Corporate Financial Strategy
Study Guide Questions
Course Introduction
Corporate Financial Strategy explores the frameworks, principles, and decision-making processes that underpin effective financial management within organizations. The course covers topics such as capital structure, valuation, mergers and acquisitions, risk management, dividend policy, and long-term investment decisions, with an emphasis on aligning financial strategies with overall corporate goals. Through case studies and real-world applications, students learn how financial strategies drive value creation, manage financial risks, and respond to evolving market dynamics, preparing them for strategic leadership roles in finance and corporate management.
Recommended Textbook
Fundamentals of Corporate Finance 8th Edition by Richard
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Page 2
Brealey
Chapter 1: Goals and Governance of the Corporation
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Q1) Corporate managers are expected to make corporate decisions that are in the best interest of:
A) top corporate management.
B) the corporation's board of directors.
C) the corporation's shareholders.
D)all corporate employees.
Answer: C
Q2) A block holder is commonly defined as an investor who:
A) owns 5 percent or more of a firm's outstanding shares.
B) invests in more than one firm within the same industry.
C) is another corporation.
D)is also one of the firm's managers or directors.
Answer: A
Q3) What two major decisions are made by financial managers?
Answer: Financial management can be broken down into (1) the investment, or capital budgeting, decision and (2) the financing decision. The firm has to decide (1) how much to invest and which real assets to invest in and (2) how to raise the necessary cash.
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3
Chapter 2: Financial Markets and Institutions
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Q1) What are the key differences between a financial intermediary and a financial institution?
Answer: Financial intermediaries such as mutual funds and pension funds pool and invest savings in financial assets. Financial institutions such as banks or insurance companies raise money in various ways-for example, by accepting deposits or selling insurance policies. They not only invest in securities but also lend directly to businesses. They also provide various other financial services such as payment and risk management services.
Q2) The cost of capital is the minimum acceptable rate of return for capital investment.
A)True
B)False
Answer: True
Q3) A primary market would be utilized when:
A) investors buy or sell existing securities.
B) shares of common stock are exchanged.
C) securities are initially issued.
D)a commission must be paid on the transaction.
Answer: C
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4
Chapter 3: Accounting and Finance
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Q1) What is the marginal tax rate for a corporation with $60,000 of taxable income and an average tax rate of 18% if the next-lowest marginal tax rate of 15% covers taxable incomes up to $50,000?
A) 15%
B) 33%
C) 18%
D)25%
Answer: D
Q2) An increase in the accounts receivable balance increases the cash flow of a firm.
A)True
B)False
Answer: False
Q3) Based on generally accepted accounting principles, assets are recorded on the balance at their current market value.
A)True
B)False
Answer: False
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Chapter 4: Measuring Corporate Performance
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Q1) In each of the following cases, explain briefly which of the two companies is likely to be characterized by the higher ratio.
a. Debt-equity ratio: an electronics store or a tour operator
b. Payout ratio: BigBookstore or HomeRobots
c. Ratio of sales to assets: a restaurant or a car rental company
d. Average collection period: The Power Company or Joe's FastFood
Q2) A firm's after-tax operating income was $1,000,000 in 2013. It started the year with a total capitalization of $8,000,000 and ended the year with a total capitalization of $9,000,000. The additional capital raised during 2013 started to affect the operating income in 2014. Which value best represents the return on capital for 2013?
A) 12.5%
B) 11.8%
C) 11.1%
D)10.0%
Q3) A deficiency of the standard measures of liquidity is that the measures:
A) ignore a firm's reserve borrowing capacity.
B) fail to include accounts receivable as an asset.
C) give inventories equal weighting in the quick ratio.
D)do not include the current portions of long-term debt.
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Chapter 5: The Time Value of Money
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Q1) Given a set future value, which of the following will contribute to a lower present value?
A) Higher discount rate
B) Fewer time periods
C) Less frequent discounting
D)Lower discount factor
Q2) How much interest will be earned in the next year on an investment paying 12% compounded annually if $100 was just credited to the account for interest?
