Corporate Financial Strategy
Exam Answer Key
Course Introduction
Corporate Financial Strategy explores the key financial decisions that drive long-term value creation in organizations. The course covers strategic financial planning, capital structure optimization, funding choices, risk management, dividend policy, mergers and acquisitions, and the alignment of financial strategies with overall corporate goals. Students gain a deep understanding of how financial insights support sustainable growth, competitive advantage, and effective stakeholder communication, preparing them to participate in strategic financial decision-making at the highest organizational levels.
Recommended Textbook
Corporate Finance 2nd Canadian by Jonathan Berk
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Chapter 1: The Corporation
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Q1) One of the major reasons that corporations have a principal-agent problem is that A) management is less transparent.
B) they have an inefficient and incompetent management team.
C) direct control and ownership are often separate.
D) there is a lack of communication between the owners and the management team.
Answer: C
Q2) In Canada,some business entities are in income trusts and they come in three forms.The three forms are
A) Limited Partnerships, Limited Liability Partnerships and Limited General Partnerships.
B) Privately Traded Corporations, Sole Proprietorships and Joint Venture Corporations.
C) Business Income Trusts, Energy Trusts and Real Estate Investment Trusts.
D) None of the above.
Answer: C
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3
Chapter 2: Introduction to Financial Statement Analysis
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Q1) Luther's earnings before interest,taxes,depreciation,and amortization (EBITDA)for the year ending December 31,2006 are closest to:
A) $19.7 million
B) $37.6 million
C) $41.2 million
D) $44.8 million
Answer: D
Q2) Which of the following is NOT a financial statement that every public company is required by IFRS to produce?
A) Income Statement
B) Statement of Sources and Uses of Cash
C) Balance Sheet
D) Statement of Shareholders' Equity
Answer: B
Q3) Depreciation is ________ that the firm ________.
A) an actual cash expense, pays
B) not an actual cash expense, receives
C) not an actual cash expense, pays
D) an actual cash expense, pays.
Answer: C
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Chapter 3: Arbitrage and Financial Decision Making
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Sample Questions
Q1) Consider an ETF that is made up of one share each of IBM,MRK,and C.The current quote for this ETF currently is $167.75 (bid)$167.85 (ask).What should you do?
Answer: There is an arbitrage opportunity.Buy the ETF at the ask of $167.85 and sell the underlying securities at the bid prices.So we have +79.45 + 39.95 + 48.50 - 167.85 = .05 arbitrage profit per share
Q2) If the value of security "C" is $180,then what must be the value of security "A"?
A) $80
B) $90
C) $100
D) Unable to determine without the risk-free rate.
Answer: A
Q3) What is the no-arbitrage price for security C?
A) $800
B) $1600
C) $3200
D) $4000
Answer: C
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Chapter 4: The Time Value of Money
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Q1) Which of the following statements regarding the timeline is false?
A) Date 1 is one year from now.
B) The $5000 below date 1 is the payment you will receive at the end of the first year.
C) The $5000 below date 2 is the payment you will receive at the beginning of the second year.
D) Date 0 represents today.
Q2) Consider a growing perpetuity that will pay $100 in one year.Each year after that,you will receive a payment on the anniversary of the last payment that is 6% larger than the last payment.This pattern of payments will continue forever.If the interest rate is 11%,then the value of this perpetuity is closest to:
A) $1,667
B) $588
C) $2,000
D) $909
Q3) Assuming that college costs continue to increase an average of 4% per year and that all her college savings are invested in an account paying 7% interest,then the amount of money she will need to have available at age 18 to pay for all four years of her undergraduate education is closest to:
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Chapter 5: Interest Rates
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Q1) Which of the following statements is false?
A) The actual return kept by an investor will depend on how the interest is taxed.
B) The equivalent after-tax interest rate is r(1 - ).
C) The highest interest rate for a given horizon is the rate paid on Treasury Bills of the Government of Canada.
D) It is important to use a discount rate that matches both the horizon and the risk of the cash flows.
Q2) An effective annual rate (EAR)is normally compounded
A) monthly.
B) quarterly.
C) semiannually.
D) annually.
