Applied Corporate Finance
Practice Questions
Course Introduction
Applied Corporate Finance focuses on the practical application of financial theories and concepts within real-world business contexts. The course covers key topics such as capital budgeting, risk assessment, capital structure, dividend policy, valuation, and financial planning. Through case studies, financial modeling, and hands-on projects, students learn how financial managers make investment and financing decisions to maximize firm value. Emphasizing both quantitative analysis and strategic thinking, the course equips students with the skills needed to analyze financial data, assess corporate financial health, and implement value-enhancing strategies within organizations.
Recommended Textbook Corporate Finance A Focused Approach 6th Edition by Michael C. Ehrhardt
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Chapter 1: An Overview of Financial Management and the Financial Environment
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Sample Questions
Q1) The primary operating goal of a publicly-owned firm interested in serving its stockholders should be to
A) Maximize the stock price per share over the long run, which is the stock's intrinsic value.
B) Maximize the firm's expected EPS.
C) Minimize the chances of losses.
D) Maximize the firm's expected total income.
E) Maximize the stock price on a specific target date.
Answer: A
Q2) Two disadvantages of a proprietorship are (1) the relative difficulty of raising new capital and (2) the owner's unlimited personal liability for the business' debts.
A)True
B)False
Answer: True
Q3) One key value of limited liability is that it lowers owners' risks and thereby enhances a firm's value.
A)True
B)False
Answer: True
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Chapter 3: Analysis of Financial Statements
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Sample Questions
Q1) 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
Q2) Emerson Inc.'s would like to undertake a policy of paying out 45% of its income. Its latest net income was $1,250,000, and it had 225,000 shares outstanding. What dividend per share should it declare?
A) $2.14
B) $2.26
C) $2.38
D) $2.50
E) $2.63
Answer: D
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Chapter 4: Time Value of Money
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Sample Questions
Q1) You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would increase the calculated value of the investment?
A) The discount rate increases.
B) The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for 10 years rather than 5 years, hence that each payment is for $10,000 rather than for $20,000.
C) The discount rate decreases.
D) The riskiness of the investment's cash flows increases.
E) The total amount of cash flows remains the same, but more of the cash flows are received in the later years and less are received in the earlier years.
Q2) Disregarding risk, if money has time value, it is impossible for the present value of a given sum to exceed its future value.
A)True
B)False
Q3) A "growing annuity" is any cash flow stream that grows over time.
A)True
B)False
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Chapter 5: Bonds, Bond Valuation, and Interest Rates
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Sample Questions
Q1) Chandler Co.'s 5-year bonds yield 7.00%, and 5-year T-bonds yield 5.15%. The real risk-free rate is r* = 3.0%, the inflation premium for 5-year bonds is IP = 1.75%, the liquidity premium for Chandler's bonds is LP = 0.75% versus zero for T-bonds, and the maturity risk premium for all bonds is found with the formula MRP = (t 1) × 0.1%, where t = number of years to maturity. What is the default risk premium (DRP) on Chandler's bonds?
A) 0.99%
B) 1.10%
C) 1.21%
D) 1.33%
E) 1.46%
Q2) Under normal conditions, which of the following would be most likely to increase the coupon rate required to enable a bond to be issued at par?
A) Adding a call provision.
B) The rating agencies change the bond's rating from Baa to Aaa.
C) Making the bond a first mortgage bond rather than a debenture.
D) Adding a sinking fund.
E) Adding additional restrictive covenants that limit management's actions.
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Chapter 6: Risk, Return, and the Capital Asset Pricing Model
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Sample Questions
Q1) DHF Company has a beta of 1.5 and is currently in equilibrium. The required rate of return on the stock is 12.00% versus a required return on an average stock of 10.00%. Now the required return on an average stock increases by 30.0% (not percentage points). Neither betas nor the risk-free rate change. What would DHF's new required return be?
A) 14.89%
B) 15.68%
C) 16.50%
D) 17.33%
E) 18.19%
Q2) According to the Capital Asset Pricing Model, investors are primarily concerned with portfolio risk, not the risks of individual stocks held in isolation. Thus, the relevant risk of a stock is the stock's contribution to the riskiness of a well-diversified portfolio.
