Corporate Finance
Practice Questions
Course Introduction
Corporate Finance explores the fundamental principles and practices that govern financial decision-making within corporations. The course covers key topics such as capital budgeting, risk analysis, cost of capital, capital structure, dividend policy, and working capital management. Students will learn how financial managers evaluate investment opportunities, allocate resources, and optimize the value of the firm through effective financial strategies. Real-world case studies and analytical tools are used to illustrate how financial theories are applied in practice, equipping students with the skills to solve complex financial problems within organizations.
Recommended Textbook Fundamentals of Corporate Finance 10th Alternate Edition by Stephen A. Ross
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Page 2
Chapter 1: Introduction to Corporate Finance
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Q1) Which one of the following is defined as a firm's short-term assets and its short-term liabilities?
A) working capital
B) debt
C) investment capital
D) net capital
E) capital structure
Answer: A
Q2) Which type of business organization has all the respective rights and privileges of a legal person?
A) sole proprietorship
B) general partnership
C) limited partnership
D) corporation
E) limited liability company
Answer: D
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Two: Financial Statements and Long-Term Financial Planning
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Q1) A firm has net working capital of $640.Long-term debt is $4,180,total assets are $6,230,and fixed assets are $3,910.What is the amount of the total liabilities?
A) $2,050
B) $2,690
C) $4,130
D) $5,590
E) $5,860
Answer: E
Q2) Which one of the following is included in a firm's market value but yet is excluded from the firm's accounting value?
A) real estate investment
B) good reputation of the company
C) equipment owned by the firm
D) money due from a customer
E) an item held by the firm for future sale
Answer: B
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Chapter 3: Working With Financial Statements
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Q1) Beach Wear has current liabilities of $350,000,a quick ratio of 1.65,inventory turnover of 3.2,and a current ratio of 2.9.What is the cost of goods sold?
A) $980,000
B) $1,060,000
C) $1,200,000
D) $1,400,000
E) $1,560,000
Answer: D
Q2) A firm has a debt-total asset ratio of 74 percent and a return on total assets of 13 percent.What is the return on equity?
A) 26 percent
B) 50 percent
C) 65 percent
D) 84 percent
E) 135 percent
Answer: B
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Chapter 4: Long-Term Financial Planning and Growthpart
Three: Valuation of Future Cash Flows
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Q1) A firm is currently operating at full capacity.Net working capital,costs,and all assets vary directly with sales.The firm does not wish to obtain any additional equity financing.The dividend payout ratio is constant at 40 percent.If the firm has a positive external financing need,that need will be met by:
A) accounts payable.
B) long-term debt.
C) fixed assets.
D) retained earnings.
E) common stock.
Q2) Fresno Salads has current sales of $6,000 and a profit margin of 6.5 percent.The firm estimates that sales will increase by 4 percent next year and that all costs will vary in direct relationship to sales.What is the pro forma net income?
A) $303.33
B) $327.18
C) $405.60
D) $438.70
E) $441.10
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Chapter 5: Introduction to Valuation: the Time Value of Money
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Q1) Sue and Neal are twins.Sue invests $5,000 at 7 percent when she is 25 years old.Neal invests $5,000 at 7 percent when he is 30 years old.Both investments compound interest annually.Both Sue and Neal retire at age 60.Which one of the following statements is correct assuming that neither Sue nor Neal has withdrawn any money from their accounts?
A) Sue will have less money when she retires than Neal.
B) Neal will earn more interest on interest than Sue.
C) Neal will earn more compound interest than Sue.
D) If both Sue and Neal wait to age 70 to retire,then they will have equal amounts of savings.
E) Sue will have more money than Neal as long as they retire at the same time.
Q2) You expect to receive $9,000 at graduation in 2 years.You plan on investing this money at 10 percent until you have $60,000.How many years will it be until this occurs?
A) 18.78 years
B) 19.96 years
C) 21.90 years
D) 23.08 years
E) 25.00 years
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Chapter 6: Discounted Cash Flow Valuation
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Q1) The entire repayment of which one of the following loans is computed simply by computing a single future value?
A) interest-only loan
B) balloon loan
C) amortized loan
D) pure discount loan
E) bullet loan
Q2) The preferred stock of Casco has a 6.25 percent dividend yield.The stock is currently priced at $59.30 per share.What is the amount of the annual dividend?
