Corporate Finance
Chapter Exam Questions
Course Introduction
Corporate Finance explores the fundamental principles and strategies used by organizations to manage their financial resources effectively. This course covers key topics such as capital budgeting, financial analysis, valuation, risk and return, capital structure decisions, dividend policy, and working capital management. Students will learn how corporations make investment and financing decisions that maximize shareholder value, analyze financial statements, assess the impact of financial markets, and understand the role of financial managers in both domestic and international contexts. Through case studies and practical applications, students gain critical skills for evaluating corporate performance and making informed financial decisions.
Recommended Textbook Fundamentals of Corporate Finance 3rd Eition by Jonathan Berk
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Page 2
Chapter 1: Corporate Finance and the Financial Manager
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Q1) Which of the following people may not manage the operations of a firm in which they are part or full owners?
A)stockholders in S corporations
B)stockholders in C corporations
C)limited partners in a limited partnership
D)general partners in a limited partnership
Answer: C
Q2) Stella places a market order with her broker to buy 1,000 shares of OneWorld Corp. The broker buys 1,000 shares at $15.80 each, and sells them to Stella at $15.95 each. He also charges a commission of $12.00. What is bid-ask spread in this case?
A)$162
B)$120
C)$210.00
D)$150
Answer: D
Q3) What are the terms for the two types of prices quoted for a stock on an exchange?
Answer: The two quotes associated with a stock quoted on the exchange are bid price and ask price.
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3
Chapter 2: Introduction to Financial Statement Analysis
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Q1) Which of the following is NOT considered to be an operating expense on the income statement?
A)administrative expenses and overhead
B)corporate taxes
C)salaries
D)depreciation and amortization
Answer: B
Q2) What role does Generally Accepted Accounting Principles (GAAP)play in the accounting process?
Answer: All firms quoted on a U.S. exchange are required to use GAAP in their financial reporting process. This standardization process makes it easier to adjust and/or compare the financial figures across different firms.
Q3) Which of the following is NOT one of the financial statements that must be produced by a public company?
A)the balance sheet
B)the income statement
C)the statement of cash flows
D)the statement of activities
Answer: D
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Page 4
Chapter 3: Time Value of Money: an Introduction
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Q1) A dollar today and a dollar in one year may be considered to be equivalent.
A)True
B)False
Answer: False
Q2) You are watching TV late one night and see an ad from Ronco for the Dial-o-matic food slicer. You learn that the Dial-o-matic sells for $29.95. Ronco also includes a set of Ginsu steak knives worth $10.95 and another free gift worth $7.95 in this deal. Assuming that there is a competitive market for Ronco items, at what price must Ronco offer this three item Dial-o-matic deal to ensure the absence of an arbitrage opportunity and uphold the Law of One Price?
Answer: 29.95 + 10.95 + 7.95 = $48.85
Q3) Sara wants to have $600,000 in her savings account when she retires. How much must she put in the account now, if the account pays a fixed interest rate of 8%, to ensure that she has $600,000 in 20 years?
A)$128,729
B)$180,221
C)$231,712
D)$139,541
Answer: A
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Page 5
Chapter 4: Time Value of Money: Valuing Cash Flow
Streams
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Q1) A perpetuity has a PV of $20,000. If the interest rate is 6%, how much will the perpetuity pay every year?
A)$600
B)$960
C)$1200
D)$720
Q2) Trial and error is the only way to compute the internal rate of return (IRR)when interest is calculated over five or more periods.
A)True
B)False
Q3) Which of the following is true about perpetuities?
A)All else equal, the present value of a perpetuity is higher when the periodic cash flow is higher.
B)All else equal, the present value of a perpetuity is higher when the interest rate is lower.
C)If two perpetuities have the same present value and the same interest rate, they must have the same cash flows.
D)All of the above are true statements.
Q4) Can we apply the growing perpetuity equation for negative growth as well?
