Business Finance
Exam Solutions
Course Introduction
Business Finance provides students with a comprehensive understanding of the basic principles and practices underlying financial management in a business environment. The course covers key topics such as financial statement analysis, time value of money, risk and return, capital budgeting, cost of capital, and methods of financing. It also explores how financial managers make decisions regarding the acquisition and allocation of resources to maximize firm value, as well as the role of financial markets and institutions. By the end of the course, students will be equipped with analytical tools necessary to evaluate financial performance and support strategic business decisions.
Recommended Textbook
Corporate Finance Core Principles and Applications 3rd Edition by Stephen A. Ross
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20 Chapters
1879 Verified Questions
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Page 2
Chapter 1: Introduction to Corporate Finance
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Sample Questions
Q1) Insider trading is:
A)legal.
B)impossible to have in our efficient market.
C)illegal.
D)discouraged, but legal.
E)list only the securities of the largest firms.
Answer: C
Q2) If the corporate form of business organization has so many advantages over the sole proprietorship,why is it so common for small businesses to initially be formed as sole proprietorships?
Answer: A significant advantage of the sole proprietorship is that it is cheap and easy to form.If the sole proprietor has limited capital to start with,it may not be desirable to spend part of that capital forming a corporation.Also,limited liability for business debts may not be a significant advantage if the proprietor has limited capital,most of which is tied up in the business anyway.Finally,for a typical small business,the heart and soul of the business is the person who founded it,so the life of the business may effectively be limited to the life of the founder during its early years.
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Chapter 2: Financial Statements Cash Flow
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Sample Questions
Q1) What is the change in net working capital from 2009 to 2010?
A)-$93
B)-$7
C)$7
D)$85
E)$97
Answer: A
Q2) According to Generally Accepted Accounting Principles,costs are:
A)recorded as incurred.
B)recorded when paid.
C)matched with revenues.
D)matched with production levels.
E)expensed as management desires.
Answer: C
Q3) What is a liquid asset and why is it necessary for a firm to maintain a reasonable level of liquid assets?
Answer: Liquid assets are those that can be sold quickly with little or no loss in value.A firm that has sufficient liquidity will be less likely to experience financial distress.
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Chapter 3: Financial Statements Analysis and Long-Term Planning
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Sample Questions
Q1) Katelyn's Kites has net income of $240 and total equity of $2,000.The debt-equity ratio is 1.0 and the plowback ratio is 40%.What is the internal growth rate?
A)2.46%
B)3.00%
C)4.92%
D)5.88%
E)6.00%
Answer: A
Q2) A banker considering loaning a firm money for ten years would most likely prefer the firm have a debt ratio of _____ and a times interest earned ratio of ______.
A).35; 3.00
B).50; 1.00
C).45; 1.75
D).40; 2.50
E).75; .75
Answer: A
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Page 5
Chapter 4: Discounted Cash Flow Valuation
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Sample Questions
Q1) You just paid $350,000 for a policy that will pay you and your heirs $12,000 a year forever.What rate of return are you earning on this policy?
A)3.25%
B)3.33%
C)3.43%
D)3.50%
E)3.67%
Q2) You just won the lottery.To supplement your income you will receive twenty payments of $300,000 to be paid at the end of each of the next twenty years.Using a discount rate of 6%,calculate the present value of the annuity.
A)$2,975,754
B)$3,000,000
C)$3,231,623
D)$3,293,984
E)$3,440,976
Q3) There are three factors that affect the future value of an annuity.Explain what these three factors are and discuss how an increase in each will impact the future value of the annuity.
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6
Chapter 5: Interest Rate and Bond Valuation
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Sample Questions
Q1) The unfunded debt of a firm is generally understood to mean the firm's:
A)preferred stock.
B)debts that mature in more than one year.
C)debentures.
D)debts that mature in less than one year.
E)secured debt.
Q2) A corporate bond with a face value of $1,000 matures in 5 years and has a 6% coupon paid at the end of each year.The current price of the bond is $1,105.What is the yield to maturity for this bond?
A)2.60%
B)3.66%
C)3.86%
D)4.20%
E)4.95%
Q3) As the yield to maturity increases,the:
A)higher the price the investor offers to buy a bond.
