Applied Corporate Finance
Exam Solutions
Course Introduction
Applied Corporate Finance focuses on the practical application of financial principles and tools to real-world corporate decision-making. The course covers key concepts such as capital budgeting, risk analysis, capital structure, cost of capital, dividend policy, mergers and acquisitions, and corporate governance. Students learn to analyze and evaluate the financial health of organizations, formulate strategic investment decisions, and understand how corporate finance theories influence daily managerial actions. Through case studies, problem-solving exercises, and interactive projects, participants gain hands-on experience in employing quantitative techniques to solve complex financial challenges faced by businesses in dynamic markets.
Recommended Textbook
Contemporary Financial Management 12th Edition by R. Charles Moyer
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Page 2
Chapter 1: The Role and Objective of Financial Management
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Sample Questions
Q1) The major factors that determine the market value of a company's shares of stock include the ____.
A) risk of its cash flows
B) timing of its cash flows
C) book value of its assets
D) risk of its cash flows and the timing of its cash flows
Answer: D
Q2) Cash flow concepts are ____ but generally accepted accounting principles are ____ in the determination of a firm's net income.
A) unambiguous, ambiguous
B) ambiguous, unambiguous
C) ambiguous, also ambiguous
D) unambiguous, straightforward
Answer: A
Q3) ____ deals with economic decisions of individuals, households, and firms.
A) Economic accounting
B) Microeconomics
C) Blue Chip econometrics
D) Macroeconomics
Answer: B
Page 3
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Chapter 2: The Domestic and International Financial Marketplace
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Sample Questions
Q1) Explain the degrees of market efficiency and their applicability to the stock market.
Answer: 1. Weak form market efficiency: No investor can earn excess returns based on historical price information or past return information.
2. Semi-strong market efficiency: No investor can earn excess returns based on an investment strategy using any public information. Stock prices consistently incorporate any new information about the stock or the issuing company.
3. Strong market efficiency: No investor can consistently earn excess returns based on any public or private information. Stock prices reflect all information, both public and private.
The number of investors who have traded with insider knowledge provides graphic evidence that the strong form efficiency does not hold.
Q2) Eurodollars are U.S. dollars that have been deposited in A) foreign banks
B) foreign branches of U.S. banks
C) foreign subsidiaries
D) foreign banks and foreign branches of U.S. banks
Answer: D
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4
Chapter 3: Evaluation of Financial Performance
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Sample Questions
Q1) The ____ ratio, sometimes called the "acid test," is a more stringent measure of ____ than the current ratio.
A) quick; liquidity
B) fixed-asset turnover; activity
C) net profit margin; gross profit margin
D) equity, activity
Answer: A
Q2) Asset management ratios indicate
A) how well a firm is using its assets to support sales
B) how efficiently a firm is allocating its liabilities
C) the return on assets
D) the profitability of the firm
Answer: A
Q3) A common-size income statement shows the firm's income and expense items as a percentage of ____.
A) stockholders' equity
B) net sales
C) industry averages
D) total assets
Answer: B
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Chapter 4: Financial Planning and Forecasting
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Sample Questions
Q1) Jones Company sales last year were $25 million and its total assets were $8 million. Accounts payable were $2 million and common stock and retained earnings were $5 million. Jones sales are forecasted to be $30 million this year, earnings after tax are expected to be 3% of sales, and dividends of $250,000 are expected to be paid. Assuming that the ratio of assets to sales and current liabilities to sales remain the same this year as last year, determine the amount of additional financing required.
A) $550,000
B) $1,200,000
C) $300,000
D) None of the above
Q2) Peerless believes that its sales next year will increase 20 percent from the current level of $800,000. Management calculates that assets must increase $110,000 to support the new sales level, and current liabilities will increase $70,000. What total financing will be needed?
