Corporate Finance
Exam Review
Course Introduction
Corporate Finance explores the fundamental principles and practices involved in the financial management of corporations. The course covers topics such as financial statement analysis, capital budgeting, risk and return, cost of capital, capital structure, dividend policy, and working capital management. Through case studies and real-world examples, students learn to make informed decisions regarding investment opportunities, financing strategies, and value maximization for shareholders. This course is essential for understanding how financial strategies can drive business growth and sustainability in competitive markets.
Recommended Textbook
Introduction to Corporate Finance 4th Edition by Sean Cleary
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Page 2
Chapter 1: An Introduction to Finance
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Sample Questions
Q1) An example of a non-marketable financial asset is a
A) demand deposit.
B) T-bill.
C) commercial paper.
D) common share.
Answer: A
Q2) Human capital is
A) based on only the current skills, but not the education, of a country's citizens.
B) based on only the education, but not the current skills, of a country's citizens.
C) based on the skills and capital of citizens and should be included in a country's wealth.
D) difficult to measure and should therefore not be included in a country's wealth.
Answer: C
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3
Chapter 2: Business Corporatefinance
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Sample Questions
Q1) Which of the following is the most correct? ______ know their exposure is limited to the amount of capital they invest in the company.
A) Employees
B) Sole proprietors
C) General partners
D) Limited partners and shareholders
Answer: D
Q2) What does it mean to "go public"?
A) to sell goods and services to the public
B) to raise money from the stock market
C) to borrow money from the debt market
D) to do business with governmental firms
Answer: B
Q3) Which of the following is NOT a form of business organization?
A) corporation
B) sole partnership
C) general partnership
D) sole proprietorship
Answer: B
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Page 4
Chapter 3: Financial Statements
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Sample Questions
Q1) A company has net income this year of $45,500.Last year,the company's net working capital was $14,300 and this year's net working capital is $15,200.Depreciation this year is $7,300.What is cash from operations this year?
A) Net income
B) Add depreciation
C) Subtract change in NWC
D) CFO
Answer: D
Q2) At the beginning of year 1,XYZ bought a machine for $50,000.The machine is in class 43 with a CCA rate of 30%.Assuming that the machine is the only asset in the class,what is the UCC (undepreciated capital cost)for the machine class after CCA is claimed at the end of year 2?
A) $27,000
B) $27,500
C) $29,750
D) $50,000
Answer: C
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5
Chapter 4: Financial Statement Analysis and Forecasting
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Sample Questions
Q1) Charles invested $3 million in the bonds of Toys & Tots Company eight years ago.Recent recalls of the toys produced by Toys & Tots has Charles worried about whether he will receive his annual interest cheque from the firm.Which ratio(s)will most directly address Charles' concern?
A) I only
B) I and II only
C) III only
D) II and III only
I.Debt / asset
II.Debt / equity
III.Times interest earned
Q2) .Which of the following ratios are "flow ratios"?
A) Debt / equity ratio
B) Times interest covered
C) Leverage ratio
D) None of the above
Q3) Mr.B.Baggins has just computed the operating margin and the gross profit margin for Hoppit Company and has found that the operating margin is greater than the gross profit margin.Is this possible? Why or why not? Explain your reasoning.
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Page 6
Chapter 5: Time Value of Money
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Sample Questions
Q1) How much should a monthly compounded account with an EAR of 18% earn semi-annually?
A) 2.80%
B) 3.00%
C) 2.77%
D) 8.63%
Q2) If I invest $1,000 in a financial instrument paying 10% simple interest payable at the end of each year,I will
A) not receive any interest for the first year.
B) receive the same amount of interest each year.
C) receive interest only for the first year.
D) receive less interest in year ten than in year two.
E) receive interest on both the principal and first year's interest in year two.
Q3) For a given effective annual rate,the quoted rate ______ as the compounding frequency increases.
A) does not change
B) increases
C) decreases
D) There is no connection between the effective annual rate and the quoted rate.
Q4) Explain the difference between simple interest and compound interest.
Page 7
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Chapter 6: Bond Valuation and Interest Rates
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Sample Questions
Q1) Marie bought a five-year 4.25 percent annual coupon bond for $974 a year ago.Today,she sold the bond at the market yield of 4 percent.What is Marie's approximate real rate of return if the inflation rate over the past year was 2.2 percent?
