Introduction to Finance Practice Questions
Course Introduction
Introduction to Finance provides students with a foundational understanding of financial concepts, principles, and tools essential for personal and professional decision-making. The course covers topics such as the time value of money, risk and return, financial markets and institutions, investment analysis, and the basics of corporate finance. By exploring real-world financial problems and case studies, students gain practical skills in budgeting, investing, and financial planning, laying the groundwork for advanced study or careers in finance, business, and related fields.
Recommended Textbook
Corporate Finance 3rd Canadian Edition by Jonathan Berk
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Page 2
Chapter 1: The Corporation
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Q1) In 2011,what position was the Toronto Stock Exchange,TSX,ranked based on domestic market capitalization in U.S.dollars?
A) The 8th position
B) The 14th position
C) The 20th position
D) None of the above
Answer: A
Q2) In a corporation,the ultimate decisions regarding business matters are made by A) the Board of Directors.
B) debt holders.
C) shareholders.
D) investors.
Answer: A
Q3) How much would you have to pay to purchase 100 shares of XYZ stock on November 18th?
A) $2,520
B) $2,525
C) $2,593
D) $2,600
Answer: D
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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 statements regarding the income statement is incorrect?
A) The income statement shows the earnings and expenses at a given point in time.
B) The income statement shows the flow of earnings and expenses generated by the firm between two dates.
C) The last or "bottom" line of the income statement shows the firm's net income.
D) The first line of an income statement lists the revenues from the sales of products or services.
Answer: A
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4
Chapter 3: Arbitrage and Financial Decision Making
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Q1) Based upon the information provided about securities A,B,and C,the risk-free rate of interest is closest to:
A) 4%
B) 5%
C) 8%
D) 10%
Answer: B
Q2) Which of the following formulas regarding NPV is incorrect?
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)
Answer: A
Q3) A competitive market is a market in which a good can be bought at ________ it is sold.
A) a lower price than B) the same price as C) a higher price than
D) any price
Answer: B
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Chapter 4: The Time Value of Money
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Q1) Assuming that university costs continue to increase an average of 4% per year and that all her university 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:
Q2) Using an Excel spreadsheet to calculate net present value (NPV)has an advantage over using a financial calculator because
A) the spreadsheet retains the full precision of all non-rounded numbers while the calculator will cumulate rounding errors.
B) not all financial calculators compute NPV using the same parameters.
C) financial calculators cannot differentiate between payments made immediately or payments deferred by one period.
D) financial calculators cannot solve when the unknown is other than NPV (e.g.: NPV given, solve for the interest rate).
Q3) If the interest rate is 6%,then the NPV of investment "B" is closest to:
A) $84
B) -$32
C) $43
D) $9
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Chapter 5: Interest Rates
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Q1) If you forgo the $2,500 rebate and finance your new car through the dealership your monthly payments (with payments made at the end of the month)will be closest to:
A) $593
B) $652
C) $595
D) $541
Q2) Assuming that you have made all of the first 24 payments on time,then the outstanding principal balance on your SUV loan is closest to:
A) $31,250
B) $20,300
C) $19,200
D) $32,000
Q3) The present value of receiving $1,000 per year with certainty at the end of the next three years is closest to:
A) $2,737
B) $2,723
C) $2,733
D) $2,744
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7
Chapter 6: Valuing Bonds
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Q1) Sovereign bonds,unlike corporate bonds,are insulated from default risk because the issuer has the ultimate ability to print money to meet debt servicing obligations. A major reason that investors do in fact associate risk with the bonds of certain countries is that A) were it necessary to print money to meet their debt obligations, this would likely increase inflation and thereby result in a decline in the real rate of return when the debt matures.
B) there is uncertainty because governments often face re-election during the period prior to the maturity of their sovereign bonds.
C) sovereign bonds are usually less liquid than corporate bonds denominated in the same currency.
D) corporate bonds are backed by tangible physical assets which is not the case with sovereign bonds.
Q2) The yield to maturity for the three year zero-coupon bond is closest to:
A) 5.4%
B) 5.8%
C) 5.6%
D) 6.0%
Q3) Plot the zero-coupon yield curve (for the first five years).
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Chapter 7: Valuing Stocks
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Q1) Which of the following statements is false?
A) The firm's weighted average cost of capital (WACC) denoted r<sub>wacc</sub> is the cost of capital that reflects the risk of the overall business, which is the combined risk of the firm's equity and debt.
B) Intuitively, the difference between the discounted free cash flow model and the dividend-discount model is that in the divided-discount model the firm's cash and debt are included indirectly through the effect of interest income and expenses on earnings.
