Corporate Finance
Exam Preparation Guide
Course Introduction
Corporate Finance explores the fundamental principles and practices guiding financial decision-making within organizations. The course covers topics such as capital budgeting, financial analysis, risk assessment, capital structure, dividend policy, and valuation of projects and firms. Students learn how to assess investment opportunities, manage corporate resources effectively, and make strategic financial decisions to maximize shareholder value. Emphasis is placed on both theoretical foundations and real-world applications, equipping students with the analytical tools and frameworks necessary for careers in finance, consulting, and corporate management.
Recommended Textbook
Corporate Finance 10th Edition by Stephen A. Ross
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Page 2
Chapter 1: Introduction to Corporate Finance
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Q1) Why might a corporation wish to list its shares on a national exchange such as the NYSE as opposed to a regional exchange or NASDAQ?
Answer: Being listed on a regional exchange effectively limits the capital access for the business. Plus,there is a prestige factor in being listed on one of the national exchanges. There is still a perceived prestige factor in moving from NASDAQ to the NYSE since the NYSE has more restrictive membership requirements. However,the lure of greater prestige certainly hasn't prompted some major corporations,such as Microsoft,to move to the NYSE.
Q2) Which one of the following statements concerning a sole proprietorship is correct?
A) The life of the firm is limited to the life span of the owner.
B) The owner can generally raise large sums of capital quite easily.
C) The ownership of the firm is easy to transfer to another individual.
D) The company must pay separate taxes from those paid by the owner.
E) The legal costs to form a sole proprietorship are quite substantial.
Answer: A
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Chapter 2: Financial Statements and Cash Flow
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Q1) Cash flow to stockholders is defined as:
A) interest payments.
B) repurchases of equity less cash dividends paid plus new equity sold.
C) cash flow from financing less cash flow to creditors.
D) cash dividends plus repurchases of equity minus new equity financing.
E) None of these.
Answer: D
Q2) Explain why the income statement is not a good representation of cash flow.
Answer: Most income statements contain some noncash items,so these must be accounted for when calculating cash flows. More importantly,however,since GAAP is used to create income statements,revenues and expenses are booked when they accrue,not when their corresponding cash flows occur.
Q3) The cash flow of the firm must be equal to:
A) cash flow to stockholders minus cash flow to debtholders.
B) cash flow to debtholders minus cash flow to stockholders.
C) cash flow to governments plus cash flow to stockholders.
D) cash flow to stockholders plus cash flow to debtholders.
E) None of these.
Answer: D
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Page 4
Chapter 3: Financial Statements Analysis and Financial Models
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Q1) If a firm bases its growth projection on the rate of sustainable growth,and shows positive net income,then the:
A) fixed assets will have to increase at the same rate, regardless of the current capacity level.
B) number of common shares outstanding will increase at the same rate of growth.
C) debt-equity ratio will have to increase.
D) debt-equity ratio will remain constant while retained earnings increase.
E) fixed assets, debt-equity ratio, and number of common shares outstanding will all increasE.
Answer: D
Q2) The financial ratio measured as earnings before interest and taxes,plus depreciation,divided by interest expense,is the:
A) cash coverage ratio.
B) debt-equity ratio.
C) times interest earned ratio.
D) gross margin.
E) total debt ratio.
Answer: A
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Chapter 4: Discounted Cash Flow Valuation
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Q1) What is the future value of investing $3,000 for 3/4 year at a continuously compounded rate of 12%?
A) $3,163
B) $3,263
C) $3,283
D) $3,287
E) $3,317
Q2) 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%
Q3) There are three factors that affect the present value of an annuity. Explain what these three factors are and discuss how an increase in each will impact the present value of the annuity.
Q4) Using the example of a savings account,explain the difference between the effective annual rate and the annual percentage rate.
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Chapter 5: Net Present Value and Other Investment Rules
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Q1) The internal rate of return may be defined as:
A) the discount rate that makes the NPV equal to zero.
B) the difference between the market rate of interest and the NPV.
C) the market rate of interest less the risk-free rate.
D) the project acceptance rate set by management.
E) None of these.
Q2) The payback period rule is a convenient and useful tool because:
A) it provides a quick estimate of how rapidly the initial investment will be recouped.
B) results of a short payback rule decision will be quickly seen.
