Test Bank to Accompany

Financial Management: Theory and Practice

Twelfth Edition
Eugene F. Brigham University of Florida Michael C. Ehrhardt University of Tennessee

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CONTENTS

PREFACE Overview of the Test Bank...................................................................................................v Debugging the Questions...................................................................................................vii Answers to Questions and Solutions to Problems...............................................................vii Computerized Test Banks...................................................................................................vii Student Preparation for a Test Bank Exam..........................................................................ix Other Uses of the Test Bank................................................................................................ix Acknowledgments................................................................................................................x Correspondence....................................................................................................................x TEST QUESTIONS Chapter 1 Chapter 2 Chapter 3 Chapter 4 Chapter 5 Extension 5A Chapter 6 Chapter 7 Chapter 8 Chapter 9 Chapter 10 Chapter 11 Chapter 12 Chapter 13 Chapter 14 Chapter 15 An Overview of Financial Management and the Financial Environment..............1 Time Value of Money.........................................................................................19 Financial Statements, Cash Flow, and Taxes.......................................................71 Analysis of Financial Statements.......................................................................103 Bonds, Bond Valuation, and Interest Rates........................................................147 Zero Coupon Bonds...........................................................................................189 Risk, Return, and the Capital Asset Pricing Model............................................201 Portfolio Theory and Other Asset Pricing Models.............................................251 Stocks, Stock Valuation, and Stock Market Equilibrium...................................271 Financial Options and Applications in Corporate Finance.................................303 The Cost of Capital............................................................................................315 The Basics of Capital Budgeting: Evaluating Cash Flows................................351 Cash Flow Estimation and Risk Analysis..........................................................407 Real Options......................................................................................................443 Financial Planning and Forecasting Financial Statements.................................455 Corporate Valuation, Value-Based Management, and Corporate Governance.....471
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Chapter 16 Chapter 17 Chapter 18 Chapter 19 Chapter 20 Chapter 21 Chapter 22 Chapter 23 Chapter 24 Chapter 25 Chapter 26

Capital Structure Decisions: The Basics............................................................481 Capital Structure Decisions: Extensions............................................................515 Distributions to Shareholders: Dividends and Repurchases..............................525 Initial Public Offerings, Investment Banking, and Financial Restructuring.......547 Lease Financing.................................................................................................567 Hybrid Financing: Preferred Stock, Warrants, and Convertibles.......................577 Working Capital Management...........................................................................589 Derivatives and Risk Management....................................................................639 Bankruptcy, Reorganization, and Liquidation...................................................645 Mergers, LBOs, Divestitures, and Holding Companies.....................................649 Multinational Financial Management................................................................667

Extension 19A Rights Offerings................................................................................................561

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PREFACE

This Test Bank is designed for use with the 12th Edition of Financial Management: Theory and Practice.

Overview of the Test Bank

When we first taught the introductory finance course, our exams consisted of open-ended problems and essay questions. However, as class sizes and demands on our time increased, we began experimenting with multiple choice exams. Also, as textbook authors, we were receiving more and more requests from professors for a really first-rate test bank. Simultaneously, our publisher was working to improve their computer system for constructing, machine grading, and automatically posting test scores to a grade book. Today, we are so well satisfied with the Test Bank, and with Thomsons computerized grading system, that we would use multiple choice exams even if our classes had only 25 students. Of course, the questions and problems must be unambiguous (or very close to it), because if students perceive the testing system as being even slightly unfair, this will lead to discontent. Also, the test bank should contain a mix of easy, straightforward questions to test students basic knowledge of a broad range of topics, plus more difficult questions and problems to test the depth of their understanding. This Test Bank provides a very large set of clear, unambiguous questions and problems, and Thomsons computerized procedures (as discussed below) permits one to expand the problem set almost infinitely. The Test Bank is available in three forms: (1) As a computerized test bank in ExamView. (2) In a second computerized package within the ThomsonNow course management program, which allows professors to algorithmically generate alternative versions of the problems and automatically record grades in a grade book. (3) In Microsoft Word for professors who find it easier to construct their exams from Word files. With all three procedures, relatively detailed answers are provided for all of the problems as well as for all questions that are not definitional in nature. Also, each of the procedures allows professors to edit our questions and/or add questions of their own. The Test Bank contains enough questions and problems to make up exams for six semesters without having to repeat questions. Moreover, with the ThomsonNow algorithmic system one can create unique, individualized problems where the basic questions are the same but inputs such as interest rates or cash flows are changed randomly so that the answers are different for each students exam. More will be said about the computerized versions of the Test Bank later in this preface.

