Corporate Finance
Practice Questions
Course Introduction
Corporate Finance is an essential course that explores the principles and techniques involved in managing a corporations financial resources. The course covers topics such as capital budgeting, capital structure, dividend policy, financial statement analysis, valuation, risk management, and the cost of capital. Through case studies and practical examples, students learn how to make sound financial decisions, analyze investment opportunities, and understand the role of financial markets in corporate operations. The course equips students with the analytical tools required to evaluate the financial health of a business and to support strategic financial planning in a competitive business environment.
Recommended Textbook
Fundamentals of Corporate Finance 4th Edition Jonathan Berk
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Page 2
Chapter 1: Corporate Finance and the Financial Manager
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Q1) Corporations have come to dominate the business world through their ability to raise large amounts of capital by sale of ownership shares to anonymous outside investors.
A)True
B)False
Answer: True
Q2) What is the most common type of firm in the United States and the world?
A) sole proprietorships
B) partnerships
C) limited partnerships
D) corporations
Answer: A
Q3) Based on the information shown above, how much would you receive from selling 2,000 shares of the above stock?
A) 40,840
B) 40,740
C) 41,000
D) 42,560
Answer: B
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Chapter 2: Introduction to Financial Statement Analysis
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Q1) What is the main problem in using a balance sheet to provide an accurate assessment of the value of a company's equity?
A) Valuable assets such as the company's reputation, the quality of its work force, and the strength of its management are not captured on the balance sheet.
B) The balance sheet does not accurately represent the book value of assets held by the company.
C) The equity shown on the balance sheet does not reflect the market capitalization of the company.
D) Knowing at a single point in time what assets a firm possesses and the liabilities a firm owes does not give any indication of what those assets can produce in the future.
Answer: A
Q2) In general, a successful firm will have a market-to-book ratio that is substantially greater than 1.
A)True
B)False
Answer: False
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4
Chapter 3: Time Value of Money: an Introduction
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Q1) A 2013 Toyota Camry can be bought in Buffalo, NY, for $18,620. The same model Camry can be purchased across the Canadian border in Hamilton, ON. If cars could be freely traded across the border, what would be the expected price of a 2013 Toyota Camry in Hamilton in Canadian dollars, given that $1 U.S. is equal to $0.92 Canadian?
A) $17,130
B) $24,287
C) $20,239
D) $28,335
Answer: A
Q2) How does arbitrage help the Law of One Price?
Answer: Any arbitrage opportunity will exploit any mispricing to restore the Law of One Price.
Q3) If the interest rate is 9%, the one-year discount factor is equal to ________.
A) 0.090
B) 1.090
C) 0.917
D) 0.981
Answer: C
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Chapter 4: Time Value of Money: Valuing Cash Flow
Streams
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Q1) You are borrowing money to buy a car. If you can make payments of $320 per month starting one month from now at an interest rate of 12%, how much will you be able to borrow for the car today if you finance the amount over 4 years?
A) $7291.00
B) $14,582.00
C) $17,012.34
D) $12,151.67
Q2) An annuity is set up that will pay $1500 per year for ten years. What is the present value (PV) of this annuity given that the discount rate is 9%?
A) $5776
B) $9626
C) $11,551
D) $13,476
Q3) Define the following terms:
(a) perpetuity
(b) annuity
(c) growing perpetuity
(d) growing annuity
Q4) Can we apply the growing perpetuity equation for negative growth as well?
Page 6
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Chapter 5: Interest Rates
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Q1) A 12% APR with bimonthly compounding is equivalent to an EAR of ________.
A) 11.98%
B) 12.50%
C) 12.00%
D) 12.62%
Q2) A pottery factory purchases a continuous belt conveyor kiln for $68,000. A 6.3% APR loan with monthly payments is taken out to purchase the kiln. If the monthly payments are $765.22, over what term is this loan being paid?
A) 8 years
B) 9 years
C) 10 years
D) 11 years
Q3) The effective annual rate (EAR) for a loan with a stated APR of 8% compounded monthly is closest to ________.
A) 8.30%
B) 9.13%
C) 9.96%
D) 10.79%
Q4) Everything else remaining same, under what situation will APR and EAR be equal?
