Corporate Finance
Study Guide Questions
Course Introduction
Corporate Finance explores the principles and techniques companies use to make financial decisions and maximize firm value. Students will examine topics such as financial statement analysis, capital budgeting, risk and return, cost of capital, capital structure, dividend policy, and working capital management. The course emphasizes both theoretical frameworks and practical applications, equipping students with the analytical tools necessary to evaluate investment opportunities, determine optimal financing strategies, and understand the impact of financial decisions on a companys overall performance and strategy.
Recommended Textbook
Fundamentals of Corporate Finance 8th Edition by Richard Brealey
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Page 2
Chapter 1: Goals and Governance of the Corporation
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Sample Questions
Q1) Established firms can create value by developing long-term relationships and maintaining a good reputation.
A)True
B)False
Answer: True
Q2) Provide at least three examples each of real and financial assets that might appear on the balance sheet of General Motors.
Answer: Examples of real assets for General Motors include cash, raw materials inventory, production facilities, tools and machines, and finished inventory of automobiles. Examples of financial assets that could have been issued by General Motors are common stock (different classes), preferred stock, corporate bonds, and bank loans. Of course, GM could show financial assets on the left side of its balance sheet also, such as short-term investments in U.S. government securities, contracts receivable from the financing of its automobiles, or possibly residential mortgages (GM, through its subsidiaries, is a large originator of residential mortgages, although most would eventually be sold in the secondary market).
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Chapter 2: Financial Markets and Institutions
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Sample Questions
Q1) The financial crisis of 2007-2009 contributed to the largest sovereign default in history by which one of these countries?
A) Italy
B) Portugal
C) Ireland
D)Greece
Answer: D
Q2) A company can pay for its expansion in all the following ways except:
A) by using the earnings generated from its sale of obsolete equipment.
B) by persuading a director's mother to make a personal loan to the company.
C) by purchasing bonds in the secondary market.
D)by selling stock certificates for a new subsidiary.
Answer: C
Q3) Financing for private corporations must flow through financial intermediaries.
A)True
B)False
Answer: False
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Chapter 3: Accounting and Finance
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Sample Questions
Q1) Accounting practices are currently standardized across all countries.
A)True
B)False
Answer: False
Q2) Businesses that aggressively exploit any means possible to increase current earnings may cross over into fraudulent account practices.
A)True
B)False
Answer: True
Q3) Which of these statements related to free cash flow is correct?
A) Free cash flow must be fully distributed to the firm's debtors and shareholders.
B) Free cash flow must be positive for a firm to acquire new fixed assets.
C) All, or part, of free cash flow can be used to increase a firm's cash reserves.
D)When capital expenditures are positive, free cash flow will exceed the cash flow from operations.
Answer: C
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Page 5
Chapter 4: Measuring Corporate Performance
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Q1) Sappy Syrup's ROA equals the industry average, but its ROE exceeds the industry average. How is this possible?
Q2) A firm with no leases has a long-term debt ratio of 50%. This means that the book value of equity:
A) equals the book value of long-term debt.
B) is less than the book value of long-term debt.
C) is greater than the book value of long-term debt.
D)is unknown in relation to the book value of long-term debt.
Q3) What are the annual sales for a firm with $400,000 in debt, a total debt ratio of .4, and an asset turnover of 3?
A) $333,333
B) $1,200,000
C) $1,800,000
D)$3,000,000
Q4) Net working capital is determined from the difference between current assets and current liabilities.
A)True
B)False
Q5) What are some potential pitfalls of ratio analysis based on accounting data?
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Chapter 5: The Time Value of Money
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Q1) What is the present value of the following payment stream, discounted at 8% annually: $1,000 at the end of year 1, $2,000 at the end of year 2, and $3,000 at the end of year 3?
A) $5,022.10
B) $5,144.03
C) $5,423.87
D)$5,520.00
Q2) Your retirement account has a current balance of $50,000. What interest rate would need to be earned in order to accumulate a total of $1,000,000 in 30 years, by adding $6,000 annually?
