Advanced Corporate Finance
Mock Exam
Course Introduction
Advanced Corporate Finance explores the complex financial decisions faced by modern corporations, building on core concepts in financial theory and corporate policy. Key topics include capital structure and cost of capital, dividend policy, mergers and acquisitions, corporate restructuring, risk management, and advanced valuation techniques. The course emphasizes the application of analytical tools to real-world scenarios, encouraging students to critically evaluate financial strategies and decisions within the context of dynamic market environments. Students will engage with case studies and current research to gain practical insights into how companies raise capital, manage financial risk, and create value for shareholders.
Recommended Textbook
Corporate Finance 2nd Canadian by Jonathan Berk
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Page 2
Chapter 1: The Corporation
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Q1) A sole proprietorship is owned by
A) one person.
B) two or more people.
C) shareholders.
D) bankers.
Answer: A
Q2) In 2008 what position was the Toronto Stock Exchange,TSX,ranked based on the value of trades in U.S.dollars?
A) The 9th position
B) The 8th position
C) The 20th position
D) None of the above
Answer: A
Q3) An investment is said to be liquid if the investment
A) has large day-to-day fluctuations in price.
B) has a large bid-ask spread.
C) can easily be converted into cash.
D) is traded on a stock exchange.
Answer: C
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Page 3
Chapter 2: Introduction to Financial Statement Analysis
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Q1) Luther's price - earnings ratio (P/E)for the year ending December 31,2006 is closest to:
A) 7.9
B) 10.1
C) 15.4
D) 16.0
Answer: C
Q2) P/B ratio is ________.
A) price-to-book ratio
B) profit-to-book ratio
C) property-to-book ratio
D) price-to-benefit ratio
Answer: A
Q3) Assuming that Luther has no convertible bonds outstanding,then for the year ending December 31,2006 Luther's diluted earnings per share are closest to:
A) $1.01
B) $1.04
C) $1.53
D) $3.92
Answer: A
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Chapter 3: Arbitrage and Financial Decision Making
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Q1) Which of the following statements regarding arbitrage is the most correct?
A) Any situation in which it is possible to make a profit without taking any risk is known as an arbitrage opportunity.
B) Any situation in which it is possible to make a profit without making any investment is known as an arbitrage opportunity.
C) We call a competitive market in which there are no arbitrage opportunities an arbitrage market.
D) The practice of buying and selling equivalent goods in different markets to take advantage of a price difference is known as arbitrage.
Answer: D
Q2) If the risk-free interest rate is 10%,then of the four projects listed,if you could only invest in one project,which one would you select?
A) Eenie
B) Meenie
C) Minie
D) Moe
Answer: A
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Page 5
Chapter 4: The Time Value of Money
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Q1) Which of the following statements is false?
A) The process of moving a value or cash flow forward in time is known as compounding.
B) The effect of earning interest on interest is known as compound interest.
C) It is only possible to compare or combine values at the same point in time.
D) A dollar in the future is worth more than a dollar today.
Q2) Draw a timeline detailing the cash flows from investment "B."
Q3) You are saving for retirement.To live comfortably,you decide that you will need $2.5 million dollars by the time you are 65.Today is your 30th birthday,and you decide that,starting today,on every birthday up to and including your 65th birthday you will deposit the same amount into your savings account.Assuming the interest rate is 5%,the amount that you must set aside each and every year on your birthday is closest to:
A) $71,430
B) $27,680
C) $26,100
D) $26,260
Q4) If the interest rate is 10%,then which investment(s),if any,would you take and why?
Q5) Draw a timeline detailing Joe's cash flows from the sale of the family business.
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Chapter 5: Interest Rates
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Q1) To calculate a loan payment,we first compute ________ from the quoted interest rate of the loan,and then equate the outstanding loan balance with ________ of the loan payments and solve for the loan payment.
A) the compounding rate, the present value
B) the discount rate, the present value
C) the discount rate, the future value
D) the compounding rate, the future value
Q2) Amortizing loans are the loans that have monthly payments and are quoted in terms of an ________ with ________ compounding.
