Corporate Finance
Study Guide Questions
Course Introduction
Corporate Finance explores the principles and practices underlying financial management within a corporation. The course covers key topics such as capital budgeting, financial statement analysis, valuation of assets and firms, risk and return, capital structure decisions, dividend policy, and options for financing growth. Students develop analytical skills to assess investment opportunities, manage financing strategies, and maximize shareholder value, while also considering ethical and regulatory issues affecting financial decision-making in a global context.
Recommended Textbook
Corporate Finance
3rd Edition by Jonathan Berk
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Chapter 1: The Corporation
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Q1) You own 100 shares of a Sub Chapter "S" corporation. The corporation earns $5.00 per share before taxes. Once the corporation has paid any corporate taxes that are due, it will distribute the rest of its earnings to its shareholders in the form of a dividend. If the corporate tax rate is 40% and your personal tax rate on (both dividend and non-dividend) income is 30%, then how much money is left for you after all taxes have been paid?
A) $210
B) $300
C) $350
D) $500
Answer: C
Q2) The Principal-Agent Problem arises:
A) because managers have little incentive to work in the interest of shareholders when this means working against their own self-interest.
B) because of the separation of ownership and control in a corporation.
C) Both A and B
D) None of the above
Answer: C
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Chapter 2: Introduction to Financial Statement Analysis
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Q1) On the balance sheet, current maturities of long-term debt appears:
A) in the Stockholders' Equity section.
B) in the Operating Expenses section.
C) in the Current Assets section.
D) in the Current Liabilities section.
Answer: D
Q2) Perrigo's return on equity (ROE) is closest to:
A) 4.6%
B) 9.1%
C) 17.2%
D) 27%
Answer: C
Q3) The firm's assets and liabilities at a given point in time are reported on the firm's:
A) income statement or statement of financial performance.
B) income statement or statement of financial position.
C) balance sheet or statement of financial performance.
D) balance sheet or statement of financial position.
Answer: D
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4
Chapter 3: Financial Decision Making and the Law of One
Price
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Q1) Without issuing the new security, the NPV for this project is closest to what amount? Should the film maker make the investment?
A) $1.7 million; Yes
B) $1.7 million; No
C) $2.7 million; Yes
D) $2.7 million; No
Answer: C
Q2) Which of the following statements regarding value additivity is FALSE?
A) The value of a portfolio is equal to the sum of the values of its parts.
B) The price or value of the entire firm is equal to the sum of the values of all projects and investments within the firm.
C) To maximize the value of the entire firm, managers should make decisions that maximize NPV.
D) Value additivity does not have important consequences for the value of the entire firm, only on portfolios of firms.
Answer: D
Q3) The price per share of the ETF in a normal market is:
Answer: Value of ETF = 2 × 121.57 + 3 × 36.59 + 3 × 3.15 = $362.36
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Chapter 4: The Time Value of Money
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Q1) You work for a pharmaceutical company that has developed a new drug. The patent on the drug will last for 17 years. You expect that the drug will produce cash flows of $10 million in its first year and that this amount will grow at a rate of 4% per year for the next 17 years. Once the patent expires, other pharmaceutical companies will be able to produce generic equivalents of your drug and competition will drive any future profits to zero. If the interest rate is 12% per year, then the present value of producing this drug is closest to:
A) $71 million
B) $90 million
C) $170 million
D) $105 million
Q2) Define the following terms:
(a) perpetuity
(b) annuity
(c) growing perpetuity
(d) growing annuity
Q3) You have been offered the following investment opportunity, if you pay $2500 today, you will receive $1000 at the end of each of the next three years. Draw a timeline detailing this investment opportunity.