Q3) Most provinces in Canada have harmonized their cost of credit disclosure requirements so that when the compounding interval for the APR is not stated explicitly,it is equal ________.
A) to the number of compounding frequencies of rate of interest in a year
B) to the number of payment intervals in a year
C) to the effective rate
D) to nominal rate
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Page 7
Chapter 6: Investment Decision Rules
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Q1) Which of the following statements is false?
A) The incremental IRR investment rule applies the IRR rule to the difference between the cash flows of the two mutually exclusive alternatives.
B) When a manager must choose among mutually exclusive investments, the NPV rule provides a straightforward answer.
C) The likelihood of multiple IRRs is greater with the regular IRR rule than with the incremental IRR rule.
D) Problems can arise using the IRR method when the mutually exclusive investments have differences in scale.
Q2) The payback period for project B is closest to:
A) 2.5 years
B) 2.0 years
C) 2.2 years
D) 2.4 years
Q3) The profitability index for project B is closest to:
A) 23.34
B) 12.64
C) 0.17
D) 0.12
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Page 8
Chapter 7: Fundamentals of Capital Budgeting
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Q1) Which of the following statements is correct?
A) Capital Cost Allowance (CCA) is a cash expense that is paid by the firm.
B) Capital Cost Allowance (CCA) is used for calculating total operating cost.
C) Capital Cost Allowance (CCA) is used to calculate financial cost that paid for capital budget.
D) Capital Cost Allowance (CCA) is a cash expense that should be allocated for tax purposes.
Q2) Epiphany would like to know how sensitive the project's NPV is to changes in the discount rate.How much can the discount rate vary before the NPV reaches zero?
Q3) An exploration of the effect on NPV of changing multiple project parameters is called
A) scenario analysis.
B) IRR analysis.
C) accounting break-even analysis.
D) sensitivity analysis.
Q4) Epiphany is worried about the reliability of the sales forecast.How sensitive is the project's NPV to a 10% change in sales.
Q5) How does scenario analysis differ from sensitivity analysis?
Q6) What is the NPV of Epiphany's project?
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Chapter 8: Valuing Bonds
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Q1) Which of the following statements is false?
A) In general, the expected future spot interest rate will reflect investor's preferences toward the risk of future interest rate fluctuations.
B) If investors did not care about risk, then they would be indifferent between investing in a two-year bond and investing in a one-year bond and rolling over the money in one-year.
C) When we refer to the one-year forward rate for year 5, we mean the rate available today on a one-year investment that begins four years from today and is repaid five years from today.
D) In general, we can compute the forward rate for year n by comparing an investment in an n-year, zero-coupon bond to an investment in an (n + 1)-year, zero-coupon bond, with the interest rate earned in the nth year being guaranteed through an interest rate forward contract.
Q2) The yield to maturity of a bond is the same rate as ________.
A) the coupon rate
B) the effective rate of interest
C) the nominal interest rate
D) the internal rate of return
Q3) What is the relationship between a bond's price and its yield to maturity?
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Chapter 9: Valuing Stocks
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Q1) You expect that Bean Enterprises will have earnings per share of $2 for the coming year.Bean plans to retain all of its earnings for the next three years.For the subsequent two years,the firm plans on retaining 50% of its earnings.It will then retain only 25% of its earnings from that point forward.Retained earnings will be invested in projects with an expected return of 20% per year.If Bean's equity cost of capital is 12%,then the price of a share of Bean's stock is closest to:
A) $17.00
B) $10.75
C) $27.75
D) $43.50
Q2) Which of the following statements is false?
A) We must discount the cash flows from stock based on the equity cost of capital for the stock.
B) The divided yield is the percentage return the investor expects to earn from the dividend paid by the stock.
C) The firm might pay out cash to its shareholders in the form of a dividend.
D) The dividend yield is the expected annual dividend of a stock, divided by its expected future sale price.
Q3) What are some common multiples used to value stocks?
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Page 11
Chapter 10: Capital Markets and the Pricing of Risk
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Q1) Which of the following statements is false?
A) Investments with higher volatility have rewarded investors with higher average returns.