A) $40,000
B) $1,600
C) $33,600
D) $8,000
Q3) Explain the cash flow generation process:
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Page 6
Chapter 5: The Time Value of Money
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Sample Questions
Q1) Your firm, New Sunrise, has just leased a $28,000 BMW for you. The lease requires six beginning of the year payments that will fully amortize the cost of the car. What is the amount of the payments if the interest rate is 12 percent?
A) $6,810.99
B) $7,766.99
C) $6,423.74
D) $6,081.25
Q2) The present value of a(n) ____ is determined by dividing the annual cash flow by the interest rate.
A) annuity
B) annuity due
C) perpetuity
D) lease
Q3) What is the present value of $1,000 received 2 years from today if the nominal interest rate is 9% and compounded monthly?
A) $842
B) $914
C) $833
D) $836
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Chapter 6: Fixed Income Securities: Characteristics and Valuation
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Sample Questions
Q1) By the capitalization-of-cash flows method, the value of an asset is a function of
A) the book value of the asset
B) the risk of the asset's cash flows
C) the age of the asset
D) both the book value and the age of the asset
Q2) The required rate of return on an asset is a function of the ____.
A) risk associated with the asset
B) risk-free interest rate
C) age of the asset
D) risk associated with the asset and the risk-free interest rate
Q3) What is the yield to maturity for a Poughkeepsie Gypsy Fortune Tellers' zero coupon bond that matures in 14 years if the bond is selling for $530.00?
A) 5.84%
B) 4.64%
C) 4.28%
D) 5.49%
Q4) List the restrictions that an indenture places on the borrower of long-term debt.
Q5) Explain a sinking fund.
Page 8
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Chapter 7: Common Stock: Characteristics, Valuation, and Issuance
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Sample Questions
Q1) What are some of the costs associated with new security offerings?
Q2) An arrangement whereby an investment banker agrees to purchase an entire new issue of securities is called
A) competitive bidding
B) syndication
C) a negotiated bid
D) underwriting
Q3) Over the past 7 years the dividends of Sunshine Mining have grown from $0.24 to the current level of $.53. What is the approximate annual compound growth rate of Sunshine's dividends?
A) 20.8%
B) 12.0%
C) 9.5%
D) 10.0%
Q4) Common stockholders' claim on assets is considered after which of the following:
A) Board of Directors' pay
B) Preferred Stockholders
C) Both a and b
D) Neither a nor b
Q5) List the responsibilities of investment bankers.
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Chapter 8: Analysis of Risk and Return
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Sample Questions
Q1) Kermit Industries current common stock dividend is $1.35 per share and the dividend is expected to grow at 6% per year into the foreseeable future. Currently the risk-free rate is 4.5% and the estimated market risk premium is 8.5%. Merrill Lynch has estimated KI's beta to be 1.10. Compute the expected price for KI's common stock.
A) $17.20
B) $10.33
C) $18.23
D) $49.35
Q2) Total risk of a security can be viewed as consisting of two parts. Which of the following apply?
I. verifiable risk
II. non-verifiable risk
A) I only
B) II only
C) Both I and II
D) Neither I nor II
Q3) Why is risk an increasing function of time?
Q4) What is an efficient portfolio?
Q5) List types of events that influence systematic (non-diversifiable) risk.
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Chapter 9: Capital Budgeting and Cash Flow Analysis
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Sample Questions
Q1) The net investment calculation for an ____ project normally includes ____.
A) asset expansion; pretax proceeds from the sale of the old asset
B) asset replacement; pretax proceeds from the sale of the old asset
C) asset expansion; after-tax proceeds from the sale of the old asset
D) asset replacement; after-tax proceeds from the sale of the old asset
Q2) Depreciation
A) does not affect cash flows.
B) does not affect profits.
C) is not a cash outflow.
D) is a cash inflow.
Q3) Allen Company is considering an investment project that is expected to generate $100,000 in annual earnings before taxes. Annual depreciation will be $50,000. Allen's marginal tax rate is 40%. Determine the project's annual net cash flows.
A) $150,000
B) $110,000
C) $90,000
D) $60,000
Q4) In classifying investment projects, there are several types of capital expenditures. List them.