A)True
B)False
Q3) The slope of the SML is determined by the value of beta.
A)True
B)False
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Chapter 7: Stocks, Stock Valuation, and Stock Market
Equilibrium
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Sample Questions
Q1) Classified stock differentiates various classes of common stock, and using it is one way companies can meet special needs such as when owners of a start-up firm need additional equity capital but don't want to relinquish voting control.
A)True
B)False
Q2) Young & Liu Inc.'s free cash flow during the just-ended year (t = 0) was $100 million, and FCF is expected to grow at a constant rate of 5% in the future. If the weighted average cost of capital is 15%, what is the firm's value of operations, in millions?
A) $948
B) $998
C) $1,050
D) $1,103
E) $1,158
Q3) The constant growth dividend model used to evaluate the prices of common stocks is conceptually similar to the model used to find the price of perpetual preferred stock or other perpetuities.
A)True
B)False
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Chapter 8: Financial Options and Applications in Corporate Finance
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Q1) If a stock's price is above the strike price of a call option written on the stock, then the exercise value is equal to the stock price minus the strike price. If the stock price is below the strike price, the exercise value of the call option is zero.
A)True
B)False
Q2) BLW Corporation is considering the terms to be set on the options it plans to issue to its executives. Which of the following actions would decrease the value of the options, other things held constant?
A) The exercise price of the option is increased.
B) The life of the option is increased, i.e., the time until it expires is lengthened.
C) The Federal Reserve takes actions that increase the risk-free rate.
D) BLW's stock price becomes more risky (higher variance).
E) BLW's stock price suddenly increases.
Q3) Since investors tend to dislike risk and like certainty, the more volatile a stock, the less valuable will be an option to purchase the stock, 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) The cost of debt, r<sub>d</sub>, is normally less than r<sub>s</sub>, so r<sub>d</sub>(1 T) will normally be much less than r<sub>s</sub>. Therefore, as long as the firm is not completely debt financed, the weighted average cost of capital (WACC) will normally be greater than r<sub>d</sub>(1 T).
A)True
B)False
Q2) Bartlett Company's target capital structure is 40% debt, 15% preferred, and 45% common equity. The after-tax cost of debt is 6.00%, the cost of preferred is 7.50%, and the cost of common using reinvested earnings is 12.75%. The firm will not be issuing any new stock. You were hired as a consultant to help determine their cost of capital. What is its WACC?
A) 8.98%
B) 9.26%
C) 9.54%
D) 9.83%
E) 10.12%
Q3) "Capital" is sometimes defined as funds supplied to a firm by investors.
A)True
B)False
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Chapter 10: The Basics of Capital Budgeting: Evaluating Cash Flows
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Sample Questions
Q1) If you were evaluating two mutually exclusive projects for a firm with a zero cost of capital, the payback method and NPV method would always lead to the same decision on which project to undertake.
A)True
B)False
Q2) Which of the following statements is CORRECT?
A) One defect of the IRR method versus the NPV is that the IRR does not take account of the time value of money.
B) One defect of the IRR method versus the NPV is that the IRR does not take account of the cost of capital.
C) One defect of the IRR method versus the NPV is that the IRR values a dollar received today the same as a dollar that will not be received until sometime in the future.
D) One defect of the IRR method versus the NPV is that the IRR does not take proper account of differences in the sizes of projects.
E) One defect of the IRR method versus the NPV is that the IRR does not take account of cash flows over a project's full life.
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Chapter 11: Cash Flow Estimation and Risk Analysis
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Sample Questions
Q1) Which of the following statements is CORRECT?
A) In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure to include interest expense as a cost when determining the project's cash flows will lead to a downward bias in the NPV.
B) The existence of any type of "externality" will reduce the calculated NPV versus the NPV that would exist without the externality.
C) If one of the assets to be used by a potential project is already owned by the firm, and if that asset could be sold or leased to another firm if the new project were not undertaken, then the net after-tax proceeds that could be obtained should be charged as a cost to the project under consideration.
