Corporate Financial Policy
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Course Introduction
Corporate Financial Policy explores the frameworks, principles, and tools that guide financial decision-making within firms. The course covers topics such as capital structure, dividend policy, financing choices, risk management, and corporate governance. Emphasis is placed on understanding how financial policies align with the overarching goals of value maximization and stakeholder management, leveraging both theoretical models and real-world case studies. Students will develop skills to critically analyze policy decisions and design appropriate financial strategies for a variety of corporate contexts.
Recommended Textbook
Corporate Finance 12th Edition by Ross
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Chapter 1: Introduction to Corporate Finance
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Q1) The process of planning and managing a firm's long-term assets is called:
A)working capital management.
B)cash management.
C)cost accounting management.
D)capital budgeting.
E)capital structure management.
Answer: D
Q2) The treasurer and the controller of a corporation generally report to the: A)board of directors.
B)chairman of the board.
C)chief executive officer.
D)president.
E)chief financial officer.
Answer: E
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Chapter 2: Financial Statements and Cash Flow
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Q1) On a balance sheet,deferred taxes are classified as:
A)stockholders' equity.
B)a current asset.
C)a long-term liability.
D)a fixed asset.
E)a current liability.
Answer: C
Q2) An increase in which one of the following will cause the operating cash flow to increase for a profitable firm?
A)Depreciation
B)Cash
C)Net working capital
D)Taxes
E)Administrative expenses
Answer: A
Q3) Why is cash flow management important?
Answer: Generally Accepted Accounting Principles (GAAP)allow significant subjective decisions to be made in many key areas.The use of cash flow as a metric to evaluate a company comes from the idea that there is less subjectivity involved and therefore,it is harder to spin the numbers.
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Chapter 3: Financial Statements and Cash Flow
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Sample Questions
Q1) Upriver Tours has balance sheet values of: Inventory $70,500; accounts receivable
$50,700; accounts payable $58,900; cash $32,300,notes payable $20,000,long-term debt
$134,700,and net fixed assets $504,500.What is the current ratio?
A)1.95
B).95
C)2.11
D)1.98
E).98
Answer: A
Q2) Narrow Falls Lumber has total assets of $913,600,total debt of $424,500,net sales of $848,600,and net income of $94,000.The tax rate is 21 percent and the dividend payout ratio is 30 percent.What is the firm's sustainable growth rate?
A)13.97 percent
B)14.46 percent
C)15.54 percent
D)12.63 percent
E)14.91 percent
Answer: C
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Chapter 4: Discounted Cash Flow Valuation
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Sample Questions
Q1) You are retired,have $264,500 in your savings,withdraw $2,000 each month,and earn 4.5 percent,compounded monthly.How long will it be until you run out of money?
A)13.67 years
B)15.25 years
C)22.08 years
D)13.02 years
E)18.78 years
Q2) You are borrowing $5,200 at 7.8 percent,compounded monthly.The monthly loan payment is $141.88.How many loan payments must you make before the loan is paid in full?
A)30
B)36
C)40
D)42
E)48
Q3) Marlene and Darlene are each the recipient of an annuity that pays $1,000 at the end of each year for twelve years.They both received their first payment on the same day.Explain how Marlene and Darlene could have different NPVs for their annuities.
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Chapter 5: Net Present Value and Other Investment Rules
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Q1) Jack is considering adding toys to his general store.He estimates the cost of toy inventory will be $4,200.The remodeling and shelving costs are estimated at $1,500.Toy sales are expected to produce net annual cash inflows of $1,200,$1,500,$1,600,and $1,750 over the next four years,respectively.Should Jack add toys to his merchandise if he requires a three-year payback period? Why or why not?
A)Yes; because the payback period is 2.94 years
B)Yes; because the payback period is 2.02 years
C)Yes; because the payback period is 3.80 years
D)No; because the payback period is 2.02 years
E)No; because the payback period is 3.80 years
Q2) A project has an initial cost of $10,600 and produces cash inflows of $3,700,$4,900,and $2,500 for Years 1 to 3,respectively.What is the discounted payback period if the required rate of return is 7.5 percent?
