Advanced Corporate Finance
Mock Exam
Course Introduction
Advanced Corporate Finance delves into the complex financial strategies and analytical frameworks used by corporations to enhance value and support long-term growth. The course covers topics such as capital structure decisions, cost of capital, dividend policies, mergers and acquisitions, corporate restructuring, and advanced valuation techniques. Emphasizing a practical, case-based approach, students learn to assess risk, apply financial modeling, and evaluate the impact of financial decisions on firm value. This course is designed to equip students with the tools and knowledge needed for informed decision-making in corporate financial management and investment banking environments.
Recommended Textbook
Corporate Finance A Focused Approach 5th Edition by Michael C. Ehrhardt
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Chapter 1: An overview of financial management and the financial environment
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Q1) Which of the following statements is CORRECT?
A) In a regular partnership, liability for other partners' misdeeds is limited to the amount of a particular partner's investment in the business.
B) Attracting large amounts of capital is more difficult for partnerships than for corporations because of such factors as unlimited liability, the need to reorganize when a partner dies, and the illiquidity (difficulty buying and selling)of partnership interests.
C) A slow-growth company, with little need for new capital, would be more likely to organize as a corporation than would a faster growing company.
D) The limited partners in a limited partnership have voting control, while the general partner has operating control over the business.Also, the limited partners are individually responsible, on a pro rata basis, for the firm's debts in the event of bankruptcy.
E) A major disadvantage of all partnerships compared to all corporations is the fact that federal income taxes must be paid by the partners rather than by the firm itself.
Answer: B
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3
Chapter 2: Financial statements, cash flow, and taxes
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Q1) The balance sheet is a financial statement that measures the flow of funds into and out of various accounts over time, while the income statement measures the firm's financial position at a point in time.
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) Firms A and B have the same current ratio, 0.75, the same amount of sales and cost of goods sold, and the same amount of current liabilities.However, Firm A has a higher inventory turnover ratio than B.Therefore, we can conclude that A's quick ratio must be smaller than B's.
A)True
B)False
Answer: False
Q2) Which of the following would indicate an improvement in a company's financial position, holding other things constant?
A) The current and quick ratios both increase.
B) The inventory and total assets turnover ratios both decline.
C) The debt ratio increases.
D) The profit margin declines.
E) The EBITDA coverage ratio declines.
Answer: A
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Chapter 4: Time value of money
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Q1) Midway through the life of an amortized loan, the percentage of the payment that represents interest could be equal to, less than, or greater than to the percentage that represents repayment of principal.The proportions depend on the original life of the loan and the interest rate.
A)True
B)False
Q2) Which of the following statements is CORRECT?
A) An investment that has a nominal rate of 6% with semiannual payments will have an effective rate that is smaller than 6%.
B) The present value of a 3-year, $150 ordinary annuity will exceed the present value of a 3-year, $150 annuity due.
C) If a loan has a nominal annual rate of 7%, then the effective rate will never be less than 7%.
D) If a loan or investment has annual payments, then the effective, periodic, and nominal rates of interest will all be different.
E) The proportion of the payment that goes toward interest on a fully amortized loan increases over time.
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Chapter 5: Bonds, bond valuation, and interest rates
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Q1) Which of the following statements is CORRECT?
A) A 10-year, 10% coupon bond has less reinvestment rate risk than a 10-year, 5% coupon bond (assuming all else equal).
B) The total return on a bond during a given year is the sum of the coupon interest payments received during the year and the change in the value of the bond from the beginning to the end of the year.
C) The price of a 20-year, 10% bond is less sensitive to changes in interest rates than the price of a 5-year, 10% bond.
D) A $1, 000 bond with $100 annual interest payments that has 5 years to maturity and is not expected to default would sell at a discount if interest rates were below 9% and at a premium if interest rates were greater than 11%.
E) 10-year, zero coupon bonds have higher reinvestment rate risk than 10-year, 10% coupon bonds.
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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Q1) The slope of the SML is determined by investors' aversion to risk.The greater the average investor's risk aversion, the steeper the SML.
A)True
B)False
Q2) The Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero, which is the risk-free rate.
A)True B)False
Q3) Stock A's stock has a beta of 1.30, and its required return is 12.00%.Stock B's beta is 0.80.If the risk-free rate is 4.75%, what is the required rate of return on B's stock? (Hint: First find the market risk premium.)
