Corporate Finance
Midterm Exam
Course Introduction
Corporate Finance explores the principles, strategies, and analytical tools used in managing a firm's financial resources to maximize shareholder value. This course covers fundamental topics such as capital budgeting, cost of capital, financing decisions, risk management, dividend policy, and corporate valuation. Students will develop skills in financial analysis, decision-making, and the application of quantitative techniques to address real-world corporate finance challenges, preparing them to critically evaluate financial strategies and understand their implications for organizational growth and sustainability.
Recommended Textbook
Corporate Finance The Core 4th Edition by Jonathan Berk
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Page 2
Chapter 1: The Corporation
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Q1) Which of the following is/are an advantage of incorporation?
A)Access to capital markets
B)Limited liability
C)Unlimited life
D)All of the above
Answer: D
Q2) The largest stock market in the world by market capitalization is:
A)the London Stock Exchange.
B)NASDAQ.
C)the American Stock Exchange.
D)the New York Stock Exchange.
Answer: D
Q3) The Principal-Agent Problem arises:
A)because managers have little incentive to work in the interest of shareholders when this means working against their own self-interest.
B)because of the separation of ownership and control in a corporation.
C)Both A and B
D)None of the above
Answer: C
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Page 3
Chapter 2: Introduction to Financial Statement Analysis
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Q1) Which of the following includes other sources of income or expenses that arise from activities that are not a central part of a company's business?
A)Earnings Before Interest and Taxes (EBIT)
B)Gross Profit
C)Operating Income
D)Operating Expenses
Answer: A
Q2) The Sarbanes-Oxley Act (SOX)was passed by Congress in 2002,in response to:
A)financial scandals,including WorldCom and Enron.
B)financial scandals,including Bernie Madoff and AIG.
C)financial scandals,including General Motors and Chrysler.
D)the Troubled Asset Relief Program (TARP).
Answer: A
Q3) IECE's Return on Assets (ROA)is:
A)5.0%
B)8.5% C)7.5%
D)15.0%
Answer: B
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Page 4
Chapter 3: Financial Decision Making and the Law of One
Price
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Sample Questions
Q1) Recycle America Inc.has the opportunity to trade 8000 pounds of plastic pellets made from recycled soda bottles for 5000 pounds of aluminum cans.If the current market price of scrap aluminum is $0.83 per pound and the current market price for plastic pellets is $0.57 per pound,then the added benefit (cost)of making this trade is:
A)($410)
B)$410
C)($780)
D)$780
Answer: A
Q2) Suppose that Bondi Inc.is a holding company that owns both Pizza Hut and Kentucky Fried Chicken Franchised Restaurants.If the value of Bondi is $130 million,and the Pizza Hut Franchises are worth $70 million,then what is the value of the Kentucky Fried Chicken Franchises?
A)$60 million
B)$70 million
C)$130 million
D)Unable to determine with the information provided
Answer: A
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Chapter 4: The Time Value of Money
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Sample Questions
Q1) If the current rate of interest is 8% APR,then the future value of an investment that pays $250 per quarter and lasts 20 years is closest to:
A)$18,519
B)$48,443
C)$9936
D)$20,000
Q2) The amount of money that would be in the account if you left the money there until your 65th birthday is closest to:
A)$29,556
B)$148,780
C)$168,824
D)$748,932
Q3) Which of the following statements is FALSE?
A)The process of moving a value or cash flow forward in time is known as compounding.
B)The effect of earning interest on interest is known as compound interest.
C)It is only possible to compare or combine values at the same point in time.
D)A dollar in the future is worth more than a dollar today.
Q4) Draw a timeline detailing Joe's cash flows from the sale of the family business.
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Chapter 5: Interest Rates
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Q1) Which of the following statements is FALSE?
A)The plot of the relationship between the investment risk and the interest rate is call the yield curve.
B)Each of the last six recessions in the United States was preceded by a period with an inverted yield curve.