Page 6
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Chapter 5: Interest Rates
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Q1) You are purchasing a new home and need to borrow $380,000 from a mortgage lender. The mortgage lender quotes you a rate of 5.75% APR for a 30-year fixed rate mortgage. The mortgage lender also tells you that if you are willing to pay two points, they can offer you a lower rate of 5.45% APR for a 30-year fixed rate mortgage. One point is equal to 1% of the loan value. So if you take the lower rate and pay the points, you will need to borrow an additional $7600 to cover points you are paying the lender. Assuming you do not pay the points and borrow from the mortgage lender at 5.75%, then your monthly mortgage payment (with payments made at the end of the month)will be closest to ________.
A)$2439
B)$2661
C)$2218
D)$3105
Q2) Which of the following situations would result in lowering of interest rates by the banking authority of a country?
A)The economy is slowing down.
B)Inflation is rising rapidly.
C)The level of investment is quite high.
D)The rate of savings is quite low.
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Page 7
Chapter 6: Bonds
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Q1) Treasury bonds have original maturities from one to ten years, while Treasury notes have original maturities of more than ten years.
A)True
B)False
Q2) Which of the following risk-free, zero-coupon bonds could be bought for the lowest price?
A)one with a face value of $1,000, a YTM of 4.8%, and 5 years to maturity
B)one with a face value of $1,000, a YTM of 3.2%, and 8 years to maturity
C)one with a face value of $1,000, a YTM of 6.8%, and 10 years to maturity
D)one with a face value of $1,000, a YTM of 5.9%, and 20 years to maturity
Q3) A university issues a bond with a face value of $5000 and a coupon rate of 4.41% that matures on July 15, 2018. The holder of such a bond receives coupon payments of $110.25. How frequently are coupon payments made in this case?
A)monthly
B)quarterly
C)semiannually
D)annually
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 a premium?
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Chapter 7: Stock Valuation
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Q1) A "round lot" consists of how many shares?
A)1
B)10
C)100
D)1,000
Q2) Chittenden Enterprises has 643 million shares outstanding. It expects earnings at the end of the year to be $960 million. The firm's equity cost of capital is 9%. Chittenden pays out 30% of its earnings in total: 20% paid out as dividends and 10% used to repurchase shares. If Chittenden's earnings are expected to grow at a constant 3% per year, what is Chittenden's share price?
A)$3.74
B)$2.24
C)$7.47
D)$14.94
Q3) Forecasting dividends requires forecasting the firm's earnings, dividend payout rate, and future share count.
A)True
B)False
Q4) How can the dividend-discount model handle changing growth rates?
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Chapter 8: Investment Decision Rules
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Q1) A company buys a color printer that will cost $16,000 to buy, and last 5 years. It is assumed that it will require servicing costing $500 each year. What is the equivalent annual annuity of this deal, given a cost of capital of 8%?
A)-$3155
B)-$3606
C)-$4057
D)-$4507
Q2) If WiseGuy Inc. uses payback period rule to choose projects, which of the projects (Project A or Project B) will rank highest?
A)Project A
B)Project B
C)Project A and Project B have the same ranking.
D)Cannot calculate a payback period without a discount rate.
Q3) Internal rate of return (IRR)can reliably be used to choose between mutually exclusive projects.
A)True
B)False
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) The Sisyphean Corporation is considering investing in a new cane manufacturing machine that has an estimated life of three years. The cost of the machine is $30,000 and the machine will be depreciated straight line over its three-year life to a residual value of $0. The cane manufacturing machine will result in sales of 2400 canes in year 1. Sales are estimated to grow by 9% each year through year 3. The price per cane that Sisyphean will charge its customers is $15 each and is to remain constant. The canes have a cost per unit to manufacture of $8 each.
Installation of the machine and the resulting increase in manufacturing capacity will require an increase in various net working capital accounts. It is estimated that the Sisyphean Corporation needs to hold 3% of its annual sales in cash, 5% of its annual sales in accounts receivable, 9% of its annual sales in inventory, and 6% of its annual sales in accounts payable. The firm is in the 35% tax bracket and has a cost of capital of 8%.
The change in net working capital from year 1 to year 2 is closest to ________.
A)a decrease of $356
B)an increase of $356
C)an increase of $389
D)a decrease of $389
Q2) Why does the option to abandon a project have value?
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Chapter 10: Stock Valuation: a Second Look
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Q1) Several methods should be used to provide an estimate of a stock's value since no single method provides a definitive value.