C) We interpret r<sub>wacc</sub> as the expected return the firm must pay to investors to compensate them for the risk of holding the firm's debt and equity together.
D) When using the discounted free cash flow model we should use the firm's equity cost of capital.
Q2) The price you would be willing to pay today for a share of Von Bora stock,if you plan to hold the stock for two years is closest to:
A) $23.15
B) $20.65
C) $21.95
D) $21.30
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Page 9
Chapter 8: Investment Decision Rules
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Q1) Which of the following statements is false?
A) The incremental IRR need not exist.
B) If a change in the timing of the cash flows does not affect the NPV, then the change in timing will not impact the IRR.
C) Although the incremental IRR rule can provide a reliable method for choosing among projects, it can be difficult to apply correctly.
D) When projects are mutually exclusive, it is not enough to determine which projects have positive NPVs.
Q2) If the appropriate discount rate for this project is 15%,then the NPV is closest to:
A) $6,000
B) -$867
C) $1,420
D) $867
Q3) The internal rate of return (IRR)for project Beta is closest to:
A) 25.0%
B) 22.7%
C) 24.5%
D) 22.2%
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Chapter 9: Fundamentals of Capital Budgeting
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Q1) What is a sunk cost? Should it be included in the incremental cash flows for a project? Why or why not?
Q2) The difference between scenario analysis and sensitivity analysis is that
A) scenario analysis is based upon the IRR and sensitivity analysis is based upon NPV.
B) only sensitivity analysis allows us to change our estimated inputs of our NPV analysis.
C) scenario analysis considers the effect on NPV of changing multiple project parameters.
D) only scenario analysis breaks the NPV calculation into its component assumptions.
Q3) In Canada,firms deduct a fraction of the cost of capital investment each year for tax purposes.This is known as
A) Capital Cost Allowance.
B) Capital Assets Depreciation.
C) Operating Assets Amortization.
D) Operating Cost Allocation.
Q4) Calculate the total Free Cash Flows for each of the three years for the Sisyphean Corporation's new project.
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Chapter 10: Capital Markets and the Pricing of Risk
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Q1) The standard deviation for the return on an portfolio of 20 type S firms is closest to:
A) 5.10%
B) 23.0%
C) 15.0%
D) 5.25%
Q2) Using the data provided in the table,calculate the average annual return,the variance of the annual returns,and the standard deviation of the average returns for the market from 1996 to 2005.
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) 0.151
B) 0.0378
C) 0
D) 0.075
Q4) Assume that you purchased General Motors stock at the closing price on December 31,2004 and sold it at the closing price on December 30,2005.Calculate your realized annual return is for the year 2005.
Q5) What is the market portfolio?
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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) The Sharpe ratio of the portfolio tells us how much our expected return will increase for a given increase in volatility.
B) We should continue to trade securities until the expected return of each security equals its required return.
C) The required return is the expected return that is necessary to compensate for the risk that an investment will contribute to the portfolio.
D) If security i's required return exceeds its expected return, then adding more of it will improve the performance of the portfolio.
Q2) To identify the efficient portfolio we must know ________,________,and ________ between investments.
A) risk level; required return; profitability
B) value of risk free; required return; correlations
C) expected return; volatilities; correlations
D) systematic risk; nonsystematic risk and required return
Q3) What are three main assumptions underlie the CAPM?
Q4) What is the efficient frontier and how does it change when more stocks are used to construct portfolios?
Page 13
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Chapter 12: Estimating the Cost of Capital
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Q1) Which of the following statements is false?
A) A market index reports the value of a particular portfolio of securities.
B) The S&P/TSX Composite Index is the standard portfolio used to represent "the market" when using the CAPM in practice.
C) Even though the S&P/TSX Composite Index includes only 244 Canadian stocks, it represents about 95% of the Canadian stock market in terms of market capitalization.
D) The S&P/TSX Composite Index is an equal-weighted portfolio of the largest Canadian stocks.
Q2) Important choices in estimating beta include all of the following EXCEPT:
A) The time horizon used
B) The index used as the market portfolio
C) The price of the stock
D) The method used to extrapolate from past betas to future betas
Q3) The unlevered cost of capital for Anteater Enterprises is closest to:
A) 10.1%
B) 9.5%
C) 9.9%
D) 10.3%
Q4) Describe two methods that can be used to estimate a firm's debt cost of capital.
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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) 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.
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Chapter 14: Financial Options
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Q1) This graph depicts the payoffs of
A) a short position in a put option at expiration.