A) an effective rate, annual
B) an equivalent rate, annual
C) annual percentage rate, monthly
D) nominal rate, semiannual
Q3) The effective annual rate (EAR)for a loan with a stated APR of 10% compounded quarterly is closest to:
A) 10.52%
B) 10.25%
C) 10.38%
D) 10.00%
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Chapter 6: Investment Decision Rules
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Q1) The maximum number of incremental IRRs that could exist for project B over project A is?
A) 1
B) 2
C) 0
D) 3
Q2) The payback period for this project is closest to:
A) 2.1 years
B) 3.0 years
C) 2 years
D) 2.2 years
Q3) Assume that projects Alpha and Beta are mutually exclusive.The correct investment decision and the best rational for that decision is to?
A) Invest in project Beta since NPV<sub>Beta</sub> > 0
B) Invest in project Alpha since NPV<sub>Beta</sub> < NPV<sub>Alpha</sub>
C) Invest in project Beta since IRR<sub>B</sub> > IRR<sub>A</sub>
D) Invest in project Beta since NPV<sub>Beta</sub> > NPV<sub>Alpha </sub>> 0
Q4) What is the incremental IRR for project B over project A? Would you feel comfortable basing your decision on the incremental IRR?
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Chapter 7: Fundamentals of Capital Budgeting
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Q1) Since the CCA deducted each year is a proportion of the undepreciated capital cost (UCC),UCC will gradually become ________.
A) zero
B) a small negative number
C) a small positive number
D) none of the above
Q2) The depreciation tax shield for Shepard Industries project in year one is closest to:
A) $84 million
B) $168 million
C) $96 million
D) $72 million
Q3) The free cash flow for the first year of Epiphany's project is closest to:
A) $43,000
B) $25,000
C) $38,000
D) $45,000
Q4) Epiphany would like to know how sensitive the project's NPV is to changes in the discount rate.How much can the discount rate vary before the NPV reaches zero?
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Chapter 8: Valuing Bonds
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Q1) Which of the following statements is false?
A) The forward rate for year 1 is the rate on an investment that starts today and is repaid in one year; it is equivalent to an investment in a one-year zero-coupon bond.
B) The forward rate is only a good predictor of spot interest rates in the future when investors are risk adverse.
C) We can use the law of one price to calculate the forward rate from the zero-coupon yield curve.
D) An interest rate forward contract is a contract today that fixes the interest rate for a loan or investment in the future.
Q2) Government of Canada Bonds pay coupons in every A) month.
B) quarter.
C) half year.
D) year.
Q3) Compute the yield to maturity for each of the five zero-coupon bonds.
Q4) Explain why the expected return of a corporate bond does not equal its yield to maturity?
Q5) What is the relationship between a bond's price and its yield to maturity?
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Chapter 9: Valuing Stocks
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Q1) Calculate the enterprise value for DM Corporation.
Q2) Which of the following statements is false?
A) There are two potential sources of cash flows from owning a stock.
B) An investor will be willing to pay a price today for a share of stock up to the point that this transaction has a zero NPV.
C) An investor might generate cash by choosing to sell the shares at some future date.
D) Because the cash flows from stock are known with certainty, we can discount them using the risk-free interest rate.
Q3) Suppose that Defenestration decides to pay a dividend of only $2 per share this year and use the remaining $2 per share to repurchase stock.If Defenestration's payout rate remains constant,then Defenestration's stock price is closest to:
A) $50.00
B) $22.25
C) $32.30
D) $30.75
Q4) What are some common multiples used to value stocks?
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Page 11
Chapter 10: Capital Markets and the Pricing of Risk
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Q1) The beta is the expected percent change in the excess return of a security for a 1% change in the ________ of the market portfolio.
A) average return
B) annual return
C) weighted return
D) excess return
Q2) The cost of capital for a project with the same beta as Merck's stock is closest to:
A) 11.2%
B) 12.8%
C) 12.4%
D) 11.6%
Q3) What is the standard deviation of Big Cure's average net income for their new blockbuster drug?
A) $0
B) $1 billion
C) $100 million
D) $500 million
Q4) What is the market portfolio?
Q5) Which pharmaceutical company faces less risk?
