Corporate Finance
Exam Solutions
Course Introduction
Corporate Finance explores the fundamental principles and analytical tools used by managers to make strategic financial decisions within organizations. The course covers topics such as capital budgeting, risk and return analysis, valuation of securities, cost of capital, capital structure, dividend policy, and working capital management. Students will learn to apply quantitative methods to assess investment opportunities, optimize financing strategies, and manage financial risks, all while considering the implications for shareholder value and corporate strategy. Through case studies and real-world examples, the course equips students with the skills necessary to address the financial challenges faced by modern businesses.
Recommended Textbook
Fundamentals of Corporate Finance 9th Canadian Edition by Richard A Brealey
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Chapter 1: Goals and Governance of the Firm
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Sample Questions
Q1) The short-term decisions of financial managers are comprised of:
A) capital structure decisions only.
B) investment decisions only.
C) financing decisions only.
D) both investment and financing decisions.
Answer: D
Q2) Which one of these statements is correct?
A) Financial managers have a fiduciary duty to stockholders.
B) Financial managers are concerned only with funds that flow to investors.
C) The chief financial officer generally reports directly to the corporate treasurer.
D) The corporate controller is primarily responsible for overseeing a firm's cash functions.
Answer: A
Q3) A firm's reputation:
A) has no value.
B) is an important firm asset.
C) is irrelevant to shareholders.
D) can be easily restored once damaged.
Answer: B
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3
Chapter 2: Financial Markets and Institutions
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Sample Questions
Q1) Which of the following information is not provided by the financial markets?
A) The price of six ounces of gold
B) The cost of borrowing $500,000 for 5 years
C) Microsoft's earnings in 2013
D) The cost of one million yen in U.S. dollars
Answer: C
Q2) Financial markets and intermediaries:
A) channel savings to real investment.
B) increase risks for businesses.
C) generally reduce the liquidity of securities.
D) prevent the transportation of cash across time.
Answer: A
Q3) A primary market would be utilized when:
A) investors buy or sell existing securities.
B) shares of common stock are exchanged.
C) securities are initially issued.
D) a commission must be paid on the transaction.
Answer: C
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Chapter 3: Accounting and Finance
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Sample Questions
Q1) What happens to a firm's net worth as it uses cash to repay accounts payable?
A) Net worth increases.
B) Net worth decreases.
C) Net worth remains constant.
D) Net worth decreases temporarily, until cash is replenished.
Answer: C
Q2) The payment of interest expense is considered a financing activity in the statement of cash flows.
A)True
B)False
Answer: False
Q3) Which of the following changes in working capital will result in an increase in cash flows?
A) Increase in accounts payable
B) Increase in inventories
C) Increase in accounts receivable
D) Decrease in other current liabilities
Answer: A
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Chapter 4: Measuring Corporate Performance
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Sample Questions
Q1) TSI Inc.has liquid assets of $1,000,enough to finance its operations for 67 days.TSI's average daily expenditures from operations are:
A) $6.70.
B) $8.23.
C) $14.93.
D) $22.28.
Q2) Which one of these changes indicates an improvement in a firm's asset management efficiency?
A) An increase in the amount of assets per dollar of sales
B) An increase in the inventory turnover rate
C) A decrease in the receivables turnover rate
D) An increase in the average days in inventory
Q3) What is the ROE for a firm with a times interest earned ratio of 2,a tax liability of $1 million,and interest expense of $1.5 million if equity equals $1.5 million?
A) 26.67%
B) 30.00%
C) 33.33%
D) 50.00%
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Chapter 5: The Time Value of Money
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Sample Questions
Q1) "Give me $5,000 today and I'll return $10,000 to you in 5 years," offers the investment broker.To the nearest percent,what annual interest rate is being offered?
A) 12.29%
B) 13.67%
C) 14.87%
D) 12.84%
Q2) An annuity factor represents the future value of $1 that is deposited today.
A)True
B)False
Q3) How much interest will be earned in the next year on an investment paying 12% compounded annually if $100 was just credited to the account for interest?
A) $88
B) $100
C) $112
D) $200
Q4) The discount factor is used to calculate the present value of $1 received in year t. A)True
B)False
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Chapter 6: Valuing Bonds
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Sample Questions
Q1) What are the conditions imposed on a debt issuer that are designed to protect bondholders ?
A) Collateral agreements
B) Vanilla wrappers
C) Protective covenants
D) Default provisions
Q2) A bond has a face value of $1,000,has 5 years until maturity,and an annual coupon rate of 7%? It yields 5% currently.By how much will the price change over the next year if the yield remains constant?
A) zero
B) decline by $86.59
C) decline by $15.67
D) rise by $15.67
Q3) Which of the following statements is correct for a 10% coupon bond that has a current yield of 7%?
A) The face value of the bond has decreased.