B) a short position in a call option at expiration.
C) a long position in a put option at expiration.
D) a long position in a call option at expiration.
Q2) 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.
Q3) Describe the conditions when it would be optimal to exercise an American Call and an American Put option prior to their expiration.
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Chapter 15: Option Valuation
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Q1) Using the binomial pricing model,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 correct?
A) It was in 2000 that Canadian accounting standards required firms to include stock option grants as part of their compensation expense.
B) Canadian accounting standards did not require firms to include stock option grants as part of their compensation expense until the Asian flu happened in the mid-90s.
C) Canadian accounting standards did not require firms to include stock option grants as part of their compensation expense until Nortel announced bankruptcy protection in 2009.
D) Until 2005, Canadian accounting standards did not require firms to include stock option grants as part of their compensation expense.
Q3) Using risk-neutral probabilities,calculate the price of a two-year put option on Kinston stock with a strike price of $9.
Q4) Construct a binomial tree detailing the option information and payoffs for a call option on KD stock with a $20 strike price that expires in one year.
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Chapter 16: Real Options
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Q1) Which of the following statements is false?
A) The hurdle rate rule for projects with the option to delay uses a lower discount rate than the cost of capital to compute the NPV, but then applies the regular NPV rule: invest whenever the NPV calculated using this lower discount rate is positive.
B) While using a hurdle rate rule for deciding when to invest might be a cost-effective way to make investment decisions, it is important to remember that this rule does not provide an accurate measure of value.
C) When the cash flows are constant and perpetual, and the reason to wait derives solely from interest rate uncertainty, the hurdle rate rule of thumb is always exact. However, when these conditions are not satisfied, the rule of thumb merely approximates the correct decision.
D) When a firm faces the same uncertainty for most of its investment decisions, using a single profitability index criterion for all projects can provide a useful rule of thumb to account for cash flow uncertainty.
Q2) Assuming that Kinston does not have the ability to sell the prototype in year one for $300,000,draw a decision tree detailing the Kinston Industries Mountain Bike Project.
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Chapter 17: Capital Structure in a Perfect Market
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Q1) One of the reasons cited as a contributing factor in the financial meltdown of 2008 was the very high leverage ratios of major banking institutions. Which of the following outcomes would NOT occur if bank leverage were reduced?
A) Lower leverage would make over-all bank financing more expensive.
B) With a drop in asset value, insolvency would be less likely to occur.
C) A decrease in leverage would result in lower return on equity.
D) A decrease in leverage would decrease the riskiness of the bank's equity.
Q2) According to MM Proposition 1,the stock price for With is closest to:
A) $8.00
B) $24.00
C) $6.00
D) $12.00
Q3) After the repurchase how many shares will Luther have outstanding?
A) 0.75 billion
B) 1.0 billion
C) 1.1 billion
D) 1.2 billion
Q4) 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 18: Debt and Taxes
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Q1) Which of the following statements is false?
A) Given a forecast of future interest payments, we can determine the interest tax shield and compute its present value by discounting it at a rate that corresponds to its risk.
B) The total value of the unlevered firm exceeds the value of the firm with leverage due to the present value of the tax savings from debt.
C) To compute the increase in the firm's total value associated with the interest tax shield, we need to forecast how a firm's debt-and therefore its interest payments-will vary over time.
D) There is an important tax advantage to the use of debt financing.
Q2) The effective tax rate for debt holders was closest to:
A) 61%
B) 52%
C) 64%
D) 29%
Q3) 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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Page 20
Chapter 19: Financial Distress, managerial Incentives, and Information
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Q1) Which of the following statements is false?
A) The agency costs of debt can arise only if there is no chance the firm will default and impose losses on its debt holders.
B) Agency costs represent another cost of increasing the firm's leverage that will affect the firm's optimal capital structure choice.
C) An under-investment problem occurs when shareholders choose to not invest in a positive-NPV project.
D) When a firm faces financial distress, it may choose not to finance new, positive-NPV projects.
Q2) The number of new shares that Kinston must issue to raise the capital needed to pay its debt obligation is closest to:
A) 4.3 million
B) 4.7 million
C) 5.0 million
D) 4.0 million
Q3) Suppose that MI has zero-coupon debt with a $140 million face value due next year.Calculate the value of levered equity,the value of debt,and the total value of MI with leverage.
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Chapter 20: Payout Policy
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Q1) A firm can repurchase shares through a(n)________,in which it offers to buy shares at a prespecified price during a short time period - generally within 20 days.