A) 5.02%
B) 7.24%
C) 9.80%
D)10.07%
Q3) For a given amount, the lower the discount rate, the less the present value.
A)True B)False
Q4) The Excel function for future value is FV (rate, nper, pmt, PV).
A)True B)False
Page 7
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Chapter 6: Valuing Bonds
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Sample Questions
Q1) A bond's payment at maturity is referred to as its face value.
A)True
B)False
Q2) TIPS are unlike most bonds in that their cash flows increase when the national rate of gross domestic product increases.
A)True
B)False
Q3) Bonds rated BB or above by Standard & Poor's are called investment grade.
A)True
B)False
Q4) Describe the shape of the normal yield curve. Why is that shape fairly typical?
Q5) An investor holds two bonds, one with 5 years until maturity and the other with 20 years until maturity. Which of the following is more likely if interest rates suddenly increase by 2%?
A) The 5-year bond will decrease more in price.
B) The 20-year bond will decrease more in price.
C) Both bonds will decrease in price similarly.
D)Neither bond will decrease in price, but their yields will increase.
Q6) Why might an investor prefer a convertible bond over a regular bond?
Q7) What is meant by "default risk" in bonds, and how do investors respond to it?
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Chapter 7: Valuing Stocks
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Sample Questions
Q1) Numerically illustrate the breakdown of the stock price between a firm's assets that are already in place and its present value of growth opportunities. Assume next year's expected earnings are $5.00 a share, the required rate of return is 13%, the return on equity is 17%, and the plowback ratio is 45%.
Q2) What should be the current price of a share of stock if a $5 dividend was just paid, the stock has a required return of 20%, and a constant dividend growth rate of 6%?
A) $19.23
B) $25.00
C) $35.71
D)$37.86
Q3) What dividend yield would be reported in the financial press for a stock that currently pays a $1 dividend per quarter and the most recent stock price was $40?
A) 2.5%
B) 4.0%
C) 10.0%
D)5.0%
Q4) How does competition among investors lead to efficient markets?
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9
Chapter 8: Net Present Value and Other Investment Criteria
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Sample Questions
Q1) The payback period considers all project cash flows.
A)True
B)False
Q2) NPV fails as a decision rule when the firm encounters:
A) capital rationing.
B) mutually exclusive projects.
C) long-lived projects.
D)independent projects.
Q3) If a project has multiple IRRs, the highest one is assumed to be correct.
A)True
B)False
Q4) A project can have as many different internal rates of return as it has:
A) cash inflows.
B) cash outflows.
C) periods of cash flow.
D)changes in the sign of the cash flows.
Q5) Soft rationing should never cost the firm anything. A)True
B)False
Q6) Why doesn't the payback rule always make shareholders better off?
Page 10
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Chapter 9: Using Discounted Cash-Flow Analysis to Make Investment Decisions
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Sample Questions
Q1) You are evaluating a new project that will introduce a revolutionary new product that will be produced by a new, highly efficient machine. Which one of these will lower the net present value of that project?
A) A reduction in the firm's total variable costs due to the purchase of the new machine
B) A loss of current sales due to the introduction of the new product
C) The increase in annual depreciation resulting from the asset purchase
D)The sale of the machine after it is fully depreciated
Q2) The statement "We've got too much invested in that project to pull out now" possibly illustrates the need to:
A) switch to an accelerated method of depreciation.
B) be reacquainted with the concept of sunk costs.
C) reduce net working capital assigned to the project.
D)reduce discount rates to improve NPV.
Q3) Corporate income statements are designed primarily to show:
A) cash flows during a period.
B) account balances at the end of a period.
C) performance during a period.
D)market values of assets and liabilities.
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Chapter 10: Project Analysis
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Sample Questions
Q1) Discuss decision trees, including how they can be useful and how they can be risky.
Q2) Operating leverage increases with fixed cost.
A)True
B)False
Q3) How much depreciation expense exists in a firm that has a break-even level of revenues of $2 million, fixed costs of $400,000, and a 60% ratio of variable costs to sales?