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Chapter 10: Capital Budgeting: Decision Criteria and Real
Option Considerations
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Sample Questions
Q1) Axa is replacing an old, fully depreciated extractor with a more efficient machine that will cost $265,000. The new extractor will be depreciated as a 7-year MACRS asset. With the more efficient production, Axa expects annual revenues to increase by $80,000, and annual operating expenses to increase by $25,000. If Axa expects to sell the machine at the beginning of year 6 for $40,000, determine the NPV of this project. Assume the firm's marginal tax rate is 40% and that the firm's cost of capital is 10%. Use the depreciation schedule listed below:
(7-Yr Dep. Schedule: 14.29%, 24.49%, 17.49%, 12.49%, 8.93%, 8.92%, 8.93%, 4.46%)
A) -$46,283
B) -$42,855
C) -$40,773
D) -$38,105
Q2) What is the internal rate of return for a project that has a net investment of $60,000 and the following net cash flows: Year 1 = $15,000; Year 2 = $20,000; Year 3 = $25,000; Year 4 = $30,000?
A) 17.3%
B) 16.7%
C) 15.7%
D) 16.3%
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Chapter 11: Capital Budgeting and Risk
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Sample Questions
Q1) The use of sensitivity analysis requires that A) a model of a project's cash flows be developed
B) probability distributions of the determinants of a project's cash flows be estimated
C) the firms have access to a very large computer
D) the firm is greatly interested in the portfolio risk reduction characteristics of a project
Q2) Technico plans to start a new product division that will have a capital structure of 70 percent debt and 30 percent equity. The levered beta for this division has been estimated to be 2.02. What will be Technico's weighted cost of capital for this new division if the after-tax cost of debt is 7 percent, the risk-free rate is 8 percent, and the market risk premium is 5 percent?
A) 14.77%
B) 10.33%
C) 18.1%
D) 1.03%
Q3) How and when should firms consider employing additional risk analysis techniques in judging the suitability of large projects prior to implementation?
Q4) What are the weaknesses of the net present value/payback approach?
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Chapter 12: The Cost of Capital
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Sample Questions
Q1) The optimal capital budget is determined by comparing the expected project returns to the company's
A) computed break points
B) cost of equity schedule
C) marginal cost of capital schedule
D) optimal opportunity curve
Q2) In determining the cost of debt, several factors must be considered. All of the following are those factors EXCEPT:
A) the firm's before-tax cost of debt
B) the firm's tax rate
C) flotation costs
D) the firm's growth rate of dividends
Q3) In considering the SML concept, the required returns for any individual security are dependent on certain values. List and discuss those values.
Q4) ____ refers to the variability in the firm's operating earnings.
A) Business risk
B) Financial risk
C) Marketability risk
D) Interest rate risk
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Chapter 13: Capital Structure Concepts
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Sample Questions
Q1) What is the present value of the tax shield to a firm that has a capital structure consisting of $100 million of perpetual debt and $180 million of equity, if the average interest rate on debt is 9%, the return on equity is 13%, and the marginal tax rate is 40%?
A) $72 million
B) $40 million
C) $60 million
D) $3.6 million
Q2) What is the market value of Barings, a firm with total assets of $100 million and $30 million in perpetual debt in its capital structure. Barings' cost of equity is 15% and its cost of debt is 10%. Expected perpetual net operating income (EBIT) will be $17 million and the marginal tax rate is 40%.
A) $86.0 million
B) $104.0 million
C) $98.0 million
D) $92.7 million
Q3) Explain how industry effects need to be considered in the capital structure decision.
Q4) There are many factors that influence a firm's business risk. List them.
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Chapter 14: Capital Structure Management in Practice
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Sample Questions
Q1) Financial leverage causes a firm's ____ to change at a rate greater than the change in ____.
