Business Finance
Chapter Exam Questions
Course Introduction
Business Finance is a foundational course that explores the principles and practices involved in financial management within organizations. It covers key topics such as financial statement analysis, budgeting, capital structure, working capital management, time value of money, risk assessment, and investment decision-making. Through theoretical concepts and practical case studies, students learn how businesses allocate resources, manage financial risks, evaluate funding options, and maximize shareholder value. The course also examines the role of financial markets and instruments in supporting corporate financial activities, providing students with essential tools for sound financial decision-making in real-world business scenarios.
Recommended Textbook Fundamentals of Corporate Finance 3rd Eition by Jonathan Berk
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Chapter 1: Corporate Finance and the Financial Manager
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Q1) A corporate raider gains a controlling fraction of the shares of a poorly managed company and replaces the board of directors. How does the corporate raider hope to make a profit in this case?
A)by the sale of the assets held by the company that hold most of its value
B)by the rise in the value of the stock held by the raider when the new board of directors is judged to be superior to the ousted board of directors
C)by motivating the board of directors and other stakeholders in the company to make difficult short-term decisions that will increase the long-term viability of the company
D)by removing the employees expectations of the continued poor performance of the company
Answer: B
Q2) Over four-fifths of all U.S. business revenue is generated by which type of firms?
A)sole proprietorships
B)partnerships
C)limited partnerships
D)corporations
Answer: D
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Chapter 2: Introduction to Financial Statement Analysis
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Q1) A manufacturer of plastic bottles for the medical trade purchases a new compression blow molder for its bottle production plant. How will the cost to the company of this piece of equipment be recorded?
A)It will be depreciated over time on the income statement and subtracted as a capital expenditure on the statement of cash flows.
B)It will be depreciated over time on the income statement and subtracted as Inventory on the statement of cash flows.
C)It will be depreciated over time on the income statement and therefore not be recorded separately on the statement of cash flows.
D)It will be subtracted from Gross Profit on the income statement and therefore, not be recorded separately on the statement of cash flows.
Answer: A
Q2) How can we cross check the statement of cash flows?
Answer: The last item in the statement of cash flows should equal the difference in cash balances between two adjacent balance sheets.
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Chapter 3: Time Value of Money: an Introduction
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Q1) A firm has contracted to supply 500,000 gallons of propane fuel for $1.46 million to the local municipality. The municipality wants to break the contract. What does the minimum current market price of propane need to be in order for the firm to benefit from breaking the contract?
A)greater than $2.90 per gallon
B)greater than $2.92 per gallon
C)greater than $2.94 per gallon
D)greater than $2.96 per gallon
Answer: B
Q2) Whenever a good trades in a competitive market, the ________ determines the value of the good.
A)supply
B)price
C)demand
D)cost
Answer: B
Q3) How does arbitrage help the Law of One Price?
Answer: Any arbitrage opportunity will exploit any mispricing to restore the Law of One Price.
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Chapter 4: Time Value of Money: Valuing Cash Flow
Streams
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Q1) Define the following terms:
(a)perpetuity
(b)annuity
(c)growing perpetuity
(d)growing annuity
Q2) What is the present value (PV)of an investment that will pay $500 in one year's time, and $500 every year after that, when the interest rate is 10%?
A)$2500
B)$4000
C)$3000
D)$5000
Q3) A bank offers a home buyer a 20-year loan at 8% per year. If the home buyer borrows $130,000 from the bank, how much must be repaid every year?
A)$15,888.95
B)$18,537.11
C)$21,185.26
D)$13,240.79
Q4) Can we apply the growing perpetuity equation for negative growth as well?
6
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Chapter 5: Interest Rates
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Q1) You are considering purchasing a new automobile with the upfront cost of $26,000 or leasing it from the dealer for a period of 48 months. The dealer offers you 2.80% APR financing for 48 months (with payments made at the end of the month). Assuming you finance the entire $26,000 through the dealer, your monthly payments will be closest to
A)$459
B)$688
C)$573
D)$802
Q2) Your firm needs to invest in a new delivery truck. The life expectancy of the delivery truck is five years. You can purchase a new delivery truck for an upfront cost of $300,000, or you can lease a truck from the manufacturer for five years for a monthly lease payment of $6000 (paid at the end of each month). Your firm can borrow at 8.00% APR with quarterly compounding. The monthly discount rate that you should use to evaluate the truck lease is closest to ________.
