Financial Management
Exam Answer Key
Course Introduction
Financial Management introduces students to the fundamental principles and practices involved in managing a firm's financial resources. The course covers topics such as financial analysis, planning and forecasting, capital budgeting, risk and return concepts, cost of capital, and working capital management. Students learn how to evaluate investment opportunities, make financing decisions, and understand the impact of financial markets on organizational strategy. Emphasis is placed on developing analytical skills to assess financial health and maximize shareholder value through effective financial decision-making.
Recommended Textbook
Corporate Finance 2nd Canadian by Jonathan Berk
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Chapter 1: The Corporation
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Q1) The Principal-Agent Problem arises
A) because managers have little incentive to work in the interest of shareholders when this means working against their own self-interest.
B) because of the separation of ownership and control in a corporation.
C) Both A and B.
D) None of the above.
Answer: C
Q2) What type of company trades on an organized stock exchange?
A) a limited liability company
B) a private company
C) a crown corporation
D) a public company
Answer: D
Q3) In 2008,the largest stock market by value of shares traded in the world was
A) the London Stock Exchange.
B) the NASDAQ.
C) the American Stock Exchange.
D) the New York Stock Exchange.
Answer: B
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Page 3
Chapter 2: Introduction to Financial Statement Analysis
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Q1) When using the book value of equity,the debt to equity ratio for Luther in 2006 is closest to:
A) 2.21
B) 2.29
C) 2.98
D) 3.03
Answer: B
Q2) Assuming that Luther has no convertible bonds outstanding,then for the year ending December 31,2006 Luther's diluted earnings per share are closest to:
A) $1.01
B) $1.04
C) $1.53
D) $3.92
Answer: A
Q3) If on December 31,2005 Luther has 8 million shares outstanding trading at $15 per share,then what is Luther's market-to-book ratio?
Answer: market-to-book = market value of equity / book value of equity market-to-book = 8 million × $15 / $63.6 = 1.89
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Chapter 3: Arbitrage and Financial Decision Making
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Q1) You have an investment opportunity in Germany that requires an investment of $250,000 today and will produce a cash flow of 208,650 in one year with no risk.Suppose the risk-free rate of interest in Germany is 6% and the current competitive exchange rate is 0.78 to $1.00.What is the NPV of this project? Would you take the project?
A) NPV = 0; No
B) NPV = 2,358; No
C) NPV = 2,358; Yes
D) NPV = 13,650; Yes
Answer: C
Q2) If the risk-free rate of interest (r<sub>f</sub>)is 6%,then you should be indifferent between receiving $250 today or:
A) $235.85 in one year.
B) $250.00 in one year.
C) $265.00 in one year.
D) none of the above.
Answer: C
Q3) The price per share of the ETF in a normal market is:
Answer: Value of ETF = 2 × 79.50 + 3 × 40.00 + 3 × 48.50 = $424.50
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Page 5
Chapter 4: The Time Value of Money
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Q1) How do you calculate (mathematically)the present value of a(n):
(a)perpetuity
(b)annuity
(c)growing perpetuity
(d)growing annuity
Q2) You are looking for a new truck and see the following advertisement."Own a new truck! No money down.Just five easy annual payments of $8000." You know that you can get the same truck from the dealer across town for only $31,120.The interest rate for the deal advertised is closest to:
A) 9%
B) 8%
C) 8.5%
D) 10%
Q3) The future value at retirement (age 65)of your savings is:
Q4) Draw a timeline detailing the cash flows from investment "B."
Q5) Define the following terms:
(a)perpetuity
(b)annuity
(c)growing perpetuity
(d)growing annuity
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Chapter 5: Interest Rates
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Q1) The effective annual rate on your firm's borrowings is closest to:
A) 6.00%
B) 6.24%
C) 6.17%
D) 6.14%
Q2) Which of the following statements is false?
A) An inverted yield curve generally signals an expected decline in future interest rates.
B) An inverted yield curve is often interpreted as a positive forecast for economic growth.
C) All the formulas for computing present values of annuities and perpetuities are based upon discounting all of the cash flows at the same rate.
