Business Finance
Exam Review
Course Introduction
Business Finance explores the fundamental concepts and principles that underlie the financial management of businesses. Students will examine topics such as financial statement analysis, time value of money, risk and return, capital budgeting, cost of capital, and working capital management. The course emphasizes practical decision-making skills in areas like financing, investment choices, and dividend policy, providing a solid foundation for analyzing financial performance and understanding the strategies firms use to maximize value. Through lectures, case studies, and problem-solving exercises, students gain the tools and knowledge necessary for financial planning and effective resource allocation within a business context.
Recommended Textbook Fundamentals of Corporate Finance 9th Asia Global Edition by Stephen A. Ross
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Chapter 1: Introduction to Corporate Finance
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Sample Questions
Q1) Describe the key advantages associated with the corporate form of organization.
Answer: The advantages of the corporate form of organization are the ease of transferring ownership, the owners' limited liability for business debts, the ability to raise large amounts of capital, and the potential for an unlimited life for the organization.
Q2) Which of the following represent cash outflows from a corporation?
I. issuance of securities
II. payment of dividends
III. new loan proceeds
IV. payment of government taxes
A)I and III only
B)II and IV only
C)I and IV only
D)I, II, and IV only
E)II, III, and IV only
Answer: B
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Chapter 2: Financial Statements, Taxes, and Cash Flow
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Sample Questions
Q1) Jensen Enterprises paid $1,300 in dividends and $920 in interest this past year. Common stock increased by $1,200 and retained earnings decreased by $310. What is the net income for the year?
A)-$210
B)$990
C)$1,610
D)$1,910
E)$2,190
Answer: B
Q2) As of 2011, which one of the following statements concerning U.S. corporate income taxes is correct?
A)The largest corporations have an average tax rate of 39 percent.
B)The lowest marginal rate is 25 percent.
C)A firm's tax is computed on an incremental basis.
D)A firm's marginal tax rate will generally be lower than its average tax rate once the firm's income exceeds $50,000.
E)When analyzing a new project, the average tax rate should be used.
Answer: C
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4
Chapter 3: Working With Financial Statements
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Sample Questions
Q1) A firm has a debt-equity ratio of 0.42. What is the total debt ratio?
A)0.30
B)0.36
C)0.44
D)1.58
E)2.38
Answer: A
Q2) The price-sales ratio is especially useful when analyzing firms that have which one of the following?
A)volatile market prices
B)negative earnings
C)positive PEG ratios
D)a negative Tobin's Q
E)increasing sales
Answer: B
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Page 5
Chapter 4: Long-Term Financial Planning and Growth
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Sample Questions
Q1) The sustainable growth rate:
A)assumes there is no external financing of any kind.
B)assumes no additional long-term debt is available.
C)assumes the debt-equity ratio is constant.
D)assumes the debt-equity ratio is 1.0.
E)assumes all income is retained by the firm.
Q2) Major Manuscripts, Inc. is currently operating at 85 percent of capacity. All costs and net working capital vary directly with sales. The tax rate, the profit margin, and the dividend payout ratio will remain constant. How much additional debt is required if no new equity is raised and sales are projected to increase by 15 percent?
A)-$810
B)-$756
C)-$642
D)$244
E)$358
Q3) Nelson's Landscaping Services just completed a pro forma statement using the percentage of sales approach. The pro forma has a projected external financing need of -$5,500. What are the firm's options in this case?
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Chapter 5: Introduction to Valuation: The Time Value of Money
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Q1) Suppose that the first comic book of a classic series was sold in 1966. In 2012, the estimated price for this comic book in good condition was about $340,000. This represented a return of 27 percent per year. For this to be true, what was the original price of the comic book in 1966?
A)$5.00
B)$5.28
C)$5.50
D)$5.71
E)$6.00
Q2) The process of determining the present value of future cash flows in order to know their worth today is called which one of the following?
A)compound interest valuation
B)interest on interest computation
C)discounted cash flow valuation
D)present value interest factoring
E)complex factoring
Q3) What lesson does the future value formula provide for young workers who are looking ahead to retiring some day?
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Chapter 6: Discounted Cash Flow Valuation
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Sample Questions
Q1) You grandfather won a lottery years ago. The value of his winnings at the time was $50,000. He invested this money such that it will provide annual payments of $2,400 a year to his heirs forever. What is the rate of return?