A) 8.76%
B) 8.98%
C) 9.21%
D) 9.44%
E) 9.68%
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8
Chapter 7: Valuation of stocks and corporations
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Q1) Kelly Enterprises' stock currently sells for $35.25 per share.The dividend is projected to increase at a constant rate of 4.75% per year.The required rate of return on the stock, rs, is 11.50%.What is the stock's expected price 5 years from now?
A) $40.17
B) $41.20
C) $42.26
D) $43.34
E) $44.46
Q2) If D? = $1.75, g (which is constant)= 3.6%, and P? = $32.00, what is the stock's expected total return for the coming year?
A) 8.37%
B) 8.59%
C) 8.81%
D) 9.03%
E) 9.27%
Q3) The corporate valuation model cannot be used unless a company doesn't pay dividends.
A)True
B)False
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Page 9
Chapter 8: Financial options and applications in corporate finance
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Q1) 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
Q2) Which of the following statements is CORRECT?
A) Call options give investors the right to sell a stock at a certain strike price before a specified date.
B) Options typically sell for less than their exercise value.
C) LEAPS are very short-term options that were created relatively recently and now trade in the market.
D) An option holder is not entitled to receive dividends unless he or she exercises their option before the stock goes ex dividend.
E) Put options give investors the right to buy a stock at a certain strike price before a specified date.
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Chapter 9: The cost of capital
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Q1) Which of the following statements is CORRECT?
A) If the calculated beta underestimates the firm's true investment risk¾i.e., if the forward-looking beta that investors think exists exceeds the historical beta¾then the CAPM method based on the historical beta will produce an estimate of rs and thus WACC that is too high.
B) Beta measures market risk, which is, theoretically, the most relevant risk measure for a publicly-owned firm that seeks to maximize its intrinsic value.This is true even if not all of the firm's stockholders are well diversified.
C) An advantage shared by both the DCF and CAPM methods when they are used to estimate the cost of equity is that they are both "objective" as opposed to "subjective, " hence little or no judgment is required.
D) The specific risk premium used in the CAPM is the same as the risk premium used in the bond-yield-plus-risk-premium approach.
E) The discounted cash flow method of estimating the cost of equity cannot be used unless the growth rate, g, is expected to be constant forever.
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Chapter 10: The basics of capital budgeting: evaluating cash flows
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Q1) Projects A and B are mutually exclusive and have normal cash flows.Project A has an IRR of 15% and B's IRR is 20%.The company's WACC is 12%, and at that rate Project A has the higher NPV.Which of the following statements is CORRECT?
A) Assuming the timing pattern of the two projects' cash flows is the same, Project B probably has a higher cost (and larger scale).
B) Assuming the two projects have the same scale, Project B probably has a faster payback than Project A.
C) The crossover rate for the two projects must be 12%.
D) Since B has the higher IRR, then it must also have the higher NPV if the crossover rate is less than the WACC of 12%.
E) The crossover rate for the two projects must be less than 12%.
Q2) Which of the following statements is NOT a disadvantage of the regular payback method?
A) Ignores cash flows beyond the payback period.
B) Does not directly account for the time value of money.
C) Does not provide any indication regarding a project's liquidity or risk.
D) Does not take account of differences in size among projects.
E) Lacks an objective, market-determined benchmark for making decisions.
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Chapter 11: Cash flow estimation and risk analysis
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Q1) Changes in net working capital should not be reflected in a capital budgeting cash flow analysis because capital budgeting relates to fixed assets, not working capital.
A)True
B)False
Q2) 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
Q3) If debt is to be used to finance a project, then when cash flows for a project are estimated, interest payments should be included in the analysis.
A)True
B)False
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Chapter 12: Corporate valuation and financial planning
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Q1) Operating plans sketch out broad approaches for realization of the firm's strategic vision.These plans usually are developed for a period no longer than a 1-year time horizon because detail is "lost" by extending out the time horizon by more than 1 year.
A)True
B)False
Q2) A company expects sales to increase during the coming year, and it is using the AFN equation to forecast the additional capital that it must raise.Which of the following conditions would cause the AFN to increase?
A) The company increases its dividend payout ratio.
B) The company begins to pay employees monthly rather than weekly.
C) The company's profit margin increases.
D) The company decides to stop taking discounts on purchased materials.
E) The company previously thought its fixed assets were being operated at full capacity, but now it learns that it actually has excess capacity.
