Corporate Finance
Practice Exam
Course Introduction
Corporate Finance explores the principles and practices of financial management within organizations, focusing on how companies make investment, financing, and dividend decisions to maximize shareholder value. The course covers key topics such as capital budgeting, risk analysis, cost of capital, capital structure, working capital management, and valuation of financial assets. Through case studies and practical examples, students will develop a comprehensive understanding of the financial tools and strategies used to evaluate opportunities and manage resources effectively in a corporate setting.
Recommended Textbook
Corporate Finance 2nd Edition by Jonathan Berk
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Chapter 1: The Corporation
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Q1) Explain the main differences between the NYSE and NASDAQ stock markets.
Answer: Key points:
NYSE has physical location-NASDAQ is an electronic market. NYSE has one specialist in each stock and his role is to match buyers and sellers. NASDAQ has multiple market makers (dealers)in each stock who stand ready to trade on their own accounts.
Q2) What are your net proceeds if you purchased 2500 shares of XYZ stock on November 11th and then sold them a week later on November 18th?
Answer: sell at bid price 11/18 = 2500 × $25.93 = $64,825
now subtract the price paid for the shares buy at ask price 11/11 = 2500 × $25.25 = $63,125 so net proceeds = 64,825 - 63,125 = $1700
Q3) Explain the benefits of incorporation.
Answer: 1.Limited liability
2.Unlimited life
3.Access to capital markets / availability of outside funding
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Chapter 2: Introduction to Financial Statement Analysis
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Q1) The Sarbanes-Oxley Act (SOX)forced companies to validate their internal financial control processes by
A) putting strict limits on the amount of non-audit fees (consulting or otherwise) that an accounting firm can earn from a firm that it audits.
B) requiring the CEO and CFO to return bonuses or profits from the sale of stock that are later shown to be due to misstated financial reports.
C) requiring auditing firms to have long-standing relationships with their clients and receive lucrative auditing and consulting fees from them.
D) requiring senior management and the boards of public companies to validate and certify the process through which funds are allocated and controlled.
Answer: D
Q2) If ECE's return on assets (ROA)is 12% ,then ECE's net income is:
A) $6 million
B) $12 million
C) $24 million
D) $36 million
Answer: C
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Chapter 3: Arbitrage and Financial Decision Making
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Q1) Which of the following statements is false?
A) Financial transactions are not sources of value, but merely serve to adjust the timing and risk of the cash flows to best suit the needs of the firm or its investors.
B) The NPV of trading a security in a normal market is zero.
C) We cannot separate a firm's investment decision from the decision of how to finance the investment.
D) In normal markets, trading securities neither creates nor destroys value.
Answer: C
Q2) Suppose a risky security pays an average cash flow of $100 in one year.The risk-free rate is 5%,and the expected return on the market index is 13%.If the returns on this security are high when the economy is strong and low when the economy is weak,but the returns vary by only half as much as the market index,then the price for this risky security is closest to:
A) $88
B) $92
C) $93
D) $95
Answer: B
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Chapter 4: The Time Value of Money
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Q1) The British government has a consol bond outstanding that pays 100 in interest each year.Assuming that the current interest rate in Great Britain is 5% and that you will receive your first interest payment one year from now,then the value of the consol bond is closest to:
A) 1000
B) 1100
C) 2100
D) 2000
Q2) Which of the following statements regarding the timeline is false?
A) Date 1 is one year from now.
B) The $5000 below date 1 is the payment you will receive at the end of the first year.
C) The $5000 below date 2 is the payment you will receive at the beginning of the second year.
D) Date 0 represents today.
Q3) The future value at retirement (age 65)of your savings is:
Q4) Draw a timeline detailing Joe's cash flows from the sale of the family business.
Q5) Draw a timeline detailing the cash flows from investment "A."
Q6) In terms of present value,how much will Joe receive for selling the family business?
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Chapter 5: Interest Rates
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Q1) The present value of receiving $1000 per year with certainty at the end of the next three years is closest to:
A) $2,737
B) $2,723
C) $2,733
D) $2,744
Q2) Which of the following statements is false?
A) The investor's opportunity cost of capital is the best available expected return offered in the market on an investment of comparable risk and term of the cash flows being discounted.