A) 1.80%
B) 2.05%
C) 5.76%
D) 5.98%
Q2) The current yield (CY)is:
A) The ratio of the semi-annual coupon interest divided by the bond's maturity value.
B) The ratio of the semi-annual coupon interest divided by the bond's current market price.
C) The ratio of the annual coupon interest divided by the bond's current market price.
D) The ratio of the annual coupon interest divided by the bond's maturity value.
Q3) J&B Co.has 8.75 percent coupon bonds quoted with a market yield of 9.25 percent.The bonds have fifteen years to mature and make annual interest payments.What is the percentage change in price for a 10 percent decrease in market yield?
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Page 8
Chapter 7: Equity Valuation
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Sample Questions
Q1) Which of the following is not a correct statement of the Constant Growth DDM?
A) It holds only when growth in dividends is expected to occur at the same rate indefinitely.
B) It holds only when kS1U1B1c S1U1B0< g.
C) It is a version of the dividend discount model for valuing common shares that assumes that dividends grow at a constant rate indefinitely.
D) Only future estimated cash flows and estimated growth in these cash flows are relevant.
Q2) Explain the difference between required rate of return and growth rate,and show the relationship between the two.
Q3) Junkies Corporation has just paid a dividend of $0.90.Dividends are expected to grow at 20% for years one and two,15% for years three and four,10% for years five and six,and 5% thereafter.What is the expected dividend for year 10 if the required return is 18 percent?
A) $2.40
B) $2.52
C) $2.65
D) $2.78
Q4) What is the sustainable growth rate?
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Chapter 8: Risk, return, and Portfolio Theory
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Sample Questions
Q1) Baxter Inc.'s annual returns for the past four years were: 2.75%,-1.8%,7.2%,and 6.5%.What are the arithmetic and geometric average annual returns for Baxter over the four-year period?
A) Arithmetic mean = 6.80%; geometric mean = 3.35%
B) Arithmetic mean = 3.66%; geometric mean = 3.60%
C) Arithmetic mean = 14.65%; geometric mean = 10.05%
D) Arithmetic mean = 18.03%; geometric mean = 21.20%
Q2) Distinguish between systematic and non-systematic risk.
Q3) The expected return on Alpha Inc.is 8 percent and the expected return on Beta Inc.is 24 percent.What is the trade-off between investing in Alpha and Beta if the portfolio weight in Alpha is increased by 1%?
A) -0.08%
B) -0.16%
C) -0.24%
D) -0.32%
Q4) Define the term "risk" and explain how it is related to the expected return.
Q5) Define and discuss expected return with regard to individual securities and a portfolio as a whole.
Q6) Does diversification always reduce the overall risk?
Page 10
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Chapter 9: The Capital Asset Pricing Model Capm
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Sample Questions
Q1) "There may be some truth in the CAPM,but my sister-in-law bought a stock last year that earned a 20 percent return,much higher than what was expected using the CAPM." Evaluate this criticism.
Q2) The expected return of Security A is 12 percent with a standard deviation of 15 percent.The expected return of Security B is 9 percent with a standard deviation of 10 percent.Securities A and B have a correlation of 0.4.The market return is 11 percent with a standard deviation of 13 percent and the risk-free rate is 4 percent.Which one of the following is not an efficient portfolio,as determined by the lowest Sharpe ratio?
A) 100% invested in A is efficient
B) 100% invested in B is efficient
C) 41% in A and 59% B is efficient
D) 59% in A and 41% B is efficient
Q3) What is the expected payoff from an investment that is equally likely to move from $100 to $180 or $100 to $70?
A) 40
B) 15
C) -15
D) 25
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Chapter 10: Market Efficiency
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Sample Questions
Q1) The price of a certain stock rises every Monday and falls every Thursday.Which form of efficiency is contradicted?
A) Weak form
B) Semi-strong form
C) Strong form
D) No form of efficiency is contradicted.
Q2) A senior manager can consistently earn excess profits by trading her company's stock.Which form of efficiency is contradicted?
A) Weak form
B) Semi-strong form
C) Strong form
D) No form of efficiency is contradicted.