D) The rate of growth of your purchasing power is determined by the real interest rate.
Q3) The present value of the lease payments for the delivery truck is closest to:
A) $206,900
B) $207,050
C) $207,680
D) $198,420
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Chapter 6: Investment Decision Rules
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Q1) The internal rate of return (IRR)for project Beta is closest to:
A) 25.0%
B) 22.7%
C) 24.5%
D) 22.2%
Q2) The NPV of Larry's three-movie Larry Boy offer is closest to:
A) 3.5 million
B) -1.6 million
C) 1.6 million
D) -1.0 million
Q3) Larry should:
A) Reject the offer because the NPV < 0
B) Accept the offer even though the IRR < 10%, because the NPV > 0
C) Reject the offer because the IRR < 10%
D) Accept the offer because the IRR > 0%
Q4) The payback period for this project is closest to:
A) 2.1 years
B) 3.0 years
C) 2 years
D) 2.2 years
8
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Chapter 7: Fundamentals of Capital Budgeting
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Q1) Firm can make best capital budgeting decision by first computing the free cash flow associated with each alternative and then choosing the alternative with the highest
A) net present value
B) net cash flow
C) payback period
D) profit index
Q2) The incremental EBIT for Shepard Industries in year one is closest to:
A) $360 million
B) $750 million
C) $595 million
D) $510 million
Q3) Money that has been or will be paid regardless of the decision as to whether or not to proceed with the project is A) cannibalization.
B) considered as part of the initial investment in the project.
C) an opportunity cost.
D) a sunk cost.
Q4) Calculate the total Free Cash Flows for each of the three years for the Sisyphean Corporation's new project.
Page 9
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Chapter 8: Valuing Bonds
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Q1) The forward rate for year 3 (the forward rate quoted today for an investment that begins in two years and matures in three years)is closest to:
A) 4.5%
B) 5.0%
C) 5.2%
D) 4.6%
Q2) Which of the four bonds is the least sensitive to a one percent increase in the YTM?
A) Bond A
B) Bond B
C) Bond C
D) Bond D
Q3) What is the price today of a two-year,default-free security with a face value of $1000 and an annual coupon rate of 5.75%? Does this bond trade at a discount,premium,or at par?
Q4) Explain why the expected return of a corporate bond does not equal its yield to maturity?
Q5) Plot the zero-coupon yield curve (for the first five years).
Q6) Compute the yield to maturity for each of the five zero-coupon bonds.
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Chapter 9: Valuing Stocks
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Q1) NoGrowth Industries presently pays an annual dividend of $1.50 per share and it is expected that these dividend payments will continue indefinitely.If NoGrowth's equity cost of capital is 12%,then the value of a share of NoGrowth's stock is closest to:
A) $10.00
B) $15.00
C) $14.00
D) $12.50
Q2) Growing Real Fast Company (GRF)is expected to have a 25 percent growth rate for the next four years (effecting D<sub>1</sub>,D<sub>2</sub>,D<sub>3</sub>,and D<sub>4</sub>).Beginning in year five,the growth rate is expected to drop to 7 percent per year and last indefinitely.If GRF just paid a $2.00 dividend and the appropriate discount rate is 15 percent,then what is the value of a share of GRF?
Q3) Calculate the enterprise value for DM Corporation.
Q4) In the discounted free cash flow model,we assume that A) we are focusing on the present value of all operating cash flows. B) we are focusing on the present value of all investing cash flows. C) we are focusing on the present value of all financing cash flows.
D) we are focusing on the present value of all cash flows in EBIT.
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Page 11
Chapter 10: Capital Markets and the Pricing of Risk
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Q1) Common risk is also called
A) firm-specific risk.
B) unsystematic risk.
C) undiversifiable risk.
D) idiosyncratic risk.
Q2) Independent risk is also called
A) market risk.
B) systematic risk.
C) undiversifiable risk.
D) idiosyncratic risk.