B)longer the time to maturity.
C)lower the rate of return desired by the investor.
D)amount the investor is willing to pay to buy a bond decreases.
E)lower the coupon rate desired by that investor.
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Chapter 6: Stock Valuation
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Sample Questions
Q1) A member of the New York Stock Exchange acting as a dealer in one or more securities on the exchange floor is called a:
A)floor trader.
B)floor post.
C)specialist.
D)floor broker.
E)commission broker.
Q2) The common stock of the Kenwith Co.pays a constant annual dividend.Thus,the market price of Kenwith stock will:
A)decrease when the market rate of return increases.
B)increase when the market rate of return increases.
C)decrease over time.
D)increase over time.
E)always remain constant.
Q3) Briefly explain the differences between preferred and common stock.
Q4) List the four types of New York Stock Exchange members and give a brief definition of what each member does.
Q5) Explain whether it is easier to find the required return on a publicly traded stock or a publicly traded bond,and explain why.
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Chapter 7: Net Present Value and Other Investment Rules
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Sample Questions
Q1) A project has an initial cost of $8,500 and produces cash inflows of $2,700,$4,800,and $1,600 over the next three years,respectively.What is the discounted payback period if the required rate of return is 8%?
A)2.13 years
B)2.33 years
C)2.67 years
D)2.91 years
E)Never
Q2) Modified internal rate of return:
A)handles the multiple IRR problem by combining cash flows until only one change in sign change remains.
B)requires the use of a discount rate.
C)does not require the use of a discount rate.
D)Both A and B.
E)Both A and C.
Q3) Academic theory states that net present value is the best capital budgeting model.Why is this the case?
Q4) Explain the differences and similarities between net present value (NPV)and the profitability index (PI).
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Chapter 8: Making Capital Investment Decisions
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Sample Questions
Q1) Sanjay's Incorporated is analyzing two machines to determine which one it should purchase.The company requires a 14% rate of return and uses straight-line depreciation to a zero book value.Machine A has a cost of $290,000,annual operating costs of $8,000,and a 3-year life.Machine B costs $180,000,has annual operating costs of $12,000,and has a 2-year life.Whichever machine is purchased will be replaced at the end of its useful life.Which machine should Sanjay's purchase and why? (Round your answer to the nearest whole dollar.)
A)machine A; because it will save the company about $8,600 a year
B)machine A; because it will save the company about $132,912 a year
C)machine B; because it will save the company about $200,000 a year
D)machine B; because it will save the company about $11,600 a year
E)machine B; because its equivalent annual cost is $199,759
Q2) All else equal,an increase in which one of the following will increase the operating cash flow?
A)Employee salaries
B)Office rent
C)Building maintenance
D)Equipment depreciation
E)Equipment rental
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Chapter 9: Risk Analysis, Real Options, and Capital Budgeting
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Sample Questions
Q1) The present value break-even point is superior to the accounting break-even point because:
A)present value break-even is more complicated to calculate.
B)present value break-even covers the economic opportunity costs of the investment.
C)present value break-even is the same as sensitivity analysis.
D)present value break-even covers the fixed costs of production, while the accounting break-even does not.
E)present value break-even covers the variable costs of production, while the accounting break-even does not.
Q2) What is the contribution margin under the expected case scenario?
A)$2.67
B)$3.00
C)$7.92
D)$8.00
E)$9.00
Q3) When should a firm consider using decision tree analysis in capital budgeting?
Q4) Discuss two shortcomings in the standard decision tree analysis that a financial manager should be cognizant of?
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Chapter 10: Risk and Return Lessons From Market History
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Sample Questions
Q1) You bought 100 shares of stock at $25 each.At the end of the year,you received a total of $500 in dividends,and your stock was worth $2,500 total.What was total dollar capital gain and total dollar return?
A)$0; $500
B)$400; $900
C)$500; $900
D)$900; $2,500
E)None of the above.
Q2) You purchased 250 shares of Deltona,Inc.stock for $44.40 a share.You have received a total of $630 in dividends and $12,040 in proceeds from selling the shares.What is your capital gains yield on this stock?