A)4.75 percent
B)4.80 percent
C)5.00 percent
D)5.10 percent
E)5.15 percent
Q2) Your father helped you start saving $20 a month beginning on your 5<sup>th</sup> birthday. He always made you deposit the money into your savings account on the first day of each month just to "start the month out right." Today completes your 17<sup>th</sup> year of saving and you now have $6,528.91 in this account. What is the rate of return on your savings?
A)5.15 percent
B)5.30 percent
C)5.47 percent
D)5.98 percent
E)6.12 percent
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Chapter 7: Interest Rates and Bond Valuation
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Sample Questions
Q1) The break-even tax rate between a taxable corporate bond yielding 7 percent and a comparable nontaxable municipal bond yielding 5 percent can be expressed as:
A)0.05/(1 - t<sup>*</sup>) = 0.07.
B)0.05 - (1 - t<sup>*</sup>) = 0.07.
C)0.07 + (1 - t<sup>*</sup>) = 0.05.
D)0.05 *(1 - t<sup>*</sup>) = 0.07.
E)0.05 F* (1 + t<sup>*</sup>) = 0.07.
Q2) A Treasury bond is quoted at a price of 101: 14 with a current yield of 7.236 percent. What is the coupon rate?
A)7.20 percent
B)7.28 percent
C)7.30 percent
D)7.34 percent
E)7.39 percent
Q3) Define liquidity risk, default risk, and taxability risk and explain how these risks relate to bonds and bond yields.
Q4) Explain the conditions that would need to exist for the Treasury yield curve to be downward sloping.
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Page 9
Chapter 8: Stock Valuation
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Sample Questions
Q1) Which one of the following statements related to the NYSE is correct?
A)Commission brokers work on behalf of brokerage firm clients.
B)Shareholders of NYSE Group, Inc.own "seats" on the exchange.
C)Specialists buy at the asked price.
D)The NYSE is primarily a dealer's market.
E)Floor brokers earn income in the form of a bid-ask spread.
Q2) KL Airlines paid an annual dividend of $1.42 a share last month. The company is planning on paying $1.50, $1.75, and $1.80 a share over the next 3 years, respectively. After that, the dividend will be constant at $2 per share per year. What is the market price of this stock if the market rate of return is 10.5 percent?
A)$15.98
B)$16.07
C)$18.24
D)$21.16
E)$24.10
Q3) Using the dividend growth model, explain why a firm would be hesitant to reduce the growth rate of its dividends.
Q4) Explain why small shareholders should prefer cumulative voting over straight voting.
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Page 10
Chapter 9: Net Present Value and Other Investment Criteria
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Sample Questions
Q1) The present value of an investment's future cash flows divided by the initial cost of the investment is called the:
A)net present value.
B)internal rate of return.
C)average accounting return.
D)profitability index.
E)profile period.
Q2) A project has an initial cost of $27,400 and a market value of $32,600. What is the difference between these two values called?
A)net present value
B)internal return
C)payback value
D)profitability index
E)discounted payback
Q3) Explain the differences and similarities between net present value (NPV) and the profitability index.
Q4) How does the net present value (NPV) decision rule relate to the primary goal of financial management, which is creating wealth for shareholders?
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11
Chapter 10: Making Capital Investment Decisions
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Sample Questions
Q1) Bi-Lo Traders is considering a project that will produce sales of $28,000 and increase cash expenses by $17,500. If the project is implemented, taxes will increase by $3,000. The additional depreciation expense will be $1,600. An initial cash outlay of $1,400 is required for net working capital. What is the amount of the operating cash flow using the top-down approach?
A)$4,500
B)$5,900
C)$6,100
D)$7,500
E)$8,900
Q2) The stand-alone principle advocates that project analysis should be based solely on which one of the following costs?
A)sunk
B)total
C)variable
D)incremental
E)fixed
Q3) Can the initial cash flow at time zero for a project ever be a positive value? If yes, give an example. If no, explain why not.
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Page 12
Chapter 11: Project Analysis and Evaluation
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Sample Questions
Q1) Precise Machinery is analyzing a proposed project. The company expects to sell 2,100 units, give or take 5 percent. The expected variable cost per unit is $260 and the expected fixed costs are $589,000. Cost estimates are considered accurate within a plus or minus 4 percent range. The depreciation expense is $129,000. The sales price is estimated at $750 per unit, plus or minus 2 percent. What is the sales revenue under the worst case scenario?