A)2.65 years
B)2.78 years
C)2.94 years
D)2.88 years
E)Never
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Chapter 6: Making Capital Investment Decisions
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Q1) Kurt's Cabinets is looking at a project that will require $80,000 in fixed assets and another $20,000 in net working capital.The project is expected to produce annual sales of $110,000 with associated costs of $70,000.The project has a life of 4 years.The company ignores bonus depreciation and instead uses straight-line depreciation to a zero book value over the life of the project.The tax rate is 21 percent.What is the annual operating cash flow for this project?
A)$31,600
B)$43,200
C)$27,000
D)$35,800
E)$40,000
Q2) For a profitable firm,an increase in which one of the following will increase the operating cash flow?
A)Employee salaries
B)Office rent
C)Building maintenance
D)Depreciation
E)Equipment rental
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Chapter 7: Risk Analysis, real Options, and Capital Budgeting
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Q1) Utilizing a decision tree,the NPV used to make the decision to commence the testing for a project is dependent on:
A)only the cash flows related to the actual test.
B)the path with the highest probability of occurrence.
C)all the project's cash flows and probabilities over the project's entire life.
D)only the cash flows and probabilities of the most successful path.
E)the cash flows and probabilities for the first year of the project's life.
Q2) Explain the primary benefit of sensitivity analysis and explain why that benefit cannot be realized by conducting scenario analysis.
Q3) A proposed 1-year project has a contribution margin of $5,fixed costs of $12,000,variable costs per unit of $12,depreciation of $30,000,an EAC of $41,185 and a tax rate of 21 percent.What is the present value break-even point in units?
A)12,458
B)9,489
C)11,232
D)10,603
E)9,617
Q4) Discuss some potential shortcomings of the standard decision tree analysis.
Page 9
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Chapter 8: Interest Rates and Bond Valuation
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Q1) A bond with a face value of $1,000 that sells for less than $1,000 in the market is called a ________ bond.
A)par
B)discount
C)premium
D)zero coupon
E)floating rate
Q2) Interest rate risk is often explained by using the concept of a teeter-totter.Explain interest rate risk and how it is related to the movements of a teeter-totter.
Q3) The ________ premium is that portion of the bond yield that represents compensation for potential difficulties that might be encountered should the bond holder wish to sell the bond prior to maturity.
A)default risk
B)taxability
C)inflation
D)liquidity
E)interest rate risk
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Chapter 9: Stock Valuation
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Q1) Which one of these factors generally has the greatest impact on a firm's PE ratio?
A)Required rate of return
B)Current dividends
C)Future opportunities
D)The overall risk level of the current firm
E)Depreciation method used by the firm
Q2) A stop order to sell at $46 will be executed:
A)at a price of $46 at the end of the day on which the order was placed.
B)at $46 following the first trade with a price below $46.
C)as a market order once a trade occurs at a price of $46 or less.
D)immediately at a price of $46.
E)as a market order once a trade occurs at a price of $46 or higher.
Q3) In the formula,P<sub>3</sub> = D<sub>x</sub>/(R g),the dividend is for period: A)two. B)five.
C)four.
D)three. E)one.
Q4) Explain the differences between a market order,a limit order,and a stop order.
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Chapter 10: Lessons From Market History
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Q1) The return earned in an average year over a multi-year period is called the ________ average return.
A)arithmetic
B)standard
C)variant
D)geometric
E)real
Q2) What are the arithmetic and geometric average returns (Answer in that order.)for a stock with annual returns of 4 percent,9 percent, 6 percent,and 18 percent?
A)5.89 percent; 6.25 percent
B)6.25 percent; 5.89 percent
C)6.25 percent; 8.33 percent
D)8.33 percent; 5.89 percent
E)8.33 percent; 8.33 percent
Q3) Based on historical market performance,what can we conclude about the relationship between return and risk?
Q4) What are the lessons learned from capital market history? What evidence is there to suggest these lessons are correct?
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Chapter 11: Return, risk, and the Capital Asset Pricing Model
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Q1) Stock M has a beta of 1.2.The market risk premium is 7.8 percent and the risk-free rate is 3.6 percent.Assume you compile a portfolio equally invested in Stock M,Stock N,and a risk-free security; the portfolio has a beta equal to the overall market.What is the expected return on the portfolio?
