Corporate Finance
Practice Questions
Course Introduction
Corporate Finance examines the fundamental principles and analytical tools required for effective financial decision-making within a corporation. The course covers topics such as capital budgeting, cost of capital, financial statement analysis, risk assessment, and valuation methods. It also delves into issues concerning capital structure, dividend policy, working capital management, and mergers and acquisitions. Through case studies and real-world examples, students will develop the skills to evaluate investment opportunities, optimize financing strategies, and understand the broader impact of financial decisions on organizational value.
Recommended Textbook
Financial Management Principles and Applications 12th Edition by Sheridan Titman
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Page 2
Chapter 1: Getting Started-Principles of Finance
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Sample Questions
Q1) Foregoing the earning potential of a dollar today is referred to as the A)time value of money.
B)opportunity cost concept.
C)risk/return tradeoff.
D)creation of wealth.
Answer: B
Q2) Which of the following is NOT true for limited partnerships?
A)Limited partners can only manage the business.
B)One general partner must exist who has unlimited liability.
C)Only the name of general partners can appear in the name of the firm.
D)Limited partners may sell their interest in the company.
Answer: A
Q3) The term stockholder is equivalent to A)general partner.
B)creditor.
C)shareholder.
D)stakeholder.
Answer: C
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3
Chapter 2: Firms and the Financial Market
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Q1) Investors in common stock increase their wealth when the A)the market value of the stock goes up.
B)when the stock pays a dividend.
C)when the stock pays interest on the original investment.
D)both A and B.
Answer: D
Q2) Insurance companies have a great deal of money to invest because A)there profit margins are so high.
B)because they are reluctant to cover insurable losses.
C)because they must hold large reserves to pay potential claims.
D)insurance do not actually have large sums to invest.
Answer: C
Q3) A bond matures in less than 10 years.
A)True
B)False
Answer: False
Q4) A company has the option to pay bond interest or not.
A)True
B)False
Answer: False
Page 4
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Chapter 3: Understanding Financial Statements,taxes,and Cash Flows
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Sample Questions
Q1) Which of the following streams of income is not affected by how a firm is financed (whether with debt or equity)?
A)Net profit after tax but before dividends
B)Net working capital
C)Operating income
D)Income before tax
Answer: C
Q2) Based on the information given in Table 1,calculate the dividends paid in 1996.
A)$3,750
B)$3,000
C)$750
D)$2,250
Answer: D
Q3) Which of the following would NOT be included as a liability in a corporate balance sheet?
A)Notes payable
B)Accounts payable
C)Bonds
D)Accumulated Depreciation
Answer: D
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Chapter 4: Financial Analysis-Sizing up Firm Performance
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Sample Questions
Q1) An increase in ________ will increase common equity.
A)paid in capital
B)retained earnings
C)dividends paid
D)both A and C
Q2) A firm has a return on equity of 20% and a total asset turnover of 4.Assuming a debt ratio of 50% and sales of $1,000,000,calculate net income.
A)$25,000
B)$50,000
C)$75,000
D)$100,000
Q3) There is no such thing as a liquidity ratio being too high.
A)True
B)False
Q4) Financial ratios comprise the principal tool of financial analysis since they can be used to answer a variety of questions regarding a firm's financial condition.
A)True
B)False
Q5) Discuss the limitations of ratio analysis.
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Chapter 5: Time Value of Money-The Basics
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Sample Questions
Q1) What will the dollar amount be if the interest is compounded semiannually for those four years?
A)$3,100
B)$3,188
C)$3,240
D)$3,290
Q2) If we invest money for 10 years at 8% interest,compounded semi-annually,we are really investing money for 20 six-month periods,during which we receive 4% interest each period.
A)True
B)False
Q3) The end of one time period and the beginning of the next occupy the same place on a timeline.
A)True
B)False
Q4) If you deposit $1,000 each year in a savings account earning 4%,compounded annually,how much will you have in 10 years?
