Finance Essentials
Final Test Solutions
Course Introduction
Finance Essentials provides a comprehensive introduction to the fundamental principles of finance, focusing on key concepts such as time value of money, risk and return, financial statement analysis, and the basics of capital budgeting. This course explores the decision-making processes used by individuals and organizations to allocate resources efficiently under conditions of uncertainty. Students will gain foundational knowledge in managing personal and corporate finance, understanding financial markets and instruments, and applying analytical tools for sound financial planning and investment. By the end of the course, participants will have developed essential skills to make informed financial decisions in various professional and personal contexts.
Recommended Textbook Fundamentals of Corporate Finance Third Canadian Edition by Jonathan Berk
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Chapter 1: Corporate Finance and the Financial Manager
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Questions
Q1) Kuljeet owns 20% of the stock of the Flin Flon Corporation.The tax rate on dividend income is 15%.If Flin Flon makes a dividend payment of $2,000,000 paid proportionally to its shareholders,how much of this amount would Kuljeet receive after taxes?
A)$450,000
B)$300,000
C)$60,000
D)$340,000
E)$400,000
Answer: D
Q2) Raising new capital by issuing bonds is an example of a commercial banking activity.
A)True
B)False
Answer: False
Q3) What are the main differences between the TSX and the TSX Venture Exchange?
Answer: The TSX has more stringent listing standards than the TSX Venture Exchange,and bid-ask spreads tend to be lower.The TSX Venture Exchange is an exchange for relatively small company stocks.
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Chapter 2: Introduction to Financial Statement Analysis
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Q1) The above diagram shows a statement of financial position for a certain company.All quantities shown are in millions of dollars.If the company has 4 million shares outstanding,and these shares are trading at a price of $8.24 per share,what does this tell you about how investors view this firm's book value?
A)Investors consider that the firm's market value is worth very much less than its book value.
B)Investors consider that the firm's market value is worth less than its book value.
C)Investors consider that the firm's market value and its book value are roughly equivalent.
D)Investors consider that the firm's market value is worth more than its book value.
E)Investors consider that the firm's market value is worth much more than its book value. Answer: C
Q2) Price-earnings ratios tend to be high for fast-growing firms.
A)True
B)False
Answer: True
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Chapter 3: The Valuation Principle: the Foundation of Financial Decision Making
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Q1) Like other metals,uranium 308 is traded in competitive markets like the New York Metals Exchange.Which of the following would most likely value a given weight of uranium 308 the most?
A)a power station that uses uranium 308 to produce electrical energy
B)a metals trader who stockpiles and sells actual physical quantities of uranium 308
C)a speculator who buys and sells uranium 308 on the market without ever using the metal
D)a uranium mining company
E)All buyers and sellers would have the same value for 250 pounds of uranium. Answer: E
Q2) What is the future value (FV)of $72,000 in 25 years,assuming the interest rate is 5.5% per year?
A)$1.9 million
B)$274,564
C)$171,000
D)$1.8 million
E)$144,000
Answer: B
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Chapter 4: The Time Value of Money
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Q1) An investor can invest $1000 at the start of a certain year,then $1000 the end of that year and the next year in a certain business.The business guarantees that the investor will receive a payment at the end of the year in five years.What is the future value (FV)of that payment if the investor is to break even,given that the discount rate over those five years is 6% per year?
A)$2002
B)$2681
C)$3000
D)$3792
E)$3370
Q2) Suppose the current interest rate is 8.5%,what is the future value of a $15 million investment in 10 years?
A)$16.275 million
B)$33.915 million
C)$17.858 million
D)$150 million
E)$15 million
Q3) In terms of present value (PV),how much will Joe receive for selling the family business?
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Chapter 5: Interest Rates
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Q1) The term "opportunity" in opportunity cost of capital comes from the fact that any worthwhile opportunity for investment will have a cost: the risk to the capital invested. A)True
B)False
Q2) What is the general relationship between the absolute values of APR and EAR for an investment?
