Multiple Choices (Each item below = 2 points, 60 points in total. Only one correct answer to each question)

1.Suppose that two hospitals are identical in all ways except that Hospital N is relatively new while Hospital O is relatively old. Which of the following statements about a comparative financial statement analysis is true? (Hint: Think about both the cost of assets over time and depreciation expense.)

Hospital N will report higher net income.

Hospital O will report higher net income.

Hospital N will report higher net fixed assets.

Hospital O will report higher net fixed assets.

Both b. and c. above are correct.

2.The statement of changes in equity (net assets) indicates how much of an organizations net income is retained within the business and hence flows through to the balance sheet equity account.

True

False

3.The Bramwell Clinic has net income of $200,000 on revenues of $2,000,000. If the firm has total debt of $500,000 and a debt ratio of 50 percent, what is Bramwell's return on assets (ROA)?

a. 5.0%

b. 10.0%

c. 15.0%

d. 20.0%

e. 25.0%

4.The primary difference between financial statement analysis and operating indicator analysis is that operating indicator analysis does not use benchmarking while financial statement analysis does.

True

False

5.White Memorial Hospital has a total (profit) margin of 4.0 percent on revenues of $10 million. Its assets total $5 million and it uses $2 million total in debt financing. What is the hospital's return on equity (ROE)? (Hint: Use the Du Pont equation.)

a. 13.3%

b. 12.0%

c. 10.3%

d. 7.6%

e. 5.3%

6.Which of the following statements about financial statement analysis is most correct?

The current ratio is the best available measure of liquidity.

Du Pont analysis is based on the fact that return on equity (ROE) can be expressed as the sum of four other ratios.

It is relatively easy to interpret a ratio in the absence of comparative data.

There are no limitations to financial statement analysis, so analysts can always be confident of their conclusions.

None of the above statements are correct.

7.The days cash on hand ratio and current ratio both are rough measures of liquidity. The best way to assess the liquidity of an organization is to construct a cash budget.

True

False

Which of the following statements about debt management ratios is false?

There are two types of debt management ratios: capitalization ratios and coverage ratios.

Capitalization ratios use balance sheet data to measure the relative amount of debt financing used.

Coverage ratios use income statement data to measure the extent to which earnings (or cash flow) cover interest (or fixed financial) obligations.

The debt ratio is a capitalization ratio while the debt-to-equity ratio is a coverage ratio.

The debt ratio is defined as total debt divided by total assets.

Which of the following statements is not a limitation of ratio analysis?

There are an insufficient number of ratios available.

Seasonal factors can distort ratios.

Different organizations can use different, but allowed under GAAP, accounting conventions.

It often is hard to tell whether a given ratio is good or bad.

Inflation effects can distort ratios.

If a bank pays quarterly compounding on its savings accounts, the ending amount after one year on a $1,000 deposit will be less than if the bank paid annual compounding.

True

False

You buy a 2-year, 8 percent savings certificate for $1,000. If interest is compounded annually, what will be its value at maturity?

a. $1,067.43

b. $1,166.40

c. $1,201.03

d. $1,396.57

e. $1,466.33

You buy a 2-year, 8 percent savings certificate for $1,000. If interest is compounded semi- annually, what will be its value at maturity?

a. $1,067.43

b. $1,146.40

c. $1,169.86

d. $1,201.03

e. $1,396.57

Which of the following statements concerning time value of money is false?

Moving to the right along a time line is called compounding.

Moving to the left along a time line is called discounting.

The appropriate discount rate to apply to investment cash flows is the opportunity cost rate.

When dealing with lump sums, it is easy to solve for future value (FV) and present value (PV), but it is quite difficult to solve for number of periods (N) and interest rate (I), even when using a financial calculator or a spreadsheet.

In an ordinary (regular) annuity, payments occur at the end of each year.

The effective annual rate (EAR) is used to compare investments that have different lifetimes; for example, 5-year and 10-year bank certificates of deposit.

True

False

Which of the following statements concerning financial risk is false?

Generically, financial risk is related to the probability of a return less than expected.

If an investment is held in isolation (stand-alone), the appropriate measure of risk is the beta coefficient.

In theory, you can create a riskless portfolio by combining a large number of investments whose returns are uncorrelated (independent of one another).

In the real world, it is not possible to create a riskless portfolio because all investment returns, to a greater or lesser extent, move with the overall economy.

Assume you know for certain that an investment will return negative 10 percent. (In other words, the probability of a -10% return is 100 percent.) Although the expected return is negative, the investment is riskless.

The security market line (SML) provides the relationship between risk and required rate of return. Which of the following statements about the SML is most correct?

The relevant risk is portfolio risk, which is measured by beta.

The relevant risk is total risk, which is measured by standard deviation.

