Corporate Finance
Exam Practice Tests
Course Introduction
Corporate Finance explores the financial principles and techniques that underpin the decision-making processes within corporations. The course covers fundamental topics such as capital budgeting, capital structure, corporate valuation, risk management, dividend policy, and the cost of capital. Students will analyze real-world case studies to understand how companies manage investment and financing strategies to maximize firm value. By examining tools for analyzing financial performance and understanding market dynamics, students will gain practical skills essential for careers in financial management, investment banking, and corporate strategy.
Recommended Textbook
Corporate Finance 2nd Edition by Jonathan Berk
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Page 2
Chapter 1: The Corporation
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Q1) A limited liability company is essentially
A) a limited partnership without limited partners.
B) a limited partnership without a general partner.
C) just another name for a limited partnership.
D) just another name for a corporation.
Answer: B
Q2) If you buy shares of Coca-Cola on the primary 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: A
Q3) How much would you receive if you sold 200 shares of XYZ stock on November 11th?
A) $5050
B) $5040
C) $5186
D) $5200
Answer: B
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3
Chapter 2: Introduction to Financial Statement Analysis
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Q1) For the year ending December 31,2009 Luther's earnings per share are closest to:
A) $0.96
B) $1.04
C) $1.28
D) $1.33
Answer: B
Q2) Perrigo's return on equity (ROE)is closest to:
A) 4.6%
B) 9.1%
C) 17.2%
D) 27%
Answer: C
Q3) Perrigo's enterprise value is closest to:
A) $952.16 million
B) $3,580.14 million
C) $4,168.06 million
D) $4,425.15 million
Answer: C
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4
Chapter 3: Arbitrage and Financial Decision Making
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Q1) If the risk-free interest rate is 10%,then of the four projects listed,if could only invest in two of these projects,which two projects would you select?
A) Mighty & Eenie
B) Mighty & Meenie
C) Eenie & Moe
D) Eenie & Meenie
Answer: A
Q2) You have an investment opportunity in Germany that requires an investment of $250,100 today and will produce a cash flow of 208,650 in one year with no risk.Suppose the risk-free rate of interest in Germany is 7% and the current competitive exchange rate is 0.78 to $1.00.What is the NPV of this project? Would you take the project?
A) NPV = -$100; No
B) NPV = $100; Yes
C) NPV = $2,358; Yes
D) NPV = $3,650; Yes
Answer: A
Q3) The price per share of the ETF in a normal market is:
Answer: Value of ETF = = 2 × 121.57 + 3 × 36.59 + 3 × 3.15 = $362.36
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Chapter 4: The Time Value of Money
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Q1) Which of the following statements regarding the timeline is false?
A) Date 1 is one year from now.
B) The $5000 below date 1 is the payment you will receive at the end of the first year.
C) The $5000 below date 2 is the payment you will receive at the beginning of the second year.
D) Date 0 represents today.
Q2) Which of the following statements is false?
A) Finding the present value and compounding are the same.
B) A dollar today and a dollar in one year are not equivalent.
C) If you want to compare or combine cash flows that occur at different points in time, you first need to convert the cash flows into the same units or move them to the same point in time.
D) The equivalent value of two cash flows at two different points in time is sometimes referred to as the time value of money.
Q3) Draw a timeline detailing Joe's cash flows from the sale of the family business.
Q4) Draw a timeline detailing the cash flows from investment "B."
Q5) Draw a timeline detailing the cash flows from investment "A."
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) Which of the following statements is false?
A) The yield curve changes over time.
B) The formulas for computing present values of annuities and perpetuities cannot be used in situations in which cash flows need to be discounted at different rates.
C) We can use the term structure to compute the present and future values of a risk-free cash flow over different investment horizons.
D) The yield curve tends to be inverted as the economy comes out of a recession.