B) Interest rates we observe in the market will vary based on quoting conventions, the term of investment, and risk.
C) The opportunity cost of capital is the return the investor forgoes when the investor takes on a new investment.
D) For a risk-free project, the opportunity cost of capital will typically be greater than the interest rate of U.S. Treasury securities with a similar term.
Q3) What is the NPV of an investment that costs $2500 and pays $1000 certain at the end of one,three,and five years ?
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Chapter 6: Investment Decision Rules
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Q1) Assuming that your capital is constrained,what is the fifth project that you should invest in?
A) Project H
B) Project I
C) Project B
D) Project A
Q2) You are considering using the incremental IRR approach to decide between the two mutually exclusive projects A & B.How many potential incremental IRRs could there be?
A) 3
B) 0
C) 2
D) 1
Q3) The NPV profile graphs
A) the project's NPV over a range of discount rates.
B) the project's IRR over a range of discount rates.
C) the project's cash flows over a range of NPVs.
D) the project's IRR over a range of NPVs.
Q4) What is the incremental IRR for project B over project A? Would you feel comfortable basing your decision on the incremental IRR?
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Chapter 7: Fundamentals of Capital Budgeting
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Q1) The incremental unlevered net income in the first year for the Sisyphean Corporation's project is closest to:
A) $8,000
B) $18,000
C) $5,200
D) $11,700
Q2) Which of the following statements is false?
A) The simplest method used to calculate depreciation is the straight-line method.
B) A sunk cost is any unrecoverable cost for which the firm is already liable.
C) Unlevered Net Income = EBIT × <sub>c</sub>.
D) The decision to continue or abandon should be based only on the incremental costs and benefits of the project going forward.
Q3) 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
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Chapter 8: Valuing Bonds
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Q1) If a bond is currently trading at its face (par)value,then it must be the case that
A) the bond's yield to maturity is less than its coupon rate.
B) the bond's yield to maturity is equal to its coupon rate.
C) the bond's yield to maturity is greater than its coupon rate.
D) the bond is a zero-coupon bond.
Q2) Which of the following statements is false?
A) One advantage of quoting the yield to maturity rather than the price is that the yield is independent of the face value of the bond.
B) Unlike the case of bonds that pay coupons, for zero-coupon bonds, there is no simple formula to solve for the yield to maturity directly.
C) Because we can convert any bond price into a yield, and vice versa, bond prices and yields are often used interchangeably.
D) The IRR of an investment in a bond is given a special name, the yield to maturity (YTM).
Q3) Assume that the YTM increases by 1% for each of the four bonds listed.Rank the bonds based upon the sensitivity of their prices from least to most sensitive.
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Chapter 9: Valuing Stocks
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Q1) Which of the following statements is false?
A) We cannot use the general dividend discount model to value the stock of a firm with rapid or changing growth.
B) As firms mature, their growth slows to rates more typical of established companies.
C) The dividend discount model values the stock based on a forecast of the future dividends paid to shareholders.
D) The simplest forecast for the firm's future dividends states that they will grow at a constant rate, g, forever.
Q2) Assuming that Novartis AG (NVS)has an EPS of $3.35,based upon the average P/E ratio for its competitors,Novartis' stock price is closest to:
A) $13.00
B) $31.86
C) $43.47
D) $44.35
Q3) If DM has $500 million of debt and 14 million shares of stock outstanding,then what is the price per share for DM Corporation?
Q4) What are some common multiples used to value stocks?
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11
Chapter 10: Capital Markets and the Pricing of Risk
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Q1) The variance of the return on Alpha Corporation is closest to:
A) 5.00%
B) 4.75%
C) 3.625%
D) 3.75%
Q2) Suppose that you want to use the 10 year historical average return on the Index to forecast the expected future return on the Index.The standard error of your estimate of the expect return is closest to:
A) 19.4%
B) 3.8%
C) 8.8%
D) 1.95%
Q3) Which of the following types of risk doesn't belong?
A) Idiosyncratic risk
B) Undiversifiable risk
C) Market risk
D) Systematic risk
Q4) What is the market portfolio?
Q5) Which pharmaceutical company faces less risk?