B) The bond's maturity value exceeds the bond's price.
C) The bond's internal rate of return is 7%.
D) The bond's market value is higher than its face value.
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Chapter 7: Valuing Stocks
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Sample Questions
Q1) If the liquidation value of a corporation exceeds the market value of the equity,then the:
A) firm has no value as a going concern.
B) firm's stock will sell for book value.
C) firm is not taking advantage of available growth opportunities.
D) dividend payout ratio has been too high.
Q2) Which statement is correct?
A) The momentum factor refers to the tendency for stock price changes to reverse.
B) The momentum factor refers to the tendency for stock price changes to persist for a while and then revert.
C) The momentum factor implies that stock prices are rather like a pendulum.
D) The momentum factor is inconsistent with the strong form of the efficient market hypothesis.
Q3) The terminal value of a share of stock:
A) is similar to the maturity value of a bond.
B) refers to the share value at the end of an investor's holding period.
C) is the value received by investors upon liquidation of the firm.
D) is the price for shares traded through a dealers' market.
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Chapter 8: Net Present Value and Other Investment Criteria
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Sample Questions
Q1) A project can have as many different internal rates of return as it has:
A) cash inflows.
B) cash outflows.
C) periods of cash flow.
D) changes in the sign of the cash flows.
Q2) What is the maximum that should be invested in a project at time zero if the inflows are estimated at $50,000 annually for 3 years,and the cost of capital is 9%?
A) $101,251.79
B) $109,200.00
C) $126,564.73
D) $130,800.00
Q3) When a manager does not accept a positive-NPV project,shareholders face an opportunity cost in the amount of the:
A) project's initial cost.
B) project's NPV.
C) project's discounted cash inflows.
D) soft capital rationing budget.
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Chapter 9: Using Discounted Cash-Flow Analysis to Make Investment Decisions
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Sample Questions
Q1) An investment today of $25,000 promises to return $10,000 annually for the next 3 years.What is the real rate of return on this investment if inflation averages 6% annually during the period?
A) 3.49%
B) 9.78%
C) 4.84%
D) 6.38%
Q2) Under the MACRS:
A) all assets are depreciated over 5 years.
B) depreciable percentages decline throughout the asset's class life.
C) straight-line depreciation percentages are doubled.
D) assets are assumed to be purchased and sold midyear.
Q3) The likely effect of discounting nominal cash flows with real interest rates will be to:
A) make an investment's NPV appear more attractive.
B) make an investment's NPV appear less attractive.
C) correctly calculate an investment's NPV if inflation is expected.
D) correctly calculate an investment's NPV, regardless of expected inflation.
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Page 11
Chapter 10: Project Analysis
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Sample Questions
Q1) The economic break-even point of a project can be found by:
A) setting the discount rate equal to the DOL.
B) solving for the annual sales that will equate total revenue with total cost.
C) solving for the annual sales that will give the project an NPV of zero.
D) solving for the level of sales that will give the project an IRR of zero.
Q2) Sensitivity analysis evaluates projects by:
A) forecasting changes in interest rates that would increase financing costs.
B) recording profitability changes while changing one variable at a time.
C) ensuring that the project sponsor has the proper incentives.
D) testing for interrelated variables.
Q3) Analysis indicates that a project's level of success is primarily dependent upon the firm controlling the variable costs.What type of analysis was conducted?
A) Sensitivity analysis
B) Break-even analysis
C) Ratio analysis
D) Real option analysis
Q4) A capital budget shows a proposed list of investments.
A)True
B)False
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Chapter 11: Introduction to Risk, Return, and the Opportunity
Cost of Capital
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Sample Questions
Q1) What is the expected return on a portfolio that will decline in value by 13% in a recession,will increase by 16% in normal times,and will increase by 23% during boom times? Each scenario has an equal likelihood of occurrence.
A) 8.67%
B) 13.00%
C) 13.43%
D) 17.33%
Q2) The S&P 500 accounts for most of the total market value of stocks traded in the United States.
A)True
B)False
Q3) Calculate the variance of returns for Alpha stock with the following historical rates of return: 2013 20%
2014 25%
2015 30%
A) 16.67
B) 33.33
C) 50.00
D) 100.00
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Chapter 12: Risk,Return,and Capital Budgeting
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Sample Questions
Q1) What is the beta of a security with an expected return of 12% if Treasury bills yield 6% and the market risk premium is 8%?
A) 0.50
B) 0.75
C) 0.90
D) 1.50
Q2) The required risk premium for any given investment is defined by the security market line.
A)True
B)False
Q3) The capital asset pricing model (CAPM)assumes that the stock market is dominated by well-diversified investors who are concerned only with market risk.
A)True
B)False
Q4) If a security plots below the security market line,it is:
A) ignoring all of the security's specific risk.