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Chapter 5: Interest Rates
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Q1) If your income tax rate is 30%, then the after-tax EAR for your home equity loan is closest to:
A) 6.0%
B) 5.9%
C) 8.6%
D) 5.8%
Q2) The highest effective rate of return you could earn on any of these investments is closest to:
A) 6.250%
B) 6.267%
C) 6.295%
D) 6.310%
Q3) The effective annual rate for a credit card that charges a 19.9% APR compounded daily is closest to:
A) 18.15%
B) 19.9%
C) 22.0%
D) 24.2%
Q4) Should the nominal interest rate ever be negative? Can the real interest rate ever be negative? Explain.
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Chapter 6: Valuing Bonds
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Q1) The credit spread on AAA-rated corporate bonds is:
A) 1.0%
B) 1.5%
C) 2.6%
D) 4.1%
Q2) Based upon the information provided in the table above, you can conclude
A) that the yield curve is flat.
B) nothing about the shape of the yield curve.
C) that the yield curve is downward sloping.
D) that the yield curve is upward sloping.
Q3) The price per $100 face value of a three-year, zero-coupon, risk-free bond is closest to:
A) $93.80
B) $90.06
C) $89.16
D) $86.39
Q4) How much are each of the semiannual coupon payments? Assuming the appropriate YTM on the Sisyphean bond is 8.8%, then at what price should this bond trade for?
Q5) Compute the yield to maturity for each of the five zero-coupon bonds.
Page 8
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Chapter 7: Investment Decision Rules
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Q1) The internal rate of return (IRR) for project Beta is closest to:
A) 25.0%
B) 22.7%
C) 24.5%
D) 22.2%
Q2) One of the IRR for Rearden's mining operation is closest to:
A) 0%
B) 10.6%
C) 12.4%
D) 72.0%
Q3) Which of the following statements is FALSE?
A) The payback investment rule is based on the notion that an opportunity that pays back its initial investments quickly is a good idea.
B) An IRR will always exist for an investment opportunity.
C) A NPV will always exist for an investment opportunity.
D) In general, there can be as many IRRs as the number of times the project's cash flows change sign over time.
Q4) If your new strip mall will have 16,000 square feet of retail space available to be leased, to which businesses should you lease and why?
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Chapter 8: Fundamentals of Capital Budgeting
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Q1) Which of the following statements is FALSE?
A) Sensitivity analysis allows us to explore the effects of errors in our estimated inputs in our NPV analysis for the project.
B) To compute the NPV for a project, you need to estimate the incremental cash flows and choose a discount rate.
C) Estimates of the cash flows and cost of capital are often subject to significant uncertainty.
D) When we are certain regarding the input to a capital budgeting decision, it is often useful to determine the break-even level of that input.
Q2) The incremental cash flow that Galt Motors will incur in year 10 if they elect to manufacture armatures in house is closest to:
A) 40,000
B) 335,000
C) 375,000
D) 415,000
Q3) Epiphany is worried about the reliability of the sales forecast. How sensitive is the project's NPV to a 10% change in sales.
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Chapter 9: Valuing Stocks
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Q1) Rearden's expected capital gains yield is closest to:
A) 4.0%
B) 6.4%
C) 8.2%
D) 10.0%
Q2) Which of the following statements is FALSE?
A) To estimate a firm's enterprise value, we compute the present value of the free cash flows (FCF) that the firm has available to pay equity holders.
B) The NPV of any individual project represents its contribution to the firm's enterprise value.
C) When using the total payout model, we discount total dividends and share repurchases, and use the growth rate in earnings when forecasting the growth of the firm's payout.
D) In the total payout model, we first value the firm's equity, rather than just a single share.
Q3) What are some implicit assumptions that are made when valuing a firm using multiples based on comparable firms?
Q4) Calculate the enterprise value for DM Corporation.
Q5) What are some common multiples used to value stocks?
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Chapter 10: Capital Markets and the Pricing of Risk
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Q1) What is the excess return for the S&P 500?
A) 5.7%
B) 7.0%
C) 0%
D) 8.4%
Q2) What is the Beta for a type S firm?