B) Investments with higher volatility should have a higher risk premium and therefore higher returns.
C) Volatility seems to be a reasonable measure of risk when evaluating returns on large portfolios and the returns of individual securities.
D) Riskier investments must offer investors higher average returns to compensate them for the extra risk they are taking on.
Q2) The standard deviation for the return on an individual firm is closest to:
A) 23.0%
B) 5.25%
C) 15.0%
D) 10.0%
Q3) Independent risk is also called
A) undiversifiable risk.
B) systematic risk.
C) uncorrelated risk.
D) autocorrelated risk.
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Page 12
Chapter 11: Optimal Portfolio Choice and the Capital Asset
Pricing Model
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Q1) Aggressive investors will invest more,choosing a portfolio that is near ________ or even beyond it by buying stocks on margin.
A) the risk-free investment
B) the efficient frontier
C) the efficient frontier of risky investment
D) the tangent portfolio
Q2) The expected return of a portfolio that is equally invested in Duke Energy and Microsoft is closest to:
A) 28%
B) 29%
C) 24%
D) 23%
Q3) Calculate the covariance between Home Depot's and IBM's returns.
Q4) Assuming that the EFT you invested in returns -10%,then the realized return on your investment is closest to:
A) -20%
B) -10%
C) -24%
D) -26%
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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) Canadian Treasury Bill
Q2) Suppose that California Gold Mining's expected return is 2%.Then California Gold Mining's alpha is closest to:
A) -3%
B) -13%
C) 7%
D) -11%
Q3) Assuming that Tom wants to maintain the current volatility of his portfolio,then the amount that Tom should invest in the market portfolio to maximize his expected return is closest to:
A) 72%
B) 92%
C) 110%
D) 140%
Q4) Describe two methods that can be used to estimate a firm's debt cost of capital.
Page 14
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Chapter 13: Investor Behaviour and Capital Market
Efficiency
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Q1) A group of portfolios from which we can form an efficient portfolio is called A) factor portfolios.
B) semi-efficient portfolios.
C) partially efficient portfolios.
D) characteristic portfolios.
Q2) One of the major reasons that there is so little consensus in practice about which of the four models to use is because
A) financial economics has reached the point where we can provide a theory of expected returns that gives a precise estimate of the cost of capital.
B) financial economics has not yet reached the point where we can provide a theory of realized returns that gives a precise estimate of the cost of capital.
C) financial economics has not yet reached the point where we can provide a theory of expected returns that gives a precise estimate of the cost of capital.
D) financial economics has reached the point where we can provide a theory of realized returns that gives a precise estimate of the cost of capital.
Q3) 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) Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk free rate,then the cash flow that equity holders will receive in one year in a weak economy is closest to:
A) $6,000
B) $10,000
C) $0
D) $33,000
Q2) Suppose that to raise the funds for the initial investment the firm borrows $80,000 at the risk free rate,then the cash flow that equity holders will receive in one year in a strong economy is closest to:
A) $0
B) $6,000
C) $33,000
D) $10,000
Q3) Suppose you own 10% of the equity of Without.What is another portfolio you could hold that would provide you with the same exact cash flows?
Q4) 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?
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Page 16
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) Rosewood's net income is closest to:
A) $450 million
B) $180 million
C) $290 million
D) $95 million
Q3) LCMS' annual interest tax shield is closest to:
A) $2.8 million
B) $2.0 million
C) $3.6 million
D) $5.6 million
Q4) Raceway Products has a market debt-to-equity ratio of .60,a corporate tax rate of 40%,and pays 8% interest on its debt.The interest tax shield on Raceway's debt lowers its WACC by what amount?
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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 total value of MI with leverage is closest to:
A) $133 million
B) $140 million
C) $147 million
D) $125 million
Q2) Which of the following statements is false?
A) Calculating the precise present value of financial distress costs is a relatively straightforward process.
B) Two key qualitative factors determine the present value of financial distress costs: (1) the probability of financial distress and (2) the magnitude of the costs after a firm is in distress.
C) Technology firms are likely to incur high costs when they are in financial distress, due to the potential for loss of customers and key personnel, as well as a lack of tangible assets that can be easily liquidated.
