Business Finance
Exam Preparation Guide
Course Introduction
Business Finance explores the fundamental concepts and practices involved in managing the financial resources of a business enterprise. The course covers topics such as financial statement analysis, time value of money, risk and return, capital budgeting, cost of capital, and working capital management. Students will learn to assess investment opportunities, make financing decisions, and understand the impact of financial markets and instruments on corporate decision-making. By the end of the course, students will be equipped with the analytical tools and financial literacy necessary for sound financial planning and effective business management.
Recommended Textbook
Corporate Finance 4th Edition by Jonathan Berk
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Page 2
Chapter 1: The Corporation
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Q1) In a corporation,the ultimate decisions regarding business matters are made by:
A)the Board of Directors.
B)debt holders.
C)shareholders.
D)investors.
Answer: A
Q2) Which of the following organization forms accounts for the greatest number of firms?
A)"S" corporation
B)Limited partnership
C)Sole proprietorship
D)"C" corporation
Answer: C
Q3) If you buy shares of Coca-Cola on the secondary market:
A)Coca-Cola receives the money because the company has issued new shares.
B)you buy the shares from another investor who decided to sell the shares.
C)you buy the shares from the New York Stock Exchange.
D)you buy the shares from the Federal Reserve.
Answer: B
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Page 3
Chapter 2: Introduction to Financial Statement Analysis
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Q1) For the year ending December 31,2009 Luther's cash flow from operating activities is:
A)9.4
B)-18.8
C)47.2
D)40.0
Answer: A
Q2) Luther Corporation's total sales for 2009 were $610.1,and gross profit was $109.0.Inventory days for 2009 is closest to:
A)27.5
B)33.4
C)153.7
D)10.9
Answer: B
Q3) Perrigo's debt to equity ratio is closest to:
A)0.24
B)0.50
C)0.75
D)0.89
Answer: D
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Chapter 3: Financial Decision Making and the Law of One
Price
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Sample Questions
Q1) Rearden Metal needs to order a new blast furnace that will be delivered in one year.The $1,000,000 price for the blast furnace is due in one year when the new furnace is installed.The blast furnace manufacturer offers Rearden Metal a discount of $50,000 if they pay for the furnace now.If the interest rate is 7%,then the NPV of paying for the furnace now is closest to:
A)($15,421)
B)$15,421
C)($46,729)
D)$46,729
Answer: Solution: $1,000,000/1.07 - $950,000 = -$15,420.56
Explanation: A)
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)Mighty
D)Moe
Answer: A
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Chapter 4: The Time Value of Money
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Sample Questions
Q1) Since your first birthday,your grandparents have been depositing $1000 into a savings account on every one of your birthdays.The account pays 4% interest annually.Immediately after your grandparents make the deposit on your 18th birthday,the amount of money in your savings account will be closest to:
A)$25,645
B)$36,465
C)$12,659
D)$18,000
Q2) If the current rate of interest is 8% APR,then the future value of an investment that pays $250 per quarter and lasts 20 years is closest to:
A)$18,519
B)$48,443
C)$9936
D)$20,000
Q3) Draw a timeline detailing the cash flows from investment "A."
Q4) In terms of present value,how much will Joe receive for selling the family business?
Q5) Draw a timeline detailing Joe's cash flows from the sale of the family business.
Q6) The future value at retirement (age 65)of your savings is:
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Chapter 5: Interest Rates
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Q1) What is the shape of the yield curve and what expectations are investors likely to have about future interest rates?
A)Inverted;Higher
B)Normal;Higher
C)Inverted;Lower
D)Normal;Lower
Q2) If the current inflation rate is 4% and you have an investment opportunity that pays 10%,then the real rate of interest on your investment is closest to:
A)10.0%
B)14.0%
C)6.0%
D)5.8%
Q3) The highest effective rate of return you could earn on any of these investments is closest to:
A)6.250%
B)6.267%
C)6.295%
D)6.310%
Q4) Should you purchase the delivery truck or lease it? Why?