A)$1,686,825
B)$1,496,250
C)$1,466,325
D)$1,543,500
E)$1,620,675
Q2) A company is considering a project with a cash break-even point of 22,600 units. The selling price is $28 a unit, the variable cost per unit is $13, and depreciation is $14,000. What is the projected amount of fixed costs?
A)$325,000
B)$339,000
C)$342,000
D)$348,000
E)$353,000
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Page 13
Chapter 12: Some Lessons From Capital Market History
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Sample Questions
Q1) Based on past 26 years, Westerfield Industrial Supply's common stock has yielded an arithmetic average rate of return of 9.63 percent. The geometric average return for the same period was 8.57 percent. What is the estimated return on this stock for the next 4 years according to Blume's formula?
A)8.70 percent
B)8.92 percent
C)9.13 percent
D)9.38 percent
E)9.50 percent
Q2) Which one of the following is a correct ranking of securities based on their volatility over the period of 1926-2007? Rank from highest to lowest.
A)large company stocks, U.S.Treasury bills, long-term government bonds
B)small company stocks, long-term corporate bonds, large company stocks
C)small company stocks, long-term corporate bonds, intermediate-term government bonds
D)large company stocks, small company stocks, long-term government bonds
E)intermediate-term government bonds, long-term corporate bonds, U.S.Treasury bills
Q3) Define and explain the three forms of market efficiency.
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Page 14
Chapter 13: Return, Risk, and the Security Market Line
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Sample Questions
Q1) Which one of the following is an example of unsystematic risk?
A)income taxes are increased across the board
B)a national sales tax is adopted
C)inflation decreases at the national level
D)an increased feeling of prosperity is felt around the globe
E)consumer spending on entertainment decreased nationally
Q2) Which one of the following risks is irrelevant to a well-diversified investor?
A)systematic risk
B)unsystematic risk
C)market risk
D)nondiversifiable risk
E)systematic portion of a surprise
Q3) Explain the difference between systematic and unsystematic risk. Also explain why one of these types of risks is rewarded with a risk premium while the other type is not.
Q4) Explain how the beta of a portfolio can equal the market beta if 50 percent of the portfolio is invested in a security that has twice the amount of systematic risk as an average risky security.
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Chapter 14: Cost of Capital
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Sample Questions
Q1) Which one of the following is the primary determinant of a firm's cost of capital?
A)debt-equity ratio
B)applicable tax rate
C)cost of equity
D)cost of debt
E)use of the funds
Q2) The cost of preferred stock:
A)is equal to the dividend yield.
B)is equal to the yield to maturity.
C)is highly dependent on the dividend growth rate.
D)is independent of the stock's price.
E)decreases when tax rates increase.
Q3) Explain how the use of internal equity rather than external equity affects the analysis of a project.
Q4) What are some advantages of the subjective approach to determining the cost of capital and why do you think that approach is utilized?
Q5) What role does the weighted average cost of capital play when determining a project's cost of capital?
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Chapter 15: Raising Capital
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Sample Questions
Q1) The Huff Co. has just gone public. Under a firm commitment agreement, Huff received $21.50 for each of the 6 million shares sold. The initial offering price was $23.65 per share, and the stock rose to $30.51 per share in the first few minutes of trading. Huff paid $1,260,000 in direct legal and other costs, and $390,000 in indirect costs. The flotation costs were what percentage of the funds raised?
A)38.56 percent
B)40.32 percent
C)41.68 percent
D)43.75 percent
E)44.09 percent
Q2) Northwest Rail wants to raise $14.2 million through a rights offering so it can purchase additional rail cars and upgrade its maintenance facilities. How many shares of stock will the firm need to sell through this offering if the current market price is $34 a share and the subscription price is $28 a share?
A)417,647 shares
B)437,856 shares
C)458,065 shares
D)482,604 shares
E)507,143 shares
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Page 17
Chapter 16: Financial Leverage and Capital Structure Policy
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Sample Questions
Q1) Butter & Jelly reduced its taxes last year by $350 by increasing its interest expense by $1,000. Which of the following terms is used to describe this tax savings?
A)interest tax shield
B)interest credit
C)financing shield
D)current tax yield
E)tax-loss interest
Q2) New Schools, Inc. expects an EBIT of $7,000 every year forever. The firm currently has no debt, and its cost of equity is 17 percent. The firm can borrow at 8 percent and the corporate tax rate is 34 percent. What will the value of the firm be if it converts to 50 percent debt?