C) it does not have to take into account time value of money.
D) All of these.
E) None of these.
Q3) The payback period rule:
A) discounts cash flows.
B) ignores initial cost.
C) always uses all possible cash flows in its calculation.
D) Both discounts cash flows; and always uses all possible cash flows in its calculation.
E) None of these.
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Chapter 6: Making Capital Investment Decisions
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Q1) Which of the following are correct methods for computing the operating cash flow of a project assuming that the interest expense is equal to zero?
I. EBIT + Depreciation - Taxes
II. EBIT + Depreciation + Taxes
III. Net Income + Depreciation
IV. (Sales - Costs) × (Taxes + Depreciation) × (1 - Taxes)
A) I and III only
B) II and IV only
C) II and III only
D) I, III, and IV only
E) II, III, and IV only
Q2) A project which is designed to improve the manufacturing efficiency of a firm but will generate no additional sales is referred to as a(n) _____ project.
A) sunk cost
B) opportunity
C) cost-cutting
D) revenue-cutting
E) revenue-generating
Q3) Explain the half year convention used in MACRS depreciation.
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Page 8
Chapter 7: Risk Analysis, Real Options, and Capital Budgeting
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Q1) Sensitivity analysis is conducted by:
A) holding all variables at their base level and changing the required rate of return assigned to a project.
B) changing the value of two variables to determine their interdependency.
C) changing the value of a single variable and computing the resulting change in the current value of a project.
D) assigning either the best or the worst possible value to every variable and comparing the results to those achieved by the base case.
E) managers after a project has been implemented to determine how each variable relates to the level of output realized.
Q2) The accounting break-even production quantity for a project is 5,600 units. The fixed costs are $39,650 and the contribution margin is $8. What is the projected depreciation expense?
A) $4,480
B) $5,100
C) $5,150
D) $5,320
E) $5,600
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Page 9
Chapter 8: Interest Rates and Bond Valuation
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Q1) A bond that pays interest annually yields a 7.25% rate of return. The inflation rate for the same period is 3.5%. What is the real rate of return on this bond?
A) 3.50%
B) 3.57%
C) 3.62%
D) 3.72%
E) 3.75%
Q2) Emmett Corporation has issued a $1,000 face value zero-coupon bond. Which of the following values is closest to the correct price for the bond if the appropriate discount rate is 4% and the bond matures in 8 years?
A) $644.61
B) $869.32
C) $1,000.00
D) $1,058.00
E) This problem cannot be worked without the annual interest payments provided
Q3) In the early 1980s,the Treasury yield curve had a severe downward slope with short-term yields near 20% and long-term yields below 15%. Explain how such a pattern might occur.
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Chapter 9: Stock Valuation
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Q1) The Bell Weather Co. is a new firm in a rapidly growing industry. The company is planning on increasing its annual dividend by 15% a year for the next four years and then decreasing the growth rate to 5% per year. The company just paid its annual dividend in the amount of $1.00 per share. What is the current value of one share if the required rate of return is 10%?
A) $27.62
B) $28.79
C) $29.23
D) $32.15
E) $33.67
Q2) A form of equity which receives no preferential treatment in either the payment of dividends or in bankruptcy distributions is called _____ stock.
A) dual class
B) cumulative
C) deferred
D) preferred
E) common
Q3) What is the difference between the enterprise value to EBITDA ratio and the PE ratio?
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11
Chapter 10: Risk and Return: Lessons From Market History
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Q1) Over the past five years,a stock produced returns of 14%,22%,-16%,2%,and 10%. What is the probability that an investor in this stock will NOT lose more than 8% nor earn more than 21% in any one given year?
A) 34%
B) 68%
C) 95%
D) 99%
E) 100%
Q2) A year ago,you purchased 300 shares of IXC Technologies,Inc. stock at a price of $9.03 per share. The stock pays an annual dividend of $.10 per share. Today,you sold all of your shares for $28.14 per share. What is your total dollar return on this investment?
A) $5,703
B) $5,733
C) $5,753
D) $5,763
E) $5,853
Q3) What are the lessons learned from capital market history? What evidence is there to suggest these lessons are correct?
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Chapter 11: Return and Risk: the Capital Asset Pricing Model
Capm
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Q1) The _____ tells us that the expected return on a risky asset depends only on that asset's nondiversifiable risk.