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Chapter 6: Valuing Bonds
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Q1) Which of the following statements is FALSE?
A)Forward rates tend not to be good predictors of future spot rates.
B)Given the risk associated with interest rate changes,corporate managers require tools to help manage this risk.
C)One of the most important tools to manage the risk of interest rate changes are interest rate forward contracts.
D)A spot rate is an interest rate that we can guarantee today for a loan or investment that will occur in the future.
Q2) Suppose that when these bonds were issued,Luther received a price of $972.42 for each bond.What is the likely rating that Luther's bonds received?
A)AA
B)BBB
C)B
D)A
Q3) Plot the zero-coupon yield curve (for the first five years).
Q4) Assuming that this bond trades for $1035.44,then the YTM for this bond is equal to:
Q5) Compute the yield to maturity for each of the five zero-coupon bonds.
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Page 8
Chapter 7: Investment Decision Rules
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Q1) Which of the following statements is FALSE?
A)When using the incremental IRR rule,you must keep track of which project is the incremental project and ensure that the incremental cash flows are initially positive and then become negative.
B)Picking one project over another simply because it has a larger IRR can lead to mistakes.
C)Problems arise using the IRR method when the mutually exclusive investments have differences in scale.
D)When the risks of two projects are different,only the NPV rule will give a reliable answer.
Q2) The NPV of project B is closest to:
A)12.6
B)23.3
C)12.0
D)15.0
Q3) Assuming that the discount rate for project A is 16% and the discount rate for B is 15%,then given that these are mutually exclusive projects,which project would you take and why?
Q4) If the discount rate for project A is 16%,then what is the NPV for project A?
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Page 9
Chapter 8: Fundamentals of Capital Budgeting
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Q1) The NPV for Epiphany's Project is closest to:
A)$4825
B)$39,000
C)$11,946
D)$20,400
Q2) The value of currently unused warehouse space that will be used as part of a new capital budgeting project is:
A)an opportunity cost.
B)irrelevant to the investment decision.
C)an overhead expense.
D)a sunk cost.
Q3) The difference between scenario analysis and sensitivity analysis is that:
A)scenario analysis is based upon the IRR and sensitivity analysis is based upon NPV.
B)only sensitivity analysis allows us to change our estimated inputs of our NPV analysis.
C)only scenario analysis considers the effect on NPV of changing multiple project parameters.
D)only scenario analysis breaks the NPV calculation into its component assumptions.
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10
Chapter 9: Valuing Stocks
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Q1) The enterprise value of CCM corporation is closest to:
A)$396 million
B)$290 million
C)$382 million
D)$350 million
Q2) Which of the following statements is FALSE?
A)As firms mature,their earnings exceed their investment needs and they begin to pay dividends.
B)Total return equals earnings multiplied by the dividend payout rate.
C)Cutting the firm's dividend to increase investment will raise the stock price if,and only if,the new investments have a positive NPV.
D)We cannot use the constant dividend growth model to value the stock of a firm with rapid or changing growth.
Q3) What do you anticipate will happen to Lockheed-Martin and Boeing's stock prices are a result of this surprise announcement?
Q4) Calculate the enterprise value for DM Corporation.
Q5) If DM has $500 million of debt and 14 million shares of stock outstanding,then what is the price per share for DM Corporation?
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Chapter 10: Capital Markets and the Pricing of Risk
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Q1) Which of the following statements is FALSE?
A)Firm-specific news is good or bad news about the company itself.
B)Firms are affected by both systematic and firm-specific risk.
C)When firms carry both types of risk,only the firm-specific risk will be diversified when we combine many firms' stocks into a portfolio.
D)The risk premium for a stock is affected by its idiosyncratic risk.
Q2) What is the excess return for Treasury Bills?
A)0%
B)-8.4%
C)-2.7%
D)-1.4%
Q3) Which of the following is NOT a diversifiable risk?