A) $88
B) $100
C) $112
D)$200
Q3) Assume the total expense for your current year in college equals $20,000. How much would your parents have needed to invest 21 years ago in an account paying 8% compounded annually to cover this amount?
A) $952.46
B) $1,600.00
C) $1,728.08
D)$3,973.11
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Chapter 6: Valuing Bonds
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Q1) When the market interest rate exceeds the coupon rate, bonds sell for less than face value to provide enough compensation to investors.
A)True
B)False
Q2) Describe two bond characteristics that increase a bond's price sensitivity to changes in market rates of interest.
Q3) An investor buys a 10-year, 7% coupon bond for $1,050, holds it for 1 year, and then sells it for $1,040. What was the investor's rate of return?
A) 5.71%
B) 6.00%
C) 6.67%
D)7.00%
Q4) If a bond offers an investor 11% in nominal return during a year in which the rate of inflation is 4%, then the investor's real return is:
A) 6.73%.
B) 6.31%.
C) 15.44%.
D)10.56%.
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8
Chapter 7: Valuing Stocks
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Q1) If it proves possible to make abnormal profits based on information regarding past stock prices, then the market is:
A) weak-form efficient.
B) not weak-form efficient.
C) semistrong-form efficient.
D)strong-form efficient.
Q2) What proportion of earnings is being plowed back into the firm if the sustainable growth rate is 8% and the firm's ROE is 20%?
A) 60%
B) 80%
C) 20%
D)40%
Q3) What is the minimum amount shareholders should expect to receive in the event of a complete corporate liquidation?
A) Market value of equity
B) Book value of equity
C) Zero
D)Shareholders may be required to pay to be liquidated.
Q4) How does competition among investors lead to efficient markets?
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Chapter 8: Net Present Value and Other Investment Criteria
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Q1) When projects are mutually exclusive, selection should be made according to the project with the:
A) longer life.
B) larger initial size.
C) highest IRR.
D)highest NPV.
Q2) The use of NPV as an investment criterion is said to be more reliable than using IRR. Discuss potential problems with the use of IRR.
Q3) Projects with an NPV of zero decrease shareholders' wealth by the cost of the project.
A)True
B)False
Q4) What is the profitability index for a project costing $40,000 and returning $15,000 annually for 4 years at an opportunity cost of capital of 12%?
A) 0.139
B) 0.320
C) 0.500
D)0.861
Q5) Why might a firm want to impose soft capital rationing?
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Chapter 9: Using Discounted Cash-Flow Analysis to Make Investment Decisions
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Q1) What effect is expected at the end of the life of a project that initially required a $20,000 increase in net working capital?
A) The $20,000 must now be paid by the firm.
B) The firm receives a $20,000 cash inflow.
C) Taxable income is reduced by $20,000.
D)No effects are expected because the $20,000 is now a sunk cost.
Q2) The present value of the total depreciation tax shield will be higher when an asset uses MACRS than when depreciated straight-line.
A)True
B)False
Q3) If the adoption of a new product will reduce the sales of an existing product, then the projected sales on the pro forma statement should:
A) reflect only the sales of the new product.
B) include only the reduction amount.
C) equal the incremental increase in total sales.
D)be adjusted upward by the reduction amount.
Q4) Sunk costs remain the same whether or not you accept the project.
A)True
B)False
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Chapter 10: Project Analysis
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Q1) The strategic planning portion of the capital budgeting process is essentially a "bottom-up" process.
A)True
B)False
Q2) The accounting break-even point for a firm is a function of its:
A) net cash flows and depreciation expense.
B) fixed costs and gross profit on each sale.
C) variable costs and tax rate.
D)revenues and fixed costs.
Q3) "What-if" questions ask what will happen to a project in various circumstances.
A)True
B)False
Q4) One characteristic of simulation analysis is that:
A) it allows only one variable at a time to change.
B) it limits variation to only a few more likely combinations.
C) many variations are analyzed regardless of their likelihood of occurrence.
D)it identifies the variable that has the greatest effect on a project's value.