A) Efficient Markets Hypothesis (EMH)
B) systematic risk principle
C) Open Markets Theorem
D) Law of One Price
E) principle of diversification
Q2) Standard deviation measures _____ risk.
A) total
B) nondiversifiable
C) unsystematic
D) systematic
E) economic
Q3) A typical investor is assumed to be:
A) a fair gambler.
B) a gambler.
C) a single security holder.
D) risk averse.
E) risk neutral.
Q4) Explain in words what beta is and why it is important.
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Chapter 12: An Alternative View of Risk and Return: The Arbitrage Pricing Theory
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Q1) Suppose that we have identified three important systematic risk factors given by exports,inflation,and industrial production. In the beginning of the year,growth in these three factors is estimated at -1%,2.5%,and 3.5% respectively. However,actual growth in these factors turns out to be 1%,-2%,and 2%. The factor betas are given by <sub>EX</sub> = 1.8, <sub>I</sub> = 0.7,and <sub>IP</sub> = 1.0. Calculate the stock's total return if the company announces that an important patent filing has been granted sooner than expected and will earn the company 5% more in return.
A) 7.95%
B) 9.95%
C) 11.55%
D) 7.90%
E) 9.35%
Q2) A security that has a beta of zero will have an expected return of:
A) zero.
B) the market risk premium.
C) the risk free rate.
D) less than the risk free rate but not negative.
E) less than the risk free rate which can be negativE.
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Chapter 13: Risk, Cost of Capital, and Valuation
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Q1) The beta of a security provides an:
A) estimate of the market risk premium.
B) estimate of the slope of the Capital Market Line.
C) estimate of the slope of the Security Market Line.
D) estimate of the systematic risk of the security.
E) None of these.
Q2) A firm with cyclical earnings is characterized by:
A) revenue patterns that vary with the business cycle.
B) high levels of debt in its capital structure.
C) high fixed costs.
D) high price per unit.
E) low contribution margins.
Q3) If the project beta and IRR coordinates plot above the SML the project should be: A) accepted.
B) rejected.
C) It is impossible to tell.
D) It will depend on the NPV.
E) None of these.
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15
Chapter 14: Efficient Capital Markets and Behavioral Challenges
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Q1) Insider trading does not offer any advantages if the financial markets are:
A) weak form efficient.
B) semiweak form efficient.
C) semistrong form efficient.
D) strong form efficient.
E) inefficient.
Q2) Market efficiency says:
A) prices may not reflect underlying value.
B) a good financial manager can time stock sales.
C) managers may profitably speculate in foreign currency.
D) managers cannot boost stock prices through creative accounting.
E) None of these.
Q3) If the market is weak form efficient:
A) semistrong form efficiency holds.
B) strong form efficiency must hold.
C) semistrong form efficiency may hold.
D) markets are not weak form efficient.
E) None of these.
Q4) Define the three forms of market efficiency.
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Chapter 15: Long-Term Financing
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Q1) Unsecured corporate debt is called a(n):
A) indenture.
B) debenture.
C) bond.
D) mortgage.
E) None of these.
Q2) Preferred stock may be desirable to issue for which of the following reason(s)?
A) If there is no taxable income, preferred stock does not impose a tax penalty.
B) The failure to pay preferred dividends, cumulative or noncumulative, will not cause bankruptcy.
C) Preferred dividends are not tax deductible and therefore will not provide a tax shield but will reduce net income.
D) Both the failure to pay preferred dividends, cumulative or noncumulative, will not cause bankruptcy; and preferred dividends are not tax deductible and therefore will not provide a tax shield but will reduce net income.
E) Both if there is no taxable income, preferred stock does not impose a tax penalty; and the failure to pay preferred dividends, cumulative or noncumulative, will not cause bankruptcy.
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Chapter 16: Capital Structure: Basic Concepts
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Q1) MM Proposition I with taxes is based on the concept that:
A) the optimal capital structure is the one that is totally financed with equity.
B) the capital structure of the firm does not matter because investors can use homemade leverage.
C) the firm is better off with debt based on the weighted average cost of capital. D) the value of the firm increases as total debt increases because of the interest tax shield.
E) the cost of equity increases as the debt-equity ratio of a firm increases.