Q2) If your income tax rate is 30%,then the after-tax return you receive on your money market fund is closest to:
A) 3.7%
B) 5.1%
C) 3.6%
D) 4.2%
Q3) The effective annual rate on your firm's borrowings is closest to:
A) 6.00%
B) 6.14%
C) 6.25%
D) 6.30%
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Chapter 6: Investment Decision Rules
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Q1) The payback period for project B is closest to:
A) 2.5 years
B) 2.0 years
C) 2.2 years
D) 2.4 years
Q2) The maximum number of IRRs that could exist for project B is:
A) 3
B) 1
C) 2
D) 0
Q3) Assume that projects A and B are mutually exclusive.The correct investment decision and the best rational for that decision is to
A) invest in project A since NPV<sub>B</sub> < NPV<sub>A.</sub>
B) invest in project B since IRR<sub>B</sub> > IRR<sub>A</sub>.
C) invest in project B since NPV<sub>B</sub> > NPV<sub>A.</sub>
D) invest in project A since NPV<sub>A</sub> > 0.
Q4) If the discount rate for project B is 15%,then what is the NPV for project B?
Q5) If the discount rate for project A is 16%,then what is the NPV for project A?
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Chapter 7: Fundamentals of Capital Budgeting
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Sample Questions
Q1) Assume that Kinston's new machine will be depreciated straight line to a salvage value of $5,000 at the end of year three.What is the NPV for this project?
Q2) Bubba Ho-Tep Company reported net income of $300 million for the most recent fiscal year.The firm had depreciation expenses of $125 million and capital expenditures of $150 million.Although they had no interest expense,the firm did have an increase in net working capital of $20 million.What is Bubba Ho-Tep's free cash flow?
A) $170 million
B) $255 million
C) $150 million
D) $5 million
Q3) Construct a simple income statement showing the incremental EBIT and the incremental unlevered net income for all three years of the Sisyphean Companies project.
Q4) The free cash flow from Shepard Industries project in year two is closest to:
A) $345
B) $455
C) $275
D) -$5
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Page 9
Chapter 8: Valuing Bonds
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Q1) Consider a zero coupon bond with 20 years to maturity.The price will this bond trade if the YTM is 6% is closest to:
A) $215
B) $312
C) $335
D) $306
Q2) Which of the following statements is false?
A) Prices of bonds with lower durations are more sensitive to interest rate changes.
B) When a bond is trading at a discount, the price increase between coupons will exceed the drop when a coupon is paid, so the bond's price will rise and its discount will decline as time passes.
C) Coupon bonds may trade at a discount, at a premium, or at par.
D) The sensitivity of a bond's price changes in interest rates is the bond's duration.
Q3) What is the relationship between a bond's price and its yield to maturity?
Q4) Assuming that this bond trades for $1,035.44,then the YTM for this bond is equal to:
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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) If DM has $500 million of debt and 14 million shares of stock outstanding,then what is the price per share for DM Corporation?
Q3) You expect KT Industries (KTI)will have earnings per share of $3 this year and expect that they will pay out $1.50 of these earnings to shareholders in the form of a dividend.KTI's return on new investments is 15% and their equity cost of capital is 12%.The value of a share of KTI's stock is closest to:
A) $39.25
B) $20.00
C) $33.35
D) $12.50
Q4) What are the implications of the efficient market hypothesis for corporate managers?
Q5) Calculate the enterprise value for DM Corporation.
Q6) What are some common multiples used to value stocks?
Page 11
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Chapter 10: Capital Markets and the Pricing of Risk
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Q1) What is the Beta for a type S firm?
A) 1.5
B) 0.0
C) 1.0
D) 0.75
Q2) Which of the following types of risk doesn't belong?
A) Idiosyncratic risk
B) Undiversifiable risk
C) Market risk
D) Systematic risk
Q3) Using the data provided in the table,calculate the average annual return,the variance of the annual returns,and the standard deviation of the average returns for Stock B from 2000 to 2009.
Q4) What is the expected payoff for Big Cure's Blockbuster drug?
A) $100 million
B) $0
C) $1 billion
D) $500 million
Q5) What is the market portfolio?
Q6) Which pharmaceutical company faces less risk?
Page 12
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Chapter 11: Optimal Portfolio Choice and the Capital Asset Pricing Model
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Q1) Which of the following statements is false?