Q5) Briefly describe several factors that increase the difficulty in selecting appropriate capital budgeting proposals.
Page 12
Q6) Why is managerial flexibility important in capital budgeting?
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Chapter 11: Introduction to Risk, Return, and the Opportunity
Cost of Capital
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Q1) The fact that historical returns on Treasury bills are less volatile than common stock returns indicates that:
A) the variance of Treasury bill returns is zero.
B) the standard deviation of Treasury bill returns is negative.
C) the real return on Treasury bills has been negative.
D)common stocks should offer a higher return than Treasury bills.
Q2) Discuss the concept of a "negative risk asset."
Q3) Historically speaking, the market risk premium in Italy has been higher than that of the United States.
A)True
B)False
Q4) Although Standard and Poor's Composite Index contains a limited number of U.S. publicly traded stocks, the Index represents:
A) all stocks in the industrial sector.
B) all stocks priced at $50 a share or more.
C) approximately 50% of U.S. stocks traded, in market value.
D)approximately 75% of U.S. stocks traded, in market value.
Q5) Discuss the statement, "Only market risk matters to a diversified investor."
Q6) When you compute standard deviation, what type of risk are you measuring?
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Chapter 12: Risk, Return, and Capital Budgeting
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Q1) You want to develop a portfolio containing U.S. Treasury bills and two stocks that is equally as risky as the market. The securities will be equally weighted. If the beta of the first stock is 1.23, what does the beta of the second stock have to be?
A) 0.77
B) 1.23
C) 0.23
D)1.77
Q2) The project cost of capital depends on the risk of the company undertaking the project.
A)True B)False
Q3) If a security plots below the security market line, it is:
A) ignoring all of the security's unique risk.
B) underpriced, a situation that should be temporary.
C) offering too little return to justify its risk.
D)a defensive security, which expects to offer lower returns.
Q4) Diversification decreases the variability of both unique and market risk.
A)True B)False
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Chapter 13: The Weighted-Average Cost of Capital and Company Valuation
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Q1) For most healthy firms, the YTM on their bonds is the rate of return investors expect from holding their bonds to maturity.
A)True
B)False
Q2) What happens when the capital structure of a firm changes?
Q3) Capital structure decisions refer to the:
A) dividend yield of the firm's stock.
B) blend of equity and debt used by the firm.
C) capital gains available on the firm's stock.
D)maturity date for the firm's securities.
Q4) Should a project be accepted if it offers an annual after-tax cash flow of $1,250,000 indefinitely, costs $10 million, is riskier than the firm's average projects, and the firm's WACC is 12.5%?
A) Yes, since the project's NPV is positive.
B) Yes, since a zero NPV indicates marginal acceptability.
C) No, since the project's NPV is zero.
D)No, since the project's NPV is negative.
Q5) How should the weighted-average cost of capital be applied to projects that are not average-risk projects?
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Chapter 14: Introduction to Corporate Financing
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Q1) Preferred stock dividends:
A) have preference over bond interest payments.
B) are guaranteed to be paid at least annually.
C) are excluded from the taxable income of their recipients.
D)have priority over common stock dividends.
Q2) Differences in classes of stock often appear in their voting rights.
A)True
B)False
Q3) One way in which control of a corporation can be removed from the current board of directors is to:
A) take away the directors' stock.
B) give voting power to management.
C) remove the Board's voting power.
D)fight a proxy contest.
Q4) To state that financing at current market terms is a zero-NPV transaction indicates that:
A) firms should avoid these methods of financing.
B) there is no cost involved in the financing.
C) the market has not set financing terms correctly.
D)there are no "bargains" when financing at current terms.
Page 16
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Chapter 15: How Corporations Raise Venture Capital and Issue Securities
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Q1) In return for providing funds, venture capitalists generally require:
A) collateral equal in value to the funds provided.
B) first right to all of the firm's assets.
C) an equity position in the firm.
D)ownership of the entire firm.
Q2) The winner's curse theory assumes that the informed investor receives the majority of the underpriced IPOs.