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Chapter 11: Optimal Portfolio Choice and the Capital Asset
Pricing Model
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Q1) The expected return of a portfolio that consists of a long position of $10,000 in Wal-Mart and a short position of $2000 in Microsoft is closest to:
A) 21%
B) 12%
C) 27%
D) 18%
Q2) The variance on a portfolio that is made up of a $6000 investment in Duke Energy stock and a $4000 investment in Wal-Mart stock is closest to:
A) .050
B) .045
C) .051
D) -0.020
Q3) CAPM states that the investment's expected return should match the expected return of ________ portfolio with the same level of market risk.
A) the capital market line
B) efficient
C) single security
D) diversified
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Chapter 12: Estimating the Cost of Capital
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Q1) Which of the following statements is false?
A) The market capitalization is the total market value of its outstanding shares.
B) The market portfolio is the portfolio of all risky investments.
C) Many practitioners believe it insensible to use the CAPM and the security market line as a practical means to estimate a stock's required return and therefore a firm's equity cost of capital.
D) To estimate the equity cost of capital using the CAPM, the first thing we need to do is identify the market portfolio.
Q2) The yield to maturity of a bond is the ________ an investor will earn from holding the bond to maturity and receiving its promised payments.
A) IRR
B) coupon rate
C) rate of return
D) capital gain
Q3) Why does the yield to maturity of a firm's debt generally overestimate its debt cost of capital?
Q4) Describe two methods that can be used to estimate a firm's debt cost of capital.
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14
Chapter 13: Investor Behaviour and Capital Market
Efficiency
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Q1) One of the most important implications of our discussion of risk and return is the benefit of ________.
A) diversification
B) take certain risk
C) pursue higher return
D) reduce risk level
Q2) Explain why the market portfolio proxy may not be efficient.
Q3) Portfolio "D"
A) falls below the SML.
B) has a negative alpha.
C) is overpriced.
D) offers an expected return equal to the risk-free rate.
Q4) Using the FFC four factor model and the historical average monthly returns,the expected monthly return for Wal-Mart is closest to:
A) 0.71%
B) 0.53%
C) 1.38%
D) 0.79%
Page 15
Q5) What does the existence of a positive alpha investment strategy imply?
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Chapter 14: Capital Structure in a Perfect Market
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Q1) With perfect capital markets,leverage has ________ effect on firm value or the firm's overall cost of capital.
A) zero
B) a positive
C) a negative
D) an unpredictable
Q2) Which of the following statements is false?
A) The levered equity return equals the unlevered return, plus an extra "kick" due to leverage.
B) By holding a portfolio of the firm's equity and its debt, we can replicate the cash flows from holding its levered equity.
C) The cost of capital of levered equity is equal to the cost of capital of unlevered equity plus a premium that is proportional to the market value debt-equity ratio.
D) If a firm is unlevered, all of the free cash flows generated by its assets are available to be paid out to its equity holders.
Q3) Based upon the three comparable firms,what asset beta would you recommend using for your firm's new project?
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Chapter 15: Debt and Taxes
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Q1) In 2000,assuming an average dividend payout ratio of 50%,the effective tax advantage for debt ( *)was closest to:
A) 40%
B) 24%
C) 30%
D) 18%
Q2) In Canada and many other countries,interest income has historically been taxed ________ dividends or capital gains from equity.
A) equally to B) less heavily than C) more heavily than D) more deliberately than
Q3) If Flagstaff currently maintains a .8 debt to equity ratio,then calculate the value of Flagstaff's interest tax shield.
Q4) The value of KD's unlevered equity is closest to:
A) $600 million
B) $470 million
C) $390 million
D) $400 million
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Chapter 16: Financial Distress, managerial Incentives, and Information
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Q1) Assume that in the event of default,20% of the value of MI's assets will be lost in bankruptcy costs.Suppose that at the start of the year,MI has no debt outstanding,but has 5.6 million shares of stock outstanding.If MI issues debt of $125 million due next year and uses the proceeds to repurchase shares,the share price following the announcement of the repurchase will be closest to:
A) $23.90
B) $23.75
C) $25.00
D) $5.15
Q2) Kinston's current share price is closest to:
A) $20.40
B) $9.40
C) $11.00
D) $10.00
Q3) What is the overall expected payoff under JR's new riskier business strategy?
A) $4 million
B) $11 million
C) $20 million
D) $15 million
Q4) List five general categories of indirect costs associated with bankruptcy.