A)0.5298%
B)0.7947%
C)0.6623%
D)0.6667%
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Chapter 6: Bonds
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Q1) The above information is for a corporate bond issued by the Markel Corporation. What sort of bond is this?
A)a high-risk bond
B)an investment grade bond
C)a speculative bond
D)a high-yield bond
Q2) Which of the following best illustrates why a bond is a type of loan?
A)The issuers of bonds make regular payments to bondholders.
B)When a company issues a bond, the buyer of that bond becomes an owner of the issuing company.
C)Funds raised are used to finance long-term projects.
D)When an investor buys a bond from an issuer, the investor is giving money to the issuer, with the assurance that it will be repaid at a date in the future.
Q3) What care, if any, should be taken regarding the timing of the cash flows while drawing the timeline and associated cash flows of a coupon bond?
Q4) How are the cash flows of a coupon bond different from an amortizing loan?
Q5) Under what situation can a zero-coupon bond be selling at par to its face value?
Q6) Under what situation can a zero-coupon bond be selling at a premium?
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Chapter 7: Stock Valuation
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Q1) Which of the following statements is FALSE?
A)Estimating dividends, especially for the distant future, is difficult.
B)A firm can only pay out its earnings to investors or reinvest their earnings.
C)Successful young firms often have high initial earnings growth rates.
D)According to the constant dividend growth model, the value of the firm depends on the current dividend level, divided by the equity cost of capital plus the grow rate.
Q2) Jumbo Transport, an air-cargo company, expects to have earnings per share of $2.00 in the coming year. It decides to retain 10% of these earnings in order to lease new aircraft. The return on this investment will be 25%. If its equity cost of capital is 11%, what is the expected share price of Jumbo Transport?
A)$12.71
B)$14.83
C)$16.94
D)$21.18
Q3) Assuming everything else remains unchanged, how does a firm's decision to increase its dividend-payout ratio affect its growth rate?
Q4) What role do dividends play in stock investing?
Q5) Can the dividend-discount model handle negative growth rates?
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Chapter 8: Investment Decision Rules
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Q1) A security company offers to provide CCTV coverage for a parking garage for ten years for an initial payment of $50,000 and additional payments of $30,000 per year. What is the equivalent annual annuity of this deal, given a cost of capital of 5%?
A)-$21,885
B)-$25,533
C)-$29,180
D)-$36,475
Q2) The owner of a hair salon spends $1,000,000 to renovate its premises, estimating that this will increase her cash flow by $220,000 per year. She constructs the above graph, which shows the net present value (NPV)as a function of the discount rate. If her discount rate is 6%, should she accept the project?
A)Yes, because the NPV is positive at that rate.
B)No, because the NPV is negative at that rate.
C)No, because the NPV is positive at that rate.
D)Cannot be determined from the information given.
Q3) What is the decision criteria using internal rate of return (IRR)rule?
Q4) How can you calculate the y-intercept of a net present value (NPV)profile without using TVM concepts?
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Chapter 9: Fundamentals of Capital Budgeting
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Q1) A company planning to market a new model of motor scooter analyzes the effect of changes in the selling price of the motor scooter, the number of units that will be sold, the cost of making the motor scooter, the effect on Net Working Capital, and the cost of capital for the project. They predict that the break-even point for sales price for the motor scooter is $2,480. What does this mean?
A)If the motor scooter is sold for $2,480, then the project will make a profit.
B)If the motor scooter is sold for $2,480, then the net present value (NPV)for the product will be zero.
C)The predicted selling price of the motor scooter is $2,480.
D)The maximum that the motor scooter can sell for and still make the project have a positive net present value (NPV)is $2,480.
Q2) Which of the following is an example of cannibalization?
A)A toothpaste manufacturer adds a new line of toothpaste (that contains baking soda)to its product line.
B)A grocery store begins selling T-shirts featuring the local university's mascot.
C)A basketball manufacturer adds basketball hoops to its product line.
D)A convenience store begins selling pre-paid cell phones.
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Chapter 10: Stock Valuation: a Second Look
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Q1) If you want to value a firm but do not want to explicitly forecast its dividends, the simplest model for you to use is ________.