A)True
B)False
Q3) A consequence of the Sarbanes-Oxley Act has been a decreased reporting burden on small public companies and a decrease in the number of companies reverting to private ownership.
A)True
B)False
Q4) Second stage financing:
A) involves a substantial increase in leverage.
B) immediately follows first-stage financing for every new business.
C) may involve issuing additional shares of stock.
D)occurs when the company is in danger of bankruptcy.
Page 17
Q5) Discuss the functions conducted by security underwriters.
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Chapter 16: Debt Policy
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Q1) When asked about key factors of debt policy, financial managers commonly mention the tax advantage of debt and the importance of maintaining their credit rating.
A)True
B)False
Q2) MM's proposition I, or the debt-irrelevance proposition, states that the value of a firm is unaffected by its capital structure.
A)True
B)False
Q3) Which one of the following lists presents the order of financing from most preferred to least preferred according to the pecking-order theory?
A) Debt issue, stock issue, internally generated funds
B) Internally generated funds, debt issue, stock issue
C) Stock issue, internally generated funds, debt issue
D)Internally generated funds, stock issue, debt issue
Q4) According to MM, restructuring the firm will not change its overall value.
A)True
B)False
Q5) Is there a rule for finding optimal capital structure?
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Chapter 17: Payout Policy
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Q1) Which one of the following is correct for a firm with $400,000 in net earnings, 50,000 shares, and a 30% payout ratio?
A) Retained earnings will increase by $120,000.
B) Each share will receive a $1.20 dividend.
C) $120,000 will be spent on new investments.
D)The dividend per share will be $2.40.
Q2) Compare the after-tax returns for a corporation that invests in preferred stock with a 12% dividend versus a common stock with no dividend but a 16% capital gain. The corporation's tax rate is 35%. The:
A) common stock returns 2.60% more than the preferred.
B) preferred stock returns 0.34% more than the common.
C) common stock returns 2.32% more than the preferred.
D)returns are equal on an after-tax basis.
Q3) Both a stock split and a stock dividend will result in an increase in:
A) the number of shares outstanding.
B) the market value of the firm.
C) the total assets of the firm.
D)both the number of shares outstanding and the total assets of the firm.
Q4) Discuss the concept of dividend signaling.
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Chapter 18: Long-Term Financial Planning
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Q1) Which effort will help a firm boost its internal growth rate?
A) Plowing back a low proportion of its earnings
B) Achieving a high return on equity
C) Decreasing reinvested earnings
D)Maintaining a low sales-to-total assets ratio
Q2) Which one of the following is not an output of a financial plan?
A) Financial ratios
B) Pro forma statements
C) Sources and uses of cash statement
D)Sales forecasts
Q3) A financial plan:
A) is generally considered to be a useless exercise due to unforeseen events.
B) should include all possible contingencies.
C) provides a basis for evaluating future performance.
D)should always be based on the worst-case scenario.
Q4) If the projected growth rate is smaller than the firm's sustainable growth rate:
A) it should increase its projected growth rate.
B) the firm will be required to decrease its plowback ratio.
C) its debt-equity ratio will decrease.
D)the firm will be required to increase borrowing.
Page 20
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Chapter 19: Short-Term Financial Planning
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Q1) What is the accounts payable period given annual sales = $1,200,000, annual cost of goods sold = $700,000, average accounts payable = $105,000?
A) 31.94 days
B) 54.75 days
C) 179.58 days
D)212.92 days
Q2) What happens to a firm whose uses of cash exceed its sources of cash during an accounting period?
A) It has a loss of net working capital.
B) It declares a net loss on the income statement.
C) It experiences a decrease in sales.
D)It experiences a decrease in its cash balance.
Q3) Banks will not usually lend the full value of the assets that are used as security. The safety margin is likely to be even larger in the case of loans that are secured by inventory.
A)True
B)False
Q4) What are some of the major sources of short-term financing and how are interest rates commonly quoted on these types of loans?