A)$29,871.17
B)$31,796.47
C)$32,407.16
D)$34,552.08
E)$37,119.30
Q3) Explain how a firm loses value during the bankruptcy process from both a creditors and a shareholders perspective.
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18
Chapter 17: Dividends and Dividend Policy
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Sample Questions
Q1) A firm wants to maintain a minimum stock price of $15 a share. Due to a recent market downturn, the stock is currently selling for $6 a share. The firm should consider a:
A)3-for-1 stock split.
B)4-for-1 stock split.
C)1-for-3 reverse stock split.
D)1-for-4 reverse stock split.
E)1-for-5 reverse stock split.
Q2) The information content of a dividend increase generally signals that:
A)the firm has a one-time surplus of cash.
B)the firm has few, if any, net present value projects to pursue.
C)management believes earnings growth will be strong going forward.
D)the firm has more cash than it needs due to a decline in future orders.
E)dividends thereafter will be lower.
Q3) An investor is more likely to prefer a high dividend payout if a firm:
A)has high flotation costs.
B)has few, if any, positive net present value projects.
C)has lower tax rates than the investor.
D)has a stock price that is increasing rapidly.
E)offers substantial gains on its equities, which are taxed at a favorable rate.
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Page 19
Chapter 18: Short-Term Finance and Planning
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Sample Questions
Q1) Which one of the following will decrease the net working capital of a firm? Assume the current ratio is greater than 1.0.
A)selling inventory at cost
B)collecting payment from a customer
C)paying a payment on a long-term debt
D)selling a fixed asset for book value
E)paying a supplier for the purchase of an inventory item
Q2) Which one of the following will increase net working capital? Assume the current ratio is greater than 1.0.
A)paying a supplier for a previous purchase
B)paying off a long-term debt
C)selling inventory at cost
D)purchasing inventory on credit
E)selling inventory at a profit on credit
Q3) Which one of the following will decrease the operating cycle?
A)decreasing the inventory turnover rate
B)decreasing the accounts payable period
C)increasing the accounts receivable turnover rate
D)increasing the accounts payable period
E)increasing the accounts receivable period
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Chapter 19: Cash and Liquidity Management
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Sample Questions
Q1) GT Motors regularly issues short-term debt to finance its daily operations. Suddenly, the credit markets froze and no funds were available for borrowing. Fortunately, the firm had some cash reserves saved that it was able to use to fund its operations until additional credit was available. The need to retain cash for situations such as this is referred to as which one of the following motives for holding cash?
A)speculative
B)float
C)compensating
D)precautionary
E)transaction
Q2) Brown Trucking is buying a U.S. Treasury bill today with the understanding that the seller will buy it back tomorrow at a slightly higher price. This investment is known as a:
A)commercial paper transaction.
B)repurchase agreement.
C)private certificate of deposit.
D)revenue anticipation note.
E)bill anticipation note.
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Chapter 20: Credit and Inventory Management
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Sample Questions
Q1) Roger's Store begins each week with 150 phasers in stock. This stock is depleted each week and reordered. The carrying cost per phaser is $48 per year and the fixed order cost is $70. What is the optimal number of orders that should be placed each year?
A)48.69
B)51.71
C)54.20
D)61.10
E)64.50
Q2) The Cellar Door currently sells 9,620 units a month for total monthly sales of $316,000. The company is considering replacing its current cash only credit policy with a net 30 policy. The variable cost per unit is $15 and the monthly interest rate is 1.5 percent. What is the switch break-even level of sales?
A)9,711 units
B)9,779 units
C)9,814 units
D)9,957 units
E)9,889 units
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22
Chapter 21: International Corporate Finance
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Sample Questions
Q1) What conditions are necessary for absolute purchasing power parity (PPP) to exist? Is it realistic to believe PPP can exist within a country let alone across national borders?
Q2) You are expecting a payment of C$100,000 four years from now. The risk-free rate of return is 3.8 percent in the U.S. and 4.1 percent in Canada. The inflation rate is 2 percent in the U.S. and 3 percent in Canada. Suppose the current exchange rate is C$1 = $0.8273. How much will the payment four years from now be worth in U.S. dollars?
A)$61,129
B)$62,414
C)$66,667
D)$78,202
E)$81,745
Q3) How many Euros can you get for $2,100 if one euro is worth $1.2762?