A)the discounted free cash flow model
B)the dividend-discount model
C)the enterprise value model
D)None of the above models can be used if you do not want to forecast dividends or use of debt.
Q2) Which is the best valuation technique when using comparables?
Q3) On a particular day, a mining company reveals that, due to new extraction technology, the extractable yield from several of its nickel/lead mines has risen by 15%. Which of the following is the LEAST likely consequence of such an announcement?
A)The price of the stock would rise.
B)Investors would determine that the estimates of the firm's value on the date prior to the announcement were too high.
C)Investors would increase their forecast of future cash flows in that firm.
D)Investors would revise their estimates of the net present value (NPV)of the firm.
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Chapter 11: Risk and Return in Capital Markets
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Q1) Is volatility a reasonable measure of risk when evaluating the investment in a single stock?
Q2) The risk that inflation rates are likely to increase in the next year is an example of common risk.
A)True
B)False
Q3) What is the diversification achieved by an investor if he invests in Exxon Mobil, Dell, and Bank of America?
Q4) Which of the following statements is FALSE?
A)Investments with higher volatility have rewarded investors with higher average returns.
B)Investments with higher volatility should have a higher risk premium and, therefore, higher returns.
C)Volatility seems to be a reasonable measure of risk when evaluating returns on large portfolios and the returns of individual securities.
D)Riskier investments must offer investors higher average returns to compensate them for the extra risk they are taking on.
Q5) Which type of investment has historically had the highest volatility?
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Chapter 12: Systematic Risk and the Equity Risk Premium
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Q1) Your estimate of the market risk premium is 6%. The risk-free rate of return is 4%, and General Motors has a beta of 1.6. According to the Capital Asset Pricing Model (CAPM), what is its expected return?
A)12.2%
B)12.9%
C)13.6%
D)14.3%
Q2) For each 1% change in the market portfolio's excess return, the investment's excess return is expected to change by ________ due to risks that it has in common with the market.
A)beta
B)alpha
C)0%
D)1%
Q3) If you build a large enough portfolio, you can diversify away all the risks of a portfolio.
A)True
B)False
Q4) Is it possible for a stock to have high total risk but low systematic risk?
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Chapter 13: The Cost of Capital
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Q1) Assume Ford Motor Company is discussing new ways to recapitalize the firm and raise additional capital. Its current capital structure has a 10% weight in equity, 20% in preferred stock, and 70% in debt. The cost of equity capital is 16%, the cost of preferred stock is 10%, and the pretax cost of debt is 8%. What is the weighted average cost of capital for Ford if its marginal tax rate is 40%?
A)6.61%
B)6.96%
C)7.31%
D)7.66%
Q2) A firm raised all its capital via equity rather than debt. Such a firm is also referred to as a(n)________ firm.
A)levered
B)margined
C)risk less
D)unlevered
Q3) A firm's cost of debt is the rate of interest it would have to pay to refinance its existing debt.
A)True
B)False
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Chapter 14: Raising Equity Capital
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Q1) You founded your own firm three years ago. You initially contributed $200,000 of your own money and in return you received 3 million shares of stock. Since then, you have sold an additional 2 million shares of stock to angel investors. You are now considering raising capital from a venture capital firm. This venture capital firm would invest $4 million and would receive 2 million newly issued shares in return. Assuming that this is the venture capitalist's first investment in your firm, what percentage of the firm will the venture capitalist own?
A)36%
B)29%
C)17%
D)21%
Q2) Which of the following best describes those shares sold when a company goes public which raise new capital?
A)primary offering
B)secondary offering
C)tertiary offering
D)preliminary offering
Q3) What is the difference between preferred stocks issued by a private company and a mature company?
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Chapter 15: Debt Financing
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Q1) Smithfield Enterprises issues debt with a maturity of 7 years. In the case of bankruptcy, holders of this debt may only claim those assets of the firm that are not already pledged as collateral on other debt. Which of the following best describes this type of corporate debt?
A)a note
B)a mortgage bond
C)an asset-backed bond
D)unsecured debt
Q2) What are notes?
Q3) Clearview Corporation, a company that deals mainly with the financing and distribution of music, issues debt with a maturity of 15 years. In the case of bankruptcy, holders of this debt will have claim to the intellectual property of Clearview. Which of the following best describes this type of corporate debt?
A)a note
B)a debenture
C)a mortgage bond
D)an asset-backed bond
Q4) What is yield to maturity?