Q3) What does informational efficiency refer to?
A) Cheap information costs
B) Prices that quickly reflect important information
C) Low number of transactions
D) Both A and B are correct.
Q4) Explain the implications of having an inefficient market.
Q5) State the semi-strong form of market efficiency and its implications.
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Chapter 11: Forwards,futures,and Swaps
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Sample Questions
Q1) Use the following statements to answer this question:
A) I is correct, II is incorrect
B) I and II are correct
C) I and II are incorrect
D) I is incorrect, and II is correct
I.Credit default swaps (CDS)is a default premium on debt issue.
II.Credit default swaps (CDS)are insurance on the default of issuers of the debt.
Q2) Profit from a short position in a forward is:
A) (X - S<sub>T</sub>)
B) [S<sub>T</sub> - F] × n
C) (S<sub>T</sub> - X)
D) [F - S<sub>T</sub>] × n
Q3) What is a relatively small (in terms of the contract value)deposit made with the clearinghouse?
A) Maintenance margin
B) Margin call
C) Initial margin
D) Daily resettlement
Q4) What are the differences between forwards and futures contracts?
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Chapter 12: Options
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Sample Questions
Q1) Montreal Smoked Meat shares are selling for $55.The 2-year put option on XYZ shares has the following characteristics: strike = $50,price = $0.25
Given that the risk-free rate is 2%,what is the price of a 2-year call option on XYZ shares with an exercise price of $50?
A) $5.25
B) $7.19
C) $4.75
D) $0
Q2) An option can be:
A) I, II, III, IV
B) I, II, III only
C) I, II only
D) I only
I.in the money
II.out of the money
III.at the money
IV.shallow
Q3) Briefly explain how to replicate the payoff of a risk-free asset using put-call parity.
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Chapter 13: Capital Budgeting, risk Considerations, and Other Special Issues
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Sample Questions
Q1) You must choose between the following projects.Project Alpha requires an initial investment of $10 million and provides an NPV of $4 million.Project Bravo requires an investment of $7 million and provides an NPV of $4 million.Project Charlie requires an investment of $8 million and provides an NPV of $4 million.Project Delta,contingent on project Alpha,requires an investment of $5 million and provides an NPV of $4.5 million.If you only have $15 million in available capital,which projects will you select?
A) Projects Alpha and Delta
B) Projects Bravo and Charlie
C) Projects Bravo and Delta
D) Projects Charlie and Delta
Q2) Capital expenditures are
A) a firm's investments in net working capital.
B) a firm's investments in long-lived tangible and non-tangible assets.
C) a firm's investments in financial securities.
D) all of the above.
Q3) Michael Porter argues that firms can create competitive advantages for themselves by adopting one of two strategies.Explain what they are.
Q4) When a business faces capital rationing,what discount rate is used and why?
Page 15
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Chapter 14: Cash Flow Estimation and Capital Budgeting
Decisions
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Sample Questions
Q1) A pharmaceutical company has discovered a new drug that treats gastrointestinal disorders.The R&D costs for the drug were $3 million.In the testing phase of this new drug,the company further discovered that there is a possibility that the drug would be effective against migraine headaches if they invest another 10% in R&D.When evaluating the capital budgeting decision for the migraine remedy,what portion of the R&D costs for the drug should be attributed to the migraine budget?
A) 0 percent of the R&D costs.
B) $300,000 of the R&D costs.
C) $1.65 million of the R&D costs.
D) It cannot be determined until the drug is further tested. There may be more uses for this drug and further testing is required.
Q2) What is the difference between the initial cash flow and the purchase price of an asset?
A) Set up costs only
B) Capital costs
C) Other capital costs and net working capital
D) None of the above
Q3) Explain the importance of scenario analysis in capital budgeting.
Q4) Explain why the CCA tax savings are discounted at the firm's cost of capital.
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Chapter 15: Mergers and Acquisitions
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Sample Questions
Q1) Which of the following is NOT a limitation of the liquidation valuation approach?
A) It leads to imprecise estimates.
B) The resulting value estimates are not forward-looking.
C) The estimates change frequently and require constant updating.
D) All of these are limitations of the liquidation valuation approach.