B) underpriced, a situation that should be temporary.
C) offering too little return to justify its risk.
D) a defensive security, which expects to offer lower returns.
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Chapter 13: The Weighted-Average Cost of Capital and Company Valuation
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Sample Questions
Q1) If a firm earns the WACC on its assets,then:
A) equityholders will be satisfied, but bondholders will not.
B) bondholders will be satisfied, but equityholders will not.
C) all investors will earn their minimum required rate of return.
D) the firm is investing in only positive NPV projects.
Q2) Other things equal,which of the following will decrease the WACC of a firm that has both debt and equity in its capital structure?
A) An increase in the stock's beta
B) An increase in the expected market return
C) An increase in the tax rate
D) An increase in the yield on preferred stock
Q3) According to CAPM estimates,what is the cost of equity for a firm with a beta of 1.5 when the risk-free interest rate is 6% and the expected return on the market portfolio is 15%?
A) 19.5%
B) 21.0%
C) 22.5%
D) 24.0%
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Chapter 14: Introduction to Corporate Financing and Governance
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Sample Questions
Q1) The term "senior debt" refers only to debt that was issued in the more distant past.
A)True
B)False
Q2) Funded debt refers to those liabilities that:
A) have established a sinking fund for repayment.
B) are not callable at the option of the firm.
C) are secured by specific collateral.
D) have a maturity of more than one year remaining.
Q3) Which one of the following equity concepts would you expect to be least important to a financial analyst?
A) Par value per share
B) Additional paid-in capital
C) Retained earnings
D) Net common equity
Q4) Companies sometimes sell the cash flows from a bundle of loans.Such bonds are known as asset-backed bonds.
A)True
B)False
Page 16
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Chapter 15: Venture Capital, IPOs, and Seasoned Offerings
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Sample Questions
Q1) One of the primary reasons for disbursing venture capital funds in installments is to:
A) avoid tax liability.
B) identify and cut losses early.
C) increase the importance of the venture capitalist.
D) take advantage of the time value of money.
Q2) Companies offering smaller security issues may prefer to issue them through a:
A) private placement because lower rates of return can be offered.
B) private placement because it is cheaper than a public issue.
C) public issue because it is cheaper than a private placement.
D) public issue because more exposure will be achieved.
Q3) In many countries it is common even for large businesses to remain privately owned.
A)True
B)False
Q4) Blue-sky laws exist in order to:
A) protect stock underwriters from fraudulent firms.
B) restrict the amount of profit from IPOs.
C) control the amount of stock owned by one investor.
D) protect investors from deceptive firms.
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Page 17
Chapter 16: Debt Policy
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Sample Questions
Q1) When a firm pays tax,MM's Proposition I no longer holds,and the capital structure of the firm can be important due to the:
A) lower tax rates on dividends than on debt.
B) higher tax rates on retained earnings than on debt.
C) interest tax shield.
D) higher operating income from lower dividends.
Q2) According to MM,debt restructuring will not change the firm's overall value.
A)True
B)False
Q3) What is the proportion of debt financing for a firm that expects a 24% return on equity,a 16% return on assets,and a 12% return on debt? Ignore taxes.
A) 54.0%
B) 60.0%
C) 66.7%
D) 75.0%
Q4) According to MM's proposition II the expected return on equity is equal to the expected return on assets for a levered firm.
A)True B)False
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Chapter 17: Payout Policy
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Sample Questions
Q1) Which of the following statements is false?
A) Most mature companies pay dividends.
B) Many companies pay dividends and repurchase stock.
C) Repurchases fluctuate more than dividends.
D) Stock repurchases have become less common over the past 30 years.
Q2) A two-for-one stock split is like a 200% stock dividend
A)True
B)False
Q3) An investor buys a stock today for $26,receives a dividend of $2 at the end of the year and then sells the stock for $30.If the dividend is taxed at 40% and the capital gain at 20%,what is his return after tax?
A) 23.08%
B) 16.92%
C) 9.23%
D) 31.15%
Q4) Companies can pay out cash to their shareholders in two ways.They can pay a dividend or they can buy back some of their outstanding shares.
A)True
B)False
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Chapter 18: Long-Term Financial Planning
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Sample Questions
Q1) Pro formas are projected or forecasted financial statements.
A)True
B)False
Q2) Financial planning may incorporate scenario analysis as part of the planning process.
A)True
B)False
Q3) A firm that wants to increase its sustainable growth rate can do so by __________ the __________ ratio or by __________ the __________,or both.
A) increasing; payout; increasing; ROE
B) increasing; plowback; increasing; ROE
C) decreasing; plowback; increasing; ROE
D) decreasing; payout; decreasing; ROE
Q4) A financial plan:
A) is generally considered to be a useless exercise due to unforeseen events.
B) should include all possible contingencies.