A) A combination of portfolios on the efficient frontier of risky investments is also on the efficient frontier of risky investments.
B) The conclusion of the CAPM that investors should hold the market portfolio combined with the risk-free investment depends on the quality of an investor's information.
C) The SML holds with some rate r* between r<sub>s</sub> and r<sub>b</sub> in place of r<sub>f</sub>, where r* depends on the proportion of savers and borrowers in the economy.
D) In reality, investors have different information and spend varying amounts of effort on research for assorted stocks.
Q2) You currently own $100,000 worth of Wal-Mart stock.Suppose that Wal-Mart has an expected return of 14% and a volatility of 23%.The market portfolio has an expected return of 12% and a volatility of 16%.The risk-free rate is 5%.Assuming the CAPM assumptions hold,what alternative investment has the highest possible expected return while having the same volatility as Wal-Mart? What is the expected return of this portfolio?
Q3) Explain how having different interest rates for borrowing and lending affects the CAPM and the SML.
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Page 13
Chapter 12: The Capital Asset Pricing Model
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Q1) The risk premium for "Meenie" is closest to:
A) 4.50%
B) 7.50%
C) 9.30%
D) 9.75%
Q2) Assume that the S&P 500 currently has a dividend yield of 3% and that on average,the dividends of S&P 500 firms have increased by about 5% per year.If the risk-free interest rate is 4%,then your estimate for the future market risk premium is:
A) 7%
B) 8%
C) 6%
D) 4%
Q3) Firms should adjust for execution risk by
A) assigning a higher cost of capital to new projects.
B) ignoring execution risk since it is diversifiable.
C) capturing this risk in the expected cash flows generated by the project.
D) noticing missteps in the firm's execution of new projects.
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Chapter 13: Investor Behavior and Capital Market Efficiency
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Q1) If the risk-free rate is 3% and the market risk premium is 5%,then the CAPM's predicted expected return for Wyatt Oil is closest to:
A) 8.5%
B) 9.0%
C) 9.5%
D) 10.0%
Q2) Portfolio "B"
A) is less risky than the market portfolio.
B) is overpriced.
C) has a positive alpha.
D) falls above the SML.
Q3) Using the FFC four factor model and the historical average monthly returns,the expected monthly return for GE is closest to:
A) 0.53%
B) 0.73%
C) 0.79%
D) 0.71%
Q4) What does the existence of a positive alpha investment strategy imply?
Q5) Explain why the market portfolio proxy may not be efficient.
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Chapter 14: Capital Structure in a Perfect Market
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Q1) The NPV for this project is closest to:
A) $6,250
B) $14,100
C) $10,000
D) $18,600
Q2) Suppose that you borrow only $30,000 in financing the project.According to MM proposition II,the firm's equity cost of capital will be closest to:
A) 21%
B) 15%
C) 20%
D) 25%
Q3) Suppose that you borrow only $60,000 in financing the project.According to MM proposition II,the firm's equity cost of capital will be closest to:
A) 45%
B) 30%
C) 25%
D) 35%
Q4) What is a market value balance sheet and how does it differ from a book value balance sheet?
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Chapter 15: Debt and Taxes
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Q1) Raceway Products has a market debt-to-equity ratio of .60,a corporate tax rate of 40%,and pays 8% interest on its debt.The interest tax shield on Raceway's debt lowers its WACC by what amount?
Q2) Assume that investors hold Google stock in retirement accounts that are free from personal taxes.If Google were to issue sufficient debt to reduce its taxes by $600 million per year permanently,then the value that would be created is closest to:
A) $6.4 billion
B) $8.6 billion
C) $9.8 billion
D) $14.3 billion
Q3) Assume that investors in Google pay a 15% tax rate on income from equity and a 35% tax rate on interest income.If Google were to issue sufficient debt to reduce its taxes by $1 billion per year permanently,then the effective tax advantage of this debt would be closest to:
A) 10%
B) 15%
C) 25%
D) 30%
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Q1) If its managers engage in empire building,then the expected market value of Luther's assets is closest to:
A) $260
B) $280 million
C) $240
D) $300 million
Q2) In an agency problem known as debt overhang,if the company has risky debt outstanding,equity holders will choose to invest only if
A) the NPV of the project exceeds a cutoff equal to the relative riskiness of the firm's debt times its debt-equity ratio.