Q2) A firm decides to defend itself from a hostile takeover.Management tries to solicit competing takeover bids from other firms.This defense involves the use of a:
A) Poison pill
B) White knight
C) Shareholders' rights plan
D) Tender offer
Q3) Empirical evidence regarding merger gains shows that,on average:
A) Target firm shareholders experience a significant gain.
B) Acquiring firm shareholders experience a significant gain, while target firm shareholders gain nothing.
C) Target firm shareholders experience no gain, while acquiring firm shareholders lose.
D) None of the above.
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17
Chapter 16: Leasing
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Q1) You are the CFO of a company.You are considering leasing photocopiers from the manufacturer instead of purchasing them for $200,000.You can borrow at 9 percent and the corporate tax rate is 35 percent.The lease payment will be $50,000 for 5 years,beginning today.At the end of the 5 years,the photocopiers will be worthless.Assume that the photocopiers can be depreciated $40,000 per year for tax purposes.What is the IRR of the lease incremental cash flows?
A) 5.85%
B) 7.00%
C) 9.00%
D) 12.03%
Q2) Which of the following changes would make leasing more attractive?
A) A reduction in the leased asset's expected economic life
B) A general increase in the corporate tax rate
C) A fall in the market interest rates
D) None of the above
Q3) The Canada Revenue Agency's definition of financial lease allows:
A) the lessor to benefit from high CCA
B) the lessor to own the asset
C) the lessee to expense payments to the lessor
D) the lessee to own the asset
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Chapter 17: Investment Banking and Securities Law
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Q1) If you are handed a formal summary of a security that describes the costs,investment objectives,and risks involved,what are you reading?
A) Annual report
B) Prospectus
C) Auditor report
D) Proxy statement
Q2) Which of the following statements is not true about underpricing?
A) It "leaves money on the table."
B) It is done to get more IPO proceeds for the issuing firm.
C) It is calculated as the difference between the initial offering price and the price on the first day of trading.
D) It involves pricing an IPO at less than its market value.
Q3) Describe a potential conflict of interest that may arise when an investment dealer underwrites a new equity issue on a bought deal basis.
Q4) Generally,initial public offerings (IPOs)are:
A) fairly priced.
B) overpriced.
C) underpriced.
Q5) Briefly explain the term "underpricing."
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Chapter 18: Debt Instruments
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Sample Questions
Q1) Short-term debt securities that are unsecured obligations issued by corporations are called:
A) Treasury bills.
B) debentures.
C) commercial paper.
D) all of the above.
Q2) Laurentide Resort Company would like to issue $100 million of commercial paper.Define liquidity support and describe why it would be important to investors.
Q3) Use the following statements to answer this question:
A) I and II are correct.
B) I and II are incorrect.
C) I is incorrect and II is correct.
D) I is correct and II is incorrect.
I.Tax deductibility of dividends makes equity very desirable.
II.An instrument can be classified as debt even if it is not so in the Income Tax Act.
Q4) Explain the implication of the failure of Lehman Brothers on short-term debt yields,and how it was remedied.
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20
Chapter 19: Equity and Hybrid Instruments
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Q1) If you are to allocate the amount of soft retractable preferred shares in the financial statements,where would they go?
A) Assets
B) Liabilities
C) Ownership equity
D) None of the above
Q2) Discuss how preferred shares have features of both debt and equity instruments.
Q3) Which of the following statements about family trusts is true?
A) Family trusts separate ownership and control.
B) Income flows to the trust beneficiaries.
C) The trustees retain the voting power.
D) All of the above statements are true.
Q4) The conversion premium is defined as which of the following?
A) The number of shares that a convertible security can be exchanged for.
B) The price at which a convertible security can be converted into common shares.
C) The value of a convertible security if it is immediately converted into common shares.
D) The percentage difference between the value at which the bonds are trading and their conversion value.
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Chapter 20: Cost of Capital
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Sample Questions
Q1) A company with a capital structure having a D/E ratio of 0.5 has:
A) 66.66% debt
B) 66.66% equity
C) 33.33% equity
D) 50.00% debt
Q2) Use the following statements to answer this question:
A) I and II are correct.
B) I and II are incorrect.
C) I is correct and II is incorrect.