Q3) Suppose an investment is equally likely to have a 35% return or a - 20% return.The variance on the return for this investment is closest to:
A) .151
B) .0378
C) 0
D) .075
Q4) Suppose that you want to use the 10 year historical average return on Microsoft to forecast the expected future return on Microsoft.Calculate the 95% confidence interval for your estimate of the expect return.
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Chapter 11: Optimal Portfolio Choice and the Capital Asset
Pricing Model
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Q1) Which of the following statements is false?
A) Without trading, the portfolio weights will decrease for the stocks in the portfolio whose returns are above the overall portfolio return.
B) The expected return of a portfolio is simply the weighted average of the expected returns of the investments within the portfolio.
C) Portfolio weights add up to 1 so that they represent the way we have divided our money between the different individual investments in the portfolio.
D) A portfolio weight is the fraction of the total investment in the portfolio held in an individual investment in the portfolio.
Q2) The amount of risk that is eliminated in a portfolio depends on the degree to which the stocks face ________ risks and their prices move together.
A) common
B) independent
C) firm-specific
D) unique
Q3) Will adding the precious metals fund improve your portfolio?
Q4) What are three main assumptions underlie the CAPM?
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Chapter 12: Estimating the Cost of Capital
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Q1) Which of the following statements is false?
A) We should be suspicious of beta estimates that are extreme relative to industry norms.
B) When using historical data, there is always the possibility of estimation error.
C) Evidence suggests that betas tend to revert toward zero over time.
D) For stocks, common practice is to use at least two years of weekly return data or five years of monthly return data when estimating beta.
Q2) Debt betas tend to be ________,though they can be significantly higher for risky debt with a ________ credit rating and a ________ maturity.
A) low, high, long
B) low, low, long
C) high, low, long
D) high, high, long
Q3) It is ________ that determines the cost of capital.
A) diversifiable risk
B) non-systematic risk
C) market risk
D) total risk
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Chapter 13: Investor Behaviour and Capital Market
Efficiency
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Q1) Stocks with lower market capitalizations have ________ average returns.This empirical result is called the size effect.
A) higher
B) lower
C) zero
D) weighted
Q2) The alpha for Bernard is closest to:
A) +5%
B) -2%
C) -3%
D) +2%
Q3) Which of the following statements is false?
A) It is not actually necessary to identify the efficient portfolio itself. All that is required is to identify a collection of portfolios from which the efficient portfolio can be constructed.
B) Although we might not be able to identify the efficient portfolio itself, we know some characteristics of the efficient portfolio.
C) An efficient portfolio can be constructed from other diversified portfolios.
D) An efficient portfolio need not be well diversified.
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Chapter 14: Capital Structure in a Perfect Market
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Q1) Consider the following equation: E + D = U = A
The E in this equation represents
A) the value of the firm's equity.
B) the value of the firm's debt.
C) the value of the firm's unlevered equity.
D) the market value of the firm's assets.
Q2) Which of the following statements is false?
A) Holding cash has the opposite effect of leverage on risk and return.
B) We use the market value of the firm's net debt when computing its WACC and unlevered beta to measure the cost of capital and market risk of the firm's business assets.
C) Since the WACC does not change with the use of leverage, the value of the firm's free cash flow evaluated using the WACC does not change, and so the enterprise value of the firm does not depend on its financing choices.
D) Even if the firm's capital structure is more complex, the WACC is calculated by computing the weighted average cost of only the firm's debt and equity.
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?
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Chapter 15: Debt and Taxes
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Q1) If Flagstaff currently maintains a .5 debt to equity ratio,then the value of Flagstaff as a levered firm is closest to:
A) $114 million
B) $100 million
C) $111 million
D) $140 million
Q2) The present value of KD's interest tax shield is closest to:
A) $130 million
B) $200 million
C) $400 million
D) $70 million
Q3) If Rosewood had no interest expense,its net income would be closest to:
A) $405 million
B) $160 million
C) $450 million
D) $290 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 expected return of MI's debt is closest to:
A) 25.0%
B) 12.5%
C) 5.0%
D) 7.8%
Q2) Which of the following statements is false?