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Chapter 17: Payout Policy
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Q1) Which of the following statements is false?
A) In perfect capital markets, buying and selling securities is a zero-NPV transaction, so it should not affect firm value.
B) Making positive-NPV investments will create value for the firm's investors, whereas saving the cash or paying it out will not.
C) In perfect capital markets, if a firm invests excess cash flows in financial securities, the firm's choice of payout versus retention is irrelevant and does not affect the initial share price.
D) After adjusting for investor taxes, there remains a substantial tax advantage for the firm to retain excess cash.
Q2) Assume that Omicron uses the entire $50 million to repurchase shares.The amount of the regular yearly dividends in the future is closest to:
A) $4.50
B) $5.00
C) $9.00
D) $4.00
Q3) Calculate the effective tax disadvantage for retaining cash in 1999,2001,and 2005.
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Page 19
Chapter 18: Capital Budgeting and Valuation With Leverage
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Q1) Which of the following statements is false?
A) The firm's unlevered cost of capital is equal to its pre-tax weighted average cost of capital - that is, using the pre-tax cost of debt, r<sub>d</sub> , rather than its after-tax cost, r<sub>d</sub> (1 - <sub>c</sub> ).
B) A firm's levered cost of capital is a weighted average of its equity and debt costs of capital.
C) When the firm maintains a target leverage ratio, its future interest tax shields have similar risk to the project's cash flows, so they should be discounted at the project's unlevered cost of capital.
D) The first step in the APV method is to calculate the value of free cash flows using the project's cost of capital if it were financed without leverage.
Q2) The interest tax shield provided by Omicron's new project in year 1 is closest to:
A) $3.00
B) $1.05
C) $50.25
D) $17.60
Q3) Describe three simplifying assumptions that we make in valuing a project
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Chapter 19: Valuation and Financial Modeling: a Case Study
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Q1) Assuming that Ideko has a EBITDA multiple of 8.5,then the continuation equity value of Ideko in 2010 is closest to:
A) $181.7 million
B) $272.8 million
C) $152.8 million
D) $301.7 million
Q2) Which of the following statements is correct?
A) A firm's enterprise value is the total value of equity plus net debt, where net debt is debt less cash and investments in marketable securities.
B) A firm's book value is the total value of equity plus net debt, where net debt is debt less cash and investments in marketable securities.
C) A firm's market value is the total value of equity plus net debt, where net debt is debt less cash and investments in marketable securities.
D) A firm's nominal value is the total value of equity plus net debt, where net debt is debt less cash and investments in marketable securities.
Q3) What is the purpose of the sensitivity analysis?
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21
Chapter 20: Financial Options
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Q1) You have decided to sell (write)5 January 2009 put options on Merck with an exercise price of $45 per share.How much money will you receive and are these contracts in- or out-of-the-money?
Q2) You are long both a put option and a call option on Rockwood stock with the same expiration date.The exercise price of the call option is $40 and the exercise price of the put option is $30.Graph the payoff of the combination of options at expiration.
Q3) The payoff to the holder of a put option is given by:
A) P = max(K - S, 0)
B) P= max(S - K, 0)
C) P = min(S - K, 0)
D) P = max(K, 0)
Q4) How many of the January 2009 put options are in-the-money?
A) 1
B) 3
C) 2
D) 4
Q5) Describe the conditions when it would be optimal to exercise an American Call and an American Put option prior to their expiration.
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Chapter 21: Option Valuation
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Q1) ________ have the highest expected returns and ________ have the lowest expected returns.
A) Out-of-the-money calls; out-of-the-money puts
B) In-the-money puts; out-of-the-money puts
C) Out-of-the-money puts; out-of-the-money calls
D) In-the-money calls; out-of-the-money puts
Q2) Which of the following statements is false?
A) For companies with high debt-to-equity ratios, the approximation that the beta of debt is zero is unrealistic; such corporations have a positive probability of bankruptcy, and this uncertainty usually has systematic components.
B) When the debt is risky, the firm's equity is always in-the-money; thus = 1.
C) If we let A be the value of the firm's assets, E be the value of equity, and D be the value of debt, then because equity is a call option on the assets of the firm, E = S + B with A = E + D = S.
D) Equity can be viewed as a call option on the firm's assets.
