Investment and Financing Decisions
Question Bank
Course Introduction
This course explores the fundamental principles and analytical frameworks underlying investment and financing decisions in business. Students will examine capital budgeting techniques, risk assessment, and the evaluation of alternative investment projects, gaining insights into methods such as Net Present Value (NPV), Internal Rate of Return (IRR), and payback analysis. The course also delves into the sources of capital, cost of capital, capital structure choices, and the impact of financing decisions on firm value. Case studies and real-world scenarios are used to enhance understanding of how financial managers maximize shareholder value through prudent investment and financing strategies.
Recommended Textbook
Introduction to Corporate Finance 4th Edition by Sean Cleary
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Chapter 1: An Introduction to Finance
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Q1) Why can't the Canadian government issue equity?
A) because assets belong to all Canadians
B) it is not listed in the financial markets
C) it has too much debt
D) because expenditures exceed revenues
Answer: A
Q2) Explain the gravity of the situation of pension holders in Quebec after the loss of 25 percent of La Caisse de Depot's portfolio (pension fund manager of Quebec)in 2008.
Answer: La Caisse de Depot is the manager of pensions in Quebec.The loss of 25 percent of its portfolio represents the loss of funds available to pay pensions. It actually did a good job after the financial crisis.The annualized return in 2009,2010,and 2011 is 9%.By 2011,its net assets were $159 billion,more than the $155.4 billion in 2007.
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Chapter 2: Business Corporatefinance
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Q1) If a controller is responsible for liquidity management,which of the following accounts is she NOT interested in?
A) Long-term Debt
B) Cash
C) Accounts Payable
D) Inventory
Answer: A
Q2) Which of the following is (are)true about a general partnership?
A) III only
B) I and III
C) II and III
D) I and II
I.Some of the partners have limited liability.
II.Some of the partners may not be involved in the day-to-day operations.
III.Some partners may receive a different percentage of the profits.
Answer: C
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Chapter 3: Financial Statements
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Q1) Which one of the following is a misrepresentation of financial statements?
A) The statements deceive investors.
B) The statements overstate earnings and inflate the value of assets.
C) The statements mislead analysts in estimating the market value of the firm.
D) All of the above.
Answer: D
Q2) The balance sheet can be best described as:
A) a snapshot taken at a single point of time
B) the accumulated result of multiple transactions
C) a representation of a firm's financial position
D) all of the above
Answer: A
Q3) Which of the following statements is true about personal taxes in Canada?
A) Individual and corporate marginal tax rates are the same.
B) Capital gains and interest income are taxed at the same rate for individuals.
C) Dividends received from Canadian corporations are taxed differently than dividends received from US corporations.
D) Capital losses occur when a depreciable asset is sold below its original purchase price.
Answer: C
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Chapter 4: Financial Statement Analysis and Forecasting
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Q1) When using a percent of sales method for forecasting,which is the most important variable to estimate?
A) COGS
B) Inventory
C) Revenue
D) Bank debt
Q2) What is the base,or denominator,of a productivity ratio?
A) Revenue
B) An asset value
C) A liability value
D) A shareholders' equity value
Q3) Which of the following is TRUE?
A) Interest expenses can be predicted with a reasonable degree of accuracy, especially when the firm uses fixed interest rates on debt.
B) Interest expenses are commonly based on a percentage of sales.
C) Depreciation costs are commonly based on a percentage of sales.
D) Forecasting sales is the last step in financial forecasting.
Q4) Discuss some difficulties when comparing the ratios of similar corporations from different countries.
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Chapter 5: Time Value of Money
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Q1) A dollar today is worth more than a dollar tomorrow because
A) the dollar can be invested and earn interest.
B) there is a risk involved in investing.
C) there is loss due to inflation.
D) of the opportunity cost of the dollar.
E) all of the above
Q2) An annuity due pays out
A) equal payments at the beginning of each time period and continues forever.
B) unequal payments at the beginning of each time period for a fixed number of periods.
C) equal payments at the beginning of each time period for a fixed number of periods.
D) unequal payments at the end of each time period for a fixed number of periods.
E) equal payments at the end of each time period and continues forever.
Q3) As interest rates rise,future values
A) increase.
B) decrease.
C) stay the same.
D) cannot be determined, need compounding frequency.
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Chapter 6: Bond Valuation and Interest Rates
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Q1) The yield to call (YTC)is:
A) the opportunity cost of forgone coupon payments.