D) The magnitude of the financial distress costs will depend on the relative importance of the sources of these costs and is likely to vary by industry.
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Chapter 17: Payout Policy
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Q1) When a firm ________ its dividend,it sends a ________ signal to investors that management expects to be able to afford the higher dividend for the foreseeable future. A) decreases; positive B) increases; negative C) increases; positive
D) None of the above
Q2) Assume that you own 2500 shares of Omicron stock and that Omicron uses the entire $50 million to repurchase shares.Suppose you are unhappy with Omicron's decision and would prefer that Omicron used the excess cash to pay a special dividend.The number of shares that you would have to sell in order to receive the same amount of cash as if Omicron paid the special dividend is closest to:
A) 275
B) 310
C) 125
D) 250
Q3) Calculate the effective tax disadvantage for retaining cash in 1999,2001,and 2005.
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19
Chapter 18: Capital Budgeting and Valuation With Leverage
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Q1) The intuition for the WACC method is that the firm's weighted average cost of capital represents the average return the firm must pay to its ________ on an after-tax basis.
A) creditors
B) shareholders
C) debtors
D) investors
Q2) The unlevered cost of capital for "Moe" is closest to:
A) 8.25%
B) 7.75%
C) 8.50%
D) 10.00%
Q3) Iota's weighted average cost of capital is closest to:
A) 8.40%
B) 9.75%
C) 10.85%
D) 11.70%
Q4) What are the three methods we can use to include the value of the interest tax shield in the capital budgeting decision?
Q5) Calculate the debt capacity of Omicron's new project for years 0,1,and 2.
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Chapter 19: Valuation and Financial Modeling: a Case Study
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Q1) What range for the market value of equity for Ideko is implied by the range of P/E multiples for the comparable firms?
Q2) If the risk-free rate of interest is 6% and the market risk premium has historically averaged 5%,then the cost of capital for Oakley is closest to:
A) 9.1%
B) 10.2%
C) 13.5%
D) 14.7%
Q3) While ________ method is the most reliable method when evaluating an acquisition investment,real-world practitioners often use ________ and ________ as alternative valuation metrics.
A) the NPV; the IRR; the cash multiple (or multiple of money)
B) the IRR; the NPV; the cash multiple (or multiple of money)
C) the NPV; the cash multiple (or multiple of money); the IRR
D) the IRR; the cash multiple (or multiple of money); the NPV
Q4) What range for the market value of equity for Ideko is implied by the range of EV/EBITDA multiples for the comparable firms if Ideko holds $6.5 million of cash in excess of its working capital needs?
Page 21
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Chapter 20: Financial Options
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Q1) Which of the following will NOT increase the value of a put option?
A) An increase in the time to maturity
B) A decrease in the stock price
C) A decrease in the stock's volatility
D) An increase in the exercise price
Q2) Graph the payoff at expiration of a short position in a put option with a strike price of $20.
Q3) Which of the following statements is false?
A) When a holder of an option enforces the agreement and buys or sells a share of stock at the agreed-upon price, he is exercising the option.
B) European options allow their holders to exercise the option on any date up to and including a final date called the expiration date.
C) Because an option is a contract between two parties, for every owner of a financial option, there is also an option writer, the person who takes the other side of the contract.
D) The price at which the holder buys or sells the share of stock when the option is exercised is called the strike price or exercise price.
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Chapter 21: Option Valuation
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Q1) Using risk-neutral probabilities,calculate the price of a two-year put option on Kinston stock with a strike price of $9.
Q2) Which of the following statements is false?
A) N(d) is the cumulative normal distribution - that is, the probability that a normally distributed variable is greater than d.
B) Of the five required inputs in the Black-Scholes formula, four are directly observable.
C) The Black-Scholes formula is derived assuming that the call is a European option.
D) The Black-Scholes Option Pricing Model can be derived from the Binomial Option Pricing Model by making the length of each period, and the movement of the stock price per period, shrink to zero and letting the number of periods grow infinitely large.
Q3) ________ have the highest expected returns and ________ have the lowest expected returns.