A) 1.5
B) 0.0
C) 1.0
D) 0.75
Q3) The beta for security "Y" is closest to:
A) -1.00
B) -0.25
C) 0.00
D) 0.25
Q4) The standard deviation of the return on Alpha Corporation is closest to:
A) 22.4%
B) 19.0%
C) 21.8%
D) 19.4%
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Chapter 11: Optimal Portfolio Choice and the Capital Asset Pricing Model
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Q1) You want to maximize your expected return without increasing your risk. Without increasing your volatility beyond its current 10%, the maximum expected return you could earn is closest to:
A) .12.0%
B) 12.5%
C) 13.4%
D) 15.0%
Q2) Which of the following statements is FALSE?
A) A combination of portfolios on the efficient frontier of risky investments is also on the efficient frontier of risky investments.
B) The conclusion of the CAPM that investors should hold the market portfolio combined with the risk-free investment depends on the quality of an investor's information.
C) The SML holds with some rate r* between r<sub>s</sub> and r<sub>b</sub> in place of r<sub>f</sub>, where r* depends on the proportion of savers and borrowers in the economy.
D) In reality, investors have different information and spend varying amounts of effort on research for assorted stocks.
Q3) Calculate the covariance between Stock Y's and Stock Z's returns .
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Chapter 12: Estimating the Cost of Capital
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Q1) In practice which market index is most widely used as a proxy for the market portfolio in the CAPM?
A) Dow Jones Industrial Average
B) Wilshire 5000
C) S&P 500
D) U.S. Treasury Bill
Q2) In a world with taxes, which of the following is the rate we should use to evaluate an all-equity financed project with the same risk as the firm?
A) The weighted-average cost of capital
B) The pre-tax WACC
C) The cost of equity
D) The cost of debt
Q3) The overall value of Wyatt Oil (in $ millions) is closest to:
A) $25,000
B) $18,846
C) $31,250
D) $15,000
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Chapter 13: Investor Behavior and Capital Market Efficiency
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Q1) The alpha for Bernard is closest to:
A) +5%
B) -2%
C) -3%
D) +2%
Q2) Portfolio "A":
A) has a relatively lower expected return than predicted. B) has a positive alpha. C) falls below the SML. D) is overpriced.
Q3) Using the FFC four factor model and the historical average monthly returns, the expected monthly return for Wal-Mart is closest to:
A) 0.71%
B) 0.53%
C) 1.38%
D) 0.79%
Q4) What does the existence of a positive alpha investment strategy imply?
Q5) Explain why the market portfolio proxy may not be efficient.
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Chapter 14: Capital Structure in a Perfect Market
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Q1) Following the borrowing of $12 and subsequent share repurchase, the expected earnings per share for RC is closest to:
A) $1.32
B) $1.44
C) $1.40
D) $1.20
Q2) Suppose that Taggart Transcontinental currently has no debt and has an equity cost of capital of 10%. Taggart is considering borrowing funds at a cost of 6% and using these funds to repurchase existing shares of stock. Assume perfect capital markets. If Taggart borrows until they achieved a debt -to-value ratio of 20%, then Taggart's levered cost of equity would be closest to:
A) 8.0%
B) 9.2%
C) 10.0%
D) 11.0%
Q3) Suppose you own 10% of the equity of With. What is another portfolio you could hold that would provide you with the same exact cash flows?
Q4) What is the conservation of value principle?
