Advanced Corporate Finance
Exam Practice Tests
Course Introduction
Advanced Corporate Finance explores complex financial strategies and decisions faced by corporations, focusing on topics such as capital structure, dividend policy, mergers and acquisitions, risk management, and valuation techniques. The course integrates theoretical frameworks with real-world case studies to equip students with analytical tools for evaluating strategic financial options, navigating financial markets, and assessing corporate investment and financing decisions. Emphasis is placed on understanding the implications of financial choices on firm value and shareholder wealth in a dynamic global environment.
Recommended Textbook
Corporate Finance A Focused Approach 5th Edition by Michael C. Ehrhardt
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Page 2
Chapter 1: An overview of financial management and the financial environment
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Sample Questions
Q1) Which of the following statements is CORRECT?
A) It is generally more expensive to form a proprietorship than a corporation because, with a proprietorship, extensive legal documents are required.
B) Corporations face fewer regulations than sole proprietorships.
C) One disadvantage of operating a business as a sole proprietorship is that the firm is subject to double taxation, at both the firm level and the owner level.
D) One advantage of forming a corporation is that equity investors are usually exposed to less liability than in a regular partnership.
E) If a regular partnership goes bankrupt, each partner is exposed to liabilities only up to the amount of his or her investment in the business.
Answer: D
Q2) Two disadvantages of a proprietorship are (1)the relative difficulty of raising new capital and (2)the owner's unlimited personal liability for the business' debts.
A)True
B)False
Answer: True
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Chapter 2: Financial statements, cash flow, and taxes
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Sample Questions
Q1) The fact that 70% of the interest income received by a corporation is excluded from its taxable income encourages firms to use more debt financing than they would in the absence of this tax law provision.
A)True
B)False
Answer: False
Q2) Which of the following statements is CORRECT?
A) Net cash flow (NCF) is defined as follows: NCF= Net income - Depreciation and Amortization.
B) Changes in working capital have no effect on free cash flow.
C) Free cash flow (FCF) is defined as follows: FCF = EBIT(1 - T) + Depreciation and Amortization - Capital expenditures required to sustain operations - Required changes in net operating working capital.
D) Free cash flow (FCF) is defined as follows: FCF = EBIT(1 - T) + Depreciation and Amortization + Capital expenditures.
E) Net cash flow is the same as free cash flow (FCF). Answer: C
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Page 4
Chapter 3: Analysis of financial statements
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Sample Questions
Q1) Lincoln Industries' current ratio is 0.5.Considered alone, which of the following actions would increase the company's current ratio?
A) Use cash to reduce long-term bonds outstanding.
B) Borrow using short-term notes payable and use the cash to increase inventories.
C) Use cash to reduce accruals.
D) Use cash to reduce accounts payable.
E) Use cash to reduce short-term notes payable.
Answer: B
Q2) It is appropriate to use the fixed assets turnover ratio to appraise firms' effectiveness in managing their fixed assets if and only if all the firms being compared have the same proportion of fixed assets to total assets.
A)True
B)False
Answer: False
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Chapter 4: Time value of money
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Sample Questions
Q1) You are in negotiations to make a 7-year loan of $25, 000 to DeVille Corporation.To repay you, DeVille will pay $2, 500 at the end of Year 1, $5, 000 at the end of Year 2, and $7, 500 at the end of Year 3, plus a fixed but currently unspecified cash flow, X, at the end of each year from Year 4 through Year 7.You are confident the payments will be made, since DeVille is essentially riskless.You regard 8% as an appropriate rate of return on a low risk but illiquid 7-year loan.What cash flow must the investment provide at the end of each of the final 4 years, that is, what is X?
A) $4, 271.67
B) $4, 496.49
C) $4, 733.15
D) $4, 969.81
E) $5, 218.30
Q2) You plan to invest some money in a bank account.Which of the following banks provides you with the highest effective rate of interest?
A) Bank 1; 6.1% with annual compounding.
B) Bank 2; 6.0% with monthly compounding.
C) Bank 3; 6.0% with annual compounding.
D) Bank 4; 6.0% with quarterly compounding.
E) Bank 5; 6.0% with daily (365-day)compounding.
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Chapter 5: Bonds, bond valuation, and interest rates
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Sample Questions
Q1) Which of the following statements is CORRECT?
A) If a 10-year, $1, 000 par, 10% coupon bond were issued at par, and if interest rates then dropped to the point where rd = YTM = 5%, we could be sure that the bond would sell at a premium above its $1, 000 par value.
B) Other things held constant, a corporation would rather issue noncallable bonds than callable bonds.
C) Other things held constant, a callable bond would have a lower required rate of return than a noncallable bond.
D) Reinvestment rate risk is worse from an investor's standpoint than interest rate price risk if the investor has a short investment time horizon.
E) If a 10-year, $1, 000 par, zero coupon bond were issued at a price that gave investors a 10% yield to maturity, and if interest rates then dropped to the point where rd = YTM = 5%, the bond would sell at a premium over its $1, 000 par value.
