly.

Depreciation is a deductible non-cash expense, so it reduces taxable income without any cash leaving the business, which is why it is described as a tax shield.

Discounting is the process of finding the present value of future cash flows. Compounding runs the other way, projecting a present amount forward.

Solve 6,000 multiplied by 1.05 to the power n equals 10,000, giving 1.05 to the n equal to 1.6667, so n equals log 1.6667 divided by log 1.05, which is about 10.5 years.

In an annuity due the payments fall at the beginning of each period, so each is discounted one period less than in an ordinary annuity, giving a higher present value.

Business finance covers financing decisions, investing decisions and the management of day-to-day expenses, so all three areas listed are addressed.

The three classic decision areas of business finance are capital budgeting (investing), capital structure (financing) and working capital management (day-to-day), hence all of the options.

In a general partnership every partner shares the gains and losses and carries unlimited personal liability for the firm's debts, unlike a limited partnership or a corporation.

The retention ratio shows what proportion of earnings is kept in the business rather than paid out, so it measures dividend policy.

The payment is an annuity, so solve 11,000 equals 1,241.08 multiplied by the present value annuity factor at 5 percent. The factor of 8.863 corresponds to 12 years.

The quick ratio excludes inventory from current assets, so converting cash, a quick asset, into inventory, a non-quick asset, reduces the numerator and lowers the ratio.

Proceeds from selling equipment are an investing cash inflow. The gain itself appears in operating activities under the indirect method, but the Rs. 5,000 received is investing.

Short-term creditors care about being paid within the cycle, which is exactly what liquidity ratios measure. Long-term solvency ratios matter to lenders over a longer horizon.

Shareholders of a joint stock company have limited liability, losing at most the amount unpaid on their shares. Sole proprietors and general partners are liable without limit.

The quick ratio is called the acid-test ratio because it is the stricter solvency test, excluding inventory from current assets.

A perpetuity is an annuity whose level cash flows continue indefinitely, so its present value is simply the payment divided by the discount rate.

Trade credit is normally the cheapest source because the firm borrows supplier funds without paying explicit interest, unless it forgoes a cash discount to do so.

Level cash flows arriving at the end of each period for a fixed number of periods define an ordinary annuity; beginning-of-period flows make it an annuity due.

The agency problem is the conflict of interest that arises when managers, as agents, pursue their own ends rather than the wealth of the shareholders who are the principals.

Compound interest is charged on the accumulated interest as well as on the principal, which distinguishes it from simple interest, option C's formula.

Nominal interest rates embed the real rate plus expected inflation, so when the real rate is high, other rates in the economy tend to rise with it.

A discount bond sells below par because its coupon is less attractive than prevailing market yields, which is the same condition stated as yield to maturity exceeding the coupon rate.

The principal repayable at maturity is the par or face value, which is distinct from the coupon payment and from the present value of the bond's cash flows.

A common-size statement expresses every line as a percentage of a base total, sales for the income statement and total assets for the balance sheet, which makes firms of different sizes comparable.

The DuPont identity decomposes return on equity into profit margin, asset use efficiency measured by total assets turnover, and financial leverage measured by the equity multiplier, so all the listed factors apply.

End-of-period level cash flows over a fixed term are an ordinary annuity, which is the default assumption unless the problem states payments begin immediately.

Profit margin relates earnings to sales and therefore measures operating efficiency, that is, how well the firm converts revenue into profit after its costs.

Profitability ratios, including gross and net margin and return on assets, assess earnings generated relative to expenses and the resources employed.

The cash flow identity states that cash generated by assets is distributed to the providers of capital, so cash flow from assets equals cash flow to creditors plus cash flow to stockholders.

Working capital is current assets minus current liabilities, the measure of the short-term financial cushion of the business.

Product costs attach to the goods manufactured and are charged as cost of goods sold when the goods are sold, whereas period costs are expensed as incurred.

Financial leverage is the use of debt, whose fixed interest charge magnifies the effect of operating profit changes on earnings per share.