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Chapter 15: Debt and Taxes
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Q1) After the recapitalization, the total value of KD as a levered firm is closest to:
A) $470 million
B) $730 million
C) $670 million
D) $530 million
Q2) If Flagstaff currently maintains a .5 debt to equity ratio, then the value of Flagstaff as an all equity firm would be closest to:
A) $80 million
B) $100 million
C) $73 million
D) $115 million
Q3) If Flagstaff maintains a debt to equity ratio of 1, then Flagstaff's pre-tax WACC is closest to:
A) 11.0%
B) 10.5%
C) 10.0%
D) 9.0%
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Chapter 16: Financial Distress, Managerial Incentives, and Information
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Q1) Suppose that MI has zero-coupon debt with a $125 million face value due next year. The initial value of MI's debt is closest to:
A) $125 million
B) $111 million
C) $100 million
D) $116 million
Q2) Suppose that MI has zero-coupon debt with a $125 million face value due next year. The total value of MI with leverage is closest to:
A) $133 million
B) $140 million
C) $147 million
D) $125 million
Q3) If its managers engage in empire building, then the expected market value of Luther's assets is closest to:
A) $260
B) $280 million
C) $240
D) $300 million
Q4) List five general categories of indirect costs associated with bankruptcy.
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Chapter 17: Payout Policy
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Q1) Suppose that d'Anconia Copper retained the $200 million in cash so that it would not need to raise new funds from outside investors for an expansion it has planned for next year. If it did raise new funds, it would have to pay issuance fees. Assuming that these fees can be expensed for corporate tax purposed, the amount that d'Anconia Copper needs to save in issuance fees to make retaining the cash beneficial for its investors is closest to:
A) $2.0 million
B) $5.5 million
C) $6.5 million
D) $7.0 million
Q2) Assume that Omicron uses the entire $50 million in excess cash to pay a special dividend. Omicron's cum-dividend price is closest to:
A) $50.00
B) $40.00
C) $5.00
D) $45.00
Q3) Calculate the effective tax disadvantage for retaining cash in 1999, 2001, and 2005.
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Chapter 18: Capital Budgeting and Valuation With Leverage
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Q1) Based upon the three comparable firms, calculate that most appropriate unlevered cost of capital for Aardvark to use on this new product.
Q2) Assuming that to fund the investment Taggart will take on $250 million in permanent debt and ignoring issuance costs, the NPV of Taggart's new rail line is closest to:
A) $195 million
B) $200 million
C) $235 million
D) $240 million
Q3) Given that Rose issues new debt of $50 million initially to fund the acquisition, the present value of the interest tax shield for this acquisition is closest to:
A) $24 million
B) $50 million
C) $20 million
D) $15 million
Q4) Describe the key steps in the flow to equity method for valuing a levered investment.
Q5) Calculate the debt capacity of Omicron's new project for years 0, 1, and 2.
Q6) Calculate the NPV for Iota's new project.
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Chapter 19: Valuation and Financial Modeling: a Case Study
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Q1) The after tax interest expense in 2010 is closest to:
A) 0
B) 2,856
C) 5,304
D) 8,160
Q2) The free cash flow to equity in 2008 is closest to:
A) -5,005
B) -1,755
C) 5,575
D) 9,995
Q3) The amount of net working capital for Ideko in 2008 is closest to:
A) $35,195
B) $26,420
C) $22,170
D) $30,510
Q4) The free cash flow to the firm in 2008 is closest to:
A) -5,005
B) -1,755
C) 5,575
D) 14,995
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Chapter 20: Financial Options
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Q1) Consider the following equation: C = P + S - PV(K) - PV(Div)
In this equation the term S refers to:
A) the payoff of a zero coupon bond.
B) the strike price of the option.
C) the value of the call option.
D) the stock's current price.
Q2) KD Industries stock is currently trading at $32 per share. Consider a put option on KD stock with a strike price of $30. The maximum value of this put option is:
A) $0
B) $32
C) $30
D) $2
Q3) The market price of an option is called the:
A) American premium.
B) European premium.
C) option premium.
D) exercising premium.
Q4) Describe the conditions when it would be optimal to exercise an American Call and an American Put option prior to their expiration.
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Chapter 21: Option Valuation
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Q1) Construct a binomial tree detailing the option information and payoffs for a call option with a $20 strike price that expires in one year.