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Chapter 13: Agency conflicts and corporate governance
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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) Two important issues in corporate governance are (1)the rules that cover the board's ability to fire the CEO and (2)the rules that cover the CEO's ability to remove members of the board.
A)True
B)False
Q3) ESOPs were originally designed to help improve worker productivity, but today they are also used to help prevent hostile takeovers.
A)True
B)False
Q4) A poison pill is also known as a corporate restructuring.
A)True
B)False
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Page 15
Chapter 14: Distributions to shareholders: dividends and repurchases
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Q1) Norton Electrical has quite a few positive NPV projects from which to choose.The problem is that it has more of these projects than it can finance without issuing new stock and the board of directors refuses to issue any new shares in the foreseeable future.Norton's projected net income is $150.0 million, its target capital structure is 25% debt and 75% equity, and its target payout ratio is 65%.The CFO now wants to determine how the maximum capital budget would be affected by changes in capital structure policy and/or the target dividend payout policy.Versus the current policy, how much larger could the capital budget be if (1)the target debt ratio were raised to 75%, other things held constant, (2)the target payout ratio were lowered to 20%, other things held constant, and (3)the debt ratio and payout were both changed by the indicated amounts.
Increase in Capital Budget
Increase Lower
Debt to 75% Payout to 20% Do both
A) $114.0 $73.3 $333.9
B) $120.0 $77.2 $351.5
C) $126.4 $81.2 $370.0
D) $133.0 $85.5 $389.5
E) $140.0 $90.0 $410.0
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Chapter 15: Capital structure decisions
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Q1) Cartwright Communications is considering making a change to its capital structure to reduce its cost of capital and increase firm value.Right now, Cartwright has a capital structure that consists of 20% debt and 80% equity, based on market values.(Its D/S ratio is 0.25.)The risk-free rate is 6% and the market risk premium, rM - rRF, is 5%.Currently the company's cost of equity, which is based on the CAPM, is 12% and its tax rate is 40%.What would be Cartwright's estimated cost of equity if it were to change its capital structure to 50% debt and 50% equity?
A) 13.00%
B) 13.64%
C) 14.35%
D) 14.72%
E) 15.60%
Q2) Based on the information below for Benson Corporation, what is the optimal capital structure?
A) Debt = 50%; Equity = 50%; EPS = $3.05; Stock price = $28.90.
B) Debt = 60%; Equity = 40%; EPS = $3.18; Stock price = $31.20.
C) Debt = 80%; Equity = 20%; EPS = $3.42; Stock price = $30.40.
D) Debt = 70%; Equity = 30%; EPS = $3.31; Stock price = $30.00.
E) Debt = 40%; Equity = 60%; EPS = $2.95; Stock price = $26.50.
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Chapter 16: Supply chains and working capital management
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Q1) The cash conversion cycle (CCC)combines three factors: The inventory conversion period, the average collection period, and the payables deferral period, and its purpose is to show how long a firm must finance its working capital.Other things held constant, the shorter the CCC, the more effective the firm's working capital management.
A)True
B)False
Q2) As a rule, managers should try to always use the free component of trade credit but should use the costly component only if the cost of this credit is lower than the cost of credit from other sources.
A)True
B)False
Q3) Refer to Exhibit 21.1.What's the difference in the projected ROEs under the restricted and relaxed policies?
A) 1.20%
B) 1.50%
C) 1.80%
D) 2.16%
E) 2.59%
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Chapter 17: Multinational financial management
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Q1) LIBOR is an acronym for London Interbank Offer Rate, which is an average of interest rates offered by London banks to smaller U.S.corporations.
A)True
B)False
Q2) In Japan, 90-day securities have a 4% annualized return and 180-day securities have a 5% annualized return.In the United States, 90-day securities have a 4% annualized return and 180-day securities have an annualized return of 4.5%.All securities are of equal risk, and Japanese securities are denominated in terms of the Japanese yen.Assuming that interest rate parity holds in all markets, which of the following statements is most CORRECT?
A) The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 180-day forward market.
B) The yen-dollar exchange rate in the 90-day forward market equals the yen-dollar exchange rate in the 180-day forward market.
C) The spot rate equals the 90-day forward rate.
D) The spot rate equals the 180-day forward rate.
E) The yen-dollar spot exchange rate equals the yen-dollar exchange rate in the 90-day forward market.
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