A) $3.30
B) $3.35
C) $3.40
D) $3.71
E) $3.90
Q3) Explain the difference between the effective annual rate (EAR)and the annual percentage rate (APR).Of the two,which one has the greater importance and why?
Q4) Why might a borrower select an interest-only loan instead of an amortized loan,which would be cheaper?
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Chapter 7: Interest Rates and Bond Valuation
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Q1) Which of the following statements is correct concerning the term structure of interest rates?
I.Expectations of lower inflation rates in the future tend to lower the slope of the term structure of interest rates.
II.The term structure of interest rates includes both an inflation premium and an interest rate risk premium.
III.The real rate of return has minimal,if any,affect on the slope of the term structure of interest rates.
IV.The term structure of interest rates and the time to maturity are always directly related.
A) I and II only
B) II and IV only
C) I,II,and III only
D) II,III,and IV only
E) I,II,and IV only
Q2) Describe the relationships that exist between the coupon rate,the yield to maturity,and the current yield for both a discount bond and a premium bond.
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Chapter 8: Stock Valuationpart Four: Capital Budgeting
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Q1) Bonnie's Ice Cream is expecting its ice cream sales to decline due to the increased interest in healthy eating.Thus,the company has announced that it will be reducing its annual dividend by 2 percent a year for the next five years.After that,it will maintain a constant dividend of $2 a share.Last year,the company paid $2.35 per share.What is this stock worth to you if you require a 9.5 percent rate of return?
A) $16.21
B) $17.48
C) $18.64
D) $19.09
E) $21.90
Q2) A stock pays a constant annual dividend and sells for $56.10 a share.If the market rate of return on this stock is 12.5 percent,what is the amount of the next annual dividend?
A) $5.67
B) $5.94
C) $6.21
D) $6.84
E) $7.30
Q3) What are the primary differences and similarities between NASDAQ and the NYSE?
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Chapter 9: Net Present Value and Other Investment Criteria
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Q1) Which two methods of project analysis were the most widely used by CEO's as of 1999?
A) net present value and payback
B) internal rate of return and payback
C) net present value and average accounting return
D) internal rate of return and net present value
E) payback and average accounting return
Q2) If a project has a net present value equal to zero,then:
A) the total of the cash inflows must equal the initial cost of the project.
B) the project earns a return exactly equal to the discount rate.
C) a decrease in the project's initial cost will cause the project to have a negative NPV.
D) any delay in receiving the projected cash inflows will cause the project to have a positive NPV.
E) the project's PI must be also be equal to zero.
Q3) Explain how the internal rate of return (IRR)decision rule is applied to projects with financing type cash flows.
Q4) How does the net present value (NPV)decision rule relate to the primary goal of financial management,which is creating wealth for shareholders?
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Chapter 10: Making Capital Investment Decisions
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Q1) Northern Railway is considering a project which will produce annual sales of $975,000 and increase cash expenses by $848,000.If the project is implemented,taxes will increase from $141,000 to $154,000 and depreciation will increase from $194,000 to $272,000.The company is debt-free.What is the amount of the operating cash flow using the top-down approach?
A) $25,000
B) $114,000
C) $157,000
D) $181,000
E) $209,000
Q2) The annual annuity stream of payments that has the same present value as a project's costs is referred to as which one of the following?
A) yearly incremental costs
B) sunk costs
C) opportunity costs
D) erosion cost
E) equivalent annual cost
Q3) How can two firms arrive at two different bid prices when bidding for the same job and given the same bid specifications?
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Chapter 11: Project Analysis and Evaluationpart Five: Risk and Return
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Q1) The Coffee Express has computed its fixed costs to be $0.34 for every cup of coffee it sells given annual sales of 212,000 cups.The sales price is $1.49 per cup while the variable cost per cup is $0.63.How many cups of coffee must it sell to break-even on a cash basis?
A) 83,814
B) 96,470
C) 123,910
D) 167,630
E) 212,000
Q2) Which one of the following characteristics best describes a project that has a low degree of operating leverage?
A) high variable costs relative to the fixed costs
B) relatively high initial cash outlay
C) an OCF that is highly sensitive to the sales quantity
D) high level of forecasting risk
E) a high depreciation expense
Q3) What is forecasting risk and why is it important to the analysis of capital expenditure projects? What methods can be used to reduce this risk?