Q2) The weighted average cost of capital is invariant to the use of leverage under MM conditions of no taxes. Graph the relationship of the weighted average cost of capital and leverage; be sure to include the cost of equity and debt. Explain why this relationship holds.
Q3) Discuss Modigliani and Miller's Propositions I and II in a world without taxes. List the basic assumptions,results,and intuition of the model.
Q4) Discuss Modigliani and Miller's Propositions I and II in a world with taxes. List the basic assumptions,results,and intuition of the model.
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Page 18
Chapter 17: Capital Structure: Limits to the Use of Debt
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Q1) Given the following information,leverage will add how much value to the unlevered firm per dollar of debt?
Corporate tax rate: 30%
Personal tax rate on income from bonds: 20%
Personal tax rate on income from stocks: 0%
A) $0.125
B) $0.472
C) $0.528
D) $0.825
E) None of these.
Q2) Suppose a Miller equilibrium exists with a corporate tax rate of 30% and a personal tax rate on income from bonds of 35%. What is the personal tax rate on income from stocks?
A) 0.0%
B) 7.1%
C) 10.05%
D) 45.5%
E) None of these.
Q3) What are the advantages of a prepackaged bankruptcy for a firm? What are the disadvantages?
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Chapter 18: Valuation and Capital Budgeting for the Levered Firm
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Q1) A very large firm has a debt beta of zero. If the cost of equity is 10%,and the risk-free rate is 3%,the cost of debt is:
A) 3%.
B) 6%.
C) 11%.
D) 15%.
E) It is impossible to tell without the expected market return.
Q2) If the WACC is used in valuing a leveraged buyout,the:
A) WACC remains constant because of the final target debt ratio desired.
B) flotation costs must be added to the total UCF.
C) WACC must be recalculated as the debt is repaid and the cost of capital changes. D) tax shields of debt are not available because the corporation is no longer publicly traded.
E) None of these.
Q3) Kelly Industries is given the opportunity to raise $5 million in debt through a local government subsidized program. While Kelly would be required to pay 12% on its debt issues,the Hampton County program sets the rate at 9%. If the debt issue expires in 4 years,calculate the NPV of this financing decision.
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Chapter 19: Dividends and Other Payouts
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Q1) Which of the following are factors that favor a high dividend policy?
I. Stockholders desire for current income
II. Tendency for higher stock prices for high dividend paying firms
III. Investor dislike of uncertainty
IV. High percentage of tax-exempt institutional stockholders
A) I and III only
B) II and IV only
C) I, III, and IV only
D) II, III, and IV only
E) I, II, III, and IV
Q2) Robinson's has 15,000 shares of stock outstanding with a par value of $1.00 per share and a market price of $36 a share. The balance sheet shows $15,000 in the common stock account,$315,000 in the capital in excess of par account,and $189,000 in the retained earnings account. The firm just announced a 3-for-2 stock split. What will the value of the common stock account be after the split?
A) $10,000
B) $12,500
C) $15,000
D) $18,500
E) $22,500
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Page 21
Chapter 20: Raising Capital
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Q1) Arguments against the use of the shelf-registration are:
A) only technology and manufacturing-based firms can use it.
B) less current information available to investors might raise the cost of debt.
C) possible market overhang from future issues depressing price.
D) Both only technology and manufacturing-based firms can use it; and possible market overhang from future issues depressing price.
E) Both less current information available to investors might raise the cost of debt; and possible market overhang from future issues depressing pricE.
Q2) For a particular stock the old stock price is $20,the ex-rights price is $15,and the number of rights needed to buy a new share is 2. Assuming everything else constant,the subscription price is ______.
A) $5
B) $13
C) $17
D) $18
E) $20
Q3) Discuss the stages of venture capital financing,defining each in detail.
Q4) Discuss what a Dutch auction is and how it works.
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Page 22
Chapter 21: Leasing
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Q1) A financial lease has the following as its primary characteristics:
A) is fully amortized, lessee maintains equipment and there is no renewal clause and no cancellation clause.
B) is not fully amortized, lessor maintains equipment and there is a renewal clause but no cancellation clause.
C) is fully amortized, lessor maintains equipment and there is a renewal clause and a no cancellation clause.
D) is not fully amortized, lessor maintains equipment and there is a renewal clause. E) is fully amortized, lessee maintains equipment and there is a renewal clause and a no cancellation clausE.
