Corporate Finance
Exam Practice Tests
Course Introduction
Corporate Finance explores the fundamental principles and practices involved in managing a firm's financial resources to maximize shareholder value. The course covers essential topics such as capital budgeting, risk and return analysis, cost of capital, financial planning, capital structure, dividend policy, and working capital management. Students will learn to analyze financial statements, evaluate investment opportunities, determine financing options, and understand the impact of financial decisions on a corporation's long-term strategy. Emphasis is placed on real-world applications, problem-solving, and the use of quantitative tools to make informed business decisions.
Recommended Textbook
Fundamentals of Corporate Finance 2nd Canadian Edition by Jonathan Berk
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Chapter 1: Corporate Finance and the Financial Manager
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Q1) It is generally not the duty of financial managers to ensure that a firm has the cash it needs for day-to-day transactions.
A)True
B)False
Answer: False
Q2) Which of the following types of firms do not have limited liability?
A) sole proprietorships
B) limited partnerships
C) private corporations
D) public corporations
E) limited liability partnerships
Answer: A
Q3) Corporations have come to dominate the business world through their ability to raise large amounts of capital by sale of ownership shares to anonymous outside investors.
A)True
B)False
Answer: True
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3
Chapter 2: Introduction to Financial Statement Analysis
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Q1) According to the text,did Enron follow Generally Accepted Accounting Principles (GAAP)in its financial reporting process?
Answer: Many of Enron's problems were kept hidden from boards and shareholders until it was too late.People felt that the accounting statements of the company,while often remaining True to the letter of GAAP,did not present an accurate picture of the financial health of the company.
Q2) What is a firm's net income?
A) earnings before interest and taxes are deducted
B) the third line of an income statement that represents the difference between sales revenues and costs
C) a measure of the firm's profitability over a given period
D) net sales less cost of sales
E) earnings after interest is deducted but before taxes are deducted
Answer: C
Q3) The statement of financial position shows the assets,liabilities,and stockholders' equity of a firm over a given length of time.
A)True
B)False
Answer: False
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Page 4
Chapter 3: The Valuation Principle: the Foundation of Financial Decision Making
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Q1) What is the present value (PV)of $85,000 received 15 years from now,assuming the interest rate is 3% per year?
A) $54,558
B) $85,000
C) $82,524
D) $132,427
E) $5,502
Answer: A
Q2) You decide to $10,000 in a bank account.If the value of your savings grows to $10,200 in one year's time,what is the interest rate on your savings?
A) 5%
B) 4%
C) 3%
D) 2%
E) 1%
Answer: D
Q3) How does arbitrage help the Law of One Price?
Answer: Any arbitrage opportunity will exploit any mispricing to restore the Law of One Price.
Page 5
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Chapter 4: The Time Value of Money
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Questions
Q1) JJ & Co has decided to donate money to a cancer research fund every year for the next 25 years.They will make annual payments of $3.5 million.What is the present value of their donation if the current market rate is 7.5%?
A) $87.5 million
B) $14.3 million
C) $33.33 million
D) $46.7 million
E) $39.0 million
Q2) Assuming that college costs continue to increase an average of 4% per year and that all her college savings are invested in an account paying 7% interest,then the amount of money she will need to have available at age 18 to pay for all four years of her undergraduate education is closest to:
A) $97,110
B) $107,532
C) $101,291
D) $50,000
E) $85,790
Q3) In terms of present value (PV),how much will Joe receive for selling the family business?
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Page 6
Chapter 5: Interest Rates
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Q1) What is the shape of the yield curve and what expectations are investors likely to have about future interest rates?
A) inverted; higher
B) normal; higher
C) inverted; lower
D) normal; lower
E) flat; unchanged
Q2) An 8% APR with monthly compounding is closest to which of the following?
A) an EAR of 6.7%
B) an EAR of 7.72%
C) an EAR of 8.3%
D) an EAR of 8.5%
E) an EAR of 9.14%
Q3) When you borrow money,the interest rate on the borrowed money is the price you pay to be able to convert your future loan payments into money today.