A) Out-of-the-money calls; out-of-the-money puts
B) In-the-money puts; out-of-the-money puts
C) Out-of-the-money puts; out-of-the-money calls
D) In-the-money calls; out-of-the-money puts
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Chapter 22: Real Options
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Q1) The NPV of project B is closest to:
A) $18.10
B) $21.70
C) $24.00
D) $16.90
Q2) Which of the following statements is false?
A) One way to understand why you would sometimes choose not to invest in a positive-NPV project is to think about the decision of when to invest as a choice between two mutually exclusive projects: (1) invest today or (2) wait.
B) You invest today only when the NPV of investing today exceeds the value of the option of waiting, which from option pricing theory we know to be always positive.
C) When you do not have the option to wait, it is optimal to invest in any positive-NPV project.
D) When you have the option of deciding when to invest, it is usually optimal to invest only when the NPV is positive but close to zero.
Q3) Assume that you are not able to sell the plant,but you are able to shut down the plant at no cost at any time.Draw a decision tree detailing this problem.
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Page 24
Chapter 23: The Mechanics of Raising Equity Capital
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Q1) Which of the following statements is false?
A) In a rights offer, the firm offers the new shares only to existing shareholders.
B) Secondary shares are shares sold by existing shareholders, including the company's founder.
C) If a firm's management is concerned that its equity may be underpriced in the market, by using a rights offering the firm can continue to issue equity without imposing a loss on its current shareholders.
D) In the United States most offers are rights offers.
Q2) Prior to an IPO,in Canada,the first step is the preparation of ________.
A) the audited financial statements and the registration statement
B) the registration statement only
C) the preliminary prospectus and the registration statement
D) the preliminary prospectus only
Q3) Underpricing in Canada is ________,but the magnitude is ________ in many other countries.
A) significant; not as large as B) insignificant; not as large as C) insignificant; as large as D) significant; as large as
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Page 25
Chapter 24: Debt Financing
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Q1) Which of the following statements is false?
A) Zero-coupon Treasury securities with maturities longer than one year also trade in the bond market.
B) Treasury securities are initially sold to the public through dealers.
C) Municipal bonds ("munis") are issued by provincial and local governments.
D) Municipal bonds' distinguishing characteristic is that the income on municipal bonds is not taxable at the federal level.
Q2) ________ and ________ are used by the Government of Canada.
A) Five kinds of domestic debt securities; four types of foreign debt securities
B) Six kinds of domestic debt securities; five types of foreign debt securities
C) Four kinds of domestic debt securities; three types of foreign debt securities
D) Three kinds of domestic debt securities; four types of foreign debt securities
Q3) What is the Yield to Call (YTC)on this bond?
Q4) Foreign bonds in Canada are known as ________.
A) registered bonds
B) maple bonds
C) bearer bonds
D) original issue discount bonds
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Page 26
Chapter 25: Leasing
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Q1) A lease will be treated as a non-tax lease if it satisfies any of the following conditions EXCEPT:
A) The property may be acquired for the fair market value of the asset at the time when the option may be exercised.
B) Some portion of the lease payments is specifically designated as interest or its equivalent.
C) The lessee receives ownership of the asset on completion of all lease payments.
D) The total amount that the lessee is required to pay for a relatively short period of use constitutes an inordinately large proportion of the total value of the asset.
Q2) If Luther acquires the new fleet of delivery trucks using a capital lease,Luther's Debt to Equity ratio will be closest to:
A) 0.66
B) 1.5
C) 0.80
D) 2.0
Q3) If St.Martin purchases the CT scanner,what is the amount of the lease-equivalent loan?
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Chapter 26: Working Capital Management
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Q1) Which of the following statements is false?
A) After a firm decides on its credit standards, it must next establish its credit terms.
B) The decision of how much credit risk to assume plays a large role in determining how much money a firm ties up in its payables.
C) Knowledge of the payments pattern is also useful for forecasting the firm's working capital requirements.
D) An aging schedule categorizes accounts by the number of days they have been on the firm's books.
Q2) Which of the following statements is false?
A) The lower the discount percentage offered, the greater the cost of forgoing the discount and using trade credit.