C)The nominal interest rate does not represent the increase in purchasing power that will result from investing.
D)A risk-free cash flow received in two years should be discounted at the two-year interest rate.
Q2) Which of the following statements is FALSE?
A)The equivalent after-tax interest rate is r - ( × r).
B)Interest rates vary based on the identity of the borrower.
C)The ability to deduct the interest expense increases the effective after-tax interest rate paid on the loan.
D)For loans to borrowers other than the U.S.Treasury,the stated interest rate is the maximum amount that investors will receive.
Q3) Should the nominal interest rate ever be negative? Can the real interest rate ever be negative? Explain.
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Chapter 6: Valuing Bonds
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Q1) Consider a bond that pays annually an 8% coupon with 20 years to maturity.The percentage change in the price of the bond if its yield to maturity increases from 5% to 7% is closest to:
A)22%
B)24%
C)-22%
D)-24%
Q2) Assuming the appropriate YTM on the Sisyphean bond is 9.0%,then the price that this bond trades for will be closest to:
A)$946
B)$919
C)$1086
D)$1000
Q3) Consider a zero-coupon bond with a $1000 face value and 10 years left until maturity.If the YTM of this bond is 10.4%,then the price of this bond is closest to:
A)$1000
B)$602
C)$1040
D)$372
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Page 8
Chapter 7: Investment Decision Rules
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Sample Questions
Q1) If the appropriate discount rate for this project is 15%,then the NPV is closest to:
A)$6000
B)-$867
C)$1420
D)$867
Q2) Which of the following statements is FALSE?
A)The IRR investment rule states you should turn down any investment opportunity where the IRR is less than the opportunity cost of capital.
B)The IRR investment rule states that you should take any investment opportunity where the IRR exceeds the opportunity cost of capital.
C)Since the IRR rule is based upon the rate at which the NPV equals zero,like the NPV decision rule,the IRR decision rule will always identify the correct investment decisions.
D)There are situations in which multiple IRRs exist.
Q3) Explain why the NPV decision rule might provide Larry with a different decision outcome than the IRR rule when evaluating Larry's three movie deal offer.
Q4) If the discount rate for project A is 16%,then what is the NPV for project A?
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Page 9
Chapter 8: Fundamentals of Capital Budgeting
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Q1) Which of the following statements is FALSE?
A)The ultimate goal in capital budgeting is to determine the effect of the decision to take a particular project on the firm's cash flows.
B)To the extent that overhead costs are fixed and will be incurred in any case,they are incremental to the project and should be included in the capital budgeting analysis.
C)Unlevered Net Income = (Revenue - Costs - Depreciation)× (1 - <sub>c</sub>).
D)Earnings are not cash flows.
Q2) The level of incremental sales associated with introducing the new one hour photo service is closest to:
A)$90,000
B)$150,000
C)$60,000
D)$120,000
Q3) Epiphany would like to know how sensitive the project's NPV is to changes in the discount rate.How much can the discount rate vary before the NPV reaches zero?
Q4) Calculate the total Free Cash Flows for each of the three years for the Sisyphean Corporation's new project.
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Page 10
Chapter 9: Valuing Stocks
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Sample Questions
Q1) You expect Whirlpool Corporation (WHR)to have earnings per share of $6.10 over the coming year.If the average P/E ratio for the appliance industry sector is 17.0,the value of a share of Whirlpool stock based upon the comparables approach is closest to:
A)$103.70
B)$27.90
C)$35.90
D)$23.10
Q2) If Nielson's equity cost of capital is 13%,then Nielson's expected share price is closest to:
A)$19.23
B)$37.86
C)$35.71
D)$50.00
Q3) MJ LTD is expected to grow at various rates over the next five years.The company just paid a $1.00 dividend.The company expects to grow at 20% for the next two years (effecting D1 and D2),then the company expects to grow at 10% for three additional years (D3,D4,D5)after which the company expects to grow at a constant rate of 5% per year indefinitely.If the required rate of return on MJ's common stock is 12%,then what is a share of MJ's stock worth?