B) the yield that an investor would expect to make if he or she bought the bond at the current price, held it to call date.
C) the yield that an investor would expect to make if he or she bought the bond at the current price, held it to maturity, received all the promised payments on their scheduled dates.
D) All of the above.
Q2) The spot ¥/C$ exchange rate is 107.9 and the one year forward exchange rate ¥/C$ $ is 103.6.If the annual interest rate on Canadian T-bill is 5.5%,what would you expect the annual interest rate to be on Japanese T-bill?
A) 1.4%
B) 3.3%
C) 1.4%.
D) 1.29%
Q3) J&B Co.has 8.75 percent coupon bonds quoted with a market yield of 9.25 percent.The bonds have fifteen years to mature and make annual interest payments.What is the percentage change in price for a 10 percent decrease in market yield?
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Chapter 7: Equity Valuation
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Q1) Dream Homes Corporation had net earnings of $200,000 this past year and paid $80,000 in dividends on the company's equity of $1,800,000.Dream Homes has 500,000 shares outstanding with a current market value of $5.What is the firm's present value of growth opportunities if the required rate of return is 10.08 percent?
A) $0.77
B) $0.84
C) $0.86
D) $0.90
Q2) Jack had an investment return of -24 percent on a stock that he bought for $100 a year ago.What is the sale price of the stock if he received a dividend of $1.75 during the year?
A) $72.75
B) $74.25
C) $76.00
D) $77.75
Q3) In what ways are preferred shares different from common shares?
Q4) If you were using a constant-dividend growth model to price a stock,what would happen if the growth rate was greater than the required rate of return?
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Chapter 8: Risk, return, and Portfolio Theory
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Q1) AMC Corp had a geometric weekly return of 5% for this past week.The daily returns for Monday through Thursday are 4 percent,3 percent,-7 percent,and 9 percent,respectively.If AMC's stock traded at $16.22 when the market closed on Friday,what is the opening price of the stock on Friday?
A) $13.47
B) $13.38
C) $13.94
D) $14.11
Q2) A stock selling for $12.00 today and expected to pay a $1.50 dividend and have a capital gain of 5% in one year will increase in price to sell at:
A) $ 13.50
B) $ 14.10
C) $ 12.60
D) $ 15.18
Q3) Which portfolio represents the minimum variance portfolio?
A) B
B) C
C) A
D) D
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Chapter 9: The Capital Asset Pricing Model Capm
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Q1) Suppose you have $4,000 to invest in Stocks X and Y.Stock X has an expected return of 13.5 percent and a beta of 1.2.Stock Y has an expected return of 18 percent and a beta of 2.How much should you invest in Stock X if you wish to have a portfolio beta of 1.8?
A) $1,000
B) $1,750
C) $2,250
D) $2,500
Q2) What is the main criticism of the CAPM referred to as Roll's critique?
A) The stock market is not efficient.
B) The CAPM does not hold because beta is not a good measure of risk.
C) The market portfolio is impossible to estimate.
D) The CAPM does not hold empirically.
Q3) Assuming the CAPM is valid,_____________ securities lie _____________the security market line.
A) undervalued, below
B) overvalued, on C) undervalued, on D) overvalued, below
Q4) What is the role of the risk-free asset in the efficient portfolio?
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Chapter 10: Market Efficiency
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Q1) Which of the following is NOT an implication of the efficient market hypothesis for corporate financial officers?
A) They should ignore dramatic changes in their company's stock price.
B) There is no point in timing the issue of new securities.
C) It does not make sense to "play" interest rates by rolling over short-term debt until long-term rates fall.
D) There is no point in timing stock repurchases in an efficient market.
Q2) Which of the following is an underlying assumption of the existence of an efficient market?
A) A few number of rational, profit-maximizing investors exist.
B) Information is costly and not widely available to market participants.
C) Information arrives at predetermined times.
D) Investors don't react quickly and fully to new information.
E) None of the above
Q3) During January and February,the stock of Pigeon Couriers was trading at about $25.On March 1,the stock price began to rise until it hit $35 on March 14.On March 15,the company disclosed that earnings were up an unanticipated 15% compared to last year,and the stock price did not change.Explain how,in an efficient market,this is possible.
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Chapter 11: Forwards,futures,and Swaps
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Q1) The dollar amount upon which a contract is valued is referred to as:
A) settlement price
B) initial margin
C) strike price
D) notional amount
Q2) Find the forward price for one forward contract for gold that is selling for $1,449 spot,if the storage cost is $10 for the year and financing cost is 10% per year.