Q2) What are some of the advantages and disadvantages of leasing?
Q3) A leveraged lease typically involves a non-recourse loan in which:
A) the lessee's payments go directly to the lender in case of default.
B) the lessor is not obligated in case of default.
C) the third party lenders have a first lien on the assets.
D) All of these.
E) None of these.
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Page 23
Chapter 22: Options and Corporate Finance
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Q1) You sold ten put option contracts on PLT stock with an exercise price of $31.20 and an option price of $1.20. Today,the option expires and the underlying stock is selling for $33 a share. Ignoring trading costs and taxes,what is your total profit or loss on this investment?
A) -$3,300
B) -$1,200
C) $120
D) $1,200
E) $3,300
Q2) The act where an owner of an option buys or sells the underlying asset,as is his right,is called ______ the option.
A) striking
B) exercising
C) opening
D) splitting
E) strangling
Q3) Suppose XYZ is priced at $125 a share,has a call with an exercise price of $150,has two months to expiration,and costs $0.125 per contract. Why do you suppose investors would be willing to purchase a call that is so far out of the money?
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Chapter 23: Options and Corporate Finance: Extensions and Applications
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Q1) The call option on a dividend paying stock compared to a non-dividend paying stock is:
A) more valuable because of the extra dividend payment.
B) equal in value because cash dividends are paid on stock only.
C) less valuable because cash dividends are paid on stock only.
D) less valuable if the dividend paying stock is in-the-money while the non-dividend paying stock if out-of-the-money.
E) None of these.
Q2) Rejecting an investment today forever may not be a good choice because:
A) the size of the firm will decline.
B) there are always errors in the estimation of NPVs.
C) the option value is negative.
D) the company's foregoing the future rights or option to the investment.
E) None of these.
Q3) The executive janitor of NuValue was granted 1,000,000 options. The stock price at the time of the granting of the options was $25 and the options are at the money. The risk free rate was 3% and the options expire in 3 years. The variance on the stock is .04. What is the value of the options contract?
Q4) Why would the company pay the executive in options as opposed to salary?
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Chapter 24: Warrants and Convertibles
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Q1) Diamond Drill Inc. has 150,000 shares and 15,000 warrants outstanding. A warrant holder can purchase a new share of stock for five warrants and $5.00 per warrant. The stock is currently selling for $27 per share. A firm has 100 shares of stock and 40 warrants outstanding. The warrants are about to expire,and all of them will be exercised. The market value of the firm's assets is $2,000,and the firm has no debt. Each warrant gives the owner the right to buy 2 shares at $15 per share. What is the price per share of the stock?
A) $11.11
B) $15.00
C) $17.78
D) $20.00
E) None of these.
Q2) The holders of Looper Industries bond with a face value of $1,000 can exchange that bond for 20 shares of stock. The stock is selling for $35.00. What is the conversion premium?
A) 10.25%
B) 35.00%
C) 42.86%
D) 142.86%
E) None of these.
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Page 26
Chapter 25: Derivatives and Hedging Risk
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Q1) A Treasury note with a maturity of 2 years pays interest semi-annually on a 9 percent annual coupon rate. The $1,000 face value is returned at maturity. If the effective annual yield for all maturities is 7 percent annually,what is the current price of the Treasury note?
A) $960.68
B) $986.69
C) $1,010.35
D) $1,034.40
E) $1,038.99
Q2) Futures market transactions are used to reduce risk. Risk may not be totally offset if:
A) the two instruments have different maturities.
B) payoff schedules of the two instruments are different.
C) the volatility of the two instruments are different.
D) the price movements are not perfectly correlated.
E) All of
Q3) The futures markets are labeled as pure speculation and even gambling. Why is this an inaccurate portrayal of the market's function?
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Chapter 26: Short-Term Finance and Planning
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Q1) With a flexible policy with regard to short term financing,over a year a firm will have:
A) some short-term borrowing.
B) some funds to invest in marketable equity securities.
C) full coverage of permanent current assets.
D) Both some short-term borrowing and some funds to invest in marketable equity securities are correct.
E) some short-term borrowing; some funds to invest in marketable equity securities; and full coverage of permanent current assets are correct.