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Page 11
Chapter 10: Capital Markets and the Pricing of Risk
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Sample Questions
Q1) What is the expected return for an individual firm?
A)14%
B)3%
C)5%
D)-5%
Q2) The expected overall payoff to Bank B is:
A)$5,000,000
B)$6,000,000
C)$94,000,000
D)$95,000,000
Q3) The excess return is the difference between the average return on a security and the average return for:
A)Treasury Bonds.
B)a portfolio of securities with similar risk.
C)a broad based market portfolio like the S&P 500 index.
D)Treasury Bills.
Q4) Do expected returns for individual stocks increase proportionately with volatility?
Q5) What is the market portfolio?
Q6) Which pharmaceutical company faces less risk?
Page 12
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Chapter 11: Optimal Portfolio Choice and the Capital Asset Pricing Model
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Q1) Will adding the precious metals fund improve your portfolio?
Q2) The variance on a portfolio that is made up of a $6000 investments in Duke Energy and a $4000 investment in Wal-Mart stock is closest to:
A).050
B).045
C).051
D)-0.020
Q3) The expected return on the alternative investment having the highest possible expected return while having the same volatility as Google is closest to?
A)21.6%
B)19.6%
C)23.4%
D)35.0%
Q4) The Correlation between Stock X's and Stock Z's returns is closest to:
A)0.71
B)0.60
C)0.62
D)0.05
Q5) Calculate the correlation between Stock Y's and Stock Z's returns .
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Chapter 12: Estimating the Cost of Capital
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Sample Questions
Q1) The value of the oil exploration division is closest to:
A)$4500
B)$7500
C)$8750
D)$10,000
Q2) Which of the following statements is FALSE?
A)The imperfections in the CAPM may be critical in the context of capital budgeting and corporate finance,where errors in estimating the cost of capital are likely to be far more important than small discrepancies in the project cash flows.
B)To estimate the expected market risk premium we can look at the historical average excess return of the market over the risk free interest rate.
C)The highest beta stocks have tended to under perform what the CAPM predicts.
D)Given an assessment of an index's future cash flows,we can estimate the expected return of the market by solving for the discount rate that is consistent with the current level of the index.
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14
Chapter 13: Investor Behavior and Capital Market Efficiency
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Q1) Which of the following statements is FALSE?
A)The risk premium of any marketable security can be written as the sum of the risk premium of each factor multiplied by the sensitivity of the stock with that factor.
B)The factor betas measure the sensitivity of the stock to a particular factor.
C)If we use more than one portfolio as factors,then together these factors will capture systematic risk,but each factor captures different components of the systematic risk.
D)When we use more than one portfolio to capture risk,the model is known as a single factor model.
Q2) The tendency of uninformed individuals to overestimate the precision of their knowledge is known as:
A)overconfidence bias.
B)herd behavior.
C)familiarity bias.
D)disposition bias.
Q3) Explain why the market portfolio proxy may not be efficient.
Q4) What does the existence of a positive alpha investment strategy imply?
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Page 15
Chapter 14: Capital Structure in a Perfect Market
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Q1) Which of the following statements is FALSE?
A)When a firm issues new shares that account for a significant percentage of its outstanding shares,the transaction is called a leveraged recapitalization.
B)MM Proposition I applies to capital structure decisions made at any time during the life of the firm.
C)By choosing positive-NPV projects that are worth more than their initial investment,the firm can enhance its value.
D)Holding fixed the cash flows generated by the firm's assets,however,the choice of capital structure does not change the value of the firm.
Q2) Suppose the risk-free interest rate is 4%.If Nielson borrows $150 million today at this rate and uses the proceeds to pay an immediate cash dividend,then according to MM,the expected return of Nielson's stock just after the dividend is paid would be closest to:
A)-17.5%
B)-12.5%
C)12.5%
D)17.5%
Q3) What is the conservation of value principle?