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Chapter 6: Bonds
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Q1) The Sisyphean Company has a bond outstanding with a face value of $5000 that reaches maturity in 8 years. The bond certificate indicates that the stated coupon rate for this bond is 8.2% and that the coupon payments are to be made semiannually. Assuming that this bond trades for $4541.53, then the YTM for this bond is closest to
A) 7.9%
B) 11.9%
C) 13.8%
D) 9.9%
Q2) An investor purchases a 30-year, zero-coupon bond with a face value of $5000 and a yield to maturity of 8.4%. He sells this bond ten years later. What is the rate of return on his investment, assuming yield to maturity does not change?
A) 6.72%
B) 5.04%
C) 8.40%
D) 4.20%
Q3) How are the cash flows of a zero-coupon bond different from those of a coupon bond?
Q4) How are the cash flows of a coupon bond different from an amortizing loan?
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Chapter 7: Stock Valuation
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Q1) A "round lot" consists of how many shares?
A) 1
B) 10
C) 100
D) 1,000
Q2) Which of the following formulas is INCORRECT?
A) Div<sub>t</sub> = EPS<sub>t</sub> × Dividend Payout Rate
B) P<sub>N</sub> = (r<sub>E</sub> - g) × Div<sub>N+1</sub>
C) earnings growth rate = retention rate × return on new investment
D) r<sub>E</sub> = (Div<sub>t</sub> / P<sub>0</sub>) + g
Q3) A floor broker is a person at the NASDAQ with a trading license who represents orders on the floor.
A)True
B)False
Q4) Which of the following is NOT a way that a firm can increase its dividend?
A) by increasing its retention rate
B) by decreasing its shares outstanding
C) by increasing its earnings (net income)
D) by increasing its dividend payout rate
Q5) How can the dividend-discount model handle changing growth rates?
Page 9
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Chapter 8: Investment Decision Rules
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Q1) If your new strip mall will have 15,000 square feet of retail space available to be leased, to which businesses should you lease and why?
Q2) How can you calculate the y-intercept of a net present value (NPV) profile without using TVM concepts?
Q3) Which of the following is true regarding the profitability index?
A) It does not use the net present value (NPV) to assess benefits.
B) It is very simple to compute.
C) Attention must be taken when using it to make sure that all of the constrained resource is utilized.
D) It is unreliable when used for choosing between different projects.
Q4) What can you comment about the shape of the net present value (NPV) profile of a multiple IRR project?
Q5) Is there a unique way for calculating the MIRR to resolve the multiple IRR situation?
Q6) How do you apply the Net Present Value rule when multiple projects are available and you have the added constraint of accepting only one project?
Q7) What is the decision criteria using internal rate of return (IRR) rule?
Q8) Under what situation can the net present value (NPV) profile be upward sloping?
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Chapter 9: Fundamentals of Capital Budgeting
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Q1) A company planning to market a new model of motor scooter analyzes the effect of changes in the selling price of the motor scooter, the number of units that will be sold, the cost of making the motor scooter, the effect on Net Working Capital, and the cost of capital for the project. They predict that the break-even point for sales price for the motor scooter is $2,480. What does this mean?
A) If the motor scooter is sold for $2,480, then the project will make a profit.
B) If the motor scooter is sold for $2,480, then the net present value (NPV) for the product will be zero.
C) The predicted selling price of the motor scooter is $2,480.
D) The maximum that the motor scooter can sell for and still make the project have a positive net present value (NPV) is $2,480.
Q2) Which of the following will cause the EBIT Break-Even for sales to increase?
A) a decrease in the sales price
B) a decrease in depreciation expense
C) a decrease in selling, general, and administrative expenses
D) a decrease in the number of units sold
Q3) What are the most difficult parts of capital budgeting?
Q4) What is the major difference between scenario analysis and sensitivity analysis?
Q5) Why does the option to abandon a project have value?
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Chapter 10: Stock Valuation: a Second Look
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Q1) Which of the following statements is FALSE?
A) We can estimate the value of a firm's shares by multiplying its current earnings per share by the average price-earnings ratio of comparable firms.
B) For valuation purposes, the trailing price-earnings ratio is generally preferred, since it is based on actual not expected earnings.
C) Forward earnings are the expected earnings over the coming 12 months.