A) $144,000
B) $266,667
C) $400,000
D)$666,667
Q4) Which one of the following statements is correct concerning sensitivity analysis?
A) It ignores interrelationships between variables.
B) Several variables are allowed to change concurrently.
C) It considers all feasible variable combinations.
D)It can guarantee a project's success.
Q5) What are some of the factors that will commonly affect the abandonment value of a project? When should abandonment be considered?
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Page 12
Chapter 11: Introduction to Risk, Return, and the Opportunity
Cost
of Capital
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Sample Questions
Q1) Specific risks are generally associated with a single firm or industry.
A)True
B)False
Q2) Every additional stock added to a portfolio reduces the portfolio's level of risk by an equal amount.
A)True
B)False
Q3) Which one of the following statements is incorrect concerning stock indexes?
A) Indexes have been developed for foreign stocks.
B) Some indexes cover only a specific market sector.
C) Most indexes include all of the publicly-traded common stocks.
D)Some indexes are equally weighted.
Q4) If one portfolio's variance exceeds that of another portfolio, its standard deviation will also be greater than that of the other portfolio.
A)True
B)False
Q5) Justify the historic ranking of returns for the following three categories of investment, listed from highest to lowest return: common stocks, long-term Treasury bonds, and Treasury bills.
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Chapter 12: Risk, Return, and Capital Budgeting
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Sample Questions
Q1) How are the terms "defensive" and "aggressive" applied to individual stocks or portfolios?
Q2) The security market line sets a standard for other investments-investors will be willing to hold other investments only if they offer equally good prospects as shown by the points on the line.
A)True
B)False
Q3) Which one of the following statements is correct when Treasury bills yield 7.5% and the market risk premium is 9.5%?
A) The S&P 500 would be expected to yield about 8.50%.
B) The S&P 500 would be expected to yield about 9.50%.
C) The S&P 500 would be expected to yield about 12.68%.
D)The S&P 500 would be expected to yield about 17.00%.
Q4) In practice, the market portfolio is often represented by:
A) a portfolio of U.S. Treasury securities.
B) a diversified stock market index.
C) an investor's mutual fund portfolio.
D)the historic record of stock market returns.
Q5) Discuss how betas are measured for individual stocks.
Q6) How can you measure and interpret the market risk, or beta, of a security?
Page 14
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Chapter 13: The Weighted-Average Cost of Capital and Company Valuation
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Sample Questions
Q1) The capital structure for the CR Corporation includes bonds valued at $5,500 and common stock valued at $11,000. If CR has an after-tax cost of debt of 6%, and a cost of common stock of 16%, what is its WACC?
A) 9.33%
B) 12.67%
C) 13.33%
D)14.67%
Q2) XYZ Company issues common stock at a price of $25 a share. The firm expects to pay a dividend of $2.20 a share next year. If the dividend is expected to grow at 2.5% annually, what is XYZ's cost of common equity?
A) 6.3%
B) 11.3%
C) 13.7%
D)8.9%
Q3) Interest tax shields are available to the firm on debt and preferred stock but not on common equity.
A)True B)False
Q4) How are the costs of debt and equity calculated?
Page 15
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Chapter 14: Introduction to Corporate Financing
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Sample Questions
Q1) Funded debt refers to those liabilities that:
A) have established a sinking fund for repayment.
B) are not callable at the option of the firm.
C) are secured by specific collateral.
D)have a maturity of more than one year remaining.
Q2) A stock's par value is represented by the:
A) maturity value of the stock.
B) price at which each share is recorded.
C) price at which an investor could sell the stock.
D)price received by the firm when the stock was issued.
Q3) Any capital surplus shown by a firm on its balance sheet results from:
A) not paying out all net income as dividends.
B) repurchasing shares for treasury stock.
C) issuing stock at a price higher than par value.
D)retained earnings.
Q4) Privately placed debt must be held until maturity and cannot be resold.
A)True
B)False
Q5) "Since internal funds provide the bulk of industry's needs for capital, the securities markets serve little function." Does the speaker have a point?