A)True
B)False
Q4) What is the net present value (NPV)of an investment that costs $2500 and pays $1000 certain at the end of one,three,and five years?
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Chapter 6: Bonds
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Q1) The yield to maturity for the three-year zero-coupon bond is closest to:
A) 5.4%
B) 5.8%
C) 5.6%
D) 6.0%
E) 5.0%
Q2) A company releases a five-year bond with a face value of $1000 and coupons paid semi-annually.If market interest rates imply a YTM of 6%,what should be the coupon rate offered if the bond is to trade at par?
A) 3%
B) 4%
C) 6%
D) 8%
E) 9%
Q3) A bond indenture indicates
A) the amounts and dates of all payments to be made. B) the individual to whom payments will be made.
C) the yield to maturity of the bond.
D) the price of the bond.
E) the bond premium.
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Chapter 7: Valuing Stocks
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Q1) Sunnyfax Publishing pays out all its earnings and has a share price of $38.In order to expand,Sunnyfax Publishing decides to cut its dividend from $3.00 to $2.00 per share and reinvest the retained funds.Once the funds are reinvested,they are expected to grow at a rate of 12%.If the reinvestment does not affect Sunnyfaxs equity cost of capital,what is the expected share price as a consequence of this decision?
A) $33.33
B) $40.00
C) $50.00
D) $60.00
E) $65.00
Q2) Bentham Books pays annual dividends and has just paid this year's dividend of $0.65.If its equity cost of capital is 12%,and dividends are expected to grow by 3% per year in the future,what is the value of Bentham's stock?
A) $5.42
B) $7.22
C) $7.44
D) $21.67
E) $5.58
Q3) How can the dividend-discount model handle changing growth rates?
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Chapter 8: Investment Decision Rules
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Sample Questions
Q1) A delivery service is buying 600 tires for its fleet of vehicles.One supplier offers to supply the tires for $85 per tire,payable in one year.Another supplier will supply the tires for $20,000 down today,then $50 per tire,payable in one year.What is the difference in PV between the first and the second offer,assuming interest rates are 8.5%?
A) $1000
B) $276
C) $645
D) -$1000
E) -$645
Q2) Assuming that your capital is constrained,what is the fifth project that you should invest in?
A) Project H
B) Project I
C) Project B
D) Project A
E) Project C
Q3) What is the decision criteria while using the payback rule?
Q4) Why is the internal rate of return (IRR)inadequate when comparing mutually exclusive investments of different scale?
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Chapter 9: Fundamentals of Capital Budgeting
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Q1) The change in net working capital from year 1 to year 2 is closest to:
A) a decrease of $360
B) an increase of $360
C) an increase of $396
D) a decrease of $396
E) an increase of $756
Q2) The amount that Ford Motor Company owes in taxes next year without the launch of the new SUV is closest to:
A) $24.0 million
B) $56.0 million
C) $31.5 million
D) $13.5 million
E) $10.5 million
Q3) The most difficult part of the capital budgeting process is accurately estimating cash flows and cost of capital.
A)True
B)False
Q4) Why does the option to abandon a project have value?
Q5) How do we handle interest expense when making a capital budgeting decision?
Page 11
Q6) What do you understand by break-even analysis?
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Chapter 10: Risk and Return in Capital Markets
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Q1) Is volatility a reasonable measure of risk when evaluating large portfolios?
Q2) The standard deviation for the return on an portfolio of 20 type S firms is closest to:
A) 15.0%
B) 23.0%
C) 5.25%
D) 5.10%
E) 20.0%
Q3) IGM Realty had a price of $30,$30,$35,$33,and $25 at the end of the last five quarters.If IGM pays a dividend of $2 at the end of each quarter,what is the annual realized return on IGM?
A) 8.61%
B) 7.6%
C) 7.10%
D) 8.09%
E) 8.24%
Q4) Which type of investment has historically had the lowest volatility?
Q5) What is the difference between systematic and unsystematic risk?