B) the profitability index of the project exceeds a cutoff equal to the relative riskiness of the firm's debt times its debt-equity ratio.
C) the NPV of the project is negative.
D) the debt holders will lose all their money.
Q3) Suppose that MI has zero-coupon debt with a $140 million face value due next year.Calculate the value of levered equity,the value of debt,and the total value of MI with leverage.
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) Wyatt Oil pays a regular dividend of $2.50 per share.Typically the stock price drops by $2.00 per share when the stock goes ex-dividend.Suppose the capital gains tax rate is 20%,but investors pay different tax rates on dividends.Absent transactions cost,the highest dividend tax rate of an investor who could gain from trading to capture the dividend is closest to:
A) 0%
B) 20%
C) 24%
D) 36%
Q2) The effective dividend tax rate in 1989 is closest to:
A) 0%
B) 20%
C) 25%
D) 30%
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) If Wyatt adjusts its debt once per year to maintain a constant debt-equity ratio of 50%,then the value of this new project is closest to:
A) $240 million
B) $320 million
C) $340 million
D) $445 million
Q2) The Debt Capacity for Omicron's new project in year 1 is closest to:
A) $38.75
B) $48.25
C) $50.25
D) $58.00
Q3) Nielson's share price is closest to:
A) $20.80
B) $24.40
C) $27.50
D) $31.20
Q4) Given that Rose issues new debt of $50 million initially to fund the acquisition,the total value of this acquisition using the APV method is equal to?
Q5) Calculate the debt capacity of Omicron's new project for years 0,1,and 2.
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Chapter 19: Valuation and Financial Modeling: a Case Study
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Q1) The free cash flow to the firm in 2010 is closest to:
A) 10,684
B) 11,559
C) 23,698
D) 26,394
E) 31,698
Q2) With the proper changes it is believed that Ideko's credit policies will allow for an account receivables days of 60.The forecasted accounts receivable for Ideko in 2006 is closest to:
A) $19,690
B) $16,970
C) 22,710
D) $14,525
Q3) Based upon Ideko's Sales and Operating Cost Assumptions,what production capacity will Ideko require in 2009?
A) 1,505 units
B) 1,115 units
C) 1,323 units
D) 1,702 units
E) 1,914 units
21
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Chapter 20: Financial Options
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Q1) The open interest for January 2009 put option that is closest to being at-the-money is:
A) 7174
B) 982
C) 319
D) 8422
Q2) You have decided to sell (write)5 January 2009 put options on Merck with an exercise price of $45 per share.How much money will you receive and are these contracts in or out of the money?
Q3) You pay $3.25 for a call option on Luther Industries that expires in three months with a strike price of $40.00.Three months later,at expiration,Luther Industries is trading at $41.00 per share.Your profit per share on this transaction is closest to?
A) -$1.00
B) $1.00
C) -$2.25
D) $2.25
Q4) Describe the conditions when it would be optimal to exercise an American Call and an American Put option prior to their expiration.
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Chapter 21: Option Valuation
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Q1) Using risk neutral probabilities,the calculated price of a one-year put option on KD stock with a strike price of $20 is closest to:
A) $2.00
B) $2.15
C) $1.45
D) $2.40
Q2) Using risk neutral probabilities,calculate the price of a two-year call option on Kinston stock with a strike price of $9.
Q3) Assuming the beta on Taggart stock is 0.75,then the beta for a one-year,at-the-money put option on Taggart stock is closest to:
A) -0.75
B) -2.84
C) -3.89
D) -6.41
Q4) Using risk neutral probabilities,calculate the price of a two-year put option on Kinston stock with a strike price of $9.
Q5) Using the binomial pricing model,calculate the price of a two-year put option on Kinston stock with a strike price of $9.