Q3) Using risk-neutral probabilities,calculate the price of a two-year call option on Kinston stock with a strike price of $9.
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Chapter 22: Real Options
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Q1) Assuming that Kinston does not have the ability to sell the prototype in year one for $300,000,draw a decision tree detailing the Kinston Industries Mountain Bike Project.
Q2) Assuming that Kinston does not have the ability to sell the prototype in year one for $300,000,the NPV of the Kinston Industries Mountain Bike Project is closest to:
A) -$45,000
B) $455,000
C) $590,000
D) $90,000
Q3) The NPV of project B is closest to:
A) $18.10
B) $21.70
C) $24.00
D) $16.90
Q4) The equivalent annual benefit of project A is closest to:
A) $21.70
B) $5.05
C) $24.00
D) $3.40
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24
Chapter 23: The Mechanics of Raising Equity Capital
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Q1) Which of the following statements is NOT true regarding venture capitalists?
A) They can provide substantial capital for young companies.
B) The firms offer limited partners a number of advantages over investing directly in start-ups themselves as angel investors.
C) They use their control to protect their investments, so they may therefore perform a key nurturing and monitoring role for the firm.
D) They might invest for strategic objectives in addition to the desire for investment returns.
Q2) Once a company goes public,it must satisfy all of the requirements and new standards that focused on more thorough ________,________ and more stringent requirements for the board of directors.These standards,in general,were designed to provide better protection for ________.
A) financial disclosure; greater accountability; companies
B) financial disclosure; less accountability; investors
C) financial disclosure; greater accountability; investors
D) financial disclosure; less accountability; companies
Q3) What will the offer price of these shares be if Luther is selling 800,000 shares?
Q4) Based upon the price/revenue ratio,what would be a reasonable value for KD?
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Page 25
Chapter 24: Debt Financing
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Q1) The ________ provision sets the call price as the ________ of the remaining coupons.
A) Canada Call; current value
B) Canada Call; future value
C) Canada Call; adjusted value
D) Canada Call; present value
Q2) Which of the following statements regarding private placements is false?
A) A private placement is a bond issue that does not trade on a public market but rather is sold to a small group of investors.
B) Privately placed debt need not conform to the same standards as public debt; as a consequence, it can be tailored to the particular situation.
C) Canadian governments never issue bonds to raise funds to meet their short-term cash flows.
D) Because a private placement does not need to be registered, it is less costly to issue.
Q3) What is the Yield to Maturity (YTM)on this bond?
Q4) What is the Yield to Call (YTC)on this bond?
Q5) What is the Yield to Maturity (YTM)on this bond?
Q6) What is the Yield to Call (YTC)on this bond?
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Chapter 25: Leasing
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Q1) Which of the following statements is false?
A) We can compare leasing to buying the asset using equivalent leverage by discounting the incremental cash flows of leasing versus buying using the after-tax borrowing rate.
B) A non-tax lease is attractive if it offers a better interest rate than would be available with a loan.
C) Evaluating a true tax lease is much more straightforward than evaluating a non-tax lease.
D) To determine whether a non-tax lease offers a better rate, we discount the lease payments at the firm's pre-tax borrowing rate and compare it to the purchase price of the asset.
Q2) With a standard loan we are financing ________,with a lease we are financing only ________ of the asset during the term of the lease.
A) the cost of the economic depreciation of the asset; the entire cost
B) the cost of the economic depreciation of the asset; a portion
C) only a portion of the asset; the cost of the economic depreciation
D) the entire cost of the asset; the cost of the economic depreciation
Q3) If St.Martin purchases the CT scanner,what is the amount of the lease-equivalent loan?
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Page 27
Chapter 26: Working Capital Management
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Q1) The cash cycle is the ________ between when a firm pays for its inventory and when it receives cash from the sale of its product.
A) average time
B) minimum time
C) maximum time
D) delayed time
Q2) Which of the following statements is false?
A) Similar to the situation with its accounts receivable, a firm should monitor its accounts payable to ensure that it is making its payments at an optimal time.
B) Some firms ignore the payment due period and pay later, in a practice referred to as pushing the accounts payable.
C) Suppliers may react to a firm whose payments are always late by imposing terms of cash on delivery (COD) or cash before delivery (CBD).