If you look through the print Test Bank you will quickly see that each chapter begins with a set of true/false questions, arranged from easiest to hardest, the some conceptual multiple choice questions, again from easy to hard, and then a set of numerical problems, and finally the answers to the questions and problems. Also, each question or problem indicates the topic and relevant section number within the chapter. The true/false questions provide a broad coverage of all the topics in the chapter, and we use them to ensure that students have a basic knowledge of all the assigned topics. The conceptual multiple choice questions test students knowledge at a deeper level, and the numerical problems cover all of the quantitative aspects of the chapter. Finally, we provide worked-out solutions to all problems, plus explanations for true/false and conceptual questions where the answers are not obvious to anyone who has studied the chapter.1 The assigned difficulty level is somewhat subjective, and the perceived difficulty level will also depend on what was emphasized in class and in review sessions. Therefore, we recommend that instructors consider our assigned level as a starting point but then make up their own minds after looking over the questions and answers. Also, difficulty depends on what information students have access to when they are taking the exam. We provide formula sheets so students wont spend too much time memorizing things that they could easily look up in the real world. Without those sheets, the exams would definitely be harder. Also, we generally give timed exams, where students have the formula sheet, a calculator, and a set amount of time to take the exam.2 If the exams are given online, students can look things up and also work on problems until they get a solution that matches one of the indicated answers, so scores will be higher. We thought about indicating approximately how long it would take to answer the various questions, but we decided that due to the differences noted above, this might do more harm than good. Instructors should, therefore, look at the questions and our worked-out solutions and then decide for themselves how long it will take their students to take the exam. Generally, the harder questions and problems will require the most time. For larger classes, we always make up an exam, have one or more student assistants take it, and then make adjustments until it seems feasible for a two-hour exam. Further, we give exams at night. We schedule them for two hours, and we try to make them end on schedule. However, if it is obvious early on that the exam is too long for even our best students, we will extend the time for an extra 15 or 20 minutes. We make it clear to the class, though, that our exams are like the SATs or GMATs in that not all students will be able to complete all the questions within the allotted time.

1 The question number is actually a Word end note reference, and the end note itself contains details regarding the answer to the question. This ensures that the answers follow the questions if they are cut and pasted or otherwise shuffled around. 2 Our students all use financial calculators for in-class exams and either calculators or Excel for online quizzes and exams. We dont worry about students storing a lot of material in their calculators or laptops for use on the exams. Indeed, entering such information is actually a good way to study, and most of our questions cant be answered from snippets of information anyway. vi

Debugging the Questions

The questions and problems have all been used in class. We tried to make them unambiguous, and we also tried to make sure that they are generic in the sense that they can be answered on the basis of material found in the text rather than requiring instructor-specific information. Obviously, we took care to ensure that they are accurate, and that the correct answer is listed in the set of possible answers. Indeed, the "quality control" procedures used for the Test Bank were at least as strenuous as those for the text per se. Still, because of the severe consequences of giving an exam that contains errors, we would never give an exam without first taking it, and in a large class we try to have several teaching assistants also take it, both to check for errors and to get an idea of how long it will take.3

Answers to Questions and Solutions to Problems

No explanation is needed for most of the true/false questions and some of the conceptual multiple choice questionsone answer is correct and the others are false, and students who have read the text carefully can identify the correct answers. However, a few of the true/false questions and many of the conceptual multiple choice questions are a bit subtle and require critical thinking, and some students might not see why the indicated answer is correct. We post the answers, and they are in sufficient detail so that students dont have to ask us why their answers were wrong. Note that while ThomsonNow algorithmically generates new final answers to problems after randomly changing inputs, it does not generate new worked-out solutions. The worked-out solution thats provided is for the base case problem as given in the print Test Bank, the Word Test Bank, and the unmodified ExamView and ThomsonNow Test Banks. Its easy, though, for students to see how the answers are foundwe provide formulas in the answers, so students can just substitute in data for their version of the problem to get the correct answer. Our students have no trouble seeing where they went wrong if they worked the problems incorrectly.

Computerized Test Banks

As noted above, the Test Bank comes as a printed book, as a Microsoft Word file that is available on a CD-ROM or as a download from the books Web site, and as a computerized test bank in both ExamView and ThomsonNow. Adopters may obtain these test banks by contacting their local sales representative.

3 In a small class, if a students asks about a question and it becomes clear that it is ambiguous, one can simply announce to the class how it should be interpreted. This is much more difficult in a large class, especially if it is being given in different rooms. Its also more difficult in online testing situations. Since classes are getting larger and larger, and online testing is increasing, test bank accuracy is increasingly important. vii

To use ExamView, one must install it on their computer and then read through the documentation. Like all sophisticated software, this requires a couple of hours. However, if you plan to use the Test Bank and will be making up a number of exams, the product is worth the time investedit really is good. Many universities use Blackboard, a web-based course management system. One powerful feature of ExamView is that the test bank questions may be exported as pools that can be imported into Blackboard. Once the questions are in a Blackboard pool, it is straightforward to create a web-based test or homework assignment, with Blackboard grading the assignment and recording the grades in a format that may be exported as an Excel file. ThomsonNow is our publishers new web-based course management platform, and it can be used for a number of things, including constructing exams from the Test Bank similarly to the way this is done with ExamView. One especially nice feature of ThomsonNow is its algorithmic problem generator. As noted earlier, one or more key input variables can be changed randomly, and this changes the correct answer. Thus, different students exams are different, and this reduces the possibility of cheating. The algorithmic feature also makes it relatively easy to make up sample exams, let students practice on them, and then give a similar real exam that has different answers. Other parts of the ThomsonNow system allows students to take practice exams, see how they did, and then go back and study those areas where they need help. If you are familiar with Microsoft Word and do not want to invest the time needed to learn how to use ExamView or ThomsonNow, then you can use the Microsoft Word files. With the appropriate chapter file retrieved, screen down to the first question to be taken from that chapter, copy the question (do not cut the question as this will alter the original test bank file) except for the first line that contains the answer, open a blank Word document, and paste the question into the blank document. Repeat this process for all the questions you want on the exam. Be sure not to copy the problems header row with the answerits embarrassing to include the answer with the question!4 We generally use 20 questions on an exam, and it takes us about 30 minutes to do the cutting and pasting to construct an exam once the questions have been selected.