Q5) What is yield to worst?
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Chapter 16: Capital Structure
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Q1) The tradeoff theory of optimal capital structure weighs the benefits of debt against the costs of ________.
A)financial distress
B)interest payments
C)dividend reinvestment
D)input factors
Q2) Which of the following statements is FALSE?
A)When a firm borrows money to repurchase shares that account for a significant percentage of its outstanding shares, the transaction is called a leveraged recapitalization.
B)MM Proposition I applies to capital structure decisions made at any time during the life of a firm.
C)By choosing positive-NPV projects that are worth more than their initial investment, a firm can enhance its value.
D)The choice of capital structure does not change the value of a firm if the cost of equity is higher than the cost of debt.
Q3) What are the issues in determining the present value (PV)of financial distress?
Q4) What role do industries play in the capital structure choice for a firm?
Q5) What are direct costs of financial distress?
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Chapter 17: Payout Policy
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Q1) Palo Alto Enterprises has $300,000 in cash. They wish to invest the money in Treasury bills at 8% and use the returns to pay dividends to shareholders after a year. Alternatively, they can pay a dividend and allow shareholders to make the investment. If corporate tax rates are 35%, which option will shareholders prefer?
A)immediate cash dividend
B)dividend after one year
C)prefer half from each source
D)indifferent between options
Q2) The typical reason for a stock split is to ________.
A)allow for growth in the company assets
B)allow liabilities to grow
C)increase earnings per share
D)keep the share price in a range
Q3) According to the ________ theory of payout policy, managers pay out cash only when pressured to do so by investors.
A)agency
B)supply
C)price pressure
D)managerial entrenchment
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Chapter 18: Financial Modeling and Pro Forma Analysis
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Q1) Building a model for long-term forecasting reveals points in the future where the firm will need ________ when retained earnings are not enough to fund planned future investments.
A)external financing
B)stock dividends
C)dividend payments
D)mergers
Q2) LG Inc. has done a long-term forecast of its balance sheet. The projected total assets for the next year are $100 million. The current liabilities are projected to be $40 million and other long term liabilities are $30 million. How much net new financing is needed in the following year?
A)$18 million
B)$22 million
C)$25 million
D)$30 million
Q3) How do we know if expansion is a good idea for the firm?
Q4) Why is EBITDA multiple used for valuation rather than sales or earnings?
Q5) What is the implied assumption in percent of sales method?
Q6) How do we compute net new financing?
Q7) What are a firm's options when it generates more cash than planned?
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Chapter 19: Working Capital Management
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Q1) Jen Industries had sales of $32 million this year and an average accounts receivable of $0.8 million per day. On average, how long does it take to collect on its sales?
A)9 days
B)11 days
C)12 days
D)19 days
Q2) Working capital alters a firm's value by affecting its free cash flow.
A)True
B)False
Q3) Luther's Accounts Receivable days is closest to ________.
A)42 days
B)39 days
C)32 days
D)59 days
Q4) What is a firm's cash cycle?
Q5) What is collection float?
Q6) What are the advantages of holding inventory?
Q7) What is cash discount?
Q8) What is a firm's operating cycle?
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Chapter 20: Short-Term Financial Planning
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Q1) A written, legally binding agreement that obligates the bank to lend a firm any amount up to a stated maximum, regardless of the financial condition of the firm (unless the firm is bankrupt)as long as the firm satisfies any restrictions in the agreement is called ________.
A)a bridge loan
B)a single, end-of-period-payment loan
C)a short-term mortgage loan
D)a committed line of credit
Q2) According to the matching principle, short-term needs for funds should be financed by short-term sources of funds; long-term need for funds should be financed by long-term sources of funds.
A)True
B)False
Q3) In which quarter are Hasbeen's seasonal working capital needs the greatest?
Q4) What do we understand by seasonality?
Q5) What do we understand by positive cash flow shocks?
Page 22
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Chapter 21: Option Applications and Corporate Finance
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Q1) An options contract gives the owner the ________ but not the ________ to buy or sell an asset at a fixed price at some future date.
A)obligation, right
B)right, option
C)right, obligation
D)option, right
Q2) For every owner of a call option there is also an option writer, the person who takes the other side.