A)4.06%
B)4.23%
C)4.68%
D)8.47%
E)8.91%
Q3) What securities have offered the highest average annual returns over the last several decades?
Can we conclude that return and risk are related in real life?
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Page 12
Chapter 11: Return and Risk: The Capital Asset Pricing Model
Capm
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Sample Questions
Q1) The excess return earned by an asset that has a beta of 1.0 over that earned by a risk- free asset is referred to as the:
A)market rate of return.
B)systematic return.
C)market risk premium.
D)real rate of return.
E)total return.
Q2) The risk premium for an individual security is computed by:
A)adding the risk-free rate to the security's expected return.
B)multiplying the security's beta by the risk-free rate of return.
C)multiplying the security's beta by the market risk premium.
D)dividing the market risk premium by the beta of the security.
E)dividing the market risk premium by the quantity (1 - beta).
Q3) A well-diversified portfolio has negligible
A)unsystematic risk.
B)systematic risk.
C)expected return.
D)variance.
E)Both C and D.
Q4) What is the separation principle?
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Chapter 12: Risk, Cost of Capital, and Capital Budgeting
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Sample Questions
Q1) The NuPress Valet Co.has an improved version of its hotel stand.The investment cost is expected to be $72 million and will return $13.5 million for 5 years in net cash flows.The ratio of debt to equity is 1 to 1.The cost of equity is 13%,the cost of debt is 9%,and the tax rate is 34%.The appropriate discount rate,assuming average risk,is:
A)8.65%
B)9%
C)9.47%
D)10.5%
E)13%
Q2) The use of WACC to select investments is acceptable when the:
A)correlation of all new projects are equal.
B)NPV is positive when discounted by the WACC.
C)risk of the projects are equal to the risk of the firm.
D)firm is well diversified and the unsystematic risk is negligible.
E)None of the above.
Q3) Given the sample of returns of the Top Black Asphalt Company and the S&P 500 index,calculate Top Black's correlation.What can be said about the relationship of Top Black and the market return behavior?
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14
Chapter 13: Efficient Capital Markets and Behavioral Challenges
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Sample Questions
Q1) An investor who picks a portfolio by throwing darts at the financial pages:
A)believes that riskier portfolios earn the same as less risky portfolios.
B)believes that efficient markets will protect the portfolio from harm as all information is priced.
C)does so because stock prices do not matter; only cash flow generated matters.
D)Both A and C.
E)Both B and C.
Q2) Which of the following is true?
A)A random walk for stock price changes is inconsistent with observed patterns in price changes.
B)If the stock market follows a random walk,price changes should be highly correlated.
C)If the stock market is weak form efficient,then stock prices follow a random walk.
D)All of the above.
E)Both B and C.
Q3) Explain why it is that in an efficient market,investments have an expected NPV of zero.
Q4) Define the three forms of market efficiency.
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Chapter 14: Capital Structure: Basic Concepts
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Sample Questions
Q1) The concept of homemade leverage is most associated with:
A)static theory proposition.
B)MM Proposition I with no tax.
C)MM Proposition II with no tax.
D)MM Proposition I with tax.
E)MM Proposition II with tax.
Q2) The reason that MM Proposition I does not hold in the presence of corporate taxation is because:
A)bondholders require higher rates of return compared with stockholders.
B)levered firms pay less taxes compared with identical unlevered firms.
C)dividends are no longer relevant with taxes.
D)earnings per share are no longer relevant with taxes.
E)All of the above.
Q3) The proposition that the cost of equity is a positive linear function of capital structure is called:
A)the capital asset pricing model.
B)MM Proposition I.
C)MM Proposition II.
D)the law of one price.
E)the efficient market hypothesis.
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Chapter 15: Capital Structure: Limits to the Use of Debt
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Sample Questions
Q1) The optimal capital structure:
A)of a firm will vary over time as taxes and market conditions change.
B)is unaffected by changes in the financial markets.
C)will be the same for all firms in the same industry.
D)places more emphasis on the operations of a firm rather than the financing of a firm.
E)will remain constant over time unless the firm makes an acquisition.
Q2) Explain the difference between direct and indirect bankruptcy costs.Give an example of each.
Q3) The possibility of bankruptcy has a negative effect on the value of the firm because:
A)increased bankruptcy risk always lowers value.