Student Preparation for a Test Bank Exam

There are far more questions and problems in the Test Bank than at the ends of the chapters, so some of the items in the bank are different from those at the ends of the chapters. Therefore, if a
4 The font may change when the question is pasted into the blank Word document. This can be corrected by selecting "Replace" from the "Edit" pull-down menu, clicking on more and then the "Format" button at the bottom of the "Dialog" box and clicking on "Font". Select "Times New Roman" as the "Find Font", and then click "OK". Click in the "Replace With" field, and then click the "Format" button again. Click "Font", and then select "Courier New" and "Size 10" before clicking "OK". Then click "Find Next" button. When the text is highlighted, click "Replace All". Word makes the change for all text in "Times New Roman." Because the problem numbers are actually endnote indicators, they will automatically renumber as you add, delete, or move problems in your exam. If they appear as Roman numerals instead of Arabic numbers, select Insert from the Word menu, then Reference, then Footnote. Select Endnotes in the dialog box and choose the format for numbers. When printing the exam, be sure not to include the section of Endnotes at the end of the exam because these include the worked-out solutions. viii

student goes cold into an exam taken from the Test Bank, he or she might be thrown for a loop even if they worked all of the end-of-chapter problems. The end-of-chapter problems were designed primarily to help students learn the material, including how it is used in practice, whereas the test bank questions are designed to test how much knowledge they have attained. Also, some of the test bank questions are convoluted, meaning that students must work backwards, from what would normally be the answer to what would normally be an input. This requires transforming equations from the form given in the text to one that solves for a different value. Also, students generally do not have severe time constraints when they work on the end-of-chapter problems, and this makes the test bank questions seem more difficult. With all this in mind, we included a number of test-bank-type questions into the Study Guide. Our students tell us that working through the Study Guide is particularly useful in getting ready for the exams. Also, we always put some of our old exams in a "Course Pack" which students can purchase from an off-campus copy center to get an idea of what the exams will be like. Finally, we go over some test-type questions in our pre-exam review sessions.

Other Uses of the Test Bank

The primary use of the Test Bank is to make up objective exams for use in large classes where it is simply not feasible to grade papers in the traditional way. However, the questions can be used for several other purposes: 1. To make up a regular, non-multiple choice, exam. It is easy to use the questions and problems to make up an open-ended examjust delete the set of answers and ask for an essay answer or a worked-out solution to a problem. 2. For additional problems. We draw from the Test Bank to make up problems that our TAs use in their pre-exam review sessions. One could also use them for make-up exams, extra-credit work, and the like. 3. To create new multiple choice test questions. The computerized versions of the Test Bank make it easy to create new problems and questions. For example, four "false" true/false questions can be combined with one "true" question to make a "which of the following is correct" multiple choice question, or statements in different multiple choice questions can be shuffled to create new questions. Similarly, data in the problems, such as years to maturity, coupon rates, growth rates, betas, et cetera, can be changed, and wording can be altered, to expand the Test Bank to an almost unlimited size. Note, though, that ThomsonNow can automatically change the numbers and simultaneously generate a new answer.

Acknowledgments
We would like to thank Professors Craig Tapley and Joel Houston for permitting us to use some of their old exam questions, and for giving us many insights into the whole examination process,
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especially with large classes and in online programs. We would also like to thank Steve Bouchard and Chris Buzzard, who helped us develop and debug the test questions. We also appreciate the help we got from a whole host of TAs and graduate students, over many years. Dana Aberwald Clark did her usual good job of riding herd on all of us, and Rob Clayton, Susan Purcell Whitman, and Amelia Bell did a great job of getting the final manuscript ready. We also received some very useful reports of errors and ambiguities from professors who were using the last edition of the Test Bank. Two who provided especially useful information were Oliver Schnusenberg of the University of North Florida, who actually went through the entire earlier Test Bank, and Henry Oppenheimer of the University of Rhode Island.

Correspondence
We would very much appreciate hearing from test bank usersplease tell us of any difficulties you are having, and make suggestions for improving things. Please address your correspondence to Mike Ehrhardt at the address given below. Eugene F. Brigham 3030 SW 70th Lane Gainesville, FL 32608 Michael C. Ehrhardt ehrhardt@utk.edu Finance Department, SMC 424 University of Tennessee Knoxville, TN 37996-0540

March 2007