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Chapter 15: How Corporations Raise Venture Capital and Issue Securities
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Sample Questions
Q1) The direct expense of a stock issue includes the:
A) cost of underpricing the stock.
B) underwriting spread and other expenses.
C) underwriting spread, other expenses, and cost of underpricing.
D)underwriting spread.
Q2) Who bears the bulk of the cost of underpricing an IPO?
A) The underwriters
B) The investors who purchase IPO shares
C) All of the after-IPO shareholders
D)The pre-IPO shareholders
Q3) What are the benefits of shelf registration to corporations?
Q4) Ajax Corporation has received a firm commitment from its underwriter to purchase 1 million shares of stock that will be marketed to the general public at $23 per share. The underwriter's spread is $1.90 per share and the issuing firm will pay an additional $1.65 million in legal and other fees. The issue was fully sold on the first day and the stock closed at $27.50 on that day. What percentage of the market value of the shares is lost to issue costs?
Q5) Why does the private placement of securities appear to be more popular with small- or medium-sized firms?
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Chapter 16: Debt Policy
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Q1) Once you recognize the fact that debt also increases financial risk and causes shareholders to demand a higher return on their investment, debt is no cheaper than equity.
A)True
B)False
Q2) Management's perceived signals to investors form an important component of pecking-order theory.
A)True
B)False
Q3) In a world with corporate taxes but no possibility of financial distress, the value of the firm is maximized when the:
A) firm uses no debt in its capital structure.
B) firm uses no equity in its capital structure.
C) firm uses a debt-equity ratio of 1.0.
D)corporate tax rate approaches 100%.
Q4) The interest tax shield is equal to the:
A) difference between the interest expense and income taxes.
B) amount of interest paid in a given year.
C) product of the interest expense and the tax rate.
D)product of the debt principal and the interest rate on debt.
Page 18
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Chapter 17: Payout Policy
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Q1) Anyone holding a stock before its ex-dividend date is entitled to the dividend.
A)True
B)False
Q2) Firms can increase their stock price by increasing their dividends to a level that appeals to the clientele group that prefers high-dividend stocks.
A)True
B)False
Q3) Recap the financial executives' responses to a 2004 survey regarding their firms' dividend policies.
Q4) A corporation that has an automatic reinvestment plan:
A) forces shareholders to automatically reinvest dividends in the company.
B) never physically pays out declared dividends.
C) gives shareholders the option of purchasing either debt or equity shares.
D)gives shareholders the option to invest in additional shares cost-free.
Q5) Stock repurchases are most commonly interpreted by investors as a signal that:
A) future repurchases will be forthcoming.
B) the firm's shares are underpriced.
C) the firm has an increasing number of positive-NPV opportunities.
D)stock repurchases will gradually replace the stock dividends.
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Chapter 18: Long-Term Financial Planning
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Sample Questions
Q1) Alternative "what if?" scenarios can be easily accommodated in financial planning by use of:
A) sustainable growth models.
B) planning outputs.
C) spreadsheet programs.
D)bond covenants.
Q2) If a firm does not want to use either dividends or debt as its balancing item, then it is most apt to use _____ for that purpose.
A) inventory
B) cash
C) equity
D)fixed assets
Q3) Why is it important that financial plans incorporate adaptability?
Q4) Financial planning models routinely adjust for present value and risk.
A)True
B)False
Q5) Financial planning should attempt to minimize risk.
A)True
B)False
Q6) How can a firm quickly determine if its desired rate of growth is feasible?
Page 20
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Chapter 19: Short-Term Financial Planning
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Q1) Provide five reasons why firms may have a policy of maintaining a minimum cash balance at all times.
Q2) Which one of the following is least likely to be correct about the factoring of receivables?
A) The selling firm bears the risk of default.
B) The higher the perceived quality of the receivables, the lower the discount rate.
C) The discount is paid by the selling firm in the form of a reduced sales price.
D)Factoring may be the cheapest method of avoiding a cash flow problem.
Q3) Ignoring defaults, what is the approximate effective cost of factoring if receivables are sold at a 4% discount and the average collection period is 2 months?