A)The risk that oil prices rise,increasing production costs
B)The risk of a product liability lawsuit
C)The risk that the CEO is killed in a plane crash
D)The risk of a key employee being hired away by a competitor
Q4) Suppose that you want to use the 10 year historical average return on the Market to forecast the expected future return on the Market.Calculate the 95% confidence interval for your estimate of the expect return.
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Chapter 11: Optimal Portfolio Choice and the Capital Asset
Pricing Model
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Sample Questions
Q1) Consider an equally weighted portfolio that contains five stocks.If the average volatility of these stocks is 40% and the average correlation between the stocks is .5,then the volatility of this equally weighted portfolio is closest to:
A).17
B).03
C).41
D).19
Q2) Suppose over the next year Ball has a return of 12.5%,Lowes has a return of 20%,and Abbott Labs has a return of -10%.The weight on Ball Corporation in your portfolio after one year is closest to:
A)20.0%
B)12.5%
C)20.7%
D)21.7%
Q3) What is the variance on a portfolio that has $2000 invested in Duke Energy,$3000 invested in Microsoft,and $5000 invested in Wal-Mart stock?
Q4) What is the variance on a portfolio that has $3000 invested in Duke Energy,$4000 invested in Microsoft,and $3000 invested in Wal-Mart stock?
Page 13
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Chapter 12: Estimating the Cost of Capital
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Q1) Your estimate of the asset beta for Taggart Transcontinental is closest to:
A)0.42
B)0.59
C)0.66
D)0.71
Q2) The overall cost of capital for Wyatt Oil is closest to:
A)8.1%
B)8.5%
C)8.8%
D)9.3%
Q3) Using the average historical excess returns for both Wyatt Oil and the Market portfolio,your estimate of Wyatt Oil's Beta is closest to:
A)0.75
B)0.84
C)1.00
D)1.19
Q4) Assume that you have $250,000 to invest and you are interested in creating a value-weighted portfolio of these four stocks.How many shares of each of the four stocks will you hold? What percentage of the shares outstanding of each stock will you hold?
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Chapter 13: Investor Behavior and Capital Market Efficiency
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Q1) Portfolio "C":
A)is less risky than the market portfolio.
B)has a relatively lower expected return than predicted.
C)is underpriced.
D)has a negative alpha.
Q2) The alpha for the informed investors is closest to:
A)-2.4%
B)-0.9%
C)0.0%
D)3.6%
Q3) Which of the following statements regarding portfolio "C" is/are correct?
1.Portfolio "C" has a negative alpha.
2.Portfolio "C" is overpriced.
3.Portfolio "C" is less risky than the market portfolio.
4.Portfolio "C" should not exist if the market portfolio is efficient.
A)1 and 3
B)2 and 4
C)1,3,and 4
D)3 only
Q4) What does the existence of a positive alpha investment strategy imply?
Page 15
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Chapter 14: Capital Structure in a Perfect Market
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Q1) What is a market value balance sheet and how does it differ from a book value balance sheet?
Q2) Which of the following statements is FALSE?
A)The relative proportions of debt,equity,and other securities that a firm has outstanding constitute its capital structure.
B)The most common choices are financing through equity alone and financing through a combination of debt and equity.
C)The project's NPV represents the value to the new investors of the firm created by the project.
D)When corporations raise funds from outside investors,they must choose which type of security to issue.
Q3) The unlevered beta for Blinkin is closest to:
A)0.95
B)1.10
C)1.00
D)0.90
Q4) Show mathematically that the stock price of Rockwood does not depend on whether they issue new stock or borrow to fund their expansion.
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Chapter 15: Debt and Taxes
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Q1) In 2005,assuming an average dividend payout ratio of 50%,the effective tax advantage for debt ( *)was closest to:
A)24%
B)18%
C)35%
D)15%
Q2) In 2005,the effective tax rate for debt holders was closest to:
A)58%
B)35%
C)40%
D)65%
Q3) Assuming that the risk of the tax shield is only 6% even though the debt pays 8%,then the present value of LCMS' interest tax shield is closest to:
A)$24.5 million
B)$18 million
C)$33.0 million
D)$20.0 million
Q4) If Flagstaff currently maintains a .8 debt to equity ratio,then calculate the value of Flagstaff's interest tax shield.