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Chapter 12: Some Lessons From Capital Market History
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Q1) The excess return is computed as the:
A) return on a security minus the inflation rate.
B) return on a risky security minus the risk-free rate.
C) risk premium on a risky security minus the risk-free rate.
D) the risk-free rate plus the inflation rate.
E) risk-free rate minus the inflation rate.
Q2) A stock had returns of 15 percent,8 percent,12 percent,-15 percent,and -4 percent for the past five years.Based on these returns,what is the approximate probability that this stock will return at least 20 percent in any one given year?
A) less than 0.5 percent
B) greater than 0.5 percent but less than 1.0 percent
C) greater than 1.0 percent but less than 2.5 percent
D) greater than 2.5 percent but less than 16 percent
E) greater than 16.0 percent
Q3) You want to invest in an index fund which directly correlates to the overall U.S.stock market.How can you determine if the market risk premium you are expecting to earn is reasonable for the long-term?
Q4) Define and explain the three forms of market efficiency.
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Six: Cost of Capital and Long-Term Financial Policy
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Q1) A stock has a beta of 1.2 and an expected return of 17 percent.A risk-free asset currently earns 5.1 percent.The beta of a portfolio comprised of these two assets is 0.85.What percentage of the portfolio is invested in the stock?
A) 71 percent
B) 77 percent
C) 84 percent
D) 89 percent
E) 92 percent
Q2) How many diverse securities are required to eliminate the majority of the diversifiable risk from a portfolio?
A) 5
B) 10
C) 25
D) 50
E) 75
Q3) A portfolio beta is a weighted average of the betas of the individual securities which comprise the portfolio.However,the standard deviation is not a weighted average of the standard deviations of the individual securities which comprise the portfolio.Explain why this difference exists.
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Chapter 14: Cost of Capital
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Q1) The Bakery is considering a new project it considers to be a little riskier than its current operations.Thus,management has decided to add an additional 1.5 percent to the company's overall cost of capital when evaluating this project.The project has an initial cash outlay of $58,000 and projected cash inflows of $17,000 in year one,$28,000 in year two,and $30,000 in year three.The firm uses 25 percent debt and 75 percent common stock as its capital structure.The company's cost of equity is 15.5 percent while the aftertax cost of debt for the firm is 6.1 percent.What is the projected net present value of the new project?
A) -$6,208
B) -$1,964
C) -$308
D) $1,427
E) $1,573
Q2) Explain how the use of internal equity rather than external equity affects the analysis of a project.
Q3) Give an example of a situation where a firm should adopt the pure play approach for determining the cost of capital for a project.
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Page 16
Chapter 15: Raising Capital
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Q1) Advertisements in a financial newspaper announcing a public offering of securities,along with a list of the investment banks handling the offering,are called:
A) red herrings.
B) tombstones.
C) Green Shoes.
D) registration statements.
E) cash offers.
Q2) The Educated Horses Corporation needs to raise $20 million to finance its expansion into new markets.The company will sell new shares of equity via a general cash offering to raise the needed funds.Suppose the offer price is $40 per share and the company's underwriters charge an 8 percent spread.The SEC filing fee and associated administrative expenses of the offering are $660,000.How many shares need to be sold?
A) 448,907
B) 461,222
C) 511,111
D) 529,937
E) 561,413
Q3) Explain why there is a tendency for IPOs to be underpriced.
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17
Chapter 16: Financial Leverage and Capital Structure Policy
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Q1) A firm should select the capital structure that:
A) produces the highest cost of capital.
B) maximizes the value of the firm.
C) minimizes taxes.
D) is fully unlevered.
E) equates the value of debt with the value of equity.
Q2) Bright Morning Foods has expected earnings before interest and taxes of $48,600,an unlevered cost of capital of 13.2 percent,and debt with both a book and face value of $25,000.The debt has an 8.5 percent coupon.The tax rate is 34 percent.What is the value of the firm?
A) $245,500
B) $247,600
C) $251,500
D) $264,800
E) $271,300
Q3) Explain how a firm loses value during the bankruptcy process from both a creditors and a shareholders perspective.
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18
Chapter 17: Dividends and Payout Policypart Seven: Short-Term
Financial Planning and Management
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Q1) Taylor's Tools declared a $0.48 per share dividend on Friday,March 7.The dividend will be paid on Monday,April 7.The ex-dividend date is Tuesday,March 18.What is the record date?
