Corporate Finance
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Course Introduction
Corporate Finance explores the fundamental principles and strategies that drive financial decision-making within corporations. The course covers key topics such as capital budgeting, capital structure, working capital management, risk and return analysis, and the valuation of financial assets. Students will learn how companies assess investment opportunities, fund operations, maximize shareholder value, and manage financial risks. By integrating theoretical concepts with real-world case studies, this course equips students with practical skills essential for financial analysis, corporate planning, and strategic financial management in a corporate environment.
Recommended Textbook
Financial Management Theory and Practice 15th Edition by Eugene F. Brigham
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Page 2
Chapter 1: An Overview of Financial Management and the Financial Environment
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Q1) The facts that a proprietorship,as a business,pays no corporate income tax,and that it is easily and inexpensively formed,are two key advantages to that form of business.
A)True
B)False
Answer: True
Q2) Which of the following statements is CORRECT?
A) It is generally more expensive to form a proprietorship than a corporation because,with a proprietorship,extensive legal documents are required.
B) Corporations face fewer regulations than sole proprietorships.
C) One disadvantage of operating a business as a sole proprietorship is that the firm is subject to double taxation,at both the firm level and the owner level.
D) One advantage of forming a corporation is that equity investors are usually exposed to less liability than in a regular partnership.
E) If a regular partnership goes bankrupt,each partner is exposed to liabilities only up to the amount of his or her investment in the business.
Answer: D
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3
Chapter 2: Financial Statements, Cash Flow, and Taxes
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Q1) Which of the following statements is CORRECT?
A) The maximum federal tax rate on personal income in 2014 was 50%.
B) Since companies can deduct dividends paid but not interest paid,our tax system favors the use of equity financing over debt financing,and this causes companies' debt ratios to be lower than they would be if interest and dividends were both deductible.
C) Interest paid to an individual is counted as income for tax purposes and taxed at the individual's regular tax rate,which in 2014 could go up to 35%,but dividends received were taxed at a maximum rate of 15%.
D) The maximum federal tax rate on corporate income in 2014 was 50%.
E) Corporations obtain capital for use in their operations by borrowing and by raising equity capital,either by selling new common stock or by retaining earnings.The cost of debt capital is the interest paid on the debt,and the cost of the equity is the dividends paid on the stock.Both of these costs are deductible from income when calculating income for tax purposes.
Answer: C
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Chapter 3: Analysis of Financial Statements
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Sample Questions
Q1) Heaton Corp.sells on terms that allow customers 45 days to pay for merchandise.Its sales last year were $425,000,and its year-end receivables were $60,000.If its DSO is less than the 45-day credit period,then customers are paying on time.Otherwise,they are paying late.By how much are customers paying early or late? Base your answer on this equation: DSO Credit period = days early or late,and use a 365-day year when calculating the DSO.A positive answer indicates late payments,while a negative answer indicates early payments.
A) 6.20
B) 6.53
C) 6.86
D) 7.20
E) 7.56
Answer: B
Q2) If a firm finances with only debt and common equity,and if its equity multiplier is 3.0,then its debt ratio must be 0.667.
A)True
B)False
Answer: True
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Chapter 4: Time Value of Money
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Q1) What is the PV of an ordinary annuity with 5 payments of $4,700 if the appropriate interest rate is 4.5%?
A) $16,806
B) $17,690
C) $18,621
D) $19,601
E) $20,633
Q2) You plan to invest some money in a bank account.Which of the following banks provides you with the highest effective rate of interest?
A) Bank 1;6.1% with annual compounding.
B) Bank 2;6.0% with monthly compounding.
C) Bank 3;6.0% with annual compounding.
D) Bank 4;6.0% with quarterly compounding.
E) Bank 5;6.0% with daily (365-day)compounding.
Q3) If the discount (or interest)rate is positive,the future value of an expected series of payments will always exceed the present value of the same series.
A)True
B)False
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6
Chapter 5: Bonds, Bond Valuation, and Interest Rates
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Q1) Which of the following statements is CORRECT?
A) A 10-year,10% coupon bond has less reinvestment rate risk than a 10-year,5% coupon bond (assuming all else equal).
B) The total return on a bond during a given year is the sum of the coupon interest payments received during the year and the change in the value of the bond from the beginning to the end of the year.
C) The price of a 20-year,10% bond is less sensitive to changes in interest rates than the price of a 5-year,10% bond.