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Chapter 16: Financial Distress,managerial Incentives,and Information
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Q1) Which of the following firms is likely to maintain low levels of debt?
A)An electric utility
B)A tobacco company
C)An Internet firm
D)A mature restaurant chain
Q2) Suppose that the managers at Rearden Metal will increase risk to maximize the expected payoff to equity holders.If Rearden has $180 million in debt due in one year,then the expected value of Rearden's assets is closest to:
A)$280 million
B)$295 million
C)$300 million
D)$900 million
Q3) Which of the following is NOT an indirect cost of bankruptcy?
A)Legal fees
B)Delayed liquidation
C)Costs to creditors
D)Loss of customers
Q4) List five general categories of indirect costs associated with bankruptcy.
Page 18
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Chapter 17: Payout Policy
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Q1) Taggart Transcontinental shares are currently trading at $200 per share.The split ratio needed to bring the stock price down to $80 is:
A)2:1
B)3:1
C)2:5
D)5:2
Q2) Which of the following statements is FALSE?
A)With a stock dividend,a firm does not pay out any cash to shareholders.As a result,the total market value of the firm's assets and liabilities,and therefore of its equity,is unchanged.
B)If the price of the stock falls too low,a company can engage in a reverse split and reduce the number of shares outstanding.
C)Stock dividends of 50% or higher are generally referred to as stock splits.
D)Rather than pay a dividend using cash or shares of its own stock,a firm can also distribute shares of a subsidiary in a transaction referred to as a off-shoot.
Q3) Calculate the effective tax disadvantage for retaining cash in 1999,2001,and 2005.
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Chapter 18: Capital Budgeting and Valuation With Leverage
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Q1) Which of the following statements is FALSE?
A)The APV approach explicitly values the market imperfections and therefore allows managers to measure their contribution to value.
B)We need to know the debt level to compute the APV,but with a constant debt-equity ratio we need to know the project's value to compute the debt level.
C)The WACC method is more complicated than the APV method because we must compute two separate valuations: the unlevered project and the interest tax shield.
D)Implementing the APV approach with a constant debt-equity ratio requires solving for the project's debt and value simultaneously.
Q2) The NPV of this project using the WACC method is closest to:
A)$10 million
B)$13 million
C)$42 million
D)$71 million
Q3) Calculate the NPV for Iota's new project.
Q4) Based upon the three comparable firms,calculate that most appropriate unlevered cost of capital for Aardvark to use on this new product.
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Page 20
Chapter 19: Valuation and Financial Modeling: a Case Study
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Q1) The unlevered beta for Nike is closest to:
A)0.70
B)1.00
C)1.50
D)0.60
Q2) The free cash flow to equity in 2010 is closest to:
A)6255
B)10,684
C)11,559
D)18,394
Q3) Ideko's Accounts Receivable Days is closest to:
A)84 days
B)95 days
C)90 days
D)75 days
Q4) The unlevered beta for Oakley is closest to:
A)0.70
B)1.50
C)1.00
D)0.60
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Chapter 20: Financial Options
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Q1) The price of a one-year American put option on Rearden Metal with a strike price of $70 per share is closest to:
A)$45
B)$50
C)$55
D)$60
Q2) 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)
Q3) This graph depicts the payoffs of:
A)a long position in a put option at expiration.
B)a short position in a call option at expiration.
C)a short position in a put option at expiration.
D)a long position in a call option at expiration.
Q4) You have decided to buy 10 January 2009 call options on Merck with an exercise price of $45 per share.How much will this transaction cost you and are these contracts in or out of the money?
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Chapter 21: Option Valuation
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Q1) Consider a one-year,at-the-money call option on Taggart stock.The effect on the price of this call option due to an increase in the volatility from 25% to 40% is closest to:
A)$0.70 increase
B)$1.70 decrease
C)$2.30 increase
D)$2.80 increase
Q2) Assuming the Beta on KD stock is 1.1,the calculated beta for a one-year call option on KD stock with a strike price of $20 is closest to:
A)-1.8
B)2.4
C)-7.7
D)4.6
Q3) Using the binomial pricing model,calculate the price of a two-year call option on Kinston stock with a strike price of $9.