A) Friday,March 14
B) Monday,March 17
C) Wednesday,March 19
D) Thursday,March 20
E) Friday,March 21
Q2) Alfonzo's Italian House has 25,000 shares of stock outstanding with a par value of $1 per share and a market price of $28 a share.The firm just announced a 5-for-3 stock split.What will the market price per share be after the split?
A) $16.80
B) $21.60
C) $28.00
D) $46.67
E) $56.00
Q3) Explain how cash dividends affect individual shareholders differently than an equal amount of funds spent on a repurchase.
Q4) Explain the meaning of the dividend clientele effect and why it is important.
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Chapter 18: Short-Term Finance and Planning
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Q1) Which one of the following statements is correct?
A) The assignment of receivables involves selling the firm's accounts receivables at full price.
B) Lines of credit frequently require a cleanup period.
C) With maturity factoring,the borrower receives the loan amount immediately.
D) Commercial paper is short-term financing offered to highly-rated corporations by major banks.
E) Credit card receivables funding is a relatively inexpensive method of borrowing on a short-term basis.
Q2) The length of time between the sale of inventory and the collection of the payment for that sale is called the:
A) operating cycle.
B) inventory period.
C) accounts receivable period.
D) accounts payable period.
E) cash cycle.
Q3) List and describe the three basic types of secured inventory loans.Compare the advantages and disadvantages of these loans.
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20
Chapter 19: Cash and Liquidity Management
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Q1) Cash management primarily involves:
A) optimizing a firm's collections and disbursements of cash.
B) maximizing the income a firm earns on its cash reserves.
C) reconciling a firm's book balance with its bank balance.
D) determining the optimal level of liquidity a firm should maintain.
E) determining the best method of raising capital.
Q2) The Burger Stop spends $52,000 a week to pay bills and maintains a lower cash balance limit of $60,000.The standard deviation of the disbursements is $7,500.The applicable weekly interest rate is 0.04 percent and the fixed cost of transferring funds is $50.What is your optimal average cash balance based on the Miller-Orr model?
A) $79,116
B) $83,208
C) $110,315
D) $237,348
E) $249,624
Q3) Explain how the Check Clearing Act for the 21<sup>st</sup> Century affects both collection and disbursement float.
Q4) Explain how a lockbox system operates and why a firm might consider implementing such a system.
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Topics in Corporate Finance
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Q1) Assume that RSF is a wholly-owned subsidiary of the Rolled Steel Company.RSF provides credit financing solely for large ticket items purchased from the Rolled Steel Company.Which one of the following terms describes RSF?
A) credit department
B) parent company
C) captive finance company
D) credit union
E) service unit
Q2) A firm sells 4,500 units of an item each year.The carrying cost per unit is $2.15 and the fixed costs per order are $69.What is the economic order quantity?
A) 374 units
B) 421 units
C) 497 units
D) 537 units
E) 623 units
Q3) Why might firms forego discounts offered by their suppliers even though it is costly to do so? What steps might a firm pursue to be able to take these discounts?
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Chapter 21: International Corporate Finance
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Q1) The expected inflation rate in Finland is 2.8 percent while it is 3.2 percent in the U.S.A risk-free asset in the U.S.is yielding 4.9 percent.What approximate real rate of return should you expect on a risk-free Finnish security?
A) 1.2 percent
B) 1.7 percent
C) 2.1 percent
D) 2.5 percent
E) 2.8 percent
Q2) The international Fisher effect states that _____ rates are equal across countries. A) spot
B) one-year future
C) nominal
D) inflation
E) real
Q3) How well do you think relative purchasing power parity (PPP)and uncovered interest parity (UIP)behave? That is,do you think it's possible to forecast the expected future spot exchange rate accurately? What complications might you run into?
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Chapter 22: Behavioral Finance: Implications for Financial Management
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Q1) When weighing a decision,Kate places greater emphasis on opinions that match her own than she does on opinions offered by others that disagree with her personal point of view.Kate illustrates which one of the following?
A) frame dependence
B) overconfidence
C) gambler's fallacy
D) confirmation bias
E) overoptimism
Q2) Roger's Meat Market is a chain of retail stores that limits its sales to fresh-cut meats.The stores have been very profitable in northern cities.However,when two stores were opened in the south,both lost money and had to be closed.Roger,the owner,has now concluded that no southern-based store should be opened as it would not be profitable.Which one of the following applies to Roger?