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Chapter 22: Real Options
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Q1) Given the embedded option to sell the plant,the value of your plant will be closest to:
A) $5.0 million
B) $4.0 million
C) $6.5 million
D) $8.0 million
Q2) Assuming that Kinston does not have the ability to sell the prototype in year one for $300,000,the NPV of the Kinston Industries Mountain Bike Project is closest to:
A) -$45,000
B) $455,000
C) $590,000
D) $90,000
Q3) Assume that Kinston has the ability to ignore the pilot production and test marketing and to go ahead and build their manufacturing plant immediately and that the probability of high or low demand would still be 50%.What is the value of the the option to do pilot production and test marketing?
Q4) Assuming you are able to see the plant,draw a decision tree detailing this problem.
Q5) Describe the two factors that affect the value of an investment timing option?
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Page 24
Chapter 23: The Mechanics of Raising Equity Capital
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Q1) Assuming that this is the venture capitalist's first investment in your firm,the post-money valuation of your shares are closest to:
A) $5.0 million
B) $12.5 million
C) $4.0 million
D) $2.5 million
Q2) Which of the following statements is false?
A) More often than not, firms return to the equity markets and offer new shares for sale, a type of offering called a seasoned equity offering (SEO).
B) Usually, profitable growth opportunities occur throughout the life of the firm, and in some cases it is not feasible to finance these opportunities out of retained earnings.
C) When a firm issues stock using an SEO, it follows many of the same steps as for an IPO. The main difference is that a market price for the stock already exists, so the price-setting process is not necessary.
D) A firm's need for outside capital usually ends at the IPO.
Q3) How much money did the venture capitalists receive?
Q4) How much money did Luther raise?
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25
Chapter 24: Debt Financing
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Q1) Which of the following statements is false?
A) Almost all bonds that are issued today are registered bonds.
B) The trust company represents the bondholders and makes sure that the terms of the indenture are enforced.
C) For private placements, the prospectus must include an indenture, a formal contract between the bond issuer and a trust company.
D) In the case of default, the trust company represents the bondholders' interests.
Q2) Treasury securities that are pure discount bonds with original maturities ranging from a few days to 26 weeks are called
A) TIPS.
B) Treasury bonds.
C) Treasury notes.
D) Treasury bills.
Q3) What is the Yield to Maturity (YTM)on this bond?
Q4) What is the Yield to Maturity (YTM)on this bond?
Q5) What is the Yield to Call (YTC)on this bond?
Q6) What is the Yield to Call (YTC)on this bond?
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Page 26
Chapter 25: Leasing
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Q1) Which of the following statements regarding leases and bankruptcy is false?
A) Operating and true tax leases are generally viewed as true leases by the courts, whereas capital and non-tax leases are more likely to be viewed as a security interest.
B) By retaining ownership of the asset, the lessor has the right to repossess it if the lease payments are not made, even if the firm seeks bankruptcy protection.
C) If a lease contract is characterized as a true lease in bankruptcy, the lessor is in a somewhat superior position than a lender if the firm defaults.
D) If the lease is classified as a true lease in bankruptcy, then the lessee retains ownership rights over the asset.
Q2) What will Luther's balance sheet look like if they acquire the new fleet of delivery trucks using a capital lease?
Q3) The monthly lease payments for a four year lease of the Bulldozer are closest to:
A) $1,870
B) $1,825
C) $1,750
D) $2,115
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Chapter 26: Working Capital Management
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Q1) The cash conversion cycle (CCC)is defined as
A) Inventory Days + Accounts Receivable Days - Accounts Payable Days.
B) Inventory Days - Accounts Receivable Days - Accounts Payable Days.
C) Inventory Days + Accounts Receivable Days + Accounts Payable Days.
D) Inventory Days + Accounts Payable Days - Accounts Receivable Days.
Q2) Hammond's net working capital in 2009 is closest to:
A) $2.3 million
B) $3.8 million
C) $6.5 million
D) $10.5 million
Q3) Luther's cash conversion cycle is closest to:
A) 51 days
B) 66 days
C) 71 days
D) 129 days
Q4) Kinston Industries has an average accounts payable balance of $220,000.Its annual cost of goods sold is $5,475,000,and it receives terms of 2/10,net 30 from its suppliers.Kinston chooses to forgo this discount.Is Kinston managing its accounts payables well?