D) A $1,000 bond with $100 annual interest payments that has 5 years to maturity and is not expected to default would sell at a discount if interest rates were below 9% and at a premium if interest rates were greater than 11%.
E) 10-year,zero coupon bonds have higher reinvestment rate risk than 10-year,10% coupon bonds.
Q2) Junk bonds are high risk,high yield debt instruments.They are often used to finance leveraged buyouts and mergers,and to provide financing to companies of questionable financial strength.
A)True B)False
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Chapter 6: Risk and Return
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Q1) If a stock's expected return as seen by the marginal investor exceeds this investor's required return,then the investor will buy the stock until its price has risen enough to bring the expected return down to equal the required return.
A)True
B)False
Q2) A portfolio's risk is measured by the weighted average of the standard deviations of the securities in the portfolio.It is this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their portfolios.
A)True
B)False
Q3) If investors become less averse to risk,the slope of the Security Market Line (SML)will increase.
A)True
B)False
Q4) The Y-axis intercept of the SML represents the required return of a portfolio with a beta of zero,which is the risk-free rate.
A)True
B)False
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Chapter 7: Corporate Valuation and Stock Valuation
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Q1) McGaha Enterprises expects earnings and dividends to grow at a rate of 25% for the next 4 years,after the growth rate in earnings and dividends will fall to zero,i.e. ,g = 0.The company's last dividend,D<sub>0</sub>,was $1.25,its beta is 1.20,the market risk premium is 5.50%,and the risk-free rate is 3.00%.What is the current price of the common stock?
A) $26.77
B) $27.89
C) $29.05
D) $30.21
E) $31.42
Q2) The free cash flow valuation model cannot be used unless a company doesn't pay dividends.
A)True
B)False
Q3) The preemptive right gives current stockholders the right to purchase,on a pro rata basis,any new shares issued by the firm.This right helps protect current stockholders against both dilution of control and dilution of value.
A)True
B)False
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Chapter 8: Financial Options and Applications in Corporate Finance
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Q1) The strike price is the price that must be paid for a share of common stock when it is bought by exercising a warrant.
A)True
B)False
Q2) BLW Corporation is considering the terms to be set on the options it plans to issue to its executives.Which of the following actions would decrease the value of the options,other things held constant?
A) The exercise price of the option is increased.
B) The life of the option is increased,i.e. ,the time until it expires is lengthened.
C) The Federal Reserve takes actions that increase the risk-free rate.
D) BLW's stock price becomes more risky (higher variance).
E) BLW's stock price suddenly increases.
Q3) If the market is in equilibrium,then an option must sell at a price that is exactly equal to the difference between the stock's current price and the option's strike price.
A)True
B)False
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Chapter 9: The Cost of Capital
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Q1) The before-tax cost of debt,which is lower than the after-tax cost,is used as the component cost of debt for purposes of developing the firm's WACC.
A)True
B)False
Q2) In general,firms should use their weighted average cost of capital (WACC)to evaluate capital budgeting projects because most projects are funded with general corporate funds,which come from a variety of sources.However,if the firm plans to use only debt or only equity to fund a particular project,it should use the after-tax cost of that specific type of capital to evaluate that project.
A)True
B)False
Q3) Refer to the data for the Collins Group.Based on the CAPM,what is the firm's cost of common stock?
A) 11.15%
B) 11.73%
C) 12.35%
D) 13.00%
E) 13.65%
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11
Chapter 10: The Basics of Capital Budgeting: Evaluating Cash Flows
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Sample Questions
Q1) Which of the following statements is CORRECT?
A) The IRR method can never be subject to the multiple IRR problem,while the MIRR method can be.
B) One reason some people prefer the MIRR to the regular IRR is that the MIRR is based on a generally more reasonable reinvestment rate assumption.
C) The higher the cost of capital,the shorter the discounted payback period.
D) The MIRR method assumes that cash flows are reinvested at the crossover rate.
E) The MIRR and NPV decision criteria can never conflict.
Q2) In theory,capital budgeting decisions should depend solely on forecasted cash flows and the opportunity cost of capital.The decision criterion should not be affected by managers' tastes,choice of accounting method,or the profitability of other independent projects.
A)True
B)False
Q3) A basic rule in capital budgeting is that if a project's NPV exceeds its IRR,then the project should be accepted.
A)True
B)False
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Chapter 11: Cash Flow Estimation and Risk Analysis
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Q1) Which one of the following would NOT result in incremental cash flows and thus should NOT be included in the capital budgeting analysis for a new product?