A) EBIT; EPS
B) EPS; EBIT
C) EBIT; sales
D) sales; EBIT
Q2) In the analysis of financial leverage, all of the following are referred to as fixed charges except:
A) bond interest
B) common stock dividends
C) bank interest
D) preferred stock dividends
Q3) A firm which has a 2.5 DOL (degree of operating leverage) would find that an 8% increase in EBIT would result from a ____ increase in sales.
A) 3.2%
B) 5.4%
C) 20.0%
D) 2.0%
Q4) In what way does management's willingness to assume risk impact the firm?
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Chapter 15: Dividend Policy
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Sample Questions
Q1) Determine the balance in the retained earnings account after the stock dividend.
A) $4,000,000
B) $1,375,000
C) $2,750,000
D) $1,250,000
Q2) In the theoretical world of Miller and Modigliani
A) a firm should pay out 100 percent of earnings as dividends to maximize shareholder wealth
B) the marginal tax rates facing investors are the most important single determinant of dividend policy
C) dividends are important only for their informational content
D) dividends reduce investors' uncertainty
Q3) Nova earned $7.20 per share and maintains a stable payout ratio of 60 percent. Nova has 1,000,000 shares outstanding and a capital budget of $5 million. If Nova maintains a debt ratio of 0.50, what were the dividends per share?
A) $4.32
B) $2.88
C) $2.20
D) cannot be determined from the information provided
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Page 17
Chapter 16: Working Capital Policy and Short-term Financing
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Q1) The firm's inventory conversion period (measured in days) is equal to its average inventory divided by its ____.
A) cost of sales
B) sales
C) cost of sales/365
D) none of the above
Q2) A firm's operating cycle is equal to its ____.
A) inventory conversion period plus receivables conversion period
B) cash conversion cycle minus payables deferral period
C) a and b
D) none of the above
Q3) All other things being equal, a policy of financing its assets with a relatively ____ proportion of short-term debt will tend to result in ____ expected after-tax earnings for the firm.
A) large, lower
B) constant, higher
C) constant, lower
D) large, higher
Q4) What is financial forecasting?
Q5) What are the classifications for short-term lenders and how do they differ?
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Chapter 17: The Management of Cash and Marketable Securities
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Sample Questions
Q1) Dupree Funds is considering the fees charges by two banks. First America charges a flat rate of $0.11 per payment and First Western requires a minimum compensating balance of $500,000, plus $0.05 per payment. What is the number of payments per year where the costs of the two banks will be equal? Assume Dupree's costs of funds is 9%.
A) 281,250
B) 750,000
C) 900,000
D) 409,091
Q2) Explain why firms would want to maintain a bank balance exceeding the compensating balance requirements.
Q3) Which of the following types of marketable securities is considered to have the lowest default risk?
A) bankers' acceptances
B) U.S. Treasury issues
C) repurchase agreements
D) commercial paper
Q4) Name the three primary components (or sources) of float:
Q5) When and why is it best to use lockboxes? Explain when should alternative methods be used.
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Chapter 18: Management of Accounts Receivable and Inventories
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Sample Questions
Q1) Capacity, which is one of the traditional "five Cs" of credit analysis, refers to
A) the general economic climate and its effect on the applicant's ability to pay
B) the willingness of the applicant to meet its financial obligations
C) the financial strength of the applicant (i.e., net worth)
D) the ability of an applicant to meet its financial obligations
Q2) To minimize the possibility of running out of inventory, most companies add a ____ to their inventory.
A) safety stock
B) lead time stock level
C) few days
D) replenishment factor
Q3) The ____ measures the promptness with which customers repay their credit obligations.
A) bad-debt loss ratio
B) average collection period
C) credit term
D) cash discount
Q4) How does an optimal credit extension policy impact a company's accounts receivables?
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Chapter 19: Lease and Intermediate-term Financing
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Q1) Which of the following leases is not likely to be viewed as a lease from the perspective of the Internal Revenue Service?
