Applied Corporate Finance
Chapter Exam Questions
Course Introduction
Applied Corporate Finance explores the practical applications of financial theory within corporate settings, focusing on how financial managers make decisions that maximize firm value. The course covers key topics such as capital budgeting, capital structure, cost of capital, dividend policy, and risk management, with an emphasis on quantitative analysis and real-world case studies. Students will learn how to evaluate investment opportunities, structure financing options, and apply valuation techniques, preparing them to tackle complex financial challenges faced by modern corporations.
Recommended Textbook Corporate Finance A Focused Approach 6th 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) There are three primary disadvantages of a regular partnership: (1) unlimited liability, (2) limited life of the organization, and (3) difficulty of transferring ownership. These combine to make it difficult for partnerships to attract large amounts of capital and thus to grow to a very large size.
A)True
B)False
Answer: True
Q2) Suppose the U.S. Treasury announces plans to issue $50 billion of new bonds. Assuming the announcement was not expected, what effect, other things held constant, would that have on bond prices and interest rates?
A) Prices and interest rates would both rise.
B) Prices would rise and interest rates would decline.
C) Prices and interest rates would both decline.
D) There would be no changes in either prices or interest rates.
E) Prices would decline and interest rates would rise.
Answer: E
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3
Chapter 3: Analysis of Financial Statements
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Sample Questions
Q1) Suppose Firms A and B have the same amount of assets, pay the same interest rate on their debt, have the same basic earning power (BEP), and have the same tax rate. However, Firm A has a higher debt ratio. If BEP is greater than the interest rate on debt, Firm A will have a higher ROE as a result of its higher debt ratio.
A)True
B)False
Answer: True
Q2) Last year Central Chemicals had sales of $205,000, assets of $127,500, a profit margin of 5.3%, and an equity multiplier of 1.2. The CFO believes that the company could reduce its assets by $21,000 without affecting either sales or costs. Had it reduced its assets in this amount, and had the debt-to-assets ratio, sales, and costs remained constant, by how much would the ROE have changed?
A) 1.81%
B) 2.02%
C) 2.22%
D) 2.44%
E) 2.68%
Answer: B
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Page 4
Chapter 4: Time Value of Money
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Sample Questions
Q1) 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.
Q2) Your Green Investment Tips subscription is about to expire. You plan to subscribe to the magazine for the rest of your life, and you can renew it by paying $85 annually, beginning immediately, or you can get a lifetime subscription for $850, also payable immediately. Assuming that you can earn 6.0% on your funds and that the annual renewal rate will remain constant, how many years must you live to make the lifetime subscription the better buy? A) 7.48
12.18
14.33
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Chapter 5: Bonds, Bond Valuation, and Interest Rates
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Sample Questions
Q1) As a general rule, a company's debentures have higher required interest rates than its mortgage bonds because mortgage bonds are backed by specific assets while debentures are unsecured.
A)True
B)False
Q2) If 10-year T-bonds have a yield of 6.2%, 10-year corporate bonds yield 8.5%, the maturity risk premium on all 10-year bonds is 1.3%, and corporate bonds have a 0.4% liquidity premium versus a zero liquidity premium for T-bonds, what is the default risk premium on the corporate bond?
A) 1.90%
B) 2.09%
C) 2.30%
D) 2.53%
E) 2.78%
Q3) A zero coupon bond is a bond that pays no interest and is offered (and subsequently sells initially) at par. These bonds provide compensation to investors in the form of capital appreciation.
A)True
B)False
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Page 6
Chapter 6: Risk, Return, and the Capital Asset Pricing Model
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Sample Questions
Q1) Which of the following statements is CORRECT?
A) A portfolio that consists of 40 stocks that are not highly correlated with "the market" will probably be less risky than a portfolio of 40 stocks that are highly correlated with the market, assuming the stocks all have the same standard deviations.
B) A two-stock portfolio will always have a lower beta than a one-stock portfolio.
C) If portfolios are formed by randomly selecting stocks, a 10-stock portfolio will always have a lower beta than a one-stock portfolio.