A) Revenues from an existing product would be lost as a result of customers switching to the new product.
B) Shipping and installation costs associated with a machine that would be used to produce the new product.
C) The cost of a study relating to the market for the new product that was completed last year.The results of this research were positive,and they led to the tentative decision to go ahead with the new product.The cost of the research was incurred and expensed for tax purposes last year.
D) It is learned that land the company owns and would use for the new project,if it is accepted,could be sold to another firm.
E) Using some of the firm's high-quality factory floor space that is currently unused to produce the proposed new product.This space could be used for other products if it is not used for the project under consideration.
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Page 13
Chapter 12: Financial Planning and Applications to Corporate Valuation
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Q1) The fact that long-term debt and common stock are raised infrequently and in large amounts lessens the need for the firm to forecast those accounts on a continual basis.
A)True
B)False
Q2) Spontaneous funds are generally defined as follows:
A) A forecasting approach in which the forecasted percentage of sales for each item is held constant.
B) Funds that a firm must raise externally through short-term or long-term borrowing and/or by selling new common or preferred stock.
C) Funds that arise out of normal business operations from its suppliers,employees,and the government,and they include immediate increases in accounts payable,accrued wages,and accrued taxes.
D) The amount of cash raised in a given year minus the amount of cash needed to finance the additional capital expenditures and working capital needed to support the firm's growth.
E) Assets required per dollar of sales.
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14
Chapter 13: Corporate Governance
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Q1) Two important issues in corporate governance are (1)the rules that cover the board's ability to fire the CEO and (2)the rules that cover the CEO's ability to remove members of the board.
A)True
B)False
Q2) The CEO of D'Amico Motors has been granted some stock options that have provisions similar to most other executive stock options.If D'Amico's stock underperforms the market,these options will necessarily be worthless.
A)True
B)False
Q3) ESOPs were originally designed to help improve worker productivity,but today they are also used to help prevent hostile takeovers.
A)True
B)False
Q4) A poison pill is also known as a corporate restructuring. A)True
B)False
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Page 15
Chapter 14: Distributions to Shareholders: Dividends and Repurchases
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Q1) Stock dividends and stock splits should,at least conceptually,have the same effect on shareholders' wealth.
A)True
B)False
Q2) In recent years Constable Inc.has suffered losses,and its stock currently sells for only $0.50 per share.Management wants to use a reverse split to get the price up to a more "reasonable" level,which it thinks is $25 per share.How many of the old shares must be given up for one new share to achieve the $25 price,assuming this transaction has no effect on total market value?
A) 47.50
B) 49.88
C) 50.00
D) 52.50
E) 55.13
Q3) The dividend irrelevance theory,proposed by Miller and Modigliani,says that provided a firm pays at least some dividends,how much it pays does not affect either its cost of capital or its stock price.
A)True
B)False
Page 16
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Chapter 15: Capital Structure Decisions
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Q1) Firm A has a higher degree of business risk than Firm B.Firm A can offset this by using less financial leverage.Therefore,the variability of both firms' expected EBITs could actually be identical.
A)True
B)False
Q2) Which of the following is NOT associated with (or does not contribute to)business risk? Recall that business risk is affected by a firm's operations.
A) Sales price variability.
B) The extent to which operating costs are fixed.
C) The extent to which interest rates on the firm's debt fluctuate.
D) Input price variability.
E) Demand variability.
Q3) Financial risk refers to the extra risk stockholders bear as a result of using debt as compared with the risk they would bear if no debt were used.
A)True
B)False
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17
Chapter 16: Supply Chains and Working Capital Management
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Q1) Suppose the suppliers of your firm offered you credit terms of 2/10 net 30 days.Your firm is not taking discounts,but is paying after 25 days instead of waiting until Day 30.You point out that the nominal cost of not taking the discount and paying on Day 30 is approximately 37%.But since your firm is neither taking discounts nor paying on the due date,what is the effective annual percentage cost (not the nominal cost)of its costly trade credit,using a 365-day year?
A) 60.3%
B) 63.5%
C) 66.7%
D) 70.0%
E) 73.5%
Q2) Andrews Corporation buys on terms of 2/8,net 45 days,it does not take discounts,and it actually pays after 58 days.What is the effective annual percentage cost of its non-free trade credit? (Use a 365-day year. )
A) 14.34%
B) 15.10%
C) 15.89%
D) 16.69%
E) 17.52%
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Chapter 19: Lease Financing
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Q1) Leasing is often referred to as off-balance sheet financing because lease payments are shown as operating expenses on a firm's income statement and,under certain conditions,leased assets and associated liabilities do not appear on the firm's balance sheet.