A)11.2 percent
B)10.8 percent
C)10.4 percent
D)11.4 percent
E)11.7 percent
Q2) The risk premium for an individual security is computed by:
A)multiplying the security's beta by the market risk premium.
B)multiplying the security's beta by the risk-free rate of return.
C)adding the risk-free rate to the security's expected return.
D)dividing the market risk premium by the quantity (1 + ).
E)dividing the market risk premium by the beta of the security.
Q3) According to the CAPM,the expected return on a risky asset depends on three components.Describe each component,and explain its role in determining expected return.
Q4) Explain in words what beta is and why it is an important tool of security valuation.
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Chapter 12: An Alternative View of Risk and Return: the Arbitrage Pricing Theory
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Q1) If an announcement by a firm causes the price of that firm's stock to suddenly change,that price change will most likely be driven by:
A)the expected part of the announcement.
B)market inefficiency.
C)the unexpected part of the announcement.
D)systematic risk.
E)expectations of a revised announcement in the near term.
Q2) The single-factor model generally uses ________ as the single factor.
A)arbitrage fees
B)GNP
C)the inflation rate
D)the market risk premium
E)the risk-free return
Q3) A factor,as used in APT,is a variable that:
A)represents a nondiversifiable risk.
B)affects the returns of risky assets in an unsystematic fashion.
C)correlates the returns of a risky asset with those of a risk-free asset.
D)measures the response of a specific asset to a systematic risk.
E)represents a firm-specific risk.
Q4) Verbally describe a graph that illustrates the one-factor model.
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Chapter 13: Risk, cost of Capital, and Valuation
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Q1) When computing the weighted average cost of capital,which of these are adjusted for taxes?
A)Cost of equity
B)Cost of preferred stock
C)Both the cost of equity and the cost of preferred stock
D)The costs of debt and preferred stock
E)Cost of debt
Q2) Lewis Bros.currently has outstanding debt but has decided to issue additional debt for expansion purposes.The pretax cost of the new debt is best estimated at the ________ of the currently outstanding debt.
A)original yield to maturity
B)current yield to maturity
C)embedded cost
D)current yield
E)coupon rate
Q3) Explain a)the factors that determine a security's beta and b)how asset beta relates to equity beta.
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Chapter 14: Efficient Capital Markets and Behavioral Challenges
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Q1) If the financial markets are efficient,then investors should expect their investments in those markets to:
A)earn extraordinary returns on a routine basis.
B)generally have positive net present values.
C)generally have zero net present values.
D)produce arbitrage opportunities on a routine basis.
E)produce negative returns on a routine basis.
Q2) Suppose firms with unexpectedly high earnings earn abnormally high returns for several months after the earnings announcement.This would be evidence of:
A)efficient markets in the weak form.
B)inefficient markets in the weak form.
C)efficient markets in the semistrong form.
D)inefficient markets in the semistrong form.
E)inefficient markets in the strong form.
Q3) Define the three forms of market efficiency.
Q4) Explain why in an efficient market all investments have an expected NPV of zero.
Q5) Suppose your cousin invests in the stock market and doubles her money in a single year while the market,on average,earned a return of only 15 percent.Is your cousin's performance a violation of market efficiency?
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Chapter 15: Long-Term Financing
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Q1) Analysts estimate that one year from today,a bond has a probability of 40 percent of being priced at $950 and a probability of 60 percent of being priced at $1,050.The bond is also callable at any time at $1,010.What is the expected value of this bond in one year?
A)$995
B)$980
C)$1,000
D)$1,010
E)$986
Q2) Which type of bond grants the bond holder the right to force the bond's issuer to repay the bond at a stated price given that a certain situation(s)occurs?
A)Put bond
B)Cat bond
C)NoNo bond
D)Income bond
E)Warrant bond
Q3) Explain some of the means by which a select group of shareholders can retain control over a corporation while still raising equity capital outside of their group.