B) A firm should choose to borrow using accounts payable only if trade credit is the cheapest source of funding.
C) A firm should always pay on the latest day allowed.
D) A firm should strive to keep its money working for it as long as possible without developing a bad relationship with its suppliers or engaging in unethical practices.
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Chapter 27: Short-Term Financial Planning
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Q1) In Canada,to extend the maturity of commercial paper beyond one year triggers registration requirements with ________.
A) the federal securities commission
B) the relevant provincial securities commission
C) the Ministry of Finance
D) the Toronto Stock Exchange (TSX)
Q2) Luther Industries is offered a $1 million dollar loan for four months at an APR of 9%.If Luther's bank requires that the firm maintain a compensating balance equal to 10% of the loan amount in a non-interest-bearing account,then the effective annual rate (EAR)for this loan is closest to:
A) 50.0%
B) 12.6%
C) 14.4%
D) 71.5%
Q3) In which quarter are Hasbeen's seasonal working capital needs the greatest?
A) 4
B) 2
C) 3
D) 1
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Chapter 28: Mergers and Acquisitions
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Q1) Which of the following statements is false?
A) Cost-reduction synergies are hard to predict and achieve.
B) Because the CEOs of small firms receive information so quickly, small firms are often able to react in a timely way to changes in the economic environment.
C) Synergies usually fall into two categories: cost reductions and revenue enhancements.
D) There may be costs associated with size.
Q2) 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.
Q3) If Martin pays no premium to acquire Luther,what will the earnings per share be after the merger?
Q4) What is a white knight?
Q5) Assume that Martin pays no premium to acquire Luther.Calculate Martin's price-earnings (P/E)ratio both pre- and post-merger.
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Chapter 29: Corporate Governance
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Q1) The Canada Corporations Act of 1970 introduced the first federal provisions regarding insider trading,and this was carried over into ________ which continues in force today.
A) the Generally Accepted Accounting Principles
B) the Corporation Law of Canada
C) the Canada Business Corporations Act
D) the International Financial Reporting Standards
Q2) ________ was amended in 2004 to create tougher insider trading laws and penalties.
A) The Corporation Law of Canada
B) The Criminal Code of Canada
C) The Generally Accepted Accounting Principles
D) The Canada Business Corporations Act
Q3) How does a pyramid structure work?
Q4) Describe the "stakeholder" model of corporate governance.
Q5) What is corporate governance?
Q6) What is the role of takeovers in corporate governance?
Q7) Describe the main requirements of the Sarbanes-Oxley Act of 2002.
Q8) What is the difference between inside,gray,and outside directors?
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Chapter 30: Risk Management
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Q1) To insure their assets against hazards such as fire,storm damage,vandalism,earthquakes,and other natural and environmental risks firms commonly purchase
A) key personnel insurance.
B) business liability insurance.
C) business interruption insurance.
D) property insurance.
Q2) If your firm is fully insured,the NPV of implementing the new safety policies is closest to:
A) $2.15 million
B) $2.5 million
C) $2.25 million
D) -$.25 million
Q3) If your firm is uninsured,the NPV of implementing the new safety policies is closest to:
A) $2.25 million
B) -$.25 million
C) $2.5 million
D) $2.15 million
Q4) What are some of the disadvantages of long-term supply contracts?
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Chapter 31: International Corporate Finance
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Q1) How do we make adjustments when a project has inputs and outputs in different currencies?
Q2) Which of the following statements is false?
A) Canadian tax policy requires Canadian corporations to pay taxes on their foreign income at the same rate as profits earned in Canada.
B) The home government gets an opportunity to tax the income from a foreign project to the domestic firm.
C) The general international arrangement prevailing with respect to taxation of corporate profits is that the home country gets the first opportunity to tax income.
D) The home government must establish a tax policy specifying its treatment of foreign income and foreign taxes paid on that income.
Q3) Calculate the pound denominated cost of capital for Luther's project.
Q4) The amount of the taxes paid in dollars for the Irish operations is closest to:
A) $20.5 million
B) $5.1 million
C) $29.5 million
D) $50.0 million
Q5) What is the pound present value of the project?
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