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Chapter 15: Debt and Taxes
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Q1) Wyatt Oil has 25 million shares outstanding and has a marginal corporate tax rate of 40%.Wyatt Oil announces that it will payout $40 million in cash to investors through a special dividend.Shareholders had previously assumed that Wyatt Oil would retain this excess cash permanently.The amount that Wyatt Oil's share price can be expected to change upon this announcement is closest to:
A)$0.56
B)$0.64
C)$0.96
D)$1.56
Q2) In 2000,assuming an average dividend payout ratio of 50%,the effective tax advantage for debt (t*)was closest to:
A)40%
B)24%
C)30%
D)18%
Q3) If Flagstaff currently maintains a .8 debt to equity ratio,then calculate the value of Flagstaff's interest tax shield.
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Chapter 16: Financial Distress,managerial Incentives,and Information
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Q1) The idea that managers who perceive the firm's equity is under-priced will have a preference to fund investment using retained earnings,or debt,rather than equity is known as the:
A)signaling theory of debt.
B)lemons principle.
C)pecking order hypothesis.
D)credibility principle.
Q2) What is the expected value of Rearden's assets if it were run efficiently?
A)$265 million
B)$280 million
C)$295 million
D)$300 million
Q3) Suppose that MI has zero-coupon debt with a $140 million face value due next year.Calculate the value of levered equity,the value of debt,and the total value of MI with leverage.
Q4) The total debt overhang associated with accepting project 1,is closest to:
A)$0 million
B)$12.5 million
C)$14.4 million
D)$22.5 million
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Chapter 17: Payout Policy
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Q1) Assume that you own 2500 shares of Omicron stock and that Omicron uses the entire $50 million to pay a special dividend.Suppose you are unhappy with Omicron's decision and would prefer that Omicron used the excess cash to repurchase shares.The number of shares that you would have to buy in order to undo the special cash dividend that Omicron paid is closest to:
A)125
B)275
C)250
D)310
Q2) Assume that you own 4000 shares of Omicron stock and that Omicron uses the entire $50 million to repurchase shares.Suppose you are unhappy with Omicron's decision and would have preferred that Omicron used the excess cash to pay a special dividend.Detail exactly how you could create a homemade dividend that will provide you with the same combination of cash and stock that you would have received if Omicron paid the special dividend.
Q3) A member of Iota's board of directors suggests that Iota's stock price would be higher if they used the $200 million to repurchase shares instead of funding the expansion.If you were advising the board,what course of action would you recommend,expansion or repurchase? Which provides the higher stock price?
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Page 19
Chapter 18: Capital Budgeting and Valuation With Leverage
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Q1) Calculate the present value of the interest tax shield provided by Omicron's new project.
Q2) Given that Rose issues new debt of $50 million initially to fund the acquisition,the present value of the interest tax shield for this acquisition is closest to:
A)$24 million
B)$50 million
C)$20 million
D)$15 million
Q3) If Wyatt adjusts its debt continuously to maintain a constant debt-equity ratio of 50%,then the appropriate WACC for this new project is closest to:
A)7.5%
B)8.6%
C)10.3%
D)10.8%
Q4) Luther's Unlevered cost of capital is closest to:
A)8.0%
B)8.5%
C)9.0%
D)6.4%
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Chapter 19: Valuation and Financial Modeling: a Case Study
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Q1) The free cash flow to the firm in 2010 is closest to:
A)10,684
B)11,559
C)23,698
D)26,394
Q2) Based upon the average EV/Sales ratio of the comparable firms,Ideko's target economic value is closest to:
A)$191 million
B)$155 million
C)$165 million
D)$157 million
Q3) If Ideko's future expected growth rate is 5%,then the estimated free cash flow for 2011 is closest to:
A)6568
B)11,151
C)11,218
D)12,137
Q4) What is the purpose of the sensitivity analysis?
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