B)reorganization is costless but risk is not.
C)a bankruptcy has real costs associated with it.
D)value enhancing strategies are no longer available.
E)None of the above.
Q4) What are the advantages of a prepackaged bankruptcy for a firm? What are the disadvantages?
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17
Chapter 16: Dividend and Other Payouts
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Sample Questions
Q1) Ignoring capital gains as an alternative,the tax law changes in 2003 tend to favor a:
A)constant dividend policy.
B)lower dividend policy.
C)higher dividend policy.
D)zero-dividend policy.
E)restrictive dividend policy.
Q2) An increase in a firm's number of shares outstanding without any change in owners' equity is called a:
A)share repurchase.
B)tender offer.
C)special dividend.
D)stock split.
E)liquidating dividend.
Q3) The date on which the firm mails out its declared dividends is called the:
A)ex-dividend date.
B)ex-rights date.
C)date of payment.
D)date of record.
E)declaration date.
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Page 18
Chapter 17: Options and Corporate Finance
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Sample Questions
Q1) A _____ is a derivative security that gives the owner the right,but not the obligation,to buy an asset at a fixed price for a specified period of time.
A)futures contract
B)call option
C)put option
D)swap
E)forward contract
Q2) A financial contract that gives its owner the right,but not the obligation,to buy or sell a specified asset at an agreed-upon price on or before a given future date is called a(n)_____ contract.
A)swap
B)futures
C)forward
D)option
E)straddle
Q3) What are the upper and lower bounds for an American call option?
Explain what would happen in each case if the bound was violated.
Q4) Distinguish the difference between American and European options.All else equal,which has more value?
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Chapter 18: Short-Term Finance and Planning
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Sample Questions
Q1) A firm has sales of $720,000.The cost of goods sold is equal to 70% of sales.The firm has an average inventory of $6,500.How many days on average does it take the firm to sell its inventory?
A)3.30 days
B)4.71 days
C)67.29 days
D)77.54 days
E)110.77 days
Q2) Dallas and More (D&M)sells its inventory in 87 days on average.Its average customer charges their purchase on a credit card whereby payment is received in ten days.On the other hand,D&M takes 56 days on average to pay for its purchases.Given this information,what is the length of D&M's operating cycle?
A)26 days
B)36 days
C)66 days
D)97 days
E)143 days
Q3) Restrictive short-term financial policies regarding current asset management include three basic actions.List and briefly describe each action.
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Page 20
Chapter 19: Raising Capital
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Sample Questions
Q1) Which of the following have been offered as justification for IPO underpricing?
I.Young firms tend to be very risky.
II.The best IPOs are oversubscribed.
III.Underwriters like to avoid lawsuits.
IV.It benefits the existing shareholders.
A)I and III only
B)II and IV only
C)I, II, and III only
D)II, III, and IV only
E)I, II, III, and IV
Q2) Northern Importers wants to raise $58 million to expand its operations into South America.The company will sell new shares of common stock using a general cash offering.The underwriters charge a 7.8 percent spread,the administrative costs are $411,000,and the offer price is $36 per share.How many shares of stock must be sold if the firm is to raise the funds it desires?
A)1,648,315 shares
B)1,759,792 shares
C)1,811,502 shares
D)1,989,415 shares
E)2,051,515 shares
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Page 21
Chapter 20: International Corporate Finance
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Sample Questions
Q1) You want to import $100,000 worth of jewelry from India.How many rupees will you need to pay for this purchase if one rupee is worth $.0256?
A)3,005,010Rs
B)3,032,288Rs
C)3,564,220Rs
D)3,906,250Rs
E)4,076,458Rs
Q2) The spot rate for the Japanese yen currently is *106 per $1.The one-year forward rate is *105 per $1.A risk-free asset in Japan is currently earning 3%.If interest rate parity holds,approximately what rate can you earn on a one-year risk-free U.S.security?
A)3.00%
B)3.12%
C)3.98%
D)4.25%
E)4.33%
Q3) What is triangle arbitrage?
Using the U.S.dollar,the Canadian dollar,and the euro,construct an example in which triangle arbitrage exists,and then show how to exploit it.
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