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Chapter 11: Optimal Portfolio Choice and the Capital Asset Pricing Model
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Q1) Which of the following statements is false?
A) When stocks are perfectly positively correlated, the set of portfolios is identified graphically by a straight line between them.
B) An investor seeking high returns and low volatility should only invest in an efficient portfolio.
C) When the correlation between securities is less than 1, the volatility of the portfolio is reduced due to diversification.
D) Efficient portfolios can be easily ranked, because investors will choose from among them those with the highest expected returns.
Q2) Which of the following equations is incorrect?
A) E[R<sub>xCML</sub>] = r<sub>f</sub> + x(E[R<sub>Mkt</sub>] + r<sub>f</sub>)
B) r<sub>i</sub> = r<sub>f</sub> + b(E[R<sub>Mkt</sub>] - r<sub>f</sub>)
C) SD(R<sub>xCML</sub>)= xSD(R<sub>Mkt</sub>)
D) E[R<sub>xCML</sub>] = (1 - x)r<sub>f</sub> + xE[R<sub>Mkt</sub>]
Q3) Calculate the correlation between Stock Y's and Stock Z's returns.
Q4) Calculate the covariance between Stock Y's and Stock Z's returns.
Q5) What is the variance on a portfolio that has $2000 invested in Duke Energy,$3000 invested in Microsoft,and $5000 invested in Wal-Mart stock?
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Chapter 12: The Capital Asset Pricing Model
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Q1) Which of the following statements is false?
A) If investors have homogeneous expectations, then each investor will identify the same portfolio as having the highest Sharpe ratio in the economy.
B) Homogeneous expectations are when all investors have the same estimates concerning future investments and returns.
C) There are many investors in the world, and each must have identical estimates of the volatilities, correlations, and expected returns of the available securities.
D) The combined portfolio of risky securities of all investors must equal the efficient portfolio.
Q2) Using the average historical excess returns for both Wyatt Oil and the Market portfolio estimate of Wyatt Oil's Beta.When using this beta,the alpha for Wyatt oil in 2007 is closest to:
A) -0.5000%
B) -0.0250%
C) -0.0125%
D) +0.0250%
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14
Chapter 13: Investor Behavior and Capital Market Efficiency
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Q1) The alpha for the passive investors is closest to:
A) -2.4%
B) -0.9%
C) 0.0%
D) 3.6%
Q2) An individual's desire for intense risk-taking experiences is known as
A) phenomenon seeking.
B) herd seeking.
C) sensation seeking.
D) rational expectations seeking.
Q3) The tendency to hang on to losers and sell winners is known as the A) cascade effect.
B) disposition effect.
C) overconfidence bias.
D) systematic behavior bias.
Q4) The alpha for Chihuahua is closest to:
A) +2%
B) -5%
C) -3%
D) +3%
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Chapter 14: Capital Structure in a Perfect Market
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Q1) Equity in a firm with debt is called
A) levered equity.
B) riskless equity.
C) unlevered equity.
D) risky equity.
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 alter the dividend is paid would be closest to:
A) -17.5%
B) -12.5%
C) 12.5%
D) 17.5%
Q3) Galt's WACC is closest to:
A) 10.6%
B) 11.2%
C) 11.8%
D) 12.5%
Q4) Based upon the three comparable firms,what asset beta would you recommend using for your firm's new project?
Page 16
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Chapter 15: Debt and Taxes
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Q1) The interest rate tax shield for Kroger in 2005 is closest to:
A) $362 million
B) $36 million
C) $102 million
D) $195 million
Q2) Assume that investors in Google pay a 15% tax rate on income from equity and a 35% tax rate on interest income.If Google were to issue sufficient debt to reduce its corporate taxes by $1 billion per year permanently,then the value that would be created is closest to:
A) $6.1 billion
B) $10.2 billion
C) $12.2 billion
D) $14.3 billion
Q3) If Flagstaff currently maintains a .5 debt to equity ratio,then the value of Flagstaff's interest tax shield is closest to:
A) $11 million
B) $18 million
C) $10 million
D) $24 million
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Chapter
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Q1) The number of new shares that Kinston must issue to raise the capital needed to pay its debt obligation is closest to:
A) 4.3 million
B) 4.7 million
C) 5.0 million
D) 4.0 million
Q2) Assume that EGI decides to raise the $100 million through the issuance of new shares prior to the release of the new video game.The number of new shares that EGI will issue is closest to:
A) 5.0 million
B) 6.25 million
C) 10 million
D) 1.6 million
Q3) Which of the following is not an indirect cost of bankruptcy?