A)True
B)False
Q2) Valuation models use the relationship between share value, future cash flows, and the cost of capital to estimate these quantities for a given firm. Realistically, for a publicly traded firm, what can we reliably use such models to determine?
I. the firm's future cash flows
II. the firm's cost of capital
III. the firm's market price
A)I only
B)II only
C)III only
D)I and II
Q3) In the method of comparables, the known values of a firm's cash flows are used to estimate the unknown cash flows of a similar firm.
A)True
B)False
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Chapter 11: Risk and Return in Capital Markets
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Q1) Consider an economy with two types of firms, S and I. S firms always move together, but I firms move independently of each other. For both types of firms there is a 40% probability that the firm will have a 20% return and a 60% probability that the firm will have a -30% return. The standard deviation for the return on an individual firm is closest to ________.
A)24.49%
B)-10.00%
C)12.25%
D)9.80%
Q2) Suppose you invested $100 in the Ishares High Yield Fund (HYG)a month ago. It paid a dividend of $2 today and then you sold it for $100. What was your dividend yield and capital gains yield on the investment?
A)2%, 2%
B)0%, 2%
C)3%, 2%
D)2%, 0%
Q3) Is volatility a reasonable measure of risk when evaluating the investment in a single stock?
Q4) Which type of investment has historically had the lowest volatility?
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Chapter 12: Systematic Risk and the Equity Risk Premium
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Q1) The amount of a stock's risk that is diversified away ________.
A)is independent of the portfolio that you add it to
B)depends on market risk premium
C)depends on risk-free rate of interest
D)depends on the portfolio that you add it to
Q2) A portfolio comprises Coke (beta of 1.4)and Wal-Mart (beta of 0.8). The amount invested in Coke is $20,000 and in Wal-Mart is $30,000. What is the beta of the portfolio?
A)1.04
B)1.20
C)1.35
D)1.25
Q3) What role does the correlation of two assets play in computation of the expected return of the two asset portfolio?
Q4) Stocks have both diversifiable risk and undiversifiable risk, but only diversifiable risk is rewarded with higher expected returns.
A)True
B)False
Q5) 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) For an unlevered firm, the cost of capital can be determined by using the
A)yield on the traded debt
B)Capital Asset Pricing Model
C)dividend yield
D)preferred stock yield
Q2) Verano Inc. has two business divisions-a software product line and a waste water clean-up product line. The software business has a cost of equity capital of 10% and the waste water clean-up business has a cost of equity capital of 7%. Verano has 50% of its revenue from software and the rest from the waste water business. Verano is considering a purchase of another company in the waste water business using equity financing. What is the appropriate cost of capital to evaluate the business?
A)10.0%
B)7.0%
C)8.5%
D)9.0%
Q3) Why do we use market values rather than book values in calculation of WACC?
Q4) What is the assumption about risk when using WACC to evaluate a project?
Q5) Should a firm with high retained earnings have a lower cost of equity?
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Chapter 14: Raising Equity Capital
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Q1) Which of the following statements is FALSE?
A)Once a company goes public, it must satisfy all of the requirements of public companies.
B)Organizations such as the Securities and Exchange Commission (SEC), the securities exchanges (including the NYSE and the NASDAQ), and Congress (through the Sarbanes-Oxley Act of 2002)adopted new standards that focused on more thorough financial disclosure, greater accountability, and more stringent requirements for the board of directors.
C)The major advantage of undertaking an IPO is also one of the major disadvantages of an IPO: When investors diversify their holdings, the equity holders of the corporation become more concentrated.
D)Several high profile corporate scandals during the early part of the twenty-first century prompted tougher regulations designed to address corporate abuses.
Q2) Newly listed firms tend to perform relatively poorly in the three to five years after their IPOs.
A)True
B)False
Q3) What are some of the highlights of Google's IPO process?
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Page 16
Chapter 15: Debt Financing
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Q1) Supreme Industries issues the following announcement to holders of an issue of callable, convertible notes: "Prior to the close of business on May 17, 2008, holders may convert their Notes into shares of Supreme Industries common stock at 33.25 shares of Supreme Industries common stock per $1,000 principal amount of the Notes. Cash will be paid in lieu of fractional shares. On April 16, 2008, the last reported sale price of Supreme Industries common stock on the NYSE was $21.60 per share."