Q6) Why must riskier investments offer higher expected returns?
Q7) How does diversification affect systematic and unsystematic risk?
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Chapter 11: Systematic Risk and the Equity Risk Premium
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Q1) We can reduce volatility by investing in less than perfectly correlated assets through diversification because the expected return of a portfolio is the weighted average of the expected returns of its stocks,but the volatility of a portfolio
A) is higher than the weighted average volatility.
B) is independent of weights in the stocks.
C) is less than the weighted average volatility.
D) depends on the expected return.
E) is the same as the weighted average volatility.
Q2) You expect General Motors (GM)to have a beta of 1.5 over the next year and the beta of Exxon Mobil (XOM)to be 1.9 over the next year.Also,you expect the volatility of General Motors to be 50% and that of Exxon Mobil to be 35% over the next year.Which stock has more systematic risk? Which stock has more total risk?
A) XOM, GM
B) GM, XOM
C) GM, GM
D) XOM, XOM
E) They both have the same risks.
Q3) Is it possible for a stock to have high total risk but low systematic risk?
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Chapter 12: Determining the Cost of Capital
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Q1) Preferred stock of Ford Motors pays a dividend of $4 each year and trades at a price of $30.What is the cost of preferred stock capital for Ford?
A) 13.3%
B) 14.5%
C) 15.5%
D) 16.2%
E) 16.5%
Q2) A firm has outstanding debt with a coupon rate of 7%,seven years maturity,and a price of $1000 per $1000 face value.What is the after-tax cost of debt if the marginal tax rate of the firm is 30%?
A) 4.9%
B) 5.2%
C) 5.5%
D) 5.9%
E) 6.3%
Q3) Should a firm with high retained earnings have a lower cost of equity?
Q4) Why do we use leverage if it increases the risk of a firm?
Q5) Which of the three costs-debt,preferred stock,and common equity-is most difficult to estimate?
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Chapter 13: Risk and the Pricing of Options
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Q1) Suppose a stock is currently trading for $23,and in one period it will either increase to $30 or decrease to $20.If the one-period risk-free rate is 5%,what is the price of a European put option that expires in one period and has an exercise price of $25?
A) $2.79
B) $2.50
C) $2.38
D) $2.21
E) $2.66
Q2) The payoff to the holder of a call option is given by:
A) C = max(S - K, 0)
B) C = min(K, 0)
C) C = max(K - S, 0)
D) C = min(K - S, 0)
E) C = min(S - K, 0)
Q3) In practice,option prices are not very sensitive to changes in the risk-free rate.
A)True B)False
Q4) How is equity like a call option on the firm's assets?
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Chapter 14: Raising Equity Capital
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Q1) After the venture capitalist's investment,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
E) $200,000
Q2) An IPO is offered at $23 per share for 12 million shares.The IPO underwriters had a spread of 6%.What proceeds did the firm receive from the IPO?
A) $259 million
B) $276 million
C) $260 million
D) $293 million
E) $270 million
Q3) The announcement of an SEO usually raises a stock's price.
A)True
B)False
Q4) What is the general long-run performance of an IPO?
Q5) How many types of seasoned equity offerings are there?
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Chapter 15: Debt Financing
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Sample Questions
Q1) A bond has a face value of $10,000 and a conversion price of $17.86.The stock is currently trading at $16.30.What is the conversion ratio?
A) 330
B) 487
C) 500
D) 560
E) 614
Q2) A company issues a callable (at par)ten-year,6% coupon bond with annual coupon payments.The bond can be called at par in one year after release or any time after that on a coupon payment date.On release,it has a price of $104 per $100 of face value.What is the yield to worst of this bond when it is released?
A) 0.60%
B) 1.92%
C) 4.00%
D) 5.47%
E) 6.00%
Q3) Bond covenants tend to increase a bond issuer's borrowing costs.
A)True
B)False
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Chapter 16: Capital Structure
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Q1) A new business will generate a one-time cash flow of $22,000 after one year.The business will be financed with 60% equity and 40% debt.If the firm's unlevered equity cost of capital is 11%,what is the levered value of the firm with perfect capital markets?