A) Loss of suppliers
B) Fire sales of assets
C) Costs of appraisers
D) Loss of employees
Q4) List five general categories of indirect costs associated with bankruptcy.
Page 18
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Chapter 17: Payout Policy
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Q1) If Wyatt Oil distributes the $70 million as a share repurchase,then the number of shares outstanding after the repurchase will be closest to:
A) 16.0 million
B) 16.5 million
C) 17.5 million
D) 18.0 million
Q2) Assume that Rockwood is not able to repurchase shares prior to the market becoming aware of the new information regarding Rockwood's true value.If Rockwood repurchases the shares following the release of the new information,then the number of shares outstanding following the repurchase is closest to:
A) 92 million
B) 90 million
C) 75 million
D) 10 million
Q3) Wyatt Oil's current stock price is closest to:
A) $11.00
B) $12.50
C) $14.00
D) $17.50
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Page 19
Chapter 18: Capital Budgeting and Valuation With Leverage
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Q1) The unlevered cost of capital for Armadillo Industries is closest to:
A) 10.3%
B) 10.1%
C) 9.5%
D) 9.9%
Q2) Which of the following statements is false?
A) If the debt-equity ratio changes over time, the risk of equity-and, therefore, its cost of capital-will change as well.
B) The FTE method can offer an advantage when calculating the value of equity for the entire firm, if the firm's capital structure is complex and the market values of other securities in the firm's capital structure are not known.
C) The FTE approach does not have the same disadvantage associated with the APV approach: We don't need to compute the project's debt capacity to determine interest and net borrowing before we can make the capital budgeting decision.
D) The WACC and APV methods compute the firm's enterprise value, so that a separate valuation of the other components of the firm's capital structure is needed to determine the value of equity.
Q3) Calculate the debt capacity of Omicron's new project for years 0,1,and 2.
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Chapter 19: Valuation and Financial Modeling: a Case Study
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Q1) Based upon Ideko's Sales and Operating Cost Assumptions,what production capacity will Ideko require in 2007?
A) 1,505 units
B) 1,323 units
C) 1,914 units
D) 1,115 units
E) 1,702 units
Q2) If Ideko's future expected growth rate is 5% and its WACC is 9%,then the continuation value in 2010 is closest to:
A) 164,200
B) 278,775
C) 280,450
D) 303,425
E) 482,850
Q3) The after tax interest expense in 2008 is closest to:
A) 2,380
B) 4,420
C) 6,800
D) 7,820
E) 9,180
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Chapter 20: Financial Options
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Q1) How many of the January 2009 put options are in the money?
A) 1
B) 3
C) 2
D) 4
Q2) Suppose that Nielson Motors stock is trading for $50 per share and that Nielson pays no dividends.What is the maximum possible price for a call option on Nielson Motors?
A) $0
B) $20
C) $50
D) infinite
Q3) This graph depicts the payoffs of
A) a long position in a put option at expiration.
B) a short position in a call option at expiration.
C) a short position in a put option at expiration.
D) a long position in a call option at expiration.
Q4) Graph the payoff at expiration of a short position in a put option with a strike price of $20.
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Chapter 21: Option Valuation
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Q1) Risk neutral probabilities are also known as all of the following except A) contingent probabilities.
B) state-contingent prices.
C) martingale prices.
D) state prices.
Q2) Using the binomial pricing model,calculate the price of a two-year call option on Kinston stock with a strike price of $9.
Q3) The risk neutral probability of an up state for KD Industries is closest to:
A) 37.5%
B) 60.0%
C) 40.0%
D) 62.5%
Q4) Using risk neutral probabilities,the calculated price of a one-year put option on KD stock with a strike price of $20 is closest to:
A) $2.00
B) $2.15
C) $1.45
D) $2.40
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23
Chapter 22: Real Options
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Q1) The constant annuity payment over the life of a project that is equivalent to receiving the NPV today is the
A) annualized annuity.