The relevant risk is mutual risk, which is measured by coefficient of variation.

The SML is an equation, but it cannot be graphed.

The SML is a graphed line, but it cannot be expressed as an equation.

Assume that the risk-free rate is 8 percent, the required rate of return on the market (or an average-risk stock) is 13 percent, and the required rate of return on Acme Healthcare stock is 15 percent. What is the implied beta coefficient of the stock? (Hint: Use the SML equation with beta as the unknown.)

a. 1.50

b. 1.40

c. 1.20

d. 1.00

e. 0.80

Consider the following information on the stock portfolio of the Gainesville City Meter Maid Retirement Fund:

Stock Investment Amount Beta Coefficient

IBM

$ 400,000

1.2

Homestake Mining

600,000

0.4

Humana Healthcare

1,000,000

1.5

Home Depot

2,000,000

0.8

$4,000,000

What is the beta coefficient of this portfolio? (Hint: The beta of a portfolio is the weighted average of the betas of the individual investments.)

a. 0.625

b. 0.730

c. 0.835

d. 0.940

e. 1.045

A portfolios return is the weighted average of each individual investments return. However, a portfolios risk is not the weighted average of each investments standard deviation.

True

False

Which of the following statements about the riskiness of a two-investment portfolio is most correct?

If the returns are perfectly positively correlated, all risk can be eliminated.

If the returns are perfectly negatively correlated, no risk can be eliminated.

If the returns have a correlation coefficient of +0.7, some but not all risk can be eliminated.

If the returns have a correlation coefficient of +0.4, some but not all risk can be eliminated.

Both c. and d. above are correct.

In the real world, as more and more randomly chosen investments are added to a portfolio, the riskiness of the portfolio decreases. If enough investments are added, all risk can be eliminated.

True

False

Which of the following statements about the riskiness of investments held as parts of portfolios is

false?

The beta coefficient measures the risk of investments held in portfolios.

A beta greater than 1.0 indicates that the investment has greater risk than that of the entire portfolio.

Standard deviation measures the risk of investments held in portfolios.

A beta less than 1.0 indicates that the investment has less risk than that of the entire portfolio.

The beta of a portfolio is a weighted average of the betas of the component investments.

Which of the following statements about the Capital Asset Pricing Model (CAPM), which is the father of the security market line (SML), is most correct?

The CAPM is based on a restrictive set of assumptions.

It has not been empirically verified.

In general, its inputs are difficult to estimate, particularly beta.

In spite of its deficiencies, it provides investors with a rational way of thinking about required rates of return.

All of the above responses are correct.

You have estimated the value of a planned project by finding the PV of all the cash inflows from that project. Which of the following would cause the project to look more appealing in terms of the present value of those cash flows?

The discount rate decreases.

The cash flows are extended over a longer period of time, but the total dollar amount of the cash flows remains the same.

The discount rate increases.

Answers b and c above.

Answers a and b above.

Which of the following statements about opportunity costs is false?

The opportunity cost rate to be applied to any investment is the rate of return that could be earned on alternative investments of similar risk.

In general, higher-risk investments should have higher opportunity costs than lower-risk investments.

Opportunity cost rates are obtained by examining the returns on securities investments.

The opportunity cost rate typically is applied in discounting situations (as opposed to compounding).

Say you just inherited $10,000. Because this money cost you nothing, it has an opportunity cost rate of zero.

What is the future value of a 5-year ordinary annuity with annual payments of $200, evaluated at a 15 percent interest rate?

a. $ 670.44

b. $ 842.91

c. $1,000.00

d. $1,348.48

e. $5,348.76

What is the present value of a $100 lump sum to be received in 5 years if the opportunity cost rate is 10 percent?

a. $ 62.09

b. $ 90.91

c. $100.00

d. $110.00

e. $161.05

What is the FV of a $100 lump sum invested for 5 years in an account paying 10 percent interest? a. $ 62.09

b. $ 90.91

c. $100.00

d. $110.00

e. $161.05

Which of the following statements about financial risk is false?

Risk requires the possibility of at least one return less favorable than the expected return.

Risk requires the possibility of more than one return.

Risk is one of the determinants of the opportunity cost rate.

In financial analysis, investors are assumed to be risk averse.

The higher the standard deviation, the lower the stand-alone risk.

Which of the below statements about an investment's financial risk is false?

Stand-alone risk is relevant only for assets held in isolation.

Corporate risk generally is relevant for not-for-profit firms.

Market risk generally is relevant for investor-owned firms.

Even though an investment may have high stand-alone risk, portfolio effects often drive its corporate risk to zero.

The portfolio risk of an individual asset is defined as the contribution of the asset to the overall riskiness of the portfolio.