Q3) Consider an investment that pays $1000 certain at the end of each of the next four years.If the investment costs $3,500 and has a net present value (NPV)of $74.26,then the four year risk-free interest rate is closest to:
A)4.5%
B)4.58%
C)4.55%
D)4.53%
E)5.0%
Q4) How are interest and return of principal handled in an amortizing loan payment?
Q5) Is it possible to analyze cash flows that occur in time intervals that are not exactly equal to a year?
Q6) What is a mortgage?
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Chapter 6: Bonds
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Q1) How much will the coupon payments be of a 30-year $10,000 bond with a 4.5% coupon rate and semi-annual payments?
A)$30
B)$225
C)$350
D)$450
E)$45
Q2) A corporate bond which receives a BBB rating from Standard and Poor's is considered
A)a junk bond.
B)an investment grade bond.
C)a defaulted bond.
D)a high-yield bond.
E)a speculative bond
Q3) Why is the yield of bonds with credit risk higher than that of otherwise identical default-free bonds?
Q4) A bond is said to mature on the date when the issuer repays its notional value.
A)True
B)False
Q5) Why do bond prices fall as interest rates rise?
Page 8
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Chapter 7: Valuing Stocks
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Q1) Several methods should be used to provide an estimate of a stock's value since no single method provides a definitive value.
A)True
B)False
Q2) Adelaide Industries expects to have earnings per share of $3.20 in the coming year.Adelaide has a return on new investment of 11%.If the firm's dividend payout rate is 60%,and its equity cost of capital is 8%,what is the value of Adelaide's stock?
A)$24.00
B)$53.33
C)$40.00
D)$88.89
E)$91.43
Q3) The ownership in a corporation is divided into shares of stock,which carry rights to share in the profits of the firm through future dividend payments.
A)True
B)False
Q4) Why is the disposition effect costly from a tax perspective?
Q5) What are the major limitations of valuation using multiples?
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Chapter 8: Investment Decision Rules
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Q1) What is a safe method to use when confronted with mutually exclusive projects?
Q2) What is the IRR for this project?
A)4.59%
B)8.63%
C)15.91%
D)21.86%
E)44.63%
Q3) Which of the following decision rules might best be used as a supplement to net present value (NPV)by a firm that favours liquidity?
A)profitability index
B)IRR
C)equivalent annual annuity
D)payback period
E)incremental IRR
Q4) Which of the following formulas regarding net present value (NPV)is correct?
A)NPV + PV(benefits)= PV(Cost)
B)NPV - PV(costs)= PV(benefits)
C)NPV = PV(all project cash flows)
D)NPV = PV(benefits)+ PV(costs)
E)NPV -PV(benefits)- PV(costs)= 0
Page 10
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Chapter 9: Fundamentals of Capital Budgeting
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Q1) Visby Rides,a livery car company,is considering buying some new luxury cars.After extensive research,they come up with the above estimates of free cash flow from this project.The cars belong to asset class 10 and have a capital cost allowance (CCA)rate of 30%.What is the net present value (NPV)of the project,given that the cost of capital is 10%,and the company faces a marginal tax rate of 25%?
A)$66,373
B)$78,564
C)$118,580
D)$151,142
E)$167,549
Q2) A maker of computer games expects to sell 500,000 games at a price of $49 per game.These units cost $12 to produce.Selling,general,and administrative expenses are $1.2 million and the CCA deduction is $280,000.What is the EBIT break-even point for the number of games sold in this case?
A)24,865
B)30,192
C)30,204
D)40,000
E)44,740
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Chapter 10: Risk and Return in Capital Markets
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Q1) Assume that you purchased Ford Motor Company stock at the closing price on December 31,2004 and sold it after the dividend had been paid at the closing price on January 26,2005.Your dividend yield for this period is closest to:
A)-8.15%
B)-8.80%
C)0.70%
D)0.75%
E)1.25%
Q2) The S&P TSX Composite index delivered a return of 14.48%,24.13%,17.26% and 9.83% over four successive years.What is the arithmetic average annual return per year?