B) independent annual benefit.
C) equivalent annual profitability.
D) equivalent annual benefit.
Q2) The idea that once a manager makes a large investment,he should not abandon the project is known as the A) negative NPV fallacy.
B) abandonment fallacy.
C) sunk cost fallacy.
D) dependence fallacy.
Q3) Rylan Inc is considering a project that has an initial cost of $2 million.It is expected to generate cash flows for the firm of $500,000 per year for 6 years.Assuming a discount rate of 7%,what is the equivalent annual benefit?
A) $75,148
B) $80,408
C) $85,889
D) $91,901
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Page 24
Chapter 23: The Mechanics of Raising Equity Capital
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Q1) Which of the following statements is false?
A) Once a company goes public, it must satisfy all of the requirements of public companies.
B) Organizations such as the Securities and Exchange Commission (SEC), the securities exchanges (including the New York Stock Exchange and the Nasdaq), and Congress (through the Sarbanes-Oxley Act of 2002) adopted new standards that focused on more thorough financial disclosure, greater accountability, and more stringent requirements for the board of directors.
C) The major advantage of undertaking an IPO is also one of the major disadvantages of an IPO: When investors diversify their holdings, the equity holders of the corporation become more concentrated.
D) Several high profile corporate scandals during the early part of the twenty-first century prompted tougher regulations designed to address corporate abuses.
Q2) When referring to IPOs,what is book building?
Q3) What will the offer price of these shares be if Luther is selling 800,000 shares?
Q4) Describe the four characteristics of IPOs that puzzle financial economists.
Q5) Based upon the price/revenue ratio,what would be a reasonable value for KD?
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Page 25
Chapter 24: Debt Financing
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Q1) Which of the following statements is false regarding a call provision?
A) The issuer can repurchase a fraction of the outstanding bonds in the market or it can make a tender offer for the entire issue.
B) A call provision allows the issuer to repurchase the bonds at a predetermined price.
C) The call price is generally set at or below, and expressed as a percentage of, the bond's face value.
D) A call feature allows the issuer of the bond the right (but not the obligation) to retire all outstanding bonds on (or after) a specific date (the call date), for the call price.
Q2) Treasury securities that are pure discount bonds with original maturities ranging from a few days to 26 weeks are called A) TIPS.
B) Treasury bonds.
C) Treasury notes.
D) Treasury bills.
Q3) What is the Yield to Call (YTC)on this bond?
Q4) What is the Yield to Maturity (YTM)on this bond?
Q5) What is the Yield to Call (YTC)on this bond?
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Page 26
Chapter 25: Leasing
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Q1) Which of the following statements is false?
A) Most financial analysts and sophisticated investors consider operating leases (which must be listed in the footnotes of the financial statements) to be additional sources of leverage.
B) By carefully avoiding the four criteria that define a operating lease for accounting purposes, a firm can avoid listing the long-term lease as a liability.
C) Because a lease is equivalent to a loan, the firm can increase its actual leverage without increasing the debt-to-equity ratio on its balance sheet.
D) For most large corporations, the amount of leverage the firm can obtain through a lease is unlikely to exceed the amount of leverage the firm can obtain through a loan.
Q2) The monthly lease payments for a four year lease of the Bulldozer are closest to:
A) $1,870
B) $1,825
C) $1,750
D) $2,115
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Chapter 26: Working Capital Management
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Q1) Your firm purchases goods from its supplier on terms of 2/10,net 40.The effective annual cost to your firm if it chooses not to take advantage of the trade discount offered and stretches the accounts payable to 60 days is closest to:
A) 20.1%
B) 15.9%
C) 13.0%
D) 11.1%
Q2) Which of the following money market investments is a short-term debt obligations of the U.S.government?