Q5) Sketch a timeline that represents an immediate investment of $20,000 with $25,000 to be received at the end of 4 years.
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Chapter 6: The Time Value of Money-Annuities and Other Topics
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Sample Questions
Q1) An investment will pay $500 in three years,$700 in five years,and $1,000 in nine years.If the opportunity rate is 6%,what is the present value of this investment?
Q2) What is a series of equal payments to be received at the beginning of each period,for a finite period of time,called?
A)A perpetuity
B)An annuity due
C)A cash cow
D)A deferred annuity
Q3) What is the present value of an annuity of $27 received at the beginning of each year for the next six years? The first payment will be received today,and the discount rate is 10% (round to nearest $10).
A)$120
B)$130
C)$100
D)$110
Q4) The present value of a $100 perpetuity discounted at 5% is $1200.
A)True
B)False
Page 8
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Chapter 7: An Introduction to Risk and Return-History of
Financial Market Returns
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Sample Questions
Q1) During the financial crisis of 2007-2009,returns on real estate investment trusts (REITS)and stocks moved in opposite directions.
A)True B)False
Q2) The higher the standard deviation,the less risk the investment has.
A)True B)False
Q3) Riskier investments have traditionally had lower returns than less risky investments have had.
A)True B)False
Q4) Are markets moving toward being more efficient or toward being less efficient?
Q5) If a market is weak form efficient,an investor can make higher than expected profits by studying the past price patterns of a stock.
A)True B)False
Q6) The cash return on an investment is calculated as purchase price-selling price. A)True B)False
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Chapter 8: Risk and Return-Capital Market Theory
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Sample Questions
Q1) The expected return on the market portfolio is currently 11%.Battmobile Corporation stockholders require a rate of return of 23.0%,and the stock has a beta of 2.5.According to CAPM,determine the risk-free rate.
A)17.5%
B)2.75%
C)3.0%
D)9.2%
Q2) Adequate portfolio diversification can be achieved by investing in several companies in the same industry.
A)True
B)False
Q3) Most financial assets have correlation coefficients between 0 and 1.
A)True
B)False
Q4) The required rate of return for Firm A is
A)8%.
B)12%.
C)16%.
D)Cannot be determined with information given.
Q5) Provide an intuitive discussion of beta and its importance for measuring risk.
Page 10
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Chapter 9: Debt Valuation and Interest Rates
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Sample Questions
Q1) Which of the following statements about bonds is true?
A)As the maturity date of a bond approaches,the market value of a bond will become more volatile.
B)Long-term bonds have less interest rate risk than do short-term bonds.
C)Bond prices move in the same direction as market interest rates.
D)If market interest rates are above a bond's coupon interest rate,then the bond will sell below its par value.
Q2) Given the following information,determine the market value of EAO Company bonds.
Par value $1,000
Coupon rate 10%
Years to maturity 6
Market rate 8%
Interest paid semiannually
Q3) A bond's value equals the present value of interest and principal the owner will receive.
A)True
B)False
Q4) Shorter-term bonds have greater interest rate risk than do longer-term bonds. A)True B)False
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Chapter 10: Stock Valuation
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Sample Questions
Q1) Edison Power and Light has an outstanding issue of cumulative preferred stock with an annual fixed dividend of $2.00 per share.It has not paid the preferred dividend for the last 3 years,but intends to pay a dividend on the common stock in the coming year.Before Edison can pay a dividend on the common stock
A)preferred shareholders may cast all their votes for a single director.
B)preferred shareholders must receive dividends totaling $8.00 per share.
C)preferred shareholders must receive $2.00 per share.
D)will not necessarily receive any dividend.
Q2) The stockholder's expected rate of return consists of a dividend yield and interest.
A)True B)False
Q3) Common stockholders are essentially creditors of the firm. A)True B)False
Q4) Discuss two reasons why preferred stock would be viewed as less risky than common stock to investors.
Q5) Determine the rate of return on a $25 common stock that pays a dividend of $2.50 in year 1 and grows at a rate of 5%.