A) $18,182
B) $20,000
C) $19,820
D) $24,200
E) $19,580
Q2) We discount the cash flows of a levered firm with a different discount rate than the cost of equity of the unlevered firm because
A) leverage decreases the risk of equity of the firm.
B) leverage changes the unlevered cost of equity.
C) leverage increases the risk of equity of the firm.
D) cost of debt decreases in this setting.
E) default risk increases.
Q3) How does the interest paid by a firm affect its value to investors?
Q4) The presence of leverage can influence the behaviour of the managers of a firm.
A)True
B)False
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Chapter 17: Payout Policy
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Q1) A firm has $400 million of assets that includes $50 million of cash and 10 million shares outstanding.The firm uses $40 million of its cash to pay dividends.If an investor has 1000 shares,how many shares must she sell to create a homemade dividend of $4900?
A) 25 shares
B) 30 shares
C) 35 shares
D) 40 shares
E) 45 shares
Q2) Fireball Furnaces is an all-equity firm with 50 million shares outstanding.Fireball has $10 million in cash,and expects future free cash flows of $2 million per year.The cash can be used to expand the firm's future operations,increasing future free cash flows to $3.5 million per year.If Fireball's cost of capital for the expansion is 7%,what will be the difference in the firm's share price compared to using the cash for a share repurchase?
A) Share price is $0.43 higher with expansion.
B) Share price is $0.43 higher with repurchase.
C) Share price is the same with both options.
D) Share price is $0.23 higher with expansion.
E) Share price is $0.23 higher with repurchase.
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Chapter 18: Financial Modelling and Pro Forma Analysis
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Q1) Assuming that Ideko has a EBITDA multiple of 9.4,then the continuation EV/Sales ratio of Ideko in 2015 is closest to:
A) 1.9
B) 1.7
C) 1.6
D) 1.8
E) 1.5
Q2) How do we know if expansion is a good idea for the firm?
Q3) What is the implied assumption in percent of sales method?
Q4) Long-term financial planning allows a financial manager to understand the business by ________ between sales,costs,capital investments,and financing.
A) increasing the spread
B) identifying linkages
C) decreasing the spread
D) identifying wastage
E) identifying differences
Q5) The amount of net working capital for Ideko in 2016 is closest to:
Q6) What is net new financing?
Q7) Why is EBITDA multiple used for valuation rather than sales or earnings?
Page 20
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Chapter 19: Working Capital Management
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Q1) Can a firm's cash cycle be longer than a firm's operating cycle?
Q2) What is the effective annual cost of credit terms of 3/15 net 30,if the firm stretches the accounts payable to 60 days?
A) 1.7%
B) 3.35%
C) 12.65%
D) 28.03%
E) 17.42%
Q3) A firm decides to stretch its accounts payable,resulting in an effective annual cost of credit of 22.4%,under terms of 3/15 net 30.When is the firm paying its accounts payable?
A) 70 days
B) 65 days
C) 60 days
D) 55 days
E) 50 days
Q4) What is the collection float?
Q5) What are the five Cs of Credit?
Q6) What are the costs of holding inventory?
Q7) What are the advantages of holding inventory?
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Chapter 20: Short Term Financial Planning
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Q1) A firm issues six-month commercial paper with a $1 million face value and receives $970,000.What is the EAR the firm is paying for these funds?
A) 6%
B) 3%
C) 3.09%
D) 6.18%
E) 6.28%
Q2) What are commitment fees and what effect does it have on the loan?
Q3) Why should permanent working capital be financed with long-term sources of funds?
Q4) What are Flinder's temporary working capital needs in the fourth quarter?
A) $390,000
B) $510,000
C) $720,000
D) $120,000
E) $650,000
Q5) The interest on commercial paper is typically paid by selling it at an initial discount. A)True B)False
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Chapter 21: Risk Management
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Q1) ________ costs impose several direct and indirect costs,including agency costs,whose insurance could lead to an increase in firm value.