Q4) 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) Assume DM Skateboard Company has estimated that,if all stages are successful,the present value of all future profits will be $4 million.If DM does the three stages in the correct order,what is the NPV of the project?
A)$128.13 thousand
B)-$34.50 thousand
C)$65.18 thousand
D)$3.79 million
Q2) The NPV of project B is closest to:
A)$18.10
B)$21.70
C)$24.00
D)$16.90
Q3) Assuming that this project will provide Rearden with perpetual annual cash flows of $80,000,Rearden should:
A)invest today since the NPV is positive.
B)invest today since the NPV is negative.
C)invest today since the NPV using the hurdle rate is positive.
D)delay investing since the NPV using the hurdle rate is negative.
E)delay investing since the NPV using the hurdle rate is positive.
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Page 24
Chapter 23: Raising Equity Capital
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Q1) Which of the following statements is FALSE?
A)The one advantage of a cash offer is that the underwriter takes on a larger role and,therefore,can credibly certify the issue's quality.
B)SEO underwriting fees average about 5% of the proceeds of the issue and,as with IPOs,the variation across issues of different sizes is relatively small.
C)As with IPOs,evidence suggests that companies over perform following a seasoned offering.
D)Often the value destroyed by the price decline can be a significant fraction of the new money raised with a SEO.
Q2) Which of the following is NOT a common name for a corporation that invests in private companies?
A)Strategic investor
B)Corporate partner
C)Venture partner
D)Strategic partner
Q3) How much money did the venture capitalists receive?
Q4) How much money did Luther raise?
Q5) What will the proceeds from the IPO be if Luther is selling 1.1 million shares?
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Chapter 24: Debt Financing
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Q1) What is the Yield to Call (YTC)on this bond?
Q2) What kind of corporate debt has a maturity of less than 10 years?
A)Asset-backed bonds
B)Debentures
C)Notes
D)Mortgage bonds
Q3) Which of the following statements is FALSE?
A)When bond yields have increased,by exercising the call on the callable bond and then immediately refinancing,the issuer can lower its borrowing costs.
B)To understand how call provisions affect the price of a bond,we first need to consider when an issuer will exercise its right to call the bond.
C)If the call provision offers a cheaper way to retire the bonds the issuer will forgo the option of purchasing the bonds in the open market and call the bonds instead.
D)An issuer can always retire one of its bonds early by repurchasing the bond in the open market.
Q4) What is the Yield to Maturity (YTM)on this bond?
Q5) What is the Yield to Maturity (YTM)on this bond?
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Page 26
Chapter 25: Leasing
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Q1) A lease will be treated as a non-tax lease if it satisfies any of the following conditions EXCEPT:
A)the property may be acquired at the fair market value of the asset at the time when the option may be exercised.
B)some portion of the lease payments is specifically designated as interest or its equivalent.
C)the lessee receives ownership of the asset on completion of all lease payments.
D)the total amount that the lessee is required to pay for a relatively short period of use constitutes an inordinately large proportion of the total value of the asset.
Q2) 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?
Q3) What will Luther's balance sheet look like if they acquire the new fleet of delivery trucks using an operating lease?
Q4) Calculate the monthly lease payments for a four year fixed price lease that allows the lessee to buy the bulldozer at the end of the lease for $8000.
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27
Chapter 26: Working Capital Management
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Q1) Luther's Accounts Receivable days is closest to:
A)42 days
B)39 days
C)32 days
D)59 days
Q2) Goldsboro Industries has an average accounts payable balance of $680,000.Its annual cost of goods sold is $4,500,000,and it receives terms of 1/10,net 40 from its suppliers.Goldsboro chooses to forgo this discount.Is Goldsboro managing its accounts payables well?
Q3) Which of the following is NOT a direct cost associated with inventory?