Q2) Using the binomial pricing model, the calculated price of a one-year put option on KD stock with a strike price of $20 is closest to:
A) -7.7
B) 2.4
C) 4.6
D) -1.8
Q3) Using risk neutral probabilities, calculate the price of a two-year put option on Kinston stock with a strike price of $9.
Q4) The Black-Scholes of a one-year, at-the-money call option on Taggart stock is closest to:
A) 0.2850
B) 0.4840
C) 0.5160
D) 0.6141
Q5) Using the binomial pricing model, calculate the price of a two-year put option on Kinston stock with a strike price of $9.
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Chapter 22: Real Options
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Q1) Assuming that this project will provide Rearden with perpetual annual cash flows of $80,000, the NPV of investing in the project today using the hurdle rate is closest to:
A) -281,000
B) +46,000
C) +83,000
D) +143,000
E) +238,000
Q2) The equivalent annual benefit of project B is closest to:
A) $5.05
B) $5.75
C) 3.45
D) $3.40
Q3) If you are not awarded the government contract and your sales decrease by 25%, then the value of your plant will be closest to:
A) -$1 million
B) $5 million
C) $8 million
D) $0
Q4) Can value be created by waiting for uncertainty to resolve?
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Chapter 23: Raising Equity Capital
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Q1) Which of the following statements is FALSE?
A) The general partners work for the venture capital firm and run the venture capital firm; they are called venture capitalists.
B) An important consideration for investors in private companies is their exit strategy-how they will eventually realize the return from their investment.
C) When a company founder decides to sell equity to outside investors for the first time, it is common practice for private companies to issue common stock rather than preferred stock to raise capital.
D) Institutional investors such as pension funds, insurance companies, endowments, and foundations manage large quantities of money.
Q2) Which of the following is NOT a common name for a corporation that invests in private companies?
A) Strategic investor
B) Corporate partner
C) Venture partner
D) Strategic partner
Q3) What will the offer price of these shares be if Luther is selling 800,000 shares?
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25
Chapter 24: Debt Financing
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Q1) Asset securitization is the process of creating a(n):
A) collateralized security.
B) asset-backed security.
C) municipal security.
D) payment security.
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) In January 2010, the U.S. Treasury issued a $1000 par, ten-year, inflation-indexed note with a coupon of 4%. On the date of issue, the consumer price index (CPI) was 200. By January 2020, the CPI had increased to 300. The principal payment that was made in January 2020 is closest to:
A) $1000
B) $1020
C) $1030
D) $1500
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Chapter 25: Leasing
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Q1) Calculate the monthly lease payments for a four year $1.00 out lease of the Bulldozer.
Q2) A lease where the lessee has the option to purchase the asset at the end of the lease for a set price that is set upfront in the lease contract is called a:
A) fixed price lease.
B) $1.00 out lease.
C) fair market value lease.
D) fair market value cap lease.
Q3) Which of the following statements is FALSE?
A) Lease payments are a fixed obligation of the firm.
B) The risk of the lease payments is no greater than the risk of secured debt, so it is reasonable to discount the lease payments at the firm's secured borrowing rate.
C) If a firm purchases a piece of equipment, the expense is a capital expenditure. Therefore, the purchase price can be depreciated over time, generating a depreciation tax shield.
D) If the equipment is leased and the lease is a non-tax lease, there is no capital expenditure, but the lease payments are an operating expense.
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Chapter 26: Working Capital Management
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Q1) Luther's Accounts Payable days is closest to:
A) 39 days
B) 32 days
C) 59 days
D) 42 days
Q2) Your firm purchases goods from its supplier on terms of 1/10, net 30. 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 45 days is closest to:
A) 13.0%
B) 11.1%
C) 15.9%
D) 20.1%
Q3) The percentage of Wyatt's receivables that are past due is closest to:
A) 20.1%
B) 32.1%
C) 38.3%
D) 42.2%
Q4) What is a compensating balance?
Q5) Describe "just-in-time" inventory management.