C) provides a basis for evaluating future performance.
D) should always be based on the worst-case scenario.
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Chapter 19: Short-Term Financial Planning
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Sample Questions
Q1) Zeta Stores places orders for 60% of the sales forecast in the next month and for 40% of the sales forecast for the following month.It pays for these goods with a 1-month delay? If sales for August are forecast at $10 million and sales for September and October are forecast at $12 million,what will be the forecast cash outflow in September?
A) $10.8 million
B) $15.6 million
C) $4.8 million
D) $9.6 million
Q2) When a firm finances long-term assets with short-term sources of funding,it:
A) reduces the risk of cash shortage.
B) will generally have lower interest expense.
C) improves the leverage ratio.
D) violates the principle of matched maturities.
Q3) Holdings of marketable securities are at worst zero-NPV investments for taxpaying firms.
A)True
B)False
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21
Chapter 20: Working Capital Management
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Sample Questions
Q1) The Canine Kennel uses 600 cases of dog food annually and orders 40 cases in each shipment.The annual carrying cost per case is $5 and the economic order quantity is 25 cases.Which one of these statements best applies to this situation?
A) The current annual ordering costs exceed $5 per case.
B) The firm needs to increase its average inventory level of dog food.
C) The current annual ordering costs are less than the carrying costs.
D) The firm needs to reduce the number of orders placed per year.
Q2) If goods are sold on terms of 5/10,net 90,what effective interest rate is if the purchaser pays on day 90?
A) 20.00%
B) 22.81%
C) 24.93%
D) 26.37%
Q3) Which of the following would be more likely to justify granting credit?
A) A higher profit margin
B) A lower probability of payment
C) A higher discount rate
D) A lower selling price
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Chapter 21: Mergers,Acquisitions,and Corporate Control
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Sample Questions
Q1) The Williams Act in addition to state laws sets forth the rules for tender offers.
A)True
B)False
Q2) If investors believe a firm may be acquired,its market value is likely to be higher than its stand-alone value.
A)True
B)False
Q3) Which one of the following statements is correct for a firm that has undergone a leveraged buyout?
A) Its shares are no longer traded publicly.
B) Its capital is mostly equity financed.
C) Its shares are not traded publicly.
D) It has a larger shareholder base.
Q4) Only the U.S.has antitrust laws that can affect mergers and acquisitions.
A)True
B)False
Q5) The 1980s were a time of little merger activity.
A)True
B)False
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Chapter 22: International Financial Management
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Q1) Which one of the following appears to be a safe assumption when there is no difference between the forward and spot exchange rates between two currencies?
A) The countries have equal nominal interest rates.
B) The spot rate is expected to change.
C) Expected inflation is less than the nominal rate.
D) Both currencies are selling at a premium relative to the other.
Q2) If the spot exchange rate of Mexican pesos for U.S.dollars is MXN9.8=USD1 and the peso is trading at a forward premium of 3%,then you will receive:
A) more than 9.8 pesos per dollar in the future.
B) less than 9.8 pesos per dollar in the future.
C) 9.83 pesos per dollar in the future.
D) 10.09 pesos per dollar in the future.
Q3) Futures contracts offer an alternative way to buy foreign currency forward.
A)True
B)False
Q4) Forward rates are always equal to the actual future exchange rates.
A)True
B)False
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Page 24
Chapter 23: Options
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Q1) An investor who sells a put option profits if:
A) stock prices go up.
B) stock prices go down.
C) the put is exercised.
D) interest rates go up.
Q2) If you sell a put option,your maximum payoff is equal to:
A) The maximum of zero or the stock price the exercise price.
B) The maximum of the exercise price the stock price or zero.
C) zero.
D) the exercise price.
Q3) A 10-year convertible bond has a face value of $1,000,a 9% coupon,and a conversion ratio of 30.The stock is currently priced at $35.If a comparable straight bond would have a yield of 9%,what is the minimum value of the call option provided by the convertible?
A) $0
B) $5
C) $50
D) $65
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Chapter 24: Risk Management
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Q1) Insurance is often an effective way to reduce risk when the insurance company can spread its risk over many different policies.
A)True
B)False
Q2) ABC Corp.borrows $5 million at 10% from a bank and swaps this loan for a 12% yen loan.The spot exchange rate is JPY105 = USD1.How much does ABC pay annually to the bank?
A) ¥1.26 million
B) ¥5.71 million
C) ¥52.50 million
D) ¥63.00 million
Q3) Which one of the following is not correct concerning futures contracts?
A) Futures contracts entail an obligation rather than an option.
B) The contract price is set at the beginning of the contract.
C) The contracts are exchange-traded.
D) Gains and losses are not settled until the contract expires.
Q4) The majority of large companies use derivatives in some way to manage their risk.
A)True
B)False
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