A) tender offer
B) open market share repurchase
C) targeted repurchase
D) Dutch auction share repurchase
Q2) The price per share of Iota if they choose not to use the $200 million to expand and hold the cash instead is closest to:
A) $16.50
B) $16.80
C) $19.00
D) $13.75
Q3) Using the available tax information for 2002,calculate the effective dividend tax rate for a:
(1)one-year individual investor
(2)buy and hold individual investor
(3)pension fund
Q4) Calculate the effective tax disadvantage for retaining cash in 1999,2001,and 2005.
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Chapter 21: Capital Budgeting and Valuation With Leverage
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Q1) The weighted average cost of capital for "Eenie" is closest to:
A) 6.0%
B) 6.5%
C) 7.5%
D) 5.5%
Q2) The NPV for Omicron's new project is closest to:
A) $23.75
B) $27.50
C) $28.75
D) $25.75
Q3) In the flow-to-equity (FTE)valuation method,the cash flows to ________ are then discounted using the ________ cost of capital.
A) debt holders; equity
B) equity holders; weighted average
C) equity holders; equity
D) debt holders; weighted average
Q4) Based upon the three comparable firms,calculate that most appropriate unlevered cost of capital for Aardvark to use on this new product.
Q5) Calculate the NPV for Iota's new project.
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Chapter 22: Valuation and Financial Modelling: a Case Study
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Q1) If the risk-free rate of interest is 6% and the market risk premium has historically averaged 5%,then the cost of capital for Nike is closest to:
A) 14.7%
B) 10.2%
C) 9.1%
D) 13.5%
Q2) Assuming that Ideko has a EBITDA multiple of 8.5,then the continuation levered P/E ratio of Ideko in 2010 is closest to:
A) 19.0
B) 17.2
C) 16.4
D) 14.5
Q3) Assuming that Ideko has a EBITDA multiple of 8.5,then the continuation EV/Sales ratio of Ideko in 2010 is closest to:
A) 1.7
B) 1.9
C) 1.6
D) 1.8
Q4) What is the purpose of the sensitivity analysis?
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Chapter 23: The Mechanics of Raising Equity Capital
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Q1) For many start-ups,the first round of outside private equity financing is often obtained from ________ which may also bring expertise to the firm that the entrepreneur lacks.
A) venture capital firms
B) angel investors
C) institutional investors
D) corporate investors
Q2) How much money did Luther raise?
Q3) What will the offer price of these shares be if Luther is selling 800,000 shares?
Q4) The fees for Canadian IPOs are ________ those for similar-sized IPOs in the U.S.but the total fee as a percent of the IPO size is calculated for every IPO,and the average percentage spread across all IPOs in Canada is ________ the average percentage spread across all IPOs in the U.S.
A) higher than; less than
B) higher than; also higher than
C) less than; higher than
D) less than; also less than
Q5) Based upon the price/earnings ratio,what would be a reasonable value for KD?
Q6) Based upon the price/revenue ratio,what would be a reasonable value for KD?
Page 25
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Chapter 24: Debt Financing
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Q1) Which of the following statements is false?
A) Almost all bonds that are issued today are registered bonds.
B) The trust company represents the bondholders and makes sure that the terms of the indenture are enforced.
C) For private placements, the prospectus must include an indenture, a formal contract between the bond issuer and a trust company.
D) In the case of default, the trust company represents the bondholders' interests.
Q2) The Government of Canada also issues ________ with maturities of up to ________ years.
A) discounted bonds; 30
B) strip bonds; 30
C) real return bonds; 30
D) real return bonds; 20
Q3) What kind of corporate debt has a maturity of less than 10 years?
A) Asset-backed bonds
B) Debentures
C) Notes
D) Mortgage bonds
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Chapter 25: Leasing
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Q1) Which of the following statements is false?
A) Most financial analysts and sophisticated investors consider operating leases (which must be listed in the footnotes of the financial statements) to be additional sources of leverage.
B) By carefully avoiding the four criteria that define an operating lease for accounting purposes, a firm can avoid listing the long-term lease as a liability.
C) Because a lease is equivalent to a loan, the firm can increase its actual leverage without increasing the debt-to-equity ratio on its balance sheet.
D) For most large corporations, the amount of leverage the firm can obtain through a lease is unlikely to exceed the amount of leverage the firm can obtain through a loan.
Q2) The risk of the lease payments is ________ the risk of secured debt,so it is reasonable to discount the lease payments at the firm's secured borrowing rate.
A) equal to
B) no less than C) no greater than D) greater than
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Chapter 26: Working Capital Management
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Q1) Stretching the accounts payable means to ________.