A) confirmation bias
B) endowment effect
C) money illusion
D) affect heuristic
E) representativeness heuristic
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Chapter 23: Enterprise Risk Management
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Q1) Which one of the following is true regarding forward contracts?
A) The upfront costs to enter a forward contract can be significant.
B) If a buyer of a forward contract earns a $200 profit then the seller will also profit by $200.
C) The buyer wins when market prices are less than the forward price.
D) The payoff profile for the buyer of a forward contract is an upward sloping linear function.
E) If the seller of a forward contract earns a profit then the buyer has neither a profit nor a loss.
Q2) The National Bank has an agreement with The Foreign Bank to exchange 500,000 U.S.dollars for 380,000 Euros on the first day of each of the next 3 calendar quarters.This agreement is best described as a(n):
A) floating exchange.
B) spot trade.
C) option.
D) futures contract.
E) swap contract.
Q3) Explain why a swap is effectively a series of forward contracts.
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Chapter 24: Options and Corporate Finance
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Q1) Your company is deciding when to invest in a new machine.The new machine will increase cash flow by $240,000 per year.You believe the technology used in the machine has a 10-year life;in other words,no matter when you purchase the machine,it will be obsolete 10 years from today.The machine is currently priced at $1,200,000.The cost of the machine will decline by $120,000 per year until it reaches $720,000,where it will remain.Your required return is 8 percent.In which year should you purchase the machine?
A) Year 0
B) Year 1
C) Year 2
D) Year 3
E) Year 4
Q2) You own a July $15 call on ABC stock.Assume today is April 20 and the call has zero intrinsic value.Which one of the following best describes this option?
A) worthless
B) unfunded
C) expired
D) in-the-money
E) out-of-the-money
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Chapter 25: Option Valuation
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Q1) Theta measures an option's:
A) intrinsic value.
B) volatility.
C) rate of time decay.
D) sensitivity to changes in the value of the underlying asset.
E) sensitivity to risk-free rate changes.
Q2) Today,you purchased 100 shares of Lazy Z stock at a market price of $47 per share.You also bought a one year,$45 put option on Lazy Z stock at a cost of $0.15 per share.What is the maximum total amount you can lose on these purchases?
A) -$4,715
B) -$4,685
C) -$4,015
D) -$215
E) -$0
Q3) Explain how option pricing theory can be used to argue that acquisitive firms pursuing conglomerate mergers are not acting in the shareholders' best interest.
Q4) Explain how an increase in T-bill rates will affect the value of an American call and an American put.
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Chapter 26: Mergers and Acquisitions
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Q1) Merchantile Exchange is being acquired by National Sales.The incremental value of the acquisition is $1,800.Merchantile Exchange has 1,500 shares of stock outstanding at a price of $18 a share.National Sales has 3,500 shares of stock outstanding at a price of $54 a share.What is the net present value of the acquisition given that the actual cost of the acquisition using company stock is $28,780?
A) $8
B) $11
C) $20
D) $37
E) $46
Q2) The primary purpose of a flip-in provision is to:
A) increase the number of shares outstanding while also increasing the value per share. B) dilute a corporate raider's ownership position.
C) reduce the market value of each share of stock.
D) give the existing corporate directors the sole right to remove a poison pill.
E) provide additional compensation to any senior manager who loses his or her job as a result of a corporate takeover.
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Chapter 27: Leasing
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Q1) Explain the "leasing paradox" and also explain why leasing is or is not a "zero sum game".
Q2) Bob's Pizza is considering either leasing or buying a new oven.The lease payments would be $10,200 a year for 3 years.The purchase price is $29,000.The equipment has a 3-year life and then is expected to have a resale value of $3,100.Bob's Pizza uses straight-line depreciation,borrows money at 10 percent,and has a 32 percent tax rate.What is the net advantage to leasing?
A) $809
B) $833
C) $848
D) $853
E) $898
Q3) Explain the differences between purchasing an asset and leasing an asset.
Q4) The most cited reason why firms enter into lease agreements is to:
A) lower taxes.
B) improve cash flows.
C) reduce uncertainty.
D) avoid balance sheet reporting.
E) bypass restrictive loan covenants.
Q5) Why might a firm opt to sell and leaseback an asset which it currently owns?
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