A) a 20 year lease for an asset having an economic life estimated to be 40 years
B) a lease offering a renewal option based on the asset's remaining value at the time of the renewal
C) a lease providing for a purchase option at the end of the lease period for a nominal sum
D) a leveraged lease in which the lessor contributes 40 percent equity
Q2) Contech (lessee) wishes to lease a printing press valued at $60,000 from Wrenn Capital (lessor) for a period of 4 years. Wrenn expects to depreciate the asset on a straight-line basis to a salvage value of $0. Actual salvage value is expected to be $8,000 at the end of 4 years. If Wrenn requires a 12 percent after-tax return on the lease, what is the lease payment that Wrenn will require from Contech? Assume a marginal tax rate of 40%. Under the terms of the lease, payments will be made at the beginning of each of the 4 years.
A) $11,385
B) $28,463
C) $18,975
D) $21,252
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Chapter 20: Financing With Derivatives
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Q1) Conversion of a convertible security can occur in two ways. Which of the following is/are correct?
I. It can be a voluntary conversion at specific times prior to the expiration date.
II. It can be a forced conversion at any time prior to the expiration date.
A) I only
B) II only
C) Both I and II
D) Neither I nor II
Q2) The market value of a convertible debt issue is usually above the A) conversion ratio
B) conversion value
C) straight-bond value
D) higher of either the conversion value or the straight-bond value
Q3) Which companies are the primary issuers of convertible securities and why do they do it?
Q4) What is an interest rate swap? Describe how they are used.
Q5) What variables affect the call option valuation?
Q6) Explain how conversion of a convertible security affects earnings and how does a firm handle this on its financial statements?
Page 22
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Chapter 21: Risk Management
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Q1) Which of the following is a firm-specific asset?
A) Sewing machines designed for the manufacture of summer and winter clothes.
B) Fire-retardant paint in lime green.
C) Auto plant that can produce six styles of vehicles.
D) A manufacturing plant that makes spiral staircases, wood railings and stairway carpeting.
Q2) All of the following are reasons to reduce financial distress EXCEPT:
A) enhanced debt capacity.
B) reduced WACC.
C) better currency exchange ratio.
D) ensure adequate cash flows.
Q3) A short hedge requires the ____ a futures contract.
A) margining
B) creating
C) buying of
D) selling of
Q4) What is marking-to-market and how is this process guaranteed?
Q5) How does hedging reduce or eliminate business risks?
Q6) What options does the buyer of a futures contract have at the time the futures contract matures?
Page 23
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Chapter 22: International Financial Management
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Q1) Firms engaged in international transactions incur ____ because of fluctuations in the exchange rates among currencies.
A) credit risk
B) political risk
C) market risk
D) exchange rate risk
Q2) Which of the following actions would not tend to increase the value of a country's currency?
A) relatively low interest rates
B) government trade policies that limit imports
C) relatively low rate of inflation
D) restrictions on foreign exchange transactions
Q3) In general, when a foreign subsidiary's assets are ____ than its liabilities, ____ will occur when the exchange rate on the currency of the country in which the foreign subsidiary operates loses value.
A) greater, currency exchange gains
B) greater, currency exchange losses
C) less, nothing
D) greater, nothing
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Chapter 23: Corporate Restructuring
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Q1) A(n) ____ is a situation in which a failing business is permitted to discharge its debt obligations by paying less than the full amounts owed to creditors.
A) assignment
B) composition
C) extension
D) insolvency
Q2) In a ____, the acquiring company effectively announces that it will pay a certain price above the current existing price for a merger candidate's shares.
A) leveraged buyout
B) tender offer
C) equity carve-out
D) divestiture
Q3) A combination of two or more companies that compete directly with each other is known as a
A) conglomerate merger
B) vertical merger
C) horizontal merger
D) takeover
Q4) A new takeover defense is boardmail. How does it work?
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Chapter 24: Continuous Compounding and Discounting
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Q1) Jane deposited $1000 into a saving account paying 12% interest compounded continuously. After 45 years, how much money did she have in the account?
A) $25, 759.09
B) $157,896.32
C) $221,406.42
D) $257,895.78
Q2) What continuously compounded effective rate of interest will yield the same present value of a future cash flow as an annual rate of interest of 2.25%?