A) 19.40%
B) 24.00%
C) 26.53%
D)27.75%
Q4) An increase in accounts payable is a source of cash.
A)True
B)False
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Chapter 20: Working Capital Management
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Q1) What would be the gain from a lock-box system given the following information?
Q2) Smith Corp. produces a product that generates repeat orders on an annual basis. The product has a current price of $2,500 and a current cost of $2,100. The company uses a 15% opportunity cost of capital. Due to the product's high cost, there is a 17% chance that each new customer will default on payment. If the customer does not default, then business from that customer forms an infinite annuity income stream. What is the expected profit from granting credit to a new customer under these conditions?
Q3) Which one of the following statements is correct about banker's acceptances?
A) They are equivalent to a sight draft.
B) They represent the norm for installment sales.
C) The bank guarantees payment of the invoice.
D)The bank retains title to the merchandise.
Q4) What is the minimum probability of collection that should be accepted by firms that have a 25% profit margin? Ignore the time value of money.
A) 20%
B) 25%
C) 50%
D)75%
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Page 22
Chapter 21: Mergers, Acquisitions, and Corporate Control
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Q1) Changing management is the only reason that firms make acquisitions.
A)True
B)False
Q2) Evidence shows that investors will generally pay a premium for diversified firms, thus firms should merge for this reason.
A)True
B)False
Q3) Management buyouts are generally all-equity financed by the new shareholders.
A)True
B)False
Q4) The big savings from merging two banks would come from consolidating operations and eliminating redundant costs.
A)True
B)False
Q5) Which one of the following is not a method of changing the management of a firm?
A) Proxy contest
B) Merger and acquisition
C) LBO
D)MBO
Q6) Briefly discuss some of the more logical reasons for mergers to occur.
Page 23
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Chapter 22: International Financial Management
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Q1) If the difference between forward and spot exchange rates is positive, interest rate parity would predict that:
A) the difference in interest rates between countries will be negative.
B) the difference in interest rates between countries will be positive.
C) there will be no difference in interest rates between countries.
D)any difference in interest rates between countries will be quickly eliminated.
Q2) Which one of these is probably the best means of reducing or offsetting political risk?
A) Refusing any foreign government assistance in building the infrastructure required for your foreign operations
B) Borrowing money in the country in which you have foreign operations to fund those activities
C) Manufacturing a complete product in a foreign country using only resources from that country
D)Paying for all foreign operations with cash originating in the home country
Q3) How do auto manufacturers in United States, Europe, and Japan hedge their economic risks?
Q4) Why should interest rate parity mean that the forward premium should equal the interest rate differential between countries?
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Chapter 23: Options
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Q1) The lower limit on a call option's value is equal to the greater of zero or the exercise price minus the stock price.
A)True
B)False
Q2) You own a $1,000 face value convertible bond with a coupon rate of 6% that matures in 5 years. The market rate on similar bonds is currently 7%. The conversion ratio is 15.5 and the stock is currently selling for $70 per share. What is the current value of this bond? Justify your answer.
Q3) The value of a call option increases as the strike price increases.
A)True
B)False
Q4) Stocks that have more volatile price changes have more valuable call options because call holders:
A) capture upside potential without downside risk.
B) realize that volatility decreases the present value of the exercise price.
C) have too little variability in the exercise price.
D)have transferred all risk to put holders.
Q5) What price risk is an investor exposed to if he owns a share of stock and has purchased a put option on the stock?
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Chapter 24: Risk Management
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Questions
Q1) General Mills paid a premium of $0.10 per bushel to buy September call options for wheat with an exercise price of $6.80. If the price of wheat at the expiration is $6.90, what is the net cost of one bushel of wheat for General Mills?
A) $6.70
B) $6.80
C) $6.90
D)$7.00
Q2) A farmer who sells a futures contract is betting that prices will _____ at the expiration of the contract.
A) decrease
B) increase
C) remain constant
D)guarantee high profits
Q3) Speculators are a necessary component of well-functioning futures markets.
A)True
B)False
Q4) Swap contracts can be based on either interest rates or currencies.
A)True
B)False
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