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Chapter 20: Working Capital Management
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Q1) An aging schedule illustrates the relationship between:
A) the time history with a customer and the number of repeat sales.
B) the average sale size and profitability over time.
C) customer ages and the average size of sales.
D)an accounts receivable and its time outstanding.
Q2) A corporation has excess cash that does not appear to be needed for several months. How can it evaluate the differences between parking the funds in commercial paper versus repurchase agreements?
Q3) Higher Z scores from a multiple discriminate analysis indicate a:
A) higher risk of bankruptcy.
B) lower degree of creditworthiness.
C) lower amount of working capital.
D)higher degree of solvency.
Q4) As the number of inventory orders per year increases, the total order costs decrease.
A)True
B)False
Q5) Determine the break-even probability of collection for the following seller: $2,000 average invoice, 64% costs, 1% per month opportunity cost of capital. Assume all dollar values are present values.
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Chapter 21: Mergers, Acquisitions, and Corporate Control
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Q1) If Georgia Pacific (lumber products) were to acquire a national homebuilding firm, the combination would be termed a:
A) horizontal merger.
B) vertical merger.
C) conglomerate merger.
D)spin-off by the national homebuilding firm.
Q2) A merger adds value by creating synergies. Which one of these is not a possible source of synergy?
A) Economies of scale
B) Economies of vertical integration
C) Combined complementary resources
D)Diversification
Q3) Evidence shows that investors will generally pay a premium for diversified firms, thus firms should merge for this reason.
A)True
B)False
Q4) How should the gains and costs of mergers to the acquiring firm be measured?
Q5) Describe the basic differences between mergers, leveraged buyouts, management buyouts, divestitures, and spin-offs.
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Chapter 22: International Financial Management
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Q1) Consider the following spot exchange rates: $1.60/£, ¥105/$, 1.6/$, and L2,020/$. Which one of the following prices for 1 troy ounce of gold seems to violate the law of one price if gold sells for $290 per troy ounce in the United States?
A) £181.25
B) ¥30,450
C) 405
D)L585,800
Q2) Why should interest rate parity mean that the forward premium should equal the interest rate differential between countries?
Q3) The following table shows the price of a Starbuck's tall latte coffee in different locations expressed in local currencies and converted into dollars using the spot rate of exchange. For example, a tall latte in London costs £1.90; at an exchange rate of $1.989 per pound, this is equivalent to a price of £1.90 × $1.989/£ = $3.78. This is 24% higher than the cost of a similar coffee in New York; for the costs to be equal, the pound would need to depreciate against the dollar.
Q4) You can purchase a futures contract on any currency.
A)True
B)False
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Chapter 23: Options
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Q1) The value of both call and put options increases as the variability of the stock price decreases.
A)True
B)False
Q2) Calculate the profit per share for an investor that exercises a put option with a strike price of $60 when the stock is selling for $46 and the premium for the put option was $4.
A) -$14
B) -$10
C) $10
D)$18
Q3) The value of a callable bond equals the value of a straight bond:
A) plus the value of the bondholder's call option.
B) minus the value of the bondholder's call option.
C) plus the value of the issuer's call option.
D)minus the value of the issuer's call option.
Q4) Convertible bonds give the investor the option to buy the firm's stock in exchange for the value of the underlying bond.
A)True
B)False
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Chapter 24: Risk Management
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Q1) While private individuals and firms can hedge risks using options, governments are forbidden from doing so.
A)True
B)False
Q2) Interest rate swaps allow both counterparties to:
A) reduce interest expenses.
B) avoid repayment of the notional principal.
C) rearrange their balance sheets.
D)pay a floating rate of interest on their debt.
Q3) A swap is the arrangement by two counterparties to exchange one stream of cash flows for another.
A)True
B)False
Q4) If managers are rational, they will hedge only when they perceive that:
A) prices are headed in an adverse direction.
B) derivative instruments are priced lower than actual value.
C) risk reduction is preferable to higher potential profits.
D)they can increase their profitability by doing so.
Q5) How can options, futures, and forward contracts be used to devise simple hedging strategies?
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