D) Trailing earnings are the earnings over the previous 12 months.
Q2) Which of the following statements is FALSE?
A) The more cash a firm uses to repurchase shares, the less it has available to pay dividends.
B) Free cash flow measures the cash generated by a firm after payments to debt or equity holders are considered.
C) We estimate a firm's current enterprise value by computing the present value (PV) of the firm's free cash flow.
D) We can interpret the enterprise value of a firm as the net cost of acquiring the firm's equity, taking its cash, and paying off all debts.
Q3) Which is the best valuation technique when using comparables?
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Chapter 11: Risk and Return in Capital Markets
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Q1) Because investors can eliminate unsystematic risk "for free" by diversifying their portfolios, they ________.
A) do not require a risk premium for bearing it
B) require a risk premium for bearing it
C) are indifferent about credit spread and risk premium
D) do not require a credit spread
Q2) Which of the following statements is FALSE?
A) On average, larger stocks have higher volatility than smaller stocks.
B) Portfolios of large stocks are typically less volatile than individual large stocks.
C) On average, smaller stocks have higher returns than larger stocks.
D) On average, Treasury Bills have lower returns than corporate bonds.
Q3) Is volatility a reasonable measure of risk when evaluating the investment in a single stock?
Q4) Which of the following investments offered the lowest overall return over the past eighty years?
A) small stocks
B) Treasury bills
C) S&P 500
D) corporate bonds
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Chapter 12: Systematic Risk and the Equity Risk Premium
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Q1) The Capital Asset Pricing Model (CAPM) says that the risk premium on a stock is equal to its beta times the market risk premium.
A)True
B)False
Q2) A portfolio comprises Coke (beta of 1.3) and Wal-Mart (beta of 0.7). The amount invested in Coke is $20,000 and in Wal-Mart is $20,000. What is the beta of the portfolio?
A) 0.9
B) 0.95
C) 1.00
D) 1.10
Q3) The beta of the market portfolio is ________.
A) 0
B) -1
C) 2
D) 1
Q4) What role does the standard deviations of two assets play in computation of the expected return of the two asset portfolio?
Q5) Is it possible for a stock to have high total risk but low systematic risk?
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Chapter 13: The Cost of Capital
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Q1) One should use accounting-based book values rather than market values of debt and equity to determine the weights for the different sources of capital.
A)True
B)False
Q2) The fact that the after-tax cost of debt is lower than the pretax cost of debt implicitly assumes that interest expense can be ________.
A) expensed
B) margined
C) refinanced
D) capitalized
Q3) A firm's overall cost of capital that is a blend of the costs of the different sources of capital is known as the firm's ________.
A) weighted average cost of capital
B) cost of equity infusion
C) cost of debt
D) cost of preferred stock
Q4) Why do we use market values rather than book values in calculation of WACC?
Q5) Why do we use leverage if it increases the risk of a firm?
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Chapter 14: Raising Equity Capital
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Q1) Which of the following statements regarding exit strategies is FALSE?
A) An alternative way to provide liquidity to its investors is for the company to become a publicly traded company.
B) An important consideration for investors in private companies is their exit strategy, or how they will eventually realize the return from their investment.
C) Often large corporations purchase successful start-up companies. In such a case, the acquiring company purchases the outstanding stock of the private company, allowing all investors to cash out.
D) Roughly 25% of venture capital exits from 2001-2005 occurred through mergers or acquisitions.
Q2) The firm commitment process is the most common practice for IPOs in the United States.
A)True
B)False
Q3) Stock issued in an IPO usually trades significantly higher at the end of the first day of trading than the original IPO price.
A)True
B)False
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Chapter 15: Debt Financing
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Q1) What are bond covenants?
Q2) A company issues a callable (at par) ten-year, 6% coupon bond with annual coupon payments. The bond can be called at par in one year after release or any time after that on a coupon payment date. On release, it has a price of $104 per $100 of face value. What is the yield to call of this bond when it is released?
A) 0.60%
B) 1.50%
C) 1.92%
D) 5.47%
Q3) What is a bond's seniority?
A) the bondholder's priority in claiming assets in the event of default
B) clauses restricting a company from issuing new debt
C) the yield to maturity of a bond as compared to bonds of comparable rating
D) the issue price of the bond as compared to its face value
Q4) What kind of unsecured corporate debt has a maturity of less than ten years?