A)16.43%
B)20.8%
C)14.48%
D)18.54%
E)15.96%
Q3) What are the two components of realized return from a stock investment?
Q4) Is volatility a reasonable measure of risk when evaluating the investment in a single stock?
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Page 12
Chapter 11: Systematic Risk and the Equity Risk Premium
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Q1) The volatility of Home Depot share prices is 30% and that of General Motors shares is 30%.When I hold both stocks in my portfolio,the overall volatility of the portfolio is:
A)30%
B)26%
C)28%
D)20%
E)More information needed.
Q2) A portfolio has three stocks - 200 shares of Yahoo (YHOO),100 Shares of General Motors (GM),and 50 shares of Standard and Poor's Index Fund (SPY).If the price of YHOO is $30,the price of GM is $30,and the price of SPY is $130,calculate the portfolio weight of YHOO and GM.
A)38.7%,19.4%
B)21.3%,35.2%
C)11.7%,12.7%
D)36.2%,21.6%
E)57.1%,28.6%
Q3) What role does the correlation of two assets play in computation of the expected return of the two asset portfolio?
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Chapter 12: Determining the Cost of Capital
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Q1) Why do we use leverage if it increases the risk of a firm?
Q2) New Flyer Industries has decided to expand its production of hybrid transit buses.The firm expects incremental cash flows of $20 million in the first year,growing by 2% every year thereafter.The upfront cost of the expansion is $95 million,and there are additional issuance costs for external financing of $12 million.If the New Flyer's WACC is 6.2%,what is the NPV of the project?
A)$228 million
B)$357 million
C)$381 million
D)$216 million
E)$369 million
Q3) Your estimate of the market risk premium is 6%.The risk-free rate of return is 4.5% and General Motors has a beta of 1.6.What is General Motors' cost of equity capital?
A)14.1%
Q4) Why do we use market values rather than book values in calculation of WACC?
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Chapter 13: Risk and the Pricing of Options
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Q1) What are American options?
Q2) When a company writes a call option on new stock in the company,it is called a: A)convertible bond.
B)put option.
C)stock option.
D)warrant.
E)stock.
Q3) A one-year European call option on ABX corporation with a strike price of $50 is currently trading for $1.45,and a one-year European put option on ABX with the same strike price is currently trading for $6.22.If the stock pays a one-time dividend of $1.50 in exactly 6 months,and the risk-free rate is 8% per year,what is the current price of ABX stock?
A)$42.97
B)$43.03
C)$49.63
D)$52.53
E)$55.41
Q4) What are European options?
Q5) What effect does volatility of the underlying asset have on the price of the option?
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Chapter 14: Raising Equity Capital
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Q1) Melanie founded her company using $250,000 of her own money,issuing herself 100,000 shares of stock.An angel investor bought an additional 50,000 shares for $350,000.She now sells another 75,000 shares to a venture capitalist for $600,000.What is the post-money valuation for the company?
A)$600,000
B)$1.2 million
C)$950,000
D)$1.8 million
E)$1 million
Q2) What is the general long-run performance of an IPO?
Q3) In an IPO,an option that allows the underwriter to issue more stock,usually amounting to 15% of the original offer size,at the IPO offer price,is called a(n):
A)final prospectus.
B)lockup.
C)IPO overdraft.
D)red herring.
E)greenshoe provision.
Q4) What are the four IPO puzzles?
Q5) What are some of the advantages of going public?
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Chapter 15: Debt Financing
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Q1) What kind of unsecured corporate debt has a maturity of greater than ten years?
A)mortgage bonds
B)asset-back bonds
C)term loans
D)notes
E)debentures
Q2) A callable bond will typically have a(n)________ yield than an otherwise identical bond without a call feature because ________.
A)lower,the firm loses flexibility with a callable bond
B)higher,the firm loses flexibility with a callable bond
C)lower,the option to call a bond is valuable
D)higher,the option to call a bond is valuable
E)identical,the call feature is without value
Q3) How might equity holders benefit from bond covenants?