A)Acquisition costs
B)Order costs
C)Carrying costs
D)Stock out costs
Q4) Calculate the number of days in Luther's Operating Cycle.
Q5) The percentage of Wyatt's receivables that are current is closest to:
A)32.1%
28
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Chapter 27: Short-Term Financial Planning
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Q1) Which of the following statements is FALSE?
A)Firms with seasonal cash flows may find themselves with a surplus of cash during some months that is sufficient to compensate for a shortfall during other months.However,because of timing differences,such firms often have short-term financing needs.
B)A company forecasts its cash flows to determine whether it will have surplus cash or a cash deficit for each period.
C)Like seasonalities,positive cash flow shocks can create short-term financing needs.
D)When sales are concentrated during a few months,sources and uses of cash are also likely to be seasonal.
Q2) d'Anconia Copper has borrowed $5 million for six months at a stated annual rate of 10%,using inventory stored in a field warehouse as collateral.The warehouse charges a $25,000 fee,payable at the end of the six months.The effect annual rate on this loan is closest to:
A)9.3%
B)11.3%
C)15.2%
D)17.1%
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Chapter 28: Mergers and Acquisitions
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Q1) What is the market reaction to a takeover announcement?
A)The price of the target increases by 15%,while the price of the acquirer decreases by 1%.
B)The price of the target increases by 15%,while the price of the acquirer increases by 1%.
C)The price of the target and acquirer both increase by 15%.
D)The price of the target increases by 1%,while the price of the acquirer increases by 15%.
Q2) When a hostile takeover appears to be inevitable,a target company will sometimes look for another,friendlier company to acquire it called a:
A)poison pill.
B)classified board.
C)golden parachute.
D)white knight.
Q3) What is Reardon's price-earnings ratio after the takeover?
A)$1.85
B)$1.90
C)$2.00
D)$2.25
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Chapter 29: Corporate Governance
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Q1) Agency costs are best defined as:
A)the costs imposed on a corporation through the laws and regulations that control corporations.
B)the costs a corporation incurs as the result of fraud.
C)the costs that arise when there are conflicts of interest between a firm's stakeholders.
D)the costs associated with compensating managers when ownership and control are separated in a firm.
Q2) What is corporate governance?
Q3) The Sarbanes-Oxley Act:
A)prohibits insiders with a fiduciary duty to their shareholders from trading on material non-public information in that stock.
B)prohibits anyone with nonpublic information about a pending or ongoing tender offer from trading on that information.
C)overhauls incentive and independence in the auditing process.
D)requires corporations to consider all stakeholders in corporate governance decisions.
Q4) What is the role of takeovers in corporate governance?
Q5) Describe the "stakeholder" model of corporate governance.
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Chapter 30: Risk Management
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Q1) In December 2005,the spot exchange rate for the British Pound was $1.7188/£.Suppose that at the same time the one-year interest rate in the United States 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.
Q2) The actuarially fair premium for this insurance policy is closest to:
A)$417,000
B)$446,000
C)$500,000
D)$568,000
Q3) What is the duration of a five-year zero-coupon bond?
A)2.5 Years
B)1 Year
C)5 Years
D)0 Years
Q4) The cash-and-carry strategy consists of all of the following simultaneous trades EXCEPT:
A)borrow euros today using a one-year loan with the interest rate r<sub> .</sub>
B)exchange the euros for dollars today at the spot exchange rate S $/ .
C)purchase a forward contract to convert $ to .
D)invest the dollars today for one year at the interest rate r<sub>$.</sub>
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Chapter 31: International Corporate Finance
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Q1) Assuming that the Irish and Mexican subsidiaries did not exist,the U.S.tax liability on the Japanese subsidiary would be closest to:
A)$0
B)$81 million
C)$103 million
D)$106 million
Q2) What is the dollar present value of the project?
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) The present value of the £5 million cash inflow computed by first discounting the £s and then converting into dollars is closest to:
A)$8,961,420
B)$8,950,495
C)$8,954,615
D)$8,943,695
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