Q2) For bonds, price sensitivity to a given change in interest rates is generally greater the longer before the bond matures.
A)True B)False
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Page 7
Chapter 6: Risk and return
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Sample Questions
Q1) A firm can change its beta through managerial decisions, including capital budgeting and capital structure decisions.
A)True
B)False
Q2) Suppose Stan holds a portfolio consisting of a $10, 000 investment in each of 8 different common stocks.The portfolio's beta is 1.25.Now suppose Stan decided to sell one of his stocks that has a beta of 1.00 and to use the proceeds to buy a replacement stock with a beta of 1.35.What would the portfolio's new beta be?
A) 1.17
B) 1.23
C) 1.29
D) 1.36
E) 1.43
Q3) If an investor buys enough stocks, he or she can, through diversification, eliminate all of the market risk inherent in owning stocks, but as a general rule it will not be possible to eliminate all diversifiable risk.
A)True
B)False
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8
Chapter 7: Valuation of stocks and corporations
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Sample Questions
Q1) Kinkead Inc.forecasts that its free cash flow in the coming year, i.e., at t = 1, will be -$10 million, but its FCF at t = 2 will be $20 million.After Year 2, FCF is expected to grow at a constant rate of 4% forever.If the weighted average cost of capital is 14%, what is the firm's value of operations, in millions?
A) $158
B) $167
C) $175
D) $184
E) $193
Q2) Barnette Inc.'s free cash flows are expected to be unstable during the next few years while the company undergoes restructuring.However, FCF is expected to be $50 million in Year 5, i.e., FCF at t = 5 equals $50 million, and the FCF growth rate is expected to be constant at 6% beyond that point.If the weighted average cost of capital is 12%, what is the horizon value (in millions)at t = 5?
A) $719
B) $757
C) $797
D) $839
E) $883
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Page 9
Chapter 8: Financial options and applications in corporate finance
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Sample Questions
Q1) The current price of a stock is $22, and at the end of one year its price will be either $27 or $17.The annual risk-free rate is 6.0%, based on daily compounding.A 1-year call option on the stock, with an exercise price of $22, is available.Based on the binomial model, what is the option's value? (Hint: Use daily compounding.)
A) $2.43
B) $2.70
C) $2.99
D) $3.29
E) $3.62
Q2) Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock, provided the strike prices for the put and call are the same.
A)True
B)False
Q3) The exercise value is also called the strike price, but this term is generally used when discussing convertibles rather than financial options.
A)True
B)False
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Chapter 9: The cost of capital
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Sample Questions
Q1) Suppose the debt ratio (D/TA)is 50%, the interest rate on new debt is 8%, the current cost of equity is 16%, and the tax rate is 40%.An increase in the debt ratio to 60% would decrease the weighted average cost of capital (WACC).
A)True
B)False
Q2) When working with the CAPM, which of the following factors can be determined with the most precision?
A) The beta coefficient, bi, of a relatively safe stock.
B) The most appropriate risk-free rate, rRF.
C) The expected rate of return on the market, rM.
D) The beta coefficient of "the market, " which is the same as the beta of an average stock.
E) The market risk premium (RPM).
Q3) The higher the firm's flotation cost for new common equity, the more likely the firm is to use preferred stock, which has no flotation cost, and reinvested earnings, whose cost is the average return on the assets that are acquired.
A)True
B)False
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Chapter 10: The basics of capital budgeting: evaluating cash flows
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Sample Questions
Q1) Lancaster Corp.is considering two equally risky, mutually exclusive projects, both of which have normal cash flows.Project A has an IRR of 11%, while Project B's IRR is 14%.When the WACC is 8%, the projects have the same NPV.Given this information, which of the following statements is CORRECT?
A) If the WACC is 9%, Project A's NPV will be higher than Project B's.
B) If the WACC is 6%, Project B's NPV will be higher than Project A's.
C) If the WACC is greater than 14%, Project A's IRR will exceed Project B's.
D) If the WACC is 9%, Project B's NPV will be higher than Project A's.
E) If the WACC is 13%, Project A's NPV will be higher than Project B's.
Q2) A basic rule in capital budgeting is that if a project's NPV exceeds its IRR, then the project should be accepted.
A)True
B)False
Q3) The regular payback method is deficient in that it does not take account of cash flows beyond the payback period.The discounted payback method corrects this fault.
A)True
B)False
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Page 12
Chapter 11: Cash flow estimation and risk analysis
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Sample Questions
Q1) The primary advantage to using accelerated rather than straight-line depreciation is that with accelerated depreciation the present value of the tax savings provided by depreciation will be higher, other things held constant.
A)True
B)False
Q2) Although it is extremely difficult to make accurate forecasts of the revenues that a project will generate, projects' initial outlays and subsequent costs can be forecasted with great accuracy.This is especially true for large product development projects.