Q6) Calculate the number of days in Luther's Operating Cycle.
28
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Chapter 27: Short-Term Financial Planning
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Q1) The temporary working capital needs for Hasbeen Toys in quarter 3 is closest to:
A) $845 million
B) $0 million
C) $770 million
D) $ 340 million
Q2) Luther Industries is offered a $1 million dollar loan for four months at an APR of 9%. Luther's bank requires that the firm maintain a compensating balance equal to 5% of the loan amount in a non-interest bearing account and the bank charges a 1% origination fee. Calculate the the effective annual rate EAR for this loan.
Q3) Hammond Motors is considering using a public warehouse loan as part of its short-term financing. The firm will require a loan of $2 million for three months. Interest on the loan will be 12% (APR, compounded quarterly) to be paid at the end of the quarter. The warehouse charges 1% of the face value of the loan, payable at the beginning of the quarter. The effect annual rate on this loan is closest to:
A) 9.3%
B) 11.3%
C) 15.2%
D) 17.1%
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Chapter 28: Mergers and Acquisitions
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Q1) A situation where every director serves a three-year term and the terms are staggered so that only one-third of the directors are up for election each year is called a: A) white knight.
B) classified board.
C) poison pill.
D) golden parachute.
Q2) Which of the following statements regarding mergers and taxes is FALSE?
A) Because it may be easier to measure performance accurately in a conglomerate, agency costs may be reduced and resources may be more efficiently allocated.
B) Because these employees are obligated to hold idiosyncratic risk, they benefit when the firm reduces that risk by conglomerating.
C) Like a large portfolio, large firms bear less idiosyncratic risk, so often mergers are justified on the basis that the combined firm is less risky.
D) Because most stockholders will already be holding a well-diversified portfolio, they get no further benefit from the firm diversifying through acquisition.
Q3) What is a white knight?
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Chapter 29: Corporate Governance
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Q1) What is the role of takeovers in corporate governance?
Q2) Which of the following was NOT a finding of the Cadbury Commission?
A) Audit and compensation committees should be made up entirely of independent directors or, at least, have a majority of them.
B) Auditors should be rotated, and there should be fuller disclosure of non-audit work.
C) The CEO should not be chairman of the board, and at the very least there should be a lead independent director with similar agenda-setting powers.
D) The CEO and the CFO should personally attest to the accuracy of the financial statements presented to shareholders.
Q3) Directors who are employees, former employees, or family members of employees are called:
A) managing directors.
B) independent directors.
C) inside directors.
D) gray directors.
Q4) How does a pyramid structure work?
Q5) Describe the main requirements of the Sarbanes-Oxley Act of 2002.
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Chapter 30: Risk Management
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Q1) 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.
Q2) Which of the following statements is FALSE?
A) Horizontal integration entails the merger of a firm and its supplier or a firm and its customer.
B) Like insurance, hedging involves contracts or transactions that provide the firm with cash flows that offset its losses from price changes.
C) For many firms, changes in the market prices of the raw materials they use and the goods they produce may be the most important source of risk to their profitability.
D) Because an increase in the price of the commodity raises the firm's costs and the supplier's revenues, these firms can offset their risks by merging.
Q3) What is the actuarially fair cost of full insurance?
Q4) 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) Calculate the pound denominated cost of capital for Luther's project.
Q2) After the Irish taxes are paid, the amount of the earnings before interest and after taxes in dollars from the Ireland operations is closest to:
A) $5.1 million
B) $20.5 million
C) $35.6 million
D) $29.5 million
Q3) What conditions cause the cash flows of a foreign project to be affected by exchange rate risk?
Q4) The NPV of this project in Euros is closest to:
A) 54 million
B) 57 million
C) 62 million
D) 65 million
Q5) How do we make adjustments when a project has inputs and outputs in different currencies?
Q6) What is the pound present value of the project?
Q7) What is the dollar present value of the project?
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