A) mortgage bonds
B) asset-backed bonds
C) debentures
D) notes
Q5) What are secured debt?
Page 17
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Chapter 16: Capital Structure
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Q1) The presence of leverage can influence the behavior of the managers of a firm.
A)True
B)False
Q2) Asymmetric information implies that ________ may have better information about a firm's cash flows than other stakeholders.
A) debt holders
B) suppliers
C) managers
D) creditors
Q3) A bankruptcy process is complex, time-consuming, and costly. The costs of bankruptcy include ________.
A) dividend payments
B) raw material costs
C) costs of hiring legal experts, appraisers, and auctioneers
D) taxes
Q4) As the level of debt increases the tax benefits of debt increase until ________.
A) interest costs exceed dividend payments
B) tax shield benefit exceeds distress costs
C) raw material costs exceed dividend payments
D) employee costs exceed interest expense
Page 18
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Chapter 17: Payout Policy
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Q1) When a firm has excessive cash, managers may make use of the funds in an inefficient manner. This is also referred to as the ________ cost of retaining cash.
A) fixed
B) agency
C) interest
D) special
Q2) A firm has $75 million of assets that includes $12 million of cash and 25 million shares outstanding. If the firm uses $12 million of cash to repurchase shares, what is the new price per share?
A) $2.40
B) $1.50
C) $3.00
D) $6.00
Q3) The Record Date falls before the Ex-Dividend Date.
A)True
B)False
Q4) What are the characteristics of special dividend?
Q5) What are the different ways a firm can repurchase shares?
Q6) What is the effect on the stock price when a firm repurchases its shares?
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Chapter 18: Financial Modeling and Pro Forma Analysis
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Q1) The amount of dividends a company pays will affect the ________ it has to finance future growth.
A) debt
B) retained earnings
C) current liabilities
D) current ratio
Q2) With the proper changes it is believed that Ideko's credit policies will extend a 60 days credit period to accounts receivables. The forecasted accounts receivable for Ideko in 2013 is closest to ________.
A) $14,525
B) $19,690
C) 22,710
D) $16,970
Q3) The estimate of a firm's value at the end of the forecast horizon using a valuation multiple is also called its ________.
A) fixed value
B) payback value
C) terminal value
D) none of the above
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Chapter 19: Working Capital Management
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Q1) Which of the following best describes short-term debt issued by banks with a minimum denomination of $100,000?
A) certificates of deposit
B) repurchase agreements
C) banker's acceptances
D) commercial paper
Q2) What is the effective annual cost of credit terms of 1/10 net 30, if the firm stretches the accounts payable to 45 days?
A) 8.49 %
B) 10.91%
C) 11.05%
D) 18.03%
Q3) A firm has an average accounts payable balance of $180,000. Its average daily cost of goods sold is $12,000. What is the average number of days that the firm takes to pay its debt?
A) 2 days
B) 8 days
C) 15 days
D) 21 days
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Chapter 20: Short-Term Financial Planning
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Q1) A firm has a committed line of credit with a maximum of $2.5 million and an interest rate of 9% (EAR) with a certain bank. The commitment fee is 0.65% (EAR). The firm borrows $2 million at the start of the year, and then repays it at the end of the year. What is the total cost of the loan?
A) $180,000
B) $183,250
C) $193,000
D) $212,500
Q2) Which of the following statements is FALSE?
A) The matching principle indicates that the firm should finance permanent working capital with short-term sources of funds.
B) Following the matching principle should, in the long run, help minimize a firm's transaction costs.
C) In a perfect capital market, the choice of financing is irrelevant; thus how the firm chooses to finance its short-term cash needs cannot affect value.
D) A portion of a firm's investment in its accounts receivable and inventory is temporary and results from seasonal fluctuations in the firm's business or unanticipated shocks.
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Chapter 21: Option Applications and Corporate Finance
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Q1) Suppose that a stock sells at a price of $60 on the expiration date. Compute the payoff to the seller of a put option if the option strike price is $80.
A) -$20
B) -$10
C) 0
D) $40
Q2) Which of the following statements is FALSE?
A) A holder would not exercise an in-the-money option.