A) Firms with steady, reliable cash flows, such as utility companies, are able to use high levels of debt and still have a very low probability of default.
B) If there were no costs of financial distress, the value of the firm would continue to increase with increasing debt until the interest on the debt exceeds the firm's earnings before interest and taxes and the tax shield is exhausted.
C) The costs of financial distress reduce the value of the levered firm, V<sup>L</sup>. The amount of the reduction decreases with the probability of default, which in turn increases with the level of the debt D.
D) The tradeoff theory states that firms should increase their leverage until it reaches the level D* for which V<sup>L</sup> is maximized.
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Chapter 17: Payout Policy
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Q1) Once the firm has already taken all positive-NPV projects,any additional projects it takes on are ________ investments.
A) zero or positive-NPV
B) positive-NPV
C) zero or negative-NPV
D) zero-NPV
Q2) Assume that you own 4000 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 have preferred that Omicron used the excess cash to pay a special dividend.Detail exactly how you could create a homemade dividend that will provide you with the same combination of cash and stock that you would have received if Omicron paid the special dividend.
Q3) The NPV of Iota's expansion project is closest to:
A) -$110 million
B) -$137.5 million
C) $0
D) $75 million
Q4) Calculate the effective tax disadvantage for retaining cash in 1999,2001,and 2005.
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Page 19
Chapter 18: Capital Budgeting and Valuation With Leverage
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Q1) Which of the following is NOT one of the simplifying assumptions made for the three main methods of capital budgeting?
A) The firm pays out all earnings as dividends.
B) The project has average risk.
C) Corporate taxes are the only market imperfection.
D) The firm's debt-equity ratio is constant.
Q2) Describe three simplifying assumptions that we make in valuing a project
Q3) Which of the following statements is false?
A) In the flow-to-equity valuation method, the cash flows to equity holders are then discounted using the weighted average cost of capital.
B) In the WACC and APV methods, we value a project based on its free cash flow, which is computed ignoring interest and debt payments.
C) In the flow-to-equity (FTE) valuation method, we explicitly calculate the free cash flow available to equity holders taking into account all payments to and from debt holders.
D) The first step in the FTE method is to determine the project's free cash flow to equity (FCFE).
Q4) 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) Assuming that Ideko has a EBITDA multiple of 9.4,then the continuation levered P/E ratio of Ideko in 2010 is closest to:
A) 17.2
B) 14.5
C) 19.0
D) 16.4
Q2) The amount of net working capital for Ideko in 2006 is closest to:
A) $22,750
B) $35,195
C) $30,510
D) $26,420
Q3) What range for the market value of equity for Ideko is implied by the range of P/E multiples for the comparable firms?
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?
Q5) What range for the market value of equity for Ideko is implied by the range of EV/Sales multiples for the comparable firms if Ideko holds $6.5 million of cash in excess of its working capital needs?
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Chapter 20: Financial Options
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Q1) Which of the following statements is false?
A) Because a short position in an option is the other side of a long position, the profits from a short position in an option are just the negative of the profits of a long position.
B) The deeper out-of-the-money the put option is, the less negative its beta, and the higher is its expected return.
C) Although payouts on a long position in an option contract are never negative, the profit from purchasing an option and holding it to expiration could well be negative because the payout at expiration might be less than the initial cost of the option.
D) The put position has a higher return in states with low stock prices; that is, if the stock has a positive beta, the put has a negative beta.
Q2) ________,options on Canadian stocks and bonds were traded on the Montreal Exchange,which was centre of the Canadian Derivatives Exchange.
A) After 1999
B) Before 1973
C) After 2008
D) Before 2008
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Chapter 21: Option Valuation
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Q1) Using risk-neutral probabilities,the calculated price of a one-year call option on KD stock with a strike price of $20 is closest to:
A) $1.45
B) $2.40
C) $2.00
D) $2.15
Q2) The risk-neutral probability of an up state for KD industries is closest to:
A) 37.5%
B) 60.0%
C) 40.0%
D) 62.5%
Q3) Using the binomial pricing model,calculate the price of a two-year put option on Kinston stock with a strike price of $9.