If on May 17, Supreme Industries is trading as $24.60, what is the value of common stock a holder of a $1,000 note would receive?
A)$664.20
B)$701.10
C)$817.95
D)$739.85
Q2) What are bond covenants?
Q3) In terms of public offerings of bonds, what is an indenture?
A)a list of the duties of a trust company representing the bondholders' interests
B)a memorandum that must be produced to describe the details of a bond offering
C)a formal contract that specifies a firm's obligations to the bondholders
D)a schedule of the fees charged by an underwriting company
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Chapter 16: Capital Structure
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Q1) Investment cash flows are independent of financing choices in a ________.
A)market with frictions
B)perfect capital market
C)setting with frictions in investment returns
D)firm with leverage
Q2) A firm requires an investment of $60,000 and borrows $30,000 at 9%. If the return on equity is 22% and the tax rate is 35%, what is the firm's WACC?
A)11.1%
B)13.9%
C)16.7%
D)27.9%
Q3) Suppose a project financed via an issue of debt requires five annual interest payments of $18 million each year. If the tax rate is 35% and the cost of debt is 7%, what is the value of the interest rate tax shield?
A)$20.66 million
B)$31.00 million
C)$25.83 million
D)$51.66 million
Q4) What effect does debt have on a firm's weighted average cost of capital?
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Chapter 17: Payout Policy
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Q1) 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
Q2) A firm has $300 million of assets that includes $40 million of cash and 8 million shares outstanding. If the firm uses $30 million of its cash to repurchase shares, what is the new price per share?
A)$30.00
B)$37.50
C)$45.00
D)$52.50
Q3) 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
Q4) What choices does a firm have in using its free cash flow?
Q5) What are the characteristics of special dividend?
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Chapter 18: Financial Modeling and Pro Forma Analysis
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Q1) Based upon Ideko's Sales and Operating Cost Assumptions, what production capacity will Ideko require in 2007?
A)1,505,000 units
B)1,323,000 units
C)1,914,000 units
D)1,115,000 units
E)1,702,000 units
Q2) The estimate of a firm's value at the end of the forecast horizon using a valuation multiple is also called its ________.
A)fixed value
B)payback value
C)terminal value
D)none of the above
Q3) Assuming that Ideko has an EBITDA multiple of 9.4, then the continuation unlevered price-earnings ratio of Ideko in 2015 is closest to ________.
A)17.2
B)16.4
C)14.5
D)28.6
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Chapter 19: Working Capital Management
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Q1) Which of the following statements is FALSE?
A)Under the Modigliani-Miller assumptions of perfect capital markets, the amount of inventory is irrelevant.
B)Unlike trade credit, inventory represents one of the required factors of production.
C)It is the firm's financial manager who must arrange for the financing necessary to support the firm's inventory policy and who is responsible for ensuring the firm's overall profitability.
D)Inventory management receives extensive coverage in courses on operations management.
Q2) Which of the following money market investments is a draft written by the borrower and guaranteed by the bank on which the draft is drawn? It is typically used in international trade transactions. The borrower is an importer who writes the draft in payment for goods.
A)Treasury bills
B)repurchase agreement
C)certificates of deposit
D)banker's acceptance
E)commercial paper
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Chapter 20: Short-Term Financial Planning
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Q1) In which quarter are Fancy's seasonal working capital needs the greatest?
A)1
B)2
C)3
D)4
Q2) Which of the following best describes an aggressive financing policy?
A)financing part or all of the permanent working capital with short-term debt
B)financing part or all of the permanent working capital with long-term debt
C)financing part or all of the temporary working capital with short-term debt
D)financing part or all of the temporary working capital with long-term debt
Q3) A firm has a committed line of credit with a maximum of $10 million and an interest rate of 8.5% (EAR)with a certain bank. The commitment fee is 0.5% (EAR). The firm borrows $2 million at the start of the year and then repays it at the end of the year. What is the total cost of the loan?
A)$520,000
B)$680,000
C)$210,000
D)$720,000
Q4) What is permanent working capital?