A)True
B)False
Q3) The value of an otherwise identical call option is ________ if the strike price the holder must pay to buy the stock is ________.
A)higher, higher
B)lower, lower
C)higher, lower
D)none of the above
Q4) When is an option at-the-money?
Q5) What is the short position of an options contract?
Q6) When is an option in-the-money?
23
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Chapter 22: Mergers and Acquisitions
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Q1) The period of the ________ is known for known for "strategic" or "global" deals that were more likely to be friendly and to involve companies in related businesses; these mergers often were designed to create strong firms on a scale that would allow them to compete globally.
A)1960s
B)1970s
C)1980s
D)1990s
Q2) The period of the ________ is known as the conglomerate wave because firms typically acquired firms in unrelated businesses.
A)1960s
B)1970s
C)1980s
D)1990s
Q3) Most acquirers pay an acquisition premium for a target. Upon announcement of the bid, the target's stock price increases, on average, so that the stock price is the same as the price bid by the acquirer.
A)True
B)False
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Chapter 23: International Corporate Finance
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Q1) Under U.S. tax law, a multinational corporation may use any excess tax credits generated in high-tax foreign countries to offset its net U.S. tax liabilities on earnings in low-tax foreign countries.
A)True
B)False
Q2) Which of the following statements is FALSE?
A)In some countries, especially in the developing world, all investors do not have equal access to financial securities.
B)Firms may face differential access to markets if there is any kind of asymmetry with respect to information about them.
C)In some cases, a country's risk-free securities are internationally integrated but markets for a specific firm's securities are not.
D)When countries' capital markets are not integrated we call them disintegrated capital markets.
Q3) With internationally integrated capital markets the value of an investment depends on the currency used in the analysis.
A)True
B)False
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Chapter 24: Leasing
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Q1) Which of the following statements regarding operating leases is FALSE?
A)They are also called a finance leases.
B)The lease is viewed as a rental for accounting purposes.
C)The lessee reports the entire lease payment as an operating expense.
D)They are disclosed in the footnotes of the lessee's financial statements.
Q2) Which of the following statements is FALSE?
A)Leasing allows the party best able to bear the risk to hold it. For example, small firms with a low tolerance for risk may prefer to lease rather than purchase assets.
B)When the lessor is the manufacturer, a lease in which the lessor bears the risk of the residual value can improve incentives and lower agency costs.
C)For leases in which the lessor retains a substantial interest in the asset's residual value, the lessee has more of an incentive to take proper care of an asset that is leased rather than purchased.
D)Whether they appear on the balance sheet or not, lease commitments are a liability for the firm.
Q3) Is St. Martin's better off leasing the CT scanner or financing the purchase of the CT scanner with a lease-equivalent loan and by how much is St Martin's better off?
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Chapter 25: Insurance and Risk Management
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Q1) Which of the following statements regarding futures contracts is FALSE?
A)Both the buyer and the seller can get out of the contract at any time by selling it to a third party at the current market price.
B)Futures prices are not prices that are paid today. Rather, they are prices agreed to today, to be paid in the future.
C)Futures contracts are traded anonymously on an exchange at a publicly observed market price and are generally very illiquid.
D)Investors are required to post collateral, called margin, when buying or selling commodities using futures contracts.
Q2) What is the actuarially fair cost of full insurance?
Q3) What are some of the disadvantages of long-term supply contracts?
Q4) Assuming that your firm will purchase insurance, what is the minimum-size deductible that would leave your firm with an incentive to implement the new safety policies?
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Chapter 26: Corporate Governance
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Q1) Which of the following statements is FALSE?
A)The United States is somewhat of an exception, in that it focuses solely on maximizing shareholder welfare.
B)A controlling family has many opportunities to expropriate minority shareholders in a pyramid structure.
C)One way for families to gain control over firms even when they do not own more than half the shares is to issue dual class shares-a scenario in which companies have more than one class of shares and one class has superior voting rights over the other class.
D)Researchers have claimed that the degree of investor protection was largely determined by the legal origin of the country-specifically, whether its legal system was based on British common law (less protection)or French, German, and Scandinavian civil law (more protection).
Q2) What is the role of takeovers in corporate governance?
Q3) The costs and benefits of a corporate governance structure ________.
A)are the same in all countries
B)are the same for all companies within a country
C)depend on cultural norms
D)are not important in maximizing shareholder wealth
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