A) 1,638.09
B) 1,645.51
C) 2,676.67
D) 2,680.02
E) 2,684.15
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Page 23
Chapter 22: Behavioral Finance: Implications for Financial Management
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Q1) Ramon opened a combination laundry and dry cleaning establishment three years ago. Due to his excellent service and reasonable prices, his business has grown and is doing quite well financially. He has considered expanding this business by opening another location but keeps putting off that decision for fear that the second location will not be a success. Ramon is currently displaying which one of the following behavior characteristics?
A)self-attribution bias
B)overconfidence
C)regret aversion
D)house money effect
E)frame dependence
Q2) You are a hard-charging manager who doesn't really like to sit at a desk for too long. You prefer to gather information quickly, make a decision, and move on to the next item on your agenda. Which one of the following applies to you?
A)availability bias
B)arbitrage limits
C)law of small numbers
D)representativeness heuristic
E)regret aversion
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Chapter 23: Risk Management: An Introduction to Financial Engineering
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Q1) Most of the evidence to date indicates that firms with which two of the following characteristics are most apt to frequently use derivatives?
I. firms with low financial distress costs
II. firms with high financial distress costs
III. firms with easy access to capital markets
IV. firms with constrained access to capital markets
A)I and III only
B)I and IV only
C)II and III only
D)II and IV only
E)III and IV only
Q2) Which one of the following obligates you only on the expiration date to sell an asset at the strike price if the option is exercised?
A)American call
B)American put
C)European call
D)European put
E)European swap
Q3) Explain why a swap is effectively a series of forward contracts.
Page 25
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Chapter 24: Options and Corporate Finance
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Q1) You sold one call option contract with a strike price of $55 when the option was quoted at $0.80. The option expires today when the value of the underlying stock is $53.70. Ignoring trading costs and taxes, what is the net profit or loss on this investment?
A)-$250
B)-$80
C)$0
D)$50
E)$80
Q2) KT Enterprises has expanded its operations into a new field, which is the production of everyday dinnerware. If this project goes well, the firm has the option to expand its production into fine china. What type of option is this?
A)financial
B)strategic
C)put
D)intangible
E)call
Q3) Explain the rationale behind the idea that equity is a call option on a firm's assets. When would a shareholder allow this call to expire?
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Chapter 25: Option Valuation
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Q1) Traci wants to have $16,000 six years from now and wants to deposit just one lump sum amount today. The annual percentage rate applicable to her investment is 6.8 percent. Which one of the following methods of compounding interest will allow her to deposit the least amount possible today?
A)annual
B)daily
C)quarterly
D)monthly
E)continuous
Q2) Assume the price of the underlying stock decreases. How will the values of the options respond to this change?
I. call value decreases
II. call value increases
III. put value decreases
IV. put value increases
A)I and III only
B)I and IV only
C)II and III only
D)II and IV only
E)I only
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Chapter 26: Mergers and Acquisitions
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Q1) Alpha is planning on merging with Beta. Alpha will pay Beta's shareholders the current value of their stock in shares of Alpha. Alpha currently has 4,200 shares of stock outstanding at a market price of $40 a share. Beta has 2,500 shares outstanding at a price of $18 a share. The after-merger earnings will be $8,800. What will the earnings per share be after the merger?
A)$1.61
B)$1.65
C)$1.75
D)$1.81
E)$1.86
Q2) Firm A is being acquired by Firm B for $54,000 worth of Firm B stock. The incremental value of the acquisition is $5,600. Firm A has 2,400 shares of stock outstanding at a price of $21 a share. Firm B has 2,700 shares of stock outstanding at a price of $50 a share. What is the actual cost of the acquisition using company stock?
A)$50,509
B)$52,276
C)$54,571
D)$56,780
E)$60,600
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Page 28
Chapter 27: Leasing
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Q1) You are comparing a lease to a purchase. The NPV associated with this analysis is referred to as the:
A)open interest net present value.
B)depreciated net present value.
C)net advantage to leasing.
D)profitability index.
E)net value of purchasing.
Q2) Frozen Foods Delivery is considering the purchase of a delivery truck costing $49,000. The truck can be leased for 3 years at $19,500 per year or it can be purchased at an interest rate of 7.5 percent. The estimated life of the truck is 3 years. The corporate tax rate is 34 percent. The company does not expect to owe any taxes for the next several years due to accumulated net operating losses. The firm uses straight-line depreciation. What is the net advantage to leasing?
A)-$1,710
B)-$866
C)$304
D)$1,006
E)$1,394
Q3) Why might a firm opt to sell and leaseback an asset which it currently owns?
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