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Chapter 16: Capital Structure: Basic Concepts
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Q1) When comparing levered versus unlevered capital structures,leverage works to increase EPS for high levels of EBIT because interest payments on the debt:
A)vary with EBIT levels.
B)stay fixed,leaving less income to be distributed over fewer shares.
C)stay fixed,leaving more income to be distributed over fewer shares.
D)stay fixed,leaving less income to be distributed over more shares.
E)stay fixed,leaving more income to be distributed over more shares.
Q2) Discuss MM Propositions I and II in a world without taxes.List the basic assumptions,results,and intuition of the model.
Q3) The firm's capital structure refers to the:
A)mix of current and fixed assets a firm holds.
B)amount of capital invested in the firm.
C)amount of dividends a firm pays.
D)mix of debt and equity used to finance the firm's assets.
E)amount of cash versus receivables the firm holds.
Q4) Explain homemade leverage and why it matters.
Q5) Discuss MM Propositions I and II in a world with taxes.List the basic assumptions,results,and intuition of the model.
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Chapter 17: Capital Structure: Limits to the Use of Debt
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Q1) Which one of these lowers cash flows?
A)Decreased use of leverage
B)Decreased costs
C)Increased sales due to an improved economy
D)The associated costs of bankruptcy
E)A decrease in the interest rate charged on debt
Q2) The MM theory with taxes implies that firms should issue maximum debt.In practice,this does not occur because:
A)debt is more risky than equity.
B)bankruptcy is a disadvantage to debt.
C)the weighted average cost of capital is inversely related to the debt-equity ratio.
D)the weighted average cost of capital is directly related to the debt-equity ratio.
E)U.S.regulations require the debt-equity ratio of publicly-traded firms to be in the range of .3 to .7.
Q3) What is the pecking order theory and what are the implications that arise from this theory?
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Chapter 18: Valuation and Capital Budgeting for the Levered Firm
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Q1) Alpha Company has riskless debt,a debt-equity ratio of .46,a tax rate of 21 percent,and an unlevered firm beta of 1.23.What is the equity beta?
A).67
B).73
C).86
D)1.68
E)1.47
Q2) Alabaster Incorporated wants to be levered at a debt-to-value ratio of .6.The cost of debt is 9 percent,the tax rate is 21 percent,and the cost of equity for an all-equity firm is 12 percent.What will be the firm's cost of equity?
A)12.31 percent
B)16.45 percent
C)12.08 percent
D)15.56 percent
E)13.58 percent
Q3) Assume a project is non-scale enhancing.Describe the basic steps required to determine the net present value of the project.
Q4) Explain how flotation costs affect the analysis of a levered project.
Page 20
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Chapter 19: Dividends and Other Payouts
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Q1) Edie's Health Supply has 125,000 shares of stock outstanding with a par value of $1 per share and a market value of $5 a share.The company has retained earnings of $76,500 and capital in excess of par of $340,000.The company just announced a 1-for-5 reverse stock split.What will be the par value per share after the split?
A)$.20
B)$.25
C)$2.50
D)$5.00
E)$10.00
Q2) Explain why executives who hold stock options prefer stock repurchases over stock dividends.
Q3) Robinson's has 15,000 shares of stock outstanding with a market price of $6 a share.What will be the market price per share if the firm does a 1-for-3 reverse stock split?
A)$18
B)$24
C)$42
D)$48
E)$54
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Chapter 20: Raising Capital
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Q1) A road show is a portion of the underwriting process known as:
A)capital reputation building.
B)bookbuilding.
C)locking-up.
D)syndication.
E)Dutch auctioning.
Q2) Wood Crafts has expended almost all its start-up funds and is seeking venture capital to begin manufacturing.Which type of financing is it seeking?
A)Mezzanine financing
B)First-round financing
C)Bridge financing
D)Seed money financing
E)Second-round financing
Q3) In comparison to debt issuance expenses,the total direct costs of equity issues are:
A)considerably less.
B)the same.
C)minimally less.
D)considerably greater.
E)minimally greater.
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Chapter 21: Leasing
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Q1) To meet IRS guidelines for leasing,the lease should:
A)limit the lessee's right to issue debt or pay dividends while the lease is operative.