Q2) Stoney Brooke,Inc. has sales of $890,000 and cost of goods sold of $640,000. The firm had a beginning inventory of $36,000 and an ending inventory of $46,000. What is the length of the inventory period?
A) 15.24 days
B) 15.61 days
C) 21.19 days
D) 21.71 days
E) 23.38 days
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Chapter 27: Cash Management
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Sample Questions
Q1) Determining the appropriate target cash balance involves assessing the trade-off between:
A) income and diversification.
B) the benefit and cost of liquidity.
C) balance sheet strength and transaction needs.
D) All of these.
E) None of these.
Q2) If a firm has achieved its target cash balance the net present value is:
A) positive because the cash balance is positive.
B) zero because increasing the cash balance increases the interest cost.
C) negative because the cash balance has a financing cost.
D) positive because decreasing the cash decreases the cost of illiquidity.
E) None of these.
Q3) Firms would need to hold zero cash when transactions related needs are:
A) greater than cash inflows.
B) less than cash inflows.
C) not perfectly synchronized with cash inflows.
D) perfectly synchronized with cash inflows.
E) None of these.
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Chapter 28: Credit and Inventory Management
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Sample Questions
Q1) Captive finance companies are:
A) parent companies to the subsidiary.
B) subsidiaries to the parent company.
C) used by firms with good credit ratings.
D) Both parent companies to the subsidiary and subsidiaries to the parent company.
E) Both subsidiaries to the parent company and used by firms with good credit ratings.
Q2) If 20% of the customers pay on day 10 and 80% pay on day 30,the average collection period is:
A) 10 days.
B) 15 days.
C) 22.5 days.
D) 24 days.
E) 26 days.
Q3) Aggie Corporation has been asked by its customers to grant them a 2% discount if they pay their bill within 15 days. The purchase size of the average order is $75,000. Normally,the customer pays within 30 days with no discount. Aggie's cost of debt capital is 12%. Should the request be granted?
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Chapter 29: Mergers, Acquisitions, and Divestitures
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Sample Questions
Q1) A public offer by one firm to directly buy the shares of another firm is called a:
A) merger.
B) consolidation.
C) tender offer.
D) spinoff.
E) divestiturE.
Q2) Alto and Solo are all-equity firms. Alto has 2,400 shares outstanding at a market price of $24 a share. Solo has 4,000 shares outstanding at a price of $17 a share. Solo is acquiring Alto for $63,000 in cash. The incremental value of the acquisition is $5,500. What is the net present value of acquiring Alto to Solo?
A) $100
B) $400
C) $1,200
D) $2,400
E) $5,500
Q3) Discuss why AT&T purchased T-Mobile in 2011.
Q4) Describe the three basic legal procedures that one firm can use to acquire another and briefly discuss the advantages and disadvantages of each.
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Chapter 30: Financial Distress
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Q1) Successful private workouts are better for firms than formal bankruptcy because:
A) direct costs are considerably lower in private workouts.
B) private workout firms can issue new debt senior to all prior debt.
C) stock price increases are greater for private workouts than for firms emerging from formal bankruptcy.
D) Both direct costs are considerably lower in private workouts; and private workout firms can issue new debt senior to all prior debt.
E) Both direct costs are considerably lower in private workouts; and stock price increases are greater for private workouts than for firms emerging from formal bankruptcy.
Q2) APR,as it relates to financial distress,means the rules of:
A) absolute profitability.
B) arbitration priority.
C) absolute priority.
D) arbitration profitability.
E) automatic profitability.
Q3) When choosing between liquidation and reorganization,what are some of the empirical factors that lead a firm toward one choice or the other?
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Chapter 31: International Corporate Finance
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Q1) Triangular arbitrage would take place if the _____ rate between two currencies was not _____ to the ratio of the two direct rates.
A) cross; equal B) spot; equal C) cross; less than D) spot; less than E) cross; greater than
Q2) In the spot market,$1 is currently equal to A$1.42. The expected inflation rate is 3 percent in Australia and 2 percent in the U.S.. What is the expected exchange rate one year from now if relative purchasing power parity exists?
A) A$1.4058
B) A$1.4062
C) A$1.4286
D) A$1.4342
E) A$1.4484
Q3) Are exchange rate changes between the U.S. dollar and the Japanese yen necessarily good or bad for Japanese automakers? Explain your reasoning.
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