A) Bankruptcy and financial distress
B) Market
C) Input
D) Output
E) Startup
Q2) What is key personnel insurance?
Q3) The risk of fire at a car assembly plant is 0.2%.If the firm will receive a payment of $30 million in one year if there is a fire during the year,what is the net present value (NPV)of purchasing insurance if the firm will face financial distress costs of $5 million and issuance costs of $1 million in the event of a loss if the risk-free rate is 5%?
A) $11,429
B) $12,367
C) $12,967
D) $13,673
E) $14,356
Q4) How does insurance allow firms to increase their use of debt financing?
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Chapter 22: International Corporate Finance
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Q1) The one-year forward exchange rate for the British pound is 1.70 CAD/GBP.If the one-year Canadian interest rate is 5% and the one-year British interest rate is 6%,compute the implied spot exchange rate in CAD/GBP.
A) 1.69
B) 1.72
C) 1.75
D) 1.78 E) 1.81
Q2) One British pound can be purchased for $1.65.What is the exchange rate in terms of pounds per dollar?
A) 0.551
B) 0.606
C) 0.626
D) 0.645
E) 0.652
Q3) Why do purely domestic businesses,with no international operations and no imports or exports,still need to be aware of FX markets?
Q4) Why do firms prefer forward contracts rather than the cash-can-carry strategy?
Q5) What is the importer-exporter dilemma?
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Chapter 23: Leasing
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Q1) A lease in which the lessor borrows from a bank or other lender to obtain the initial capital for the purchase of an asset and using the lease payments to pay the interest and principal on the loan is called a
A) sales-type lease.
B) direct lease.
C) sale and leaseback.
D) leveraged lease.
E) synthetic lease.
Q2) Generally speaking,if the asset's CCA deductions are slower than its lease payments,there are tax gains from a true tax lease if the lessor is in a higher tax bracket than the lessee.
A)True
B)False
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
E) Buy the scanner, the NPV of the decision = -$104,027
Q4) What is the difference between an operating lease and a finance lease?
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Chapter 24: Mergers and Acquisitions
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Q1) Martin Manufacturing has earnings per share (EPS)of $3.00,5 million shares outstanding,and a share price of $32.Martin is considering buying Luther Industries,which has earnings per share of $2.50,2 million shares outstanding,and a share price of $20.Martin will pay for Luther by issuing new shares.There are no expected synergies from the transaction.
Assume that Martin pays no premium to acquire Luther.Calculate Martin's price-earnings (P/E)ratio both pre- and post-merger.
Q2) Sol Company has announced plans to acquire Luna Corporation.Sol is trading for $23 per share,and has a premerger value of $7 billion,while Luna is trading for $56 per share and has a premerger value of $5 billion.The projected synergies from the merger are $500 million.If the offer is for $2 billion in cash and the remainder in stock,what is the maximum exchange ratio that Sol could offer in the stock swap portion and still generate a positive NPV?
A) 3.04
B) 2.68
C) 2.84
D) 0.48
E) 0.45
Q3) What are synergies?
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Chapter 25: Corporate Governance
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Q1) What is the drawback of having more independent directors on the board?
Q2) When a board's monitoring duties have been compromised by connections or perceived loyalties to management,it is said to be
A) a dysfunctional board.
B) an institutional board.
C) a failed board.
D) a divided board.
E) a captured board.
Q3) Having a founder and top executive also be a major shareholder
A) always results in agency conflicts that are bad for minority shareholders.
B) can sometimes, as in the case of Google, have benefits that outweigh the costs.
C) is illegal in Canada and most other industrialized countries.
D) is never beneficial to employees.
E) inevitably leads to insider trading.
Q4) How does a pyramid structure work?
Q5) What is the cost of aligning managers' interests with those of shareholders?
Q6) How do securities analysts provide outside monitoring of a corporation?
Q7) Describe the main requirements of the Sarbanes-Oxley Act of 2002.
Q8) What is the difference among inside,grey,and outside directors?
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