A) 2.23%
B) 3.15%
C) .95%
D) 1.28%
Q3) What is the effective interest rate on 12% if interest is compounded continuously?
A) 15.11%
B) 16.25%
C) 14.11%
D) 12.75%
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Chapter 25: Mutually Exclusive Investments Having Unequal Lives
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Q1) Using a replacement chain, which project should be chosen? Assume that in 5 years, Project A will still cost $120,000 and produce 5 more years of $37,000 annual net cash flows.
A) Project B. NPV of A is negative
B) Project A. NPV of B is negative
C) Project B. NPV is $492 higher
D) Project A. NPV is $6,468 higher
Q2) Marvec needs to replace an extruder and two replacements look good. Extruder A costs $102,000 and has a 10 year life. Extruder B costs only $56,000 but its expected life is 6 years. Extruder A will generate net cash flows of $17,600 per year for 10 years and B will generate net cash flows of $13,800 per year for 6 years. If Marvec's cost of capital is 11%, which extruder should be chosen and what is its NPV? Use equivalent annual annuities.
A) B, $564
B) B, $2,388
C) A, $1,646
D) A, $280
Q3) The importance of time discrepancies depends on several items when making capital budgeting decisions. State those items:
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Chapter 26: Breakeven Analysis
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Q1) Another name for breakeven analysis is:
A) cost-volume-profit analysis
B) graphic analysis
C) EBIT-EPS analysis
D) degree of operating leverage
Q2) The breakeven point occurs where total revenues intersect with:
A) market returns
B) the risk-free rate
C) total costs
D) total interest and taxes
Q3) An example of a noncash outlay is:
A) property
B) marketing costs
C) advertising
D) depreciation
Q4) The contribution margin per unit is the difference between:
A) the selling price per unit and fixed costs
B) the fixed costs and the variable costs
C) the variable cost per unit and the selling price per unit
D) the variable costs and the number of units sold
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Chapter 27: Bond Refunding Analysis
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Q1) In a bond refunding analysis, the net investment calculation includes
A) aftertax call premium
B) flotation cost of new debt
C) overlapping interest
D) all of the above
Q2) Clinch River Power is considering refunding a $150 million 12% coupon bond with a 10% coupon bond, 20 year bond. The current bond also matures in 20 years and is now callable at 110% of par. The unamortized flotation cost on the old issue is $540,000 and the flotation cost of the new issue is 0.925%. Clinch River estimates that there would be a 4 week period where both bonds would be outstanding. The company has a weighted cost of capital of 11% and a 40% marginal tax rate. Should Clinch River sell the refunding issue?
A) Yes, NPV is approximately $9.838 million
B) Yes, NPV is approximately $9.930 million
C) Yes, NPV is approximately $9.655 million
D) Yes, NPV is approximately $10.808 million
Q3) What is the principal inflow and what is the principal outflow from a bond refunding situation?
Q4) Why is the after-tax cost of debt used in bond refunding analysis?
Q5) Why would a corporation consider bond refunding?
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Chapter 28: Taxes
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Sample Questions
Q1) How are dividends received by a corporation treated for tax purposes?
Q2) AMX corporation had operating income of $420,000 in 2010; received $12,000 in interest income; paid $22,000 in interest; received $20,000 in dividends; and paid $50,000 in dividends. What is the tax liability for AMX?
A) $141,440
B) $146,200
C) $148,920
D) none of the above
Q3) Last year Cell 2 had a net operating loss of $120,000 and a capital loss of $80,000. This year (2010) the firm has an operating income of $230,000 and a capital gain of $40,000. What is Cell 2's tax liability this year? Assume there are no other tax loss carry backs or carry forwards.
A) $4,500
B) $72,950
C) $26,150
D) $12,500
Q4) Explain the difference between average tax rate and marginal tax rate.
Q5) How does a tax loss affect a corporation as it applies to past and future income?
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