Q3) The six-month forward rate is C$ 1.00 per US$.Ahmed assumes a 1,000 long position in the forward contract and his profit in six months is C$30.00.What is the spot rate in six months?
A) C$ 1.030 per US$
B) C$ 1.031 per US$
C) C$ 1.029 per US$
D) C$ 0.970 per US$
Q4) What are the differences between forwards and futures contracts?
Q5) Company JH enters a swap to pay a fixed rate of 12% and the counterparty MI will pay a floating rate of LIBOR + 0.3%.What are the net payments (in %)from JH's point of view given that LIBOR for the next five periods equals: 8.0,9.0,11.0,12.0,12.3
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Chapter 12: Options
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Q1) Which of the following best defines implied volatility?
A) An estimate of the price volatility of an option.
B) The observed relationship of past and present option prices.
C) An estimate of the price volatility of the underlying asset based on observed option prices.
D) The observed relationship of past and present price volatility of the underlying asset.
Q2) The intrinsic value of an in-the-money put option is:
A) X S<sub>T</sub>
B) S<sub>T</sub> X
C) X S<sub>T</sub>+P
D) 0
Q3) An option that can be exercised only at maturity is referred to as:
A) a European option
B) a call option
C) a protective put
D) an American option
Q4) Create a table depicting the payoffs for a collar given Xput = $50,S = $55,and Xcall = $60.Assume the value of the asset in 2 months will be: $40,$50,$55,$60,$75,$80.
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Chapter 13: Capital Budgeting, risk Considerations, and Other Special Issues
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Q1) Which of the following is the best answer for a reason(s)that firms make foreign investments?
A) They want to enter new markets.
B) They want to have access to new technology.
C) They want to take advantage of cheaper resources.
D) All of the above
Q2) Use the following statements to answer these questions:
A) I and II are correct.
B) I and II are incorrect.
C) I is correct and II is incorrect.
D) I is incorrect and II is correct.
I.Everything else held constant,increasing the proportion of debt in the project would increase the WACC.
II.A typical project of the company should be discounted using a risk-adjusted rate different than the WACC.
Q3) When a business faces capital rationing,what discount rate is used and why?
Q4) Why is the NPV rule a better choice than the IRR rule to rank projects?
Q5) Differentiate between projects that are mutually exclusive and projects that are contingent upon each other.
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Chapter 14: Cash Flow Estimation and Capital Budgeting
Decisions
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Q1) A firm is considering a project that requires an initial cash outflow of $1,000,000 for the purchase of a capital asset,which has an eight-year life and a CCA rate of 20 percent,with the asset class remaining open.The expected salvage value of the asset is $75,000 at the end of eight years.The project will generate sales revenue of $450,000 in the first year,which will grow at 5 percent per year in the subsequent years.Variable costs will be $200,000 for the first year,which will also grow at 5 percent per year.The firm's marginal tax rate is 40 percent and required return is 12 percent.What is the project's NPV?
A) $123,498
B) $166,707
C) $1,402,183
D) $1,509,326
Q2) Explain why the CCA tax savings are discounted at the firm's cost of capital.
Q3) Explain what externalities are and give an example.
Q4) A firm is considering launching a new product into the market.The research and development team showed that the new product is superior to the existing product and would not need the many spare parts currently required that the company must provide.How should the finance department evaluate this project?
Q5) Discuss the two ways inflation impacts capital budgeting.
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Chapter 15: Mergers and Acquisitions
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Q1) Once an investor has purchased 20% of the outstanding shares of a firm,which of the following is NOT allowed?
A) Open market share purchase with a takeover bid.
B) Open market sale of the stake.
C) Open market share purchase without a takeover bid.
D) A hostile takeover bid.
Q2) The Canadian term for a merger process is called a(n):
A) Amendment
B) Combination
C) Amalgamation
D) Joint venture
Q3) Use the following statements to answer this question:
A) I is correct and II is correct.
B) I is incorrect and II is incorrect.
C) I is correct and II is incorrect.
D) I is incorrect and II is correct.
I.The white knight is a strategy to avoid being acquired by another firm.
II.Selling the crown jewels can lead to a long-term decrease in the value of the firm.
Q4) Define synergy and explain what effect it can have on a merged company.
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Chapter 16: Leasing
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Questions
Q1) MontRec Company is considering a recycling project.The project will result in a