A)True B)False
Q2) Leasing is typically a financing decision and not a capital budgeting decision.Thus,the availability of lease financing cannot affect the size of the capital budget.
A)True B)False
Q3) From the lessee viewpoint,the riskiness of the cash flows,with the possible exception of the residual value,is about the same as the riskiness of the lessee's
A) capital budgeting project cash flows.
B) debt cash flows.
C) pension fund cash flows.
D) sales.
E) equity cash flows.
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21
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Q1) Which of the following statements is most CORRECT?
A) One important difference between warrants and convertibles is that convertibles bring in additional funds when they are converted,but exercising warrants does not bring in any additional funds.
B) The coupon rate on convertible debt is normally set below the coupon rate that would be set on otherwise similar straight debt even though investing in convertibles is more risky than investing in straight debt.
C) The value of a warrant to buy a safe,stable stock should exceed the value of a warrant to buy a risky,volatile stock,other things held constant.
D) Warrants can sometimes be detached and traded separately from the debt with which they were issued,but this is unusual.
E) Warrants have an option feature but convertibles do not.
Q2) A warrant is an option,and as such it cannot be used as a "sweetener."
A)True B)False
Q3) The owner of a convertible bond owns,in effect,both a bond and a call option.
A)True B)False
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Chapter 21: Dynamic Capital Structures and Corporate Valuation
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Q1) The present value of the free cash flows discounted at the unlevered cost of equity is the value of the firm's operations if it had no debt.
A)True
B)False
Q2) A local firm has debt worth $200,000,with a yield of 9%,and equity worth $300,000.It is growing at a 5% rate,and its tax rate is 40%.A similar firm with no debt has a cost of equity of 12%.Using the compressed adjusted present value model,what is the value of your firm's tax shield,i.e. ,how much value does the use of debt add?
A) $92,571
B) $102,857
C) $113,143
D) $124,457
E) $136,903
Q3) In a world with no taxes,MM show that a firm's capital structure does not affect the firm's value.However,when taxes are considered,MM show a positive relationship between debt and value,i.e. ,its value rises as its debt is increased.
A)True
B)False
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Chapter 22: Mergers and Corporate Control
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Q1) Since the primary rationale for any operating merger is synergy,in planning such mergers,the development of accurate pro forma cash flows is the single most important action.
A)True
B)False
Q2) The primary reason managers give for most mergers is to acquire more assets so as to increase sales and market share.
A)True
B)False
Q3) Which of the following statements is most CORRECT?
A) Regulations in the United States prohibit acquiring firms from using common stock to purchase another firm.
B) Defensive mergers are designed to make a company less vulnerable to a takeover.
C) Hostile mergers always create value for the acquiring firm.
D) In a tender offer,the target firm's management always remain after the merger is completed.
E) A conglomerate merger is one where a firm combines with another firm in the same industry.
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Chapter 23: Enterprise Risk Management
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Q1) Suppose the December CBOT Treasury bond futures contract has a quoted price of 80'07.What is the implied annual interest rate inherent in the futures contract?
A) 6.86%
B) 7.22%
C) 7.60%
D) 8.00%
E) 8.40%
Q2) Suppose the September CBOT Treasury bond futures contract has a quoted price of 89'09.What is the implied annual interest rate inherent in this futures contract?
A) 6.32%
B) 6.65%
C) 7.00%
D) 7.35%
E) 7.72%
Q3) In theory,reducing the volatility of its cash flows will always increase a company's value.
A)True B)False
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25
Chapter 24: Bankruptcy, Reorganization, and Liquidation
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Q1) Even if a firm's cash flow projections indicate that it will soon be unable to meet its interest payments,a bankruptcy case cannot begin until the firm actually defaults on a scheduled payment.
A)True
B)False
Q2) A central question that must be addressed in bankruptcy proceedings is whether the firm's inability to meet scheduled interest payments results from a temporary cash flow problem or from a potentially permanent problem caused by falling asset values.
A)True
B)False
Q3) The primary test of feasibility in a reorganization is whether the firm's fixed charges after reorganization can be covered by its projected cash flows.
A)True
B)False
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Chapter 25: Portfolio Theory and Asset Pricing Models
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Q1) Which is the best measure of risk for an asset held in isolation,and which is the best measure for an asset held in a diversified portfolio?
A) Standard deviation;correlation coefficient.
B) Beta;variance.
C) Coefficient of variation;beta.
D) Beta;beta.
E) Variance;correlation coefficient.
Q2) Stock A's beta is 1.5 and Stock B's beta is 0.5.Which of the following statements must be true about these securities? (Assume market equilibrium. )
A) Stock B must be a more desirable addition to a portfolio than Stock A.
B) Stock A must be a more desirable addition to a portfolio than Stock B.
C) The expected return on Stock A should be greater than that on Stock B.
D) The expected return on Stock B should be greater than that on Stock A.
E) When held in isolation,Stock A has greater risk than Stock B.
Q3) It is possible for a firm to have a positive beta,even if the correlation between its returns and those of another firm are negative.
A)True
B)False
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Chapter 26: Real Options
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Q1) Which of the following is NOT a real option?
A) The option to buy shares of stock if its price goes up.
B) The option to expand into a new geographic region.
C) The option to abandon a project.
D) The option to switch the type of fuel used in an industrial furnace.
E) The option to expand production if the product is successful.
Q2) The option to abandon a project is a real option,but a call option on a stock is not a real option.
A)True
B)False
Q3) Refer to the data for Drilling Experts,Incorporated.Since the project is considered to be quite risky,a 20% cost of capital is used.What is the project's expected NPV,in thousands of dollars?
A) $336.15
B) $373.50
C) $415.00
D) $461.11
E) $507.22
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Chapter 27: Providing and Obtaining Credit
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Q1) Refer to Exhibit 27.3.What would be the cost to Van Doren of the discounts taken?
A) $116,750
B) $108,750
C) $155,000
D) $225,000
E) $260,500
Q2) Cash discounts are mostly used to get new customers in the door since existing customers almost always use the delayed payment terms.
A)True
B)False
Q3) Refer to Exhibit 27.1.How large are your brother's monthly payments?
A) $6,250
B) $7,000
C) $7,500
D) $5,250
E) $6,875
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Chapter 28: Advanced Issues in Cash Management and Inventory Control
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Q1) Humphrey's Housing has been practicing cash management for some time by using the Baumol model for determining cash balances.Some time ago,the model called for an average balance (C*/2)of $500;at that time,the rate on marketable securities was 4 percent.A rapid increase in interest rates has driven the interest rate up to 9 percent.What is the appropriate average cash balance now?
A) $200
B) $333
C) $414
D) $500
E) $666
Q2) The cash balances of most firms consist of transactions,compensating,precautionary,and speculative balances.We can produce a total desired cash balance by calculating the amount needed for each purpose and then summing them together.
A)True
B)False
Q3) If a company increases its safety stock,then its average inventory will go up.
A)True
B)False
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Chapter 29: Pension Plan Management
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Q1) Which of the following statements about defined contribution plans is incorrect?
A) In general,employees can choose the investment vehicle under a defined contribution plan.Thus,highly risk-averse employees can choose low-risk investments,while more risk-tolerant employees can choose high-risk investments.
B) In a defined contribution plan,the employer must make larger-than-average contributions to the pension plan when investment returns have been below expectations.
C) Defined benefit plans are used more often by large corporations than by small companies.
D) The PBGC insures a portion of pension benefits.
E) A defined contribution plan places the risk of poor pension portfolio performance on the employee.
Q2) If employees have a right to receive pension benefits even if they leave the company prior to retirement,their pension rights are said to be vested.
A)True
B)False
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Businesses
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Sample Questions
Q1) Which of the following statements about project risk analysis in not-for-profit firms is incorrect?
A) A project's corporate beta measures the contribution of the project to the overall corporate risk of the firm.
B) A project's corporate beta is found (at least conceptually)by regressing returns on the project against returns on the market portfolio.
C) A project's corporate beta is defined as ( <sub>P</sub>/ <sub>F</sub>)r<sub>PF</sub>,where <sub>P</sub> is the standard deviation of the project's returns, <sub>F</sub> is the standard deviation of the firm's returns,and r<sub>PF</sub> is the correlation among the two sets of returns.
D) In practice,it is usually difficult,if not impossible,to directly measure a project's corporate risk,so project risk analysis typically focuses on stand-alone risk.
E) The market risk of a project is not relevant to not-for-profit firms.
Q2) Since not-for-profit firms do not pay taxes,they receive no tax benefits whatsoever from using debt financing.
A)True
B)False
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