Q4) What kind of corporate debt must be secured by real property?
A)mortgage bonds
B)notes
C)asset-backed bonds
D)debentures
E)unsecured debt
17
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Chapter 16: Capital Structure
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Q1) Suppose Blank Company has only one project,as forecast above,and an unlevered cost of equity of 8%.If the company borrows $10,000 at 5% to make the investment,what is the return to equity holders if demand is weak?
A)8.0%
B)-37.5%
C)-58.6%
D)-35.3%
E)-12.5%
Q2) A firm requires an investment of $30,000 and borrows $20,000 at 7%.If the return on equity is 15% and the tax rate is 30%,what is the firm's WACC?
A)8.27%
B)9.13%
C)10.4%
D)8.91%
E)9.67%
Q3) Equity in a firm with no debt is called unlevered equity.
A)True
B)False
Q4) What is the capital structure of a firm?
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Chapter 17: Payout Policy
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Q1) Collingwood Costumes is an all-equity firm with 80 million shares outstanding.Collingwood has $75 million in cash,and expects future free cash flows of $15 million per year.The cash can be used to expand the firm's future operations,increasing future free cash flows to $16 million per year.If Collingwood's cost of capital for the expansion is 10%,what will be the difference in the firm's share price compared to using the cash for a share repurchase?
A)Share price is $0.12 higher with expansion.
B)Share price is $0.12 higher with repurchase.
C)Share price is the same with both options.
D)Share price is $0.81 higher with expansion.
E)Share price is $0.81 higher with repurchase.
Q2) BC Brewery has a current share price of $37.50,and has announced a dividend payment of $1.25 per share.Assuming perfect capital markets,what should the price of BC Brewery be once the stock begins trading ex-dividend?
A)$37.50
B)$36.25
C)$38.75
D)$35
E)$38
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Chapter 18: Financial Modelling and Pro Forma Analysis
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Q1) The percent of sales method relies on the fact that capacity increases are ________,even though in practice such increases are ________.
A)incremental,lumpy
B)incremental,incremental
C)lumpy,incremental
D)lumpy,lumpy
E)incremental,smooth
Q2) Compute the value of a firm with free cash flows of $9000,$7000,and $5000 over the next three years,a terminal firm value of $30,000 after three years,and the unlevered cost of capital is 10%.Assume that the interest rate tax shield is zero.
A)$36,109
B)$37,098
C)$38,745
D)$40,263
E)$42,772
Q3) What is the major shortcoming of the percent of sales method for firms experiencing rapid growth?
Q4) What is minimum required cash?
Q5) What are a firm's options when it generates more cash than planned?
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Chapter 19: Working Capital Management
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Q1) What should a firm do after establishing a credit policy?
A)Decide what should be done for those customers who do not pay their accounts on time.
B)Monitor its accounts receivable to analyze whether its credit policy is effective.
C)Decide on the length of the period before payment must be made.
D)Determine what percent of monthly sales are collected in the month after that sale.
E)Encourage as many customers as possible to use credit.
Q2) Cooper Copper,a manufacturer of copper piping,buys copper on credit on March 10.It processes this copper to make pipes on March 25 and pays cash for the copper on April 9.On April 14 it sells the pipes to a construction company,and on May 14 receives cash payment for this sale.What is the length of the cash cycle in this case?
A)15 days
B)20 days
C)65 days
D)30 days
E)35 days
Q3) What is the discount period?
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Chapter 20: Short-Term Financial Planning
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Q1) Bradford Maintenance,a firm that provides lawn care services,has some seasonal variations in its cash flow needs,since much of the demand for its services is in the summer months.It uses long-term sources of funds to finance its assets such as its fleet of vehicles and lawn-care equipment and for the permanent funds that it must have at all times.For its peak seasonal needs it uses some short-term debt.What best describes the financial policy being followed by Bradford?