D) If the accounts payable outstanding is 40 days and the terms are 2/10, net 30, the firm can conclude that it generally pays late and may be risking supplier difficulties.
Q3) Calculate the number of days in Luther's Operating Cycle.
Q4) Describe "just-in-time" inventory management.
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28
Chapter 27: Short-Term Financial Planning
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Q1) Which of the following is NOT a specific financing option for temporary working capital?
A) Secured financing
B) Commercial paper
C) Bank loans
D) Repurchase agreements
Q2) The major current assets that are used for short-term secured financing are ________.
A) accounts receivable and inventory
B) accounts receivable and short-term investments
C) inventory and short-term investments
D) prepaid expenses and taxes recoverable
Q3) Luther Industries wants to borrow $1 million for two months.Using its inventory as collateral,it can obtain a 10% (APR)loan (compounded monthly).The lender requires that a warehouse arrangement be used.The warehouse fee is $10,000,payable at the end of the two months.Calculate the effective annual rate of this loan for Luther Industries.
Q4) Calculate the temporary working capital needs for each of the four quarters for Hasbeen Toys.
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Chapter 28: Mergers and Acquisitions
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Q1) Which of the following statements regarding vertical integration is false?
A) Vertically integrated companies may be large, but unlike other large corporations, since they remain focused in one industry they are easy to run.
B) A company might not be happy with how its products are being distributed, so it might decide to take control of its distribution channels.
C) A company might conclude that it can enhance its product if it has direct control of the inputs required to make the product.
D) The principal benefit of vertical integration is coordination. By putting two companies under central control, management can ensure that both companies work toward a common goal.
Q2) ________ are/is by far the most common justification that bidders give for the premium they pay for a target.
A) Small risks
B) Value Added
C) Diversification
D) Large synergies
Q3) What is a white knight?
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Chapter 29: Corporate Governance
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Q1) Directors who are not as directly connected to the firm but who have existing or potential business relationships with the firm are called
A) Gray Directors.
B) Independent Directors.
C) Advising Directors.
D) Inside Directors.
Q2) What is the difference between inside,gray,and outside directors?
Q3) Which of the following statements is false?
A) The Canadian rules require firms to report option grants within ten days of the grant date, which may help prevent further abuses.
B) Studies have found evidence that the practice of timing the release of information to maximize the value of CEO stock options is widespread.
C) Managers have an incentive to manipulate the release of financial forecasts so that good news comes out before options are granted and bad news is delayed until after the options are granted.
D) The factor contributing most to the climb in CEO total compensation for the 1990s was the sharp increase in the value of stock and options granted each year.
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Chapter 30: Risk Management
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Q1) To protect the firm against the loss of earnings if the business operations are disrupted due to fire,accident,or some other insured peril a firm would purchase
A) property insurance.
B) key personnel insurance.
C) business liability insurance.
D) business interruption insurance.
Q2) If your firm is uninsured,the NPV of implementing the new safety policies is closest to:
A) $2.25 million
B) -$.25 million
C) $2.5 million
D) $2.15 million
Q3) In December 2005,the spot exchange rate for the British Pound was CND$1.7188/£.Suppose that at the same time the one-year interest rate in Canada was 4.85% and the one-year interest rate in Great Britain was 3.15%.Based on these rates,what forward exchange rate is consistent with no arbitrage?
Q4) What are some of the disadvantages of long-term supply contracts?
Q5) What is the actuarially fair cost of full insurance?
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Page 32
Chapter 31: International Corporate Finance
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Q1) The amount of the taxes paid in dollars for the Japanese operations is closest to:
A) $29.5 million
B) $5.1 million
C) $50.0 million
D) $20.5 million
Q2) Using the covered interest parity condition,the calculated three-year forward rate
F<sub>3 </sub>is closest to:
A) $1.8568/£
B) $1.9161/£
C) $1.8961/£
D) $1.8764/£
Q3) Using the covered interest parity condition,the calculated one-year forward rate
F<sub>1 </sub>is closest to:
A) $1.8568/£
B) $1.8764/£
C) $1.9161/£
D) $1.8961/£
Q4) Calculate the pound denominated cost of capital for Luther's project.
Q5) What is the pound present value of the project?
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