A) reduce the trade credit period
B) raise the amount of accounts payable
C) decrease the discount percentage offered
D) increase the trade credit period
Q2) Describe "just-in-time" inventory management.
Q3) Which of the following statements is false?
A) Similar to the situation with its accounts receivable, a firm should monitor its accounts payable to ensure that it is making its payments at an optimal time.
B) Some firms ignore the payment due period and pay later, in a practice referred to as pushing the accounts payable.
C) Suppliers may react to a firm whose payments are always late by imposing terms of cash on delivery (COD) or cash before delivery (CBD).
D) If the accounts payable outstanding is 40 days and the terms are 2/10, net 30, the firm can conclude that it generally pays late and may be risking supplier difficulties.
Q4) Calculate the number of days in Luther's Operating Cycle.
Q5) What is a compensating balance?
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Chapter 27: Short-Term Financial Planning
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Q1) Which of the following statements is false?
A) The prime rate is the rate banks charge other banks.
B) With a variable interest rate, the terms of the loan may indicate that the rate will vary with some spread relative to a benchmark rate, such as the yield on one-year Treasury securities or the prime rate.
C) With a discount loan, the borrower is required to pay the interest at the beginning of the loan period.
D) A common benchmark rate is the London Inter-Bank Offered Rate, or LIBOR, which is the rate of interest at which banks borrow funds from each other in the London interbank market.
Q2) A short-term bank loan that is often used until a firm can arrange for long-term financing is called
A) a committed line of credit.
B) a short-term mortgage loan.
C) a bridge loan.
D) a single, end-of-period-payment loan.
Q3) Calculate the temporary working capital needs for each of the four quarters for Hasbeen Toys.
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29
Chapter 28: Mergers and Acquisitions
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Q1) Which of the following statements is false?
A) Merger activity is greater during economic expansions than during contractions and correlates with bull markets.
B) Merger activity is greater during economic contractions than during expansions and correlates with bear markets.
C) According to Thomson Reuters, 2007 saw the value of merger and acquisition activity hit an all-time high, with over $4.5 trillion worth of deals announced globally.
D) The latest merger wave came to a crashing end as the credit crisis of late 2007 and 2008 curtailed the ability to finance mergers.
Q2) This period is known as the conglomerate wave because firms typically acquired firms in unrelated businesses:
A) 1960s
B) 1970s
C) 1980s
D) 1990s
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) It is important to keep in mind that good governance is value enhancing and so, in principle, is something investors in the firm should strive for.
B) Corporate governance is a system of checks and balances that trades off costs and benefits.
C) Because good governance is based upon a basic set of principles, like those detailed in the Cadbury Commission's findings, one should expect all firms to display similar governance structures.
D) The costs and benefits of a corporate governance system also depend on cultural norms.
Q2) What are some of the negative effects of increasing the sensitivity of managerial pay to firm performance?
Q3) How does a pyramid structure work?
Q4) ________ 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
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Chapter 30: Risk Management
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Q1) The Century 22 Fund has invested in a portfolio of mortgage-backed securities that has a current market value of $245 million.The duration of this portfolio of mortgage-backed securities is 14.7 years.The fund has borrowed to purchase these securities,and the current value of its liabilities (i.e.,the current value of the bonds Century 22 has issued)is $160 million.The duration of these liabilities is 5.4 years.What is the initial duration of the equity for the Century 22 fund?
Q2) What are some of the disadvantages of long-term supply contracts?
Q3) Insurance that compensates for the loss or unavoidable absence of crucial employees in the firm is called
A) key personnel insurance.
B) business liability insurance.
C) property insurance.
D) business interruption insurance.
Q4) Exchange rate risk naturally arises whenever transacting parties use ________.
A) a fixed exchange rate
B) the same currency
C) different currencies
D) a floating exchange rate
Q5) What is the actuarially fair cost of full insurance?
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Chapter 31: International Corporate Finance
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Q1) 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
Q2) The present value of the £5 million cash inflow computed by first converting into dollars and then discounting is closest to:
A) $8,950,495
B) $8,954,615
C) $8,943,695
D) $8,961,420
Q3) Under the condition of internationally integrated capital markets,the value of an investment ________ we use in the analysis because of ________.
A) depends on the currency; the Law of One Price
B) depends on the currency; the exchange rate between two currencies
C) does not depend on the currency; the Law of One Price
D) does not depend on the currency; the exchange rate between two currencies
Q4) What is the dollar present value of the project?
Q5) What is the pound present value of the project?
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