A)True
B)False
Q3) Suppose Walker Publishing Company is considering bringing out a new finance text whose projected revenues include some revenues that will be taken away from another of Walker's books.The lost sales on the older book are a sunk cost and as such should not be considered in the analysis for the new book.
A)True
B)False
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13
Chapter 12: Corporate valuation and financial planning
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Sample Questions
Q1) North Construction had $850 million of sales last year, and it had $425 million of fixed assets that were used at only 60% of capacity.What is the maximum sales growth rate North could achieve before it had to increase its fixed assets?
A) 54.30%
B) 57.16%
C) 60.17%
D) 63.33%
E) 66.67%
Q2) To determine the amount of additional funds needed (AFN), you may subtract the expected increase in liabilities, which represents a source of funds, from the sum of the expected increases in retained earnings and assets, both of which are uses of funds.
A)True
B)False
Q3) Firms pay a low interest rate on spontaneous liabilities so these funds are its cheapest source of capital.Consequently, the firm should make arrangements with its suppliers to use as much of this credit as possible.
A)True
B)False
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Chapter 13: Agency conflicts and corporate governance
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Sample Questions
Q1) The CEO of D'Amico Motors has been granted some stock options that have provisions similar to most other executive stock options.If D'Amico's stock underperforms the market, these options will necessarily be worthless.
A)True
B)False
Q2) ESOPs were originally designed to help improve worker productivity, but today they are also used to help prevent hostile takeovers.
A)True
B)False
Q3) Which of the following is NOT normally regarded as being a good reason to establish an ESOP?
A) To enable the firm to borrow at a below-market interest rate.
B) To make it easier to grant stock options to employees.
C) To help prevent a hostile takeover.
D) To help retain valued employees.
E) To increase worker productivity.
Q4) A poison pill is also known as a corporate restructuring.
A)True
B)False
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Chapter 14: Distributions to shareholders: dividends and repurchases
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Sample Questions
Q1) Sanchez Company has planned capital expenditures that total $2, 000, 000.The company wants to maintain a target capital structure that is 35% debt and 65% equity.The company forecasts that its net income this year will be $1, 800, 000.If the company follows a residual dividend policy, what will be its total dividend payment?
A) $100, 000
B) $200, 000
C) $300, 000
D) $400, 000
E) $500, 000
Q2) One implication of the bird-in-the-hand theory of dividends is that a given reduction in dividend yield must be offset by a more than proportionate increase in growth in order to keep a firm's required return constant, other things held constant.
A)True
B)False
Q3) If investors prefer firms that retain most of their earnings, then a firm that wants to maximize its stock price should set a low payout ratio.
A)True
B)False
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Chapter 15: Capital structure decisions
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Sample Questions
Q1) It is possible that two firms could have identical financial and operating leverage, yet have different degrees of risk as measured by the variability of EPS.
A)True B)False
Q2) Morales Publishing's tax rate is 40%, its beta is 1.10, and it uses no debt.However, the CFO is considering moving to a capital structure with 30% debt and 70% equity.If the risk-free rate is 5.0% and the market risk premium is 6.0%, by how much would the capital structure shift change the firm's cost of equity?
A) 1.53%
B) 1.70%
C) 1.87%
D) 2.05%
E) 2.26%
Q3) A firm's business risk is largely determined by the financial characteristics of its industry, especially by the amount of debt the average firm in the industry uses.
A)True B)False
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17
Chapter 16: Supply chains and working capital management
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Sample Questions
Q1) Firms generally choose to finance temporary current operating assets with short-term debt because
A) short-term interest rates have traditionally been more stable than long-term interest rates.
B) a firm that borrows heavily on a long-term basis is more apt to be unable to repay the debt than a firm that borrows short term.
C) the yield curve is normally downward sloping.
D) short-term debt has a higher cost than equity capital.
E) matching the maturities of assets and liabilities reduces risk under some circumstances, and also because short-term debt is often less expensive than long-term capital.
Q2) Krackle Korn Inc.had credit sales of $3, 500, 000 last year and its days sales outstanding was DSO = 35 days.What was its average receivables balance, based on a 365-day year?
A) $335, 616
B) $352, 397
C) $370, 017
D) $388, 518
E) $407, 944
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Chapter 17: Multinational financial management
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Sample Questions
Q1) Suppose a foreign investor who holds tax-exempt Eurobonds paying 9% is considering investing in an equivalent-risk domestic bond in a country with a 28% withholding tax on interest paid to foreigners.If 9% after-tax is the investor's required return, what before-tax rate would the domestic bond need to pay to provide the required after-tax return?
A) 9.00%
B) 10.20%
C) 11.28%
D) 12.50%
E) 13.57%
Q2) The cash flows relevant for a foreign investment should, from the parent company's perspective, include the financial cash flows that the subsidiary can legally send back to the parent company plus the cash flows that must remain in the foreign country. A)True B)False
Q3) A Eurodollar is a U.S.dollar deposited in a bank outside the United States. A)True B)False
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