A)matching
B)conservative
C)integrated
D)seasonal
E)aggressive
Q2) Which of the following firms is likely to have the highest short-term financing needs?
A)a pharmaceutical manufacturer
B)a grocery store
C)an electric utility
D)a toy store
E)an internet service provider
Q3) How does seasonality lead to short-term financing needs?
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Chapter 21: Risk Management
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Q1) A firm can borrow at fixed AA rates plus 1% for long-term loans.If it swaps its long-term payments so that it receives the fixed AA rate and pays a AA floating rate,what is the rate of interest on its borrowing if the floating rate is r%?
A)r + 1%
B)r - 1%
C)r%
D)1%
E)2%
Q2) Marking to market for a futures contract will ensure that the sum of the daily changes to the margin account will equal the difference between the original contract price and the price at the end of the contract.
A)True
B)False
Q3) How does insurance allow firms to reduce issuance costs?
Q4) A buyer's margin account must always have a daily balance sufficient to cover at least one day's potential loss.
A)True
B)False
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Chapter 22: International Corporate Finance
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Q1) The spot exchange rate for the Mexican peso is 0.114 CAD/MXN,and the one-year forward rate is 0.104 CAD/MXN.If the one-year Canadian interest rate is 3.5% and the one-year Mexican interest rate is 9.0%,what is the credit spread on Mexican one-year bonds?
A)4.5%
B)5.5%
C)1%
D)3.5%
E)5%
Q2) The ________ market is where currencies are traded twenty-four hours a day and with a large turnover.
A)foreign exchange
B)bond
C)stock
D)interbank
E)derivatives
Q3) What is covered interest parity?
Q4) What is the best explanation for the existence of currency swaps,and how do they mitigate exchange rate risk?
Q5) What are internationally integrated capital markets?
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Chapter 23: Leasing
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Q1) If your firm's borrowing cost is 3% and the tax rate is 45%,what is the NPV of buying and leasing?
A)$5,422
B)$14,694
C)$11,620
D)$15,069
E)$20,479
Q2) What will Luther's balance sheet look like if they acquire the new fleet of delivery trucks using an operating lease?
Q3) A lease in which the lessee receives cash from the sale of the asset and then makes lease payments to retain the use of the asset is called a:
A)sales-type lease.
B)direct lease.
C)sale and leaseback.
D)leveraged lease.
E)synthetic lease.
Q4) For a lease in which the lessor bears the risk of the residual value,why does the lease improve incentives and lower agency costs when the lessor is the manufacturer of the asset?
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Chapter 24: Mergers and Acquisitions
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Q1) The synergies of a merger add so much value to the combined firm that,upon announcement of a merger,the stock prices of both the target and the acquirer increase substantially.
A)True
B)False
Q2) The freezeout tender offer has a significant disadvantage compared to a leveraged buyout because an acquiring corporation must make an all-cash offer.
A)True
B)False
Q3) The acquiring corporation in a merger typically captures the value created by the merger.
A)True
B)False
Q4) What is the major drawback of adopting a poison pill?
Q5) Why does a recapitalization make a firm a less attractive target for a takeover?
Q6) What is the difference between a friendly takeover and a hostile takeover?
Q7) What are synergies?
Q8) What is a conglomerate merger?
Q9) What is a poison pill,and how does it prevent a hostile takeover?
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Chapter 25: Corporate Governance
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Q1) What is a captured board?
Q2) What are some of the negative effects of increasing the sensitivity of managerial pay to firm performance?
Q3) The Smith family has a 62% stake in A company and A company has a 34% stake in B company.Finally,B company has a 29% stake in C company.What percentage ownership does the Smith family have in C company?
A)21%
B)18%
C)10%
D)29%
E)6%
Q4) What is tunnelling?
Q5) Directors who are employees,former employees,or family members of employees are called:
A)managing directors.
B)independent directors.
C)inside directors.
D)grey directors.
E)unelected directors.
Q6) What is the drawback of having more independent directors on the board?
Page 27
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