D) I is incorrect and II is correct.
I.The source of volatility in operating income is caused by fixed costs.
II.Operating leverage does not necessarily increase with increases in the volatility of net income.
Q3) The Saguenay Tourism Company has a beta of 1.30,the risk-free rate is 3 percent,and the return on the market is 4 percent.The required return on the firm's equity is:
A) 3.9%
B) 6.5%
C) 4.30%
D) 9.50%
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Chapter 21: Capital Structure Decisions
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Q1) When measuring the potential effect of leverage on a firm,what must we consider?
A) The stock of debt outstanding
B) The maturity of the debt outstanding
C) Any sinking fund payments
D) All of the above
Q2) Determine the EPS indifference EBIT level for Poutine Company for the following two scenarios: A debt/equity ratio of .6,pre-tax cost of debt is 8 percent,annual interest payments are $2,000,and the company has 1,000 shares outstanding.In scenario 2,the firm is all equity financed and has 1,500 shares outstanding.The tax rate is 40 percent for both scenarios.
The EPS indifference EBIT level for Poutine Company is:
A) $10,000
B) $6,000
C) $4,000
D) $2,000
Q3) Indifference analysis is developed through the relationship between
A) debt-equity ratio and expected earnings.
B) earnings before interest and taxes and earnings per share.
C) beta and expected return.
D) after-tax earnings and earnings per share.
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Chapter 22: Dividend Policy
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Q1) Which of the following is not a side effect of a stock split?
A) There is no effect on retained earnings account
B) Investors face no tax implications
C) The average share price will be reduced to reflect the split
D) There will be no change in the number of shares outstanding
Q2) Dividend yields:
A) Increase when share prices increase and dividends remain stable
B) Are similar among Canadian firms
C) Increase when dividends increase and share prices remain stable
D) Are always greater than 5%
Q3) What is the most probable reason for stock splits?
A) The economic benefit for the firm
B) The increase in the number of shares where the price stays the same
C) Trading price at an acceptable level for small investors
D) Trading price at the penny stock level
Q4) Toronto Trust Corp.is expecting an earnings increase this year.The CEO thinks that the earnings increase may be temporary.Instead of raising dividends,she decides to repurchase stock.Why does she choose stock repurchases over dividend increases?
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Page 24
Chapter 23: Working Capital Management: General Issues
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Q1) For a given operating cycle,a firm estimates the amount of financing it requires by
A) Calculating the expected profit from sales over the operating cycle
B) Calculating the total expected sales over the operating cycle
C) Calculating the longest period it can possibly obtain to fulfill its payables
D) Calculating the longest period it can possibly grant for customers' payables
Q2) Montreal Bagel Bakery collects 45% of its monthly sales immediately and the rest a month later.Its production costs are 60% of sales.It holds 1 month of sales in inventory,and it pays half its bills immediately and half after 30 days.Calculate the cash conversion cycle and the operating cycle for Montreal Bagel Bakery.
Q3) Montreal Skaters Corp.collects 35% of its monthly sales immediately and the rest a month later.Its production costs are 65% of sales.It holds 1 month of sales in inventory,and it pays half its bills immediately and half after 30 days.What is this firm's break-even sales growth rate?
A) 200.0%
B) 46.8%
C) 56.0%
D) 104.0%
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Page 25
Chapter 24: Working Capital Management: Current Assets and
Current Liabilities
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Q1) Cash on hand provides:
A) low return, high liquidity, and low default risk.
B) high return, high liquidity, and low default risk.
C) high return, high liquidity, and high default risk.
D) low return, high liquidity, and high default risk.
Q2) Which of the following scenarios is an example of the precautionary motive to hold cash?
A) A retailer holds a reserve of cash in case customers return products for a cash refund.
B) A bank holds cash on deposit for its customers.
C) A car dealership holds cash to pay its utility bill.
D) A small business pays a cash dividend to its owner because she's not sure she will have enough funds to pay for Christmas gifts for her family.
Q3) An open account credit occurs when a firm grants:
A) trade credit to customers who have an account with the firm.
B) trade credit to customers who have depository accounts.
C) trade credit to customers by collateralizing the assets sold to the customer.
D) credit to customers who have an open bank account.
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Page 26