B)offer renewal options only at fair market value.
C)pay a very low rate of return to the lessor.
D)transfer ownership of the asset at the end of the lease at below fair market value.
E)have a term of 30 years or more.
Q2) Explain the term "bargain purchase price option" and identify at least one application of that term.
Q3) When computing the incremental cash flows from leasing relative to purchasing,the:
A)cost of the asset is a negative cash flow.
B)lost depreciation tax benefit is a negative cash flow.
C)pretax lease payment is a positive cash flow.
D)lease payments are ignored.
E)tax benefit of the lease payment is a negative cash flow.
Q4) Discuss some of the pros and cons of leasing.
Q5) Explain the characteristics of both operating and financial leases.
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Chapter 22: Options and Corporate Finance
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Q1) Assume you own both a May 40 put and a May 40 call on ABC stock.Which one of the following statements is correct concerning your option positions? Ignore taxes and transaction costs.
A)An increase in the stock price will increase the value of your put and decrease the value of your call.
B)Both a May 45 put and a May 45 call will have higher values than your May 40 options.
C)The time premiums on both your put and call are less than the time premiums on equivalent June options.
D)A decrease in the stock price will decrease the value of both of your options.
E)You can never profit on your positions as your profits on one option will be offset by losses on the other option.
Q2) All else held constant,the value of a call decreases when the:
A)time to expiration increases.
B)risk-free rate of return increases.
C)stock price increases.
D)exercise price increases.
E)volatility of the price of the underlying stock increases.
Q3) How do options apply to capital budgeting? Explain and provide an example.
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Chapter 23: Options and Corporate Finance: Extensions and Applications
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Q1) A ________ period prohibits executives from exercising their options for a stated period of time.
A)investing
B)freeze-out
C)valuation
D)guaranteed
E)strike
Q2) The call option on a dividend-paying stock compared to a comparable non-dividend paying stock is:
A)more valuable because of the dividend payments.
B)equal in value.
C)less valuable because cash dividends lower the stock price.
D)equal to the cost of the non-dividend paying stock option.
E)either equal to or greater than the value of the non-dividend paying stock option.
Q3) Why is straight NPV analysis flawed as compared to models that include option pricing in the analysis?
Q4) In what instances is the binomial option pricing model superior to the Black-Scholes option pricing model?
25
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Chapter 24: Warrants and Convertibles
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Q1) A convertible bond is selling for $967,matures in 15 years,has a $1,000 face value,pays interest semiannually,and has a coupon rate of 8 percent.Similar non-convertible bonds are priced to yield 4.25 percent per six months.The conversion ratio is 20.The stock currently sells for $47.50 a share.Calculate the convertible bond's option value.
A)$2.92
B)$7.27
C)$2.03
D)$8.95
E)$1.48
Q2) A bond with a face value of $1,000 can be exchanged for 35 shares of stock with a current market price of $22 per share.What would the conversion ratio and conversion price be if the bond's issuer declared a stock split of 3-for-1?
A)75; $7.33
B)105; $9.52
C)105; $22.00
D)35; $22.00
E)105; $7.33
Q3) Explain how a noncallable convertible bond's value is determined.
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Chapter 25: Derivatives and Hedging Risk
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Q1) Caps and floors are used in conjunction with derivatives to:
A)limit any impact from interest rate changes.
B)increase the rate of return to the derivative holder.
C)increase the volatility of the at-risk asset.
D)offset the costs associated with establishing the derivative position.
E)lower acquisition costs irrespective of financing costs.
Q2) You hold a futures contract to take delivery of U.S.Treasury bonds in 6 months.If the entire term structure of interest rates shifts down over the 6-month period,the value of the forward contract will have ________ the date of delivery.
A)increased in value by B)decreased in value by C)the same value as when obtained on D)either decreased in value or have a zero value by E)zero value by
Q3) There are always at least ________ counterparties in a credit default swap.
E)more than three
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Chapter 26: Short-Term Finance and Planning
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Q1) Brook Side reported sales of $738,000 and cost of goods sold of $584,000 for the year.The firm had a beginning inventory of $51,000 and an ending inventory of $46,000.What is the length of the inventory period?