Q4) ________ on a positive beta stock have very large ________ betas,respectively.
A) Calls and puts; negative and positive
B) Calls and puts; positive and negative
C) Puts and calls; positive and negative
D) None of the above
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Chapter 22: Real Options
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Q1) Given the embedded option to sell the plant,the value of your plant will be closest to:
A) $5.0 million
B) $4.0 million
C) $6.5 million
D) $8.0 million
Q2) Mortgage interest rates ________ Government of Canada bond rates because mortgages have ________ that the bonds do not have.
A) are lower than; an abandonment option
B) are higher than; a growth option
C) are lower than; a growth option
D) are higher than; an abandonment option
Q3) The NPV of project B is closest to:
A) $18.10
B) $21.70
C) $24.00
D) $16.90
Q4) Describe the two factors that affect the value of an investment timing option?
Q5) Using the equivalent annual benefit method,which project would you select and why?
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Chapter 23: The Mechanics of Raising Equity Capital
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Q1) Luther Industries currently has 100 million shares of stock outstanding at a price of $25 per share.The company would like to raise money and has announced a rights issue.Every existing shareholder will be sent one right per share of stock that he or she owns.The company plans to require twenty rights to purchase one share at a price of $20 per share.The amount of money that Luther will raise through its rights offering is closest to:
A) $500 million
B) $125 million
C) $100 million
D) $400 million
Q2) What will the proceeds from the IPO be if Luther is selling 1.1 million shares ?
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
Q4) What will the offer price of these shares be if Luther is selling 800,000 shares?
Q5) Based upon the price/revenue ratio,what would be a reasonable value for KD?
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Chapter 24: Debt Financing
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Q1) Which of the following statements is false?
A) When bond yields have increased, by exercising the call on the callable bond and then immediately refinancing, the issuer can lower its borrowing costs.
B) To understand how call provisions affect the price of a bond, we first need to consider when an issuer will exercise its right to call the bond.
C) If the call provision offers a cheaper way to retire the bonds the issuer will forgo the option of purchasing the bonds in the open market and will call the bonds instead.
D) An issuer can always retire one of its bonds early by repurchasing the bond in the open market.
Q2) Treasury securities that are pure discount bonds with original maturities ranging from a few days to 26 weeks are called
A) TIPS.
B) Treasury bonds.
C) Treasury notes.
D) Treasury bills.
Q3) What is the Yield to Maturity (YTM)on this bond?
Q4) What is the Yield to Call (YTC)on this bond?
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Chapter 25: Leasing
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Q1) What will Luther's balance sheet look like if they acquire the new fleet of delivery trucks using a capital lease?
Q2) Under CICA,________ is viewed as a rental for accounting purposes.In this case,the lessee reports the entire lease payment as an operating expense.
A) a capital lease
B) an operating lease
C) a short-term lease
D) a temporary lease
Q3) The CICA distinguishes two types of leases based on the lease terms,and this classification determines the lease's accounting treatment.The two types of leases are
A) fixed leases and variable leases.
B) long-term leases and short-term leases.
C) operating leases and capital leases.
D) temporary leases and permanent leases.
Q4) Calculate the monthly lease payments for a four-year fixed price lease that allows the lessee to buy the bulldozer at the end of the lease for $8,000.
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Chapter 26: Working Capital Management
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Q1) Any ________ in working capital requirements generates a ________ free cash flow that the firm can distribute immediately to shareholders.
A) reduction; negative B) increase; positive C) reduction; positive D) increase; negative
Q2) The ________ the discount percentage offered,the ________ the cost of forgoing the discount. A) lower; greater B) higher; smaller C) higher; greater D) lower; the more expensive
Q3) Describe "just-in-time" inventory management.
Q4) Luther Industries bills its accounts on terms of 2/10,net 30.The firm's accounts receivable include $250,000 that has been outstanding for 10 or fewer days,$375,000 outstanding for 11 to 30 days,$70,000 outstanding for 31 to 40 days,$35,000 outstanding for 41 to 50 days,$20,000 outstanding for 51 to 60 days,and $8,000 outstanding for more than 60 days.Prepare an aging schedule for Luther Industries.