D) A stock with an above-average standard deviation must also have an above-average beta.
E) A two-stock portfolio will always have a lower standard deviation than a one-stock portfolio.
Q2) We would almost always find that the beta of a diversified portfolio is less stable over time than the beta of a single security.
A)True B)False
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Chapter 7: Stocks, Stock Valuation, and Stock Market
Equilibrium
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Sample Questions
Q1) Alcott's preferred stock pays a dividend of $1.00 per quarter. If the price of the stock is $45.00, what is its nominal (not effective) annual rate of return?
A) 8.03%
B) 8.24%
C) 8.45%
D) 8.67%
E) 8.89%
Q2) Kellner Motor Co.'s stock has a required rate of return of 11.50%, and it sells for $25.00 per share. Kellner's dividend is expected to grow at a constant rate of 7.00%. What was the last dividend, D<sub>0</sub>?
A) $0.95
B) $1.05
C) $1.16
D) $1.27
E) $1.40
Q3) The free cash flow valuation model cannot be used unless a company doesn't pay dividends.
A)True
B)False
Page 8
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Chapter 8: Financial Options and Applications in Corporate Finance
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Sample Questions
Q1) An investor who writes standard call options against stock held in his or her portfolio is said to be selling what type of options?
A) Put
B) Naked
C) Covered
D) Out-of-the-money
E) In-the-money
Q2) Other things held constant, the value of an option depends on the stock's price, the risk-free rate, and the
A) Variability of the stock price.
B) Option's time to maturity.
C) Strike price.
D) All of the above.
E) None of the above.
Q3) Because of the time value of money, the longer before an option expires, the less valuable the option will be, other things held constant.
A)True
B)False
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Chapter 9: The Cost of Capital
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Sample Questions
Q1) Trahern Baking Co. common stock sells for $32.50 per share. It expects to earn $3.50 per share during the current year, its expected dividend payout ratio is 65%, and its expected constant dividend growth rate is 6.0%. New stock can be sold to the public at the current price, but a flotation cost of 5% would be incurred. What would be the cost of equity from new common stock?
A) 12.70%
B) 13.37%
C) 14.04%
D) 14.74%
E) 15.48%
Q2) The lower the firm's tax rate, the lower will be its after-tax cost of debt and also its WACC, other things held constant.
A)True
B)False
Q3) The cost of preferred stock to a firm must be adjusted to an after-tax figure because 70% of dividends received by a corporation may be excluded from the receiving corporation's taxable income.
A)True
B)False
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Page 10
Chapter 10: The Basics of Capital Budgeting: Evaluating Cash Flows
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Sample Questions
Q1) One advantage of the payback method for evaluating potential investments is that it provides information about a project's liquidity and risk.
A)True
B)False
Q2) For a project with one initial cash outflow followed by a series of positive cash inflows, the modified IRR (MIRR) method involves compounding the cash inflows out to the end of the project's life, summing those compounded cash flows to form a terminal value (TV), and then finding the discount rate that causes the PV of the TV to equal the project's cost.
A)True
B)False
Q3) In theory, capital budgeting decisions should depend solely on forecasted cash flows and the opportunity cost of capital. The decision criterion should not be affected by managers' tastes, choice of accounting method, or the profitability of other independent projects.
A)True
B)False
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Page 11
Chapter 11: Cash Flow Estimation and Risk Analysis
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Q1) The two cardinal rules that financial analysts should follow to avoid capital budgeting errors are: (1) in the NPV equation, the numerator should use income calculated in accordance with generally accepted accounting principles, and (2) all incremental cash flows should be considered when making accept/reject decisions.
A)True
B)False
Q2) Because of improvements in forecasting techniques, estimating the cash flows associated with a project has become the easiest step in the capital budgeting process.
A)True
B)False
Q3) We can identify the cash costs and cash inflows to a company that will result from a project. These could be called "direct inflows and outflows," and the net difference is the direct net cash flow. If there are other costs and benefits that do not flow from or to the firm, but to other parties, these are called externalities, and they need not be considered as a part of the capital budgeting analysis.