Q5) Describe "just-in-time" inventory management.
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Chapter 27: Short-Term Financial Planning
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Q1) A loan agreement requires that the firm pay interest on the loan and pay back the principal in one lump sum at the end of the loan is called
A) a short-term mortgage loan.
B) a single, end-of-period-payment loan.
C) a bridge loan.
D) a line of credit.
Q2) Luther Industries is offered a $1 million dollar loan for four months at an APR of 9%.If Luther's bank requires that the firm maintain a compensating balance equal to 10% of the loan amount in a non-interest bearing account,then the effective annual rate EAR for this loan is closest to:
A) 50.0%
B) 12.6%
C) 14.4%
D) 71.5%
Q3) Kinston Industries issued $4,000,000 in commercial paper which matures in six months and received $3,876,000.Calculate the effective annual rate that Kinston is paying.
Q4) Calculate the temporary working capital needs for each of the four quarters for Hasbeen Toys.
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Chapter 28: Mergers and Acquisitions
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Q1) 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.
Q2) Which of the following statements regarding vertical integration is false?
A) Vertically integrated companies may be large, but unlike other large corporations, since they remain focused in one industry they are easy to run.
B) A company might not be happy with how its products are being distributed, so it might decide to take control of its distribution channels.
C) A company might conclude that it can enhance its product if it has direct control of the inputs required to make the product.
D) The principal benefit of vertical integration is coordination. By putting two companies under central control, management can ensure that both companies work toward a common goal.
Q3) What is a white knight?
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Chapter 29: Corporate Governance
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Q1) Insider trading is best described as
A) when a member of the management team makes a trade based upon privileged information.
B) when a member of the management team makes a trade based upon public information.
C) when any investor makes a trade based upon public information.
D) when any investor makes a trade based upon privileged information.
Q2) Regarding board size,researchers have found that
A) smaller boards are associated with greater firm value and performance, since small groups make better decisions than larger groups.
B) smaller boards are associated with lower firm value and performance, since small groups are more likely to be compromised by connections to management.
C) larger boards are associated with greater firm value and performance, since larger boards tend to have directors with a more diverse range of backgrounds and talents.
D) larger boards are associated with lower firm value and performance, since larger groups are more likely to be compromised by connections to management.
Q3) What is the difference between Inside,gray,and outside directors?
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Chapter 30: Risk Management
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Q1) If the going price next year is $1.40 per pound,d'Anconia Copper's operating profit next year will be closest to:
A) $325 million
B) $365 million
C) $375 million
D) $425 million
Q2) Assuming that your firm will purchase insurance,what is the minimum-size deductible that would leave your firm with an incentive to implement the new safety policies?
Q3) Suppose the current exchange rate is $1.42/ ,the interest rate in the United States is 4.0%,the interest rate in the EU is 6%,and the volatility of the $/ exchange rate is 20%.Using the Black-Scholes formula,the price of a three-month European call option on the Euro with a strike price of $1.45/ will be closest to:
A) $0.040/
B) $0.059/
C) $0.078/
D) $0.097/
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 31: International Corporate Finance
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Q1) The present value of the £5 million cash inflow computed by first converting into dollars and then discounting is closest to:
A) $8,950,495
B) $8,954,615
C) $8,943,695
D) $8,961,420
Q2) Which of the following statements is false?
A) When the foreign tax rate is less than the U.S. tax rate, deferral can provide significant benefits.
B) The U.S. tax liability is not incurred until the profits are brought back home if the foreign operation is set up as a foreign branch rather than as a separately incorporated subsidiary.
C) If a company chooses not to repatriate £12.5 million in pre-tax earnings, for example, it effectively reinvests those earnings abroad and defers its U.S. tax liability.
D) When the foreign tax rates exceed the U.S. tax rates, there are no benefits to deferral because in such a case there is no additional U.S. tax liability.
Q3) What is the pound present value of the project?
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