Q5) What is temporary working capital?
Page 22
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Chapter 21: Option Applications and Corporate Finance
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Q1) This graph depicts the payoffs of a ________.
A)long position in a put option at expiration
B)short position in a call option at expiration
C)short position in a put option at expiration
D)long position in a call option at expiration
Q2) The open interest for a January 2011 call option that is closest to being at-the-money is ________.
A)1436
B)2245
C)872
D)523
Q3) Assume you want to buy five call option contracts that with an exercise price closest to being at-the-money and that expires December 2010. The current price that you would have to pay for such a contract is ________.
A)$550
B)$110
C)$475
D)$300
Q4) What is the short position of an options contract?
Q5) When is an option at-the-money?
23
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Chapter 22: Mergers and Acquisitions
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Q1) Which of the following statements regarding poison pills is FALSE?
A)Companies with poison pills are harder to take over, and when they are taken over, the premium that existing shareholders receive for their stock is higher.
B)Because a poison pill increases the cost of a takeover, all else equal, a target company must be in better shape to justify the expense of waging a takeover battle.
C)Poison pills also increase the bargaining power of the target firm when negotiating with the acquirer because poison pills make it difficult to complete the takeover without the cooperation of the target board.
D)By adopting a poison pill, a company effectively entrenches its management by making it much more difficult for shareholders to replace bad managers, thereby potentially destroying value.
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
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Chapter 23: International Corporate Finance
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Q1) After the Japanese taxes are paid, the amount of the earnings before interest and after taxes in dollars from the Japanese operations is closest to ________.
A)$20.5 million
B)$29.5 million
C)$5.1 million
D)$50.0 million
Q2) How are exchange rates quoted in the Wall Street Journal?
Q3) If the cash flows generated by a foreign investment are ________ with ________, we do not need to consider the impact of exchange rate risk.
A)uncorrelated, costs
B)negatively correlated, revenues
C)uncorrelated, cash flows
D)none of the above
Q4) If a foreign project is owned by a domestic corporation, managers and shareholders need to determine the home currency value of the foreign currency cash flows.
A)True
B)False
Q5) What are the timings of the foreign exchange market?
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Chapter 24: Leasing
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Q1) What will Luther's balance sheet look like if they acquire the new fleet of delivery trucks using a capital lease?
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) Should St. Martin lease the scanner or borrow the funds and buy the scanner?
A)Buy the scanner; the NPV of the decision = $74,890.28.
B)Buy the scanner; the NPV of the decision = $1,749,890.28
C)Lease the scanner; the NPV of the decision = $1,812,027.19
D)Lease the scanner; the NPV of the decision = $692,559.51
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Chapter 25: Insurance and Risk Management
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Q1) If your firm is uninsured, the NPV of implementing the new safety policies is closest to
A)$2.25 million
B)-$.25 million
C)$2.5 million
D)$2.15 million
Q2) An interest rate that adjusts to current market conditions is called a(n)________.
A)floating rate
B)fixed rate
C)notional rate
D)arbitrage rate
Q3) The duration of a five-year bond with 8% annual coupons trading at par is closest to
A)2.5 years
B)4.3 years
C)5.0 years
D)6.2 years
Q4) What are some of the disadvantages of long-term supply contracts?
Q5) What is the actuarially fair cost of full insurance?
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Chapter 26: Corporate Governance
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Q1) Directors who are not employees, former employees, or family members of employees and who do not have existing or potential business relationships with the firm are called ________.
A)monitoring directors
B)independent directors
C)gray directors
D)inside directors
Q2) Which of the following statements is FALSE?
A)Controlling shareholders pay for their control rights because the firm effectively faces a higher cost of equity for outside capital.
B)Most countries follow what is called the stakeholder model, giving explicit consideration to other stakeholders-in particular, rank-and-file employees.
C)In a pyramid structure, a family first creates a company in which it owns more than 50% of the shares and therefore has a controlling interest.
D)A conflict of interest arises because the family has an incentive to try to move profits (and hence dividends)down the pyramid-that is, toward companies in which it has few cash flow rights and away firms in which it has more cash flow rights.
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