B) The option seller, also called the option writer, sells (or writes) the option and has a short position in the contract.
C) Because the long side has the option to exercise, the short side has an obligation to fulfill the contract.
D) When the exercise price of an option is equal to the current price of the stock, the option is said to be at-the-money.
Q3) What are European options?
Q4) What is the short position of an options contract?
Q5) What are American options?
Q6) When is an option out-the-money?
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Chapter 22: Mergers and Acquisitions
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Q1) Which of the following statements regarding monopoly mergers is FALSE?
A) It is often argued that merging with or acquiring a major rival enables a firm to substantially reduce competition within the industry and thereby increase profits.
B) Financial researchers have found that the share prices of other firms in the same industry did not significantly increase following the announcement of a merger within the industry.
C) While only the merging company benefits when competition is reduced, all companies in an industry pay the associated costs.
D) Society as a whole bears the cost of monopoly strategies, so most countries have antitrust laws that limit such activity.
Q2) If Martin pays no premium to acquire Luther, what will the earnings per share be after the merger?
Q3) Assume that Martin pays no premium to acquire Luther. Calculate Martin's price-earnings (P/E) ratio both pre and post merger.
Q4) What is a white knight?
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Chapter 23: International Corporate Finance
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Q1) ________ are players in the foreign exchange market.
A) Global investment banks
B) Large multinational firms
C) Central banks
D) All of the above
Q2) The amount of the taxes paid in dollars for the Irish operations is closest to ________.
A) $20.5 million
B) $5.1 million
C) $29.5 million
D) $50.0 million
Q3) All investors in the developed and developing world have access to the financial securities in all markets.
A)True
B)False
Q4) If a foreign project is owned by a domestic corporation, managers and shareholders need to determine the home currency value of the foreign currency cash flows.
A)True
B)False
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Chapter 24: Leasing
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Q1) Which of the following statements is FALSE?
A) By offering assets together with complementary services, lessors can achieve efficiency gains and offer attractive lease rates.
B) Assets leased under a true lease are afforded bankruptcy protection and cannot be seized in the event of default.
C) Because of the higher recovery value in the event of default, a lessor may be able to offer more attractive financing through the lease than an ordinary lender could.
D) Lessors often have efficiency advantages over lessees in maintaining or operating certain types of assets.
Q2) What will Luther's balance sheet look like if they acquire the new fleet of delivery trucks using an operating lease?
Q3) Which of the following discount rates should be used for the lease versus borrow decision?
A) the risk-free rate of interest
B) the company's cost of borrowing
C) the company's after-tax cost of borrowing
D) the company's weighted average cost of capital
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Chapter 25: Insurance and Risk Management
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Q1) Which of the following statements is FALSE?
A) Because insurance reduces the risk of financial distress, it can relax this tradeoff and allow the firm to increase its use of debt financing.
B) By lowering the volatility of the stock, insurance can discourage concentrated ownership by an outside director or investor who will monitor the firm and its management.
C) When a firm is subject to graduated income tax rates, insurance can produce a tax savings if the firm is in a higher tax bracket when it pays the premium than the tax bracket it is in when it receives the insurance payment in the event of a loss.
D) In a perfect market without other frictions, insurance companies should compete until they are just earning a fair return and the NPV from selling insurance is zero. The NPV is zero if the price of insurance equals the present value of the expected payment; in that case, we say the price is actuarially fair.
Q2) What is the actuarially fair cost of full insurance?
Q3) 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?
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Chapter 26: Corporate Governance
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Q1) Which of the following statements is FALSE?
A) A board is said to be classified when its monitoring duties have been compromised by connections or perceived loyalties to management.
B) Even the most active independent directors spend only one or two days per month on firm business, and many independent directors sit on multiple boards, further dividing their attention.
C) On a board composed of insider, gray, and independent directors, the role of the independent director is really that of a watchdog.
D) Because independent directors' personal wealth is likely to be less sensitive to performance than that of insider and gray directors, they have less incentive to closely monitor the firm.
Q2) Describe the "stakeholder" model of corporate governance.
Q3) What is the difference between inside, gray, and outside directors?
Q4) Which of the following countries has employees appoint some board members?
A) Canada
B) the United States
C) Turkey
D) Germany
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