D) If one of the assets to be used by a potential project is already owned by the firm but is not being used, then any costs associated with that asset is a sunk cost and should be ignored.
E) In a capital budgeting analysis where part of the funds used to finance the project would be raised as debt, failure to include interest expense as a cost when determining the project's cash flows will lead to an upward bias in the NPV.
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Chapter 12: Financial Planning and Forecasting Financial Statements
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Sample Questions
Q1) If Decker had a financing deficit, it could remedy the situation by
A) buying back common stock
B) paying a special dividend
C) paying down its long-term debt
D) borrowing on its line of credit
E) borrowing from retained earnings
Q2) The AFN equation assumes that the ratios of assets and liabilities to sales remain constant over time. However, this assumption can be relaxed when we use the forecasted financial statement method. Three conditions where constant ratios cannot be assumed are economies of scale, lumpy assets, and excess capacity.
A)True
B)False
Q3) The capital intensity ratio is the amount of assets required per dollar of sales and it has a major impact on a firm's capital requirements.
A)True
B)False
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Chapter 13: Corporate Valuation, Value-Based Management and
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Sample Questions
Q1) A poison pill is also known as a corporate restructuring.
A)True
B)False
Q2) 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
Q3) 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
Q4) ESOPs were originally designed to help improve worker productivity, but today they are also used to help prevent hostile takeovers.
A)True
B)False
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Chapter 14: Distributions to Shareholders: Dividends and Repurchases
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Sample Questions
Q1) United Builders wants to maintain a target capital structure with 30% debt and 70% equity. Its forecasted net income is $550,000, and because of market conditions, the company will not issue any new stock during the coming year. If the firm follows the residual dividend policy, what is the maximum capital budget that is consistent with maintaining the target capital structure?
A) $673,652
B) $709,107
C) $746,429
D) $785,714
E) $825,000
Q2) David Rose Inc. forecasts a capital budget of $500,000 next year with forecasted net income of $400,000. The company wants to maintain a target capital structure of 30% debt and 70% equity. If the company follows the residual dividend policy, how much in dividends, if any, will it pay?
A) $42,869
B) $45,125
C) $47,500
D) $50,000
E) $52,500
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Chapter 15: Capital Structure Decisions
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Q1) 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
Q2) A firm's capital structure does not affect its calculated free cash flows, because FCF reflects only operating cash flows.
A)True
B)False
Q3) If Miller and Modigliani had incorporated the costs of bankruptcy into their model, it is unlikely that they would have concluded that 100% debt financing is optimal.
A)True
B)False
Q4) The MM model is the same as the Miller model, but with zero corporate taxes.
A)True
B)False
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Chapter 16: Working Capital Management
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Q1) Which of the following statement completions is CORRECT? If the yield curve is upward sloping, then the marketable securities held in a firm's portfolio, assumed to be held for emergencies, should
A) consist mainly of short-term securities because they pay higher rates.
B) consist mainly of U.S. Treasury securities to minimize interest rate risk.
C) consist mainly of short-term securities to minimize interest rate risk.
D) be balanced between long- and short-term securities to minimize the adverse effects of either an upward or a downward trend in interest rates.
E) consist mainly of long-term securities because they pay higher rates.
Q2) Cash is often referred to as a "non-earning" asset. Thus, one goal of cash management is to minimize the amount of cash necessary for conducting a firm's normal business activities.
A)True
B)False
Q3) "Stretching" accounts payable is a widely accepted, entirely ethical, and costless financing technique.
A)True
B)False
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Chapter 17: Multinational Financial Management
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Q1) If the inflation rate in the United States is greater than the inflation rate in Britain, other things held constant, the British pound will
A) Depreciate against the U.S. dollar.
B) Remain unchanged against the U.S. dollar.
C) Appreciate against other major currencies.
D) Appreciate against the dollar and other major currencies.
E) Appreciate against the U.S. dollar.
Q2) Exchange rate quotations consist solely of direct quotations.
A)True
B)False
Q3) 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
Q4) The United States and most other major industrialized nations currently operate under a system of floating exchange rates.
A)True
B)False
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