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Chapter 11: Investment Decision Criteria
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Sample Questions
Q1) Most firms use the payback period as a secondary capital-budgeting technique,which in a sense allows them to control for risk.
A)True B)False
Q2) The equivalent annual cost (EAC)method is appropriate for evaluating accessibility projects mandated by the Americans With Disabilities Act.
A)True B)False
Q3) Why are capital budgeting decisions among the most important decisions made by any company? Give a few examples from recent business developments.
Q4) The internal rate of return (IRR)will increase as the required rate of return of a project is increased.
A)True B)False
Q5) Capital budgeting is the decision-making process with respect to investment in working capital.
A)True B)False
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Chapter 12: Analyzing Project Cash Flows
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Sample Questions
Q1) XYZ,Inc.is considering adding a product line that would utilize floor space in their manufacturing plant which is currently used for storage.XYZ will need to rent new storage space elsewhere.The floor space would be considered a(n)
A)variable cost.
B)opportunity cost.
C)sunk cost.
D)irrelevant cash flow.
Q2) Schiller Construction Inc.has estimated the following revenues and expenses related to phase I of a proposed new housing development.Incremental sales= $5,000,000,total cash operating expenses
$3,500,000,depreciation
$500,000,taxes 35%,interest expense,$200,000.Operating cash flow equals
A)$650,000
B)$1,000,000
C)$1,150,000
D)$975,000
Q3) To be conservative,capital budgeting analysis assumes that projects cannot add sales to existing lines of business.
A)True
B)False
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Page 14
Chapter 13: Risk Analysis and Project Evaluation
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Sample Questions
Q1) Projects may appear to have less risk when real options are considered.
A)True
B)False
Q2) When using simulation to analyze a large capital project,the decision rule is
A)there is no clear cut decision rule,but the probabilities will produce a more informed decision.
B)accept the project if the probability of a positive NPV is greater than 50%.
C)reject the project if the probability of a negative NPV is greater than 5%.
D)reject the project if the probability of a negative NPV is greater than 16%
Q3) Briefly distinguish between sensitivity analysis,scenario analysis,and simulation.
Q4) A would be entrepreneur is considering buying a franchise from a national chain of fitness centers.Identify some of the risks she might face.
Q5) Real options can have the effect of
A)increasing a project's NPV.
B)reducing a project's risk.
C)gaining information about future opportunities.
D)all of the above.
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Page 15
Chapter 14: The Cost of Capital
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Sample Questions
Q1) In theory using the same discount rate to evaluate all projects can lead to A)rejection of low risk projects that should be accepted.
B)acceptance of high risk projects that should be rejected.
C)control of efforts by employees with a vested interested in a project to manipulate the discount rate.
D)all of the above.
Q2) Sutter Corporation's common stock is selling for $16.80 a share.Last year,Sutter paid a dividend of $.80.Investors are expecting Sutter's dividends to grow at a rate of 5% per year.What is the cost of common equity?
Q3) Flotation costs increase the amount of funds that must be raised to finance an investment.
A)True
B)False
Q4) The weighted cost of capital assumes that the company maintains a constant debt to equity ratio.
A)True
B)False
Q5) Why are market values preferred to book (balance sheet)values when computing a firm's weighted average cost of capital.
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Chapter 15: Capital Structure Policy
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Sample Questions
Q1) Weaknesses of the EBIT-EPS analysis include
A)that it disregards the implicit costs of debt financing.
B)that it ignores the effect of the specific financing decision on the firm's cost of common equity capital.
C)that it considers only the level of the earnings stream and ignores the variability inherent in it.
D)all of the above.
Q2) The most acceptable view of capital structure,according to the text,is that the weighted average cost of capital
A)first falls with moderate levels of leverage and then increases as a firm's leverage becomes high.
B)does not change with leverage.
C)increases proportionately with increases in leverage.
D)increases with moderate amounts of leverage and then falls.