Q5) Calculate the number of days in Luther's Operating Cycle.
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Chapter 27: Short-Term Financial Planning
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Q1) Which of the following statements is false?
A) Bank loans are typically initiated with a promissory note, which is a written statement that indicates the amount of the loan, the date payment is due, and the interest rate.
B) The most straightforward type of bank loan is a single, end-of-period-payment loan.
C) With a fixed interest rate, the specific rate that the bank will charge is stipulated at the time the loan is made.
D) One of the primary sources of short-term financing, especially for small businesses, is the investment bank.
Q2) Financing part or all of the ________ working capital with ________ debt is known as an aggressive financing policy.
A) permanent; long-term
B) permanent; short-term
C) temporary; short-term
D) temporary; long-term
Q3) Calculate the temporary working capital needs for each of the four quarters for Hasbeen Toys.
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Chapter 28: Mergers and Acquisitions
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Q1) Which of the following statements is false?
A) Any acquirer shares received in full or partial exchange for target shares triggers an immediate tax liability for target shareholders.
B) In a friendly takeover, the target board of directors supports the merger, negotiates with potential acquirers, and agrees on a price that is ultimately put to a shareholder vote.
C) How the acquirer pays for the target affects the taxes of both the target shareholders and the combined firm.
D) If the acquirer purchases the target assets directly (rather than the target stock), then it can step up the book value of the target's assets to the purchase price.
Q2) The merger of two companies in the same industry that make products required at different stages of the production cycle is called
A) economies of scope.
B) vertical integration.
C) economies of scale.
D) horizontal integration.
Q3) What is a white knight?
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Chapter 29: Corporate Governance
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Q1) Which of the following statements is false?
A) The Canadian rules require firms to report option grants within ten days of the grant date, which may help prevent further abuses.
B) Studies have found evidence that the practice of timing the release of information to maximize the value of CEO stock options is widespread.
C) Managers have an incentive to manipulate the release of financial forecasts so that good news comes out before options are granted and bad news is delayed until after the options are granted.
D) The factor contributing most to the climb in CEO total compensation for the 1990s was the sharp increase in the value of stock and options granted each year.
Q2) When the different stakeholders in a firm all have their own interests and the interests diverge,we may have ________.
A) a governance issue
B) an effective issue
C) agent issues
D) an efficiency issue
Q3) What is the role of takeovers in corporate governance?
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Chapter 30: Risk Management
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Q1) Insurance allows the firm to exchange a(n)________ future loss for a certain ________ expense.
A) uncertain; upfront
B) certain; upfront
C) uncertain; afterward
D) certain; afterward
Q2) The interest rate sensitivity of a single cash flow ________ with its maturity; the interest rate sensitivity of a stream of cash flows ________ with its duration.
A) decreases; increases
B) increases; decreases
C) decreases; decreases
D) increases; increases
Q3) The risk that the firm will not have,or be able to raise,the cash required to meet the margin calls on its hedges is called
A) liquidity risk.
B) basis risk.
C) commodity price risk.
D) speculation risk.
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) Which of the following statements is false?
A) Differential access to national capital markets is common enough that it provides the best explanation for the existence of currency swaps, which are like the interest rate swap contracts, but with the holder receiving coupons in one currency and paying coupons denominated in a different currency.
B) Currency swaps generally also have final face value payments, also in different currencies.
C) Using a currency swap, a firm can borrow in the market where it has the best access to capital, and then "swap" the coupon and principal payments to whichever currency it would prefer to make payments in.
D) With differential access to national markets, to maximize shareholder value, the firm should raise capital in the foreign market; the method of valuing the foreign project as if it were a domestic project would then provide the correct NPV.
Q2) Suppose the interest rate on Russian government bonds is 7.8%,and the current exchange rate is 26.8 rubles per dollar.If the forward exchange rate is 27.2 rubles per dollar,and the current Canadian risk-free interest rate is 4.6%,what is the implied credit spread for the Russian government bonds?
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