A)True
B)False
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Chapter 12: Financial Planning and Forecasting Financial Statements
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Sample Questions
Q1) A firm's AFN must come from external sources. Typical sources include short-term bank loans, long-term bonds, preferred stock, and common stock.
A)True
B)False
Q2) Refer to the Judd Enterprises financial statements. If Judd does not plan on issuing new stock or additional long-term debt, then what is the additional net financing needed for the projected year?
A) $30
B) $33
C) $37
D) $339
E) $396
Q3) One of the first steps in arriving at a firm's forecasted financial statements is a review of industry-average operating ratios relative to these same ratios for the firm to determine whether changes to the ratios need to be made.
A)True
B)False
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Page 13
Chapter 13: Corporate Valuation, Value-Based
6
6
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Sample Questions
Q1) A poison pill is also known as a corporate restructuring.
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) 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
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Chapter 14: Distributions to Shareholders: Dividends and Repurchases
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Sample Questions
Q1) A reverse split reduces the number of shares outstanding.
A)True
B)False
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 a firm adheres strictly to the residual dividend policy, the issuance of new common stock would suggest that
A) the dividend payout ratio is increasing.
B) no dividends were paid during the year.
C) the dividend payout ratio is decreasing.
D) the dollar amount of investments has decreased.
E) the dividend payout ratio has remained constant.
Q4) Stock dividends and stock splits should, at least conceptually, have the same effect on shareholders' wealth.
A)True
B)False
15
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Chapter 15: Capital Structure Decisions
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Sample Questions
Q1) Firms U and L both have a return on invested capital (ROIC) of 12% and each has the same amount of assets. Firm U is unleveraged, i.e., it is 100% equity financed, while Firm L is financed with 50% debt and 50% equity. Firm L's debt has an after-tax cost of 4.8%. Both firms have positive net income. Which of the following statements is CORRECT?
A) Firm L has a lower ROA than Firm U.
B) Firm L has a lower ROE than Firm U.
C) Firm L has the higher times interest earned (TIE) ratio.
D) Firm L has a higher EBIT than Firm U.
E) The two companies have the same times interest earned (TIE) ratio.
Q2) Refer to the data for Eccles Inc.What is the value of the firm according to MM with corporate taxes?
A) $475,875
B) $528,750
C) $587,500
D) $646,250
E) $710,875
Q3) The MM model is the same as the Miller model, but with zero corporate taxes.
A)True
B)False
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Page 16
Chapter 16: Working Capital Management
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Sample Questions
Q1) Which of the following statements is CORRECT?
A) The cash budget and the capital budget are developed separately, and although they are both important to the firm, one does not affect the other.
B) Since depreciation is a non-cash charge, it neither appears on nor has any effect on the cash budget.
C) The target cash balance should be set such that it need not be adjusted for seasonal patterns and unanticipated fluctuations in receipts, although it should be changed to reflect long-term changes in the firm's operations.
D) The typical cash budget reflects interest paid on loans as well as income from the investment of surplus cash. These numbers, as well as other items on the cash budget, are expected values; hence, actual results might vary from the budgeted amounts.
E) Shorter-term cash budgets, in general, are used primarily for planning purposes, while longer-term budgets are used for actual cash control.
Q2) The aging schedule is a commonly used method for monitoring receivables.
A)True
B)False
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Chapter 17: Multinational Financial Management
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Sample Questions
Q1) Exchange rates influence a multinational firm's inventory policy because changing currency values can affect the value of inventory.
A)True
B)False
Q2) Credit policy for multinational firms is generally more risky due in part to the additional consideration of exchange rates and also due to uncertainty regarding the credit worthiness of many foreign customers.
A)True
B)False
Q3) Suppose a carton of hockey pucks sell in Canada for 105 Canadian dollars, and 1 Canadian dollar equals 0.71 U.S. dollars. If purchasing power parity (PPP) holds, what is the price of hockey pucks in the United States?
A) $14.79
B) $63.00
C) $74.55
D) $85.88
E) $147.88
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Page 18