Q3) When benchmarking a firm's capital structure,management should compare it to A)firms in S&P 500.
B)firms in the same geographic region.
C)firms recognized for the quality of their management.
D)firms in similar lines of business.
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Page 17
Chapter 16: Dividend Policy
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Sample Questions
Q1) A reasonable conclusion about dividend policy is that management should avoid surprising investors when it comes to the firm's dividend decision.
A)True
B)False
Q2) A stock dividend will cause changes in the dollar value of which of the below capital accounts?
A)Common stock
B)Additional paid-in capital
C)Retained earnings
D)All of the above
Q3) The dividend policy that states smoothing of the dividend stream in order to minimize the effect of company reversals is called the
A)increasing-stream hypothesis of dividend policy.
B)stable dividend policy.
C)clientele effect policy.
D)residual payout policy.
Q4) Reducing dividends will usually have a negative impact on the stock price.
A)True
B)False
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Chapter 17: Financial Forecasting and Planning
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Q1) Based on the information in Table 3,what are Thompson's projected total receipts (collections)for March?
A)$400,000
B)$310,000
C)($20,000)
D)$320,000
Q2) Long-term financial plans must include capital expenditures.
A)True
B)False
Q3) Short-term financial planning results in
A)a cash budget.
B)pro forma financial statements.
C)a sales forecast for the next 1 to 3 years.
D)a general narrative detailing near-term scenarios.
Q4) Pro forma statements provide single point estimates of each budgeted item. A)True B)False
Q5) The key ingredient in a firm's financial planning is the sales forecast. A)True
B)False
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Chapter 18: Working Capital Management
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Sample Questions
Q1) A company which foregoes the discount when credit terms are 4/15 net 70 is essentially borrowing money from his supplier for an additional
A)40 days.
B)55 days.
C)70 days.
D)85 days.
Q2) The Omega Corp.plans to borrow $10,000 for a 2 months.At maturity,Omega will repay the $10,000 principal plus $100 interest.What is the annual percentage rate (APR)rate of interest on this loan?
A)6%
B)1%
C)4%
D)6.4%
Q3) Which of the following money market instruments may not be subject to state and local taxes?
A)Bankers' acceptances.
B)Repurchase agreements
C)U.S.Treasury bills
D)Federal agency securities
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Page 20
Chapter 19: International Business Finance
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Sample Questions
Q1) What keeps foreign exchange quotes in two different countries in line with each other?
A)Cross rates
B)Forward rates
C)Arbitrage
D)Spot rates
Q2) What is the role of arbitrage in the foreign exchange markets?
Q3) Which of the following statements is true?
A)Interest rate parity indicates that the forward premium or discount should be greater than the differences in the national interest rates for securities of the same maturity.
B)Purchasing power parity indicates that,in the long run,exchange rates adjust to reflect international differences in inflation so that the purchasing power of each currency tends to remain the same.
C)The International Fisher Effect indicates that the nominal interest rate should be the same all over the world at all times if the market is efficient.
D)Both B and C.
Q4) What is meant by interest rate parity?
Q5) What is the law of one price? How does it apply to foreign exchange rates?
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Chapter 20: Corporate Risk Management
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Q1) Erin wrote a put option on Verizon stock with a striking price of $53 price per share.At the expiration date,Verizon was selling for $50 per share.Which statement best describes the course of action that Erin should or must take?
A)Erin will do nothing because the market price is lower than the striking price.
B)Erin is obliged to buy the Verizon shares at $53,even though the market price is $3.00 lower.
C)Erin must sell the Verizon stock for $53 per share.
D)Erin has the right to sell Verizon stock at $3.00 per share over the market price.
Q2) A seller of commodities who has entered into forward contracts with customers will profit if prices fall before the purchase is concluded.
A)True
B)False
Q3) The optimal corporate risk management strategy is to
A)avoid or transfer every possible risk.
B)do nothing to transfer risk.
C)transfer about half the risk.
D)there is no strategy that is optimal for all firms.
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Page 22