A) Treasury Bill
B) Repurchase Agreement
C) Commercial Paper
D) Certificates of Deposit (CD)
E) Banker's Acceptance
Q3) Luther's Accounts Payable days is closest to:
A) 39 days
B) 32 days
C) 59 days
D) 42 days
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Page 28
Chapter 27: Short-Term Financial Planning
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Q1) Wyatt Oil has an issue of commercial paper with a face value of $10,000,000 and a maturity of three months.Wyatt received $9,800,000 when it sold the paper.The effect annual rate for this financing is closest to:
A) 5.6%
B) 6.6%
C) 7.2%
D) 8.4%
Q2) Rearden Metal has borrowed $4 million for three months at a stated annual rate of 8%,using inventory stored in a field warehouse as collateral.The warehouse charges a $10,000 fee,payable at the end of the month.The effect annual rate on this loan is closest to:
A) 9.3%
B) 11.3%
C) 15.2%
D) 17.1%
Q3) Which alternative should Taggart choose?
A) Alternative #1 since it has the lowest EAR
B) Alternative #2 since it has the lowest EAR
C) Alternative #3 since it has the lowest EAR
D) Alternative #2 since it has the highest actual rate
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Chapter 28: Mergers and Acquisitions
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Q1) The structure of a merger transaction is summarized in a(n)
A) swap sheet.
B) term sheet.
C) exchange sheet.
D) merger sheet.
Q2) Which of the following statements regarding efficiency gains is false?
A) Takeovers relying on the improvement of target management are difficult to complete, and post-takeover resistance to change can be great. Thus not all inefficiently run organizations are necessarily more efficient following a takeover.
B) Although identifying poorly performing corporations is relatively easy, fixing them is another matter entirely.
C) A justification that acquirers cite for paying a premium for a target is efficiency gains, which are often achieved through an elimination of duplication.
D) A chief executive of an inefficiently run corporation can be ousted by current shareholders voting to replace the board of directors, and in fact a large number of ineffective managers are replaced in this way.
Q3) What is a white knight?
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Chapter 29: Corporate Governance
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Q1) Which of the following statements is false?
A) Researchers have hypothesized that boards with a majority of outside directors are better monitors of managerial effort and actions.
B) Studies have found that firms with independent boards make fewer value-creating acquisitions but are more likely to act in shareholders' interests if targeted in an acquisition.
C) One early study showed that a board was more likely to fire the firm's CEO for poor performance if the board had a majority of outside directors.
D) Although the firm's stock price increases on the announcement of its addition of an independent board member, the increased firm value appears to come from the potential for the board to make better decisions on acquisitions and CEO turnover rather than from improvements in the firm's operating performance.
Q2) What are some of the negative effects of increasing the sensitivity of managerial pay to firm performance?
Q3) What is corporate governance?
Q4) What is the role of takeovers in corporate governance?
Q5) Describe the main requirements of the Sarbanes-Oxley Act of 2002.
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Page 31
Chapter 30: Risk Management
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Q1) Assuming that your firm will purchase insurance,what is the minimum-size deductible that would leave your firm with an incentive to implement the new safety policies?
Q2) Suppose the current exchange rate is $1.42/ ,the interest rate in the United States is 4.0%,the interest rate in the EU is 6%,and the volatility of the $/ exchange rate is 20%.Using the Black-Scholes formula,the price of a three-month European call option on the Euro with a strike price of $1.45/ will be closest to:
A) $0.040/
B) $0.059/
C) $0.078/
D) $0.097/
Q3) In December 2005,the spot exchange rate for the British Pound was $1.7188/£.Suppose that at the same time the on-year interest rate in the United States was 4.85% and the one-year interest rate in Great Britain was 3.15%.Based on these rates,what forward exchange rate is consistent with no arbitrage.
Q4) What is the actuarially fair cost of full insurance?
Q5) What are some of the disadvantages of long-term supply contracts?
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Page 32
Chapter 31: International Corporate Finance
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Q1) Incorporated Tools total U.S.tax liability on its foreign earnings is closest to:
A) $0
B) $81 million
C) $106 million
D) $112 million
Q2) Which of the following statements is false?
A) In some countries, especially in the developing world, all investors do not have equal access to financial securities.
B) Firms may face differential access to markets if there is any kind of asymmetry with respect to information about them.
C) In some cases, a country's risk-free securities are internationally integrated but markets for a specific firm's securities are not.
D) When countries' capital markets are not integrated we call them disintegrated capital markets.
Q3) What is the dollar present value of the project?
Q4) How do we make adjustments when a project has inputs and outputs in different currencies?
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