A)15.24 days
B)15.16 days
C)31.19 days
D)29.87 days
E)30.31 days
Q2) Which one of these statements concerning the cash cycle is correct?
A)The cash cycle is equal to the operating cycle minus the inventory period.
B)A negative cash cycle is actually preferable to a positive cash cycle.
C)Granting credit to slower paying customers tends to decrease the cash cycle.
D)The cash cycle plus the accounts receivable period is equal to the operating cycle.
E)The most desirable cash cycle is the one that equals zero days.
Q3) List and describe three basic types of secured inventory loans.What are the advantages and disadvantages of each type of loan?
Q4) Identify the three primary characteristics of a restrictive short-term financial policy.
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Chapter 27: Cash Management
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Q1) KN Florals receives the same checks each month.Of these monthly checks,48 are for $82.60 each,15 are for $71.50 each,and 9 are for $40.70 each.The delay for the $82.60 checks is 1.8 days,for the $71.50 checks 1.1 days,and for the $40.70 checks 1.3 days.Calculate the average daily float.Assume a 30-day month.
A)$293.09
B)$287.46
C)$309.10
D)$299.47
E)$358.02
Q2) Which one of the following is a money-market security that has limited marketability?
A)Jumbo certificates of deposit (CD's)
B)Commercial paper
C)Common stock
D)U.S.Treasury bills
E)Ordinary preferred stock
Q3) Processing float
Q4) Availability float
Q5) Availability float Collection float includes:
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Chapter 28: Credit and Inventory Management
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Q1) Explain how inventory is managed under an ABC inventory system.
Q2) One key reason for establishing a captive finance company is the:
A)reduction of legal restrictions on the amount of debt that can be incurred.
B)increased opportunities for internal sales.
C)lower level of required financial insurance.
D)anticipated decrease in accounts receivable.
E)expected decrease in the cost of the debt required to finance receivables.
Q3) Which one of the following statements is false as it relates to considerations firms use when establishing a credit policy?
A)A firm that supplies a perishable product will tend to offer restrictive credit terms.
B)A firm whose customers are in a high-risk business will tend to offer restrictive credit terms.
C)Lengthening the credit period effectively reduces the price paid by the customer.
D)Small accounts,associated with firms that find it difficult to acquire a line of credit,tend to receive longer credit periods.
E)Larger accounts tend to receive more favorable credit terms.
Q4) Explain the purpose of a safety stock and how this relates to reorder points.
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Chapter 30: Financial Distress
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Q1) Why would a firm's creditors voluntarily agree to a prepackaged reorganization that offers those creditors less than they are owed?
Q2) Some of the key reasons why a firm would choose a formal bankruptcy over a private workout include all the following except the:
A)issuance of debtor-in-possession debt.
B)tax treatment of tax loss carryforwards.
C)tax treatment of debt forgiveness.
D)ability to issue new debt that is senior to all prior debts.
E)higher priority given to the existing stockholders.
Q3) Most firms in financial distress do not fail or cease to exist.In fact,many firms can actually benefit from financial distress by:
A)re-evaluating their core operations and restructuring their assets.
B)selectively ceasing payment on some of their outstanding debts.
C)filing for Chapter 7 bankruptcy.
D)liquidating.
E)increasing their debt load.
Q4) There are a number of ways firms can deal with financial distress.Identify at least 5 of these.
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Chapter 31: International Corporate Finance
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Q1) You want to import $56,000 worth of rugs from India.How many rupees will you need to pay for this purchase if one rupee is worth $.01606?
A)Rs3,015,030
B)Rs2,666,667
C)Rs3,486,924
D)Rs3,008,001
E)Rs2,847,319
Q2) The price of one country's currency expressed in terms of another country's currency is called the:
A)absolute currency rate.
B)cross inflation rate.
C)depository rate.
D)exchange rate.
E)foreign interest rate.
Q3) For absolute purchasing power parity to hold:
A)transaction costs must be observable.
B)interest rates must be uniform on a nominal basis.
C)inflation rates must be uniform in all markets.
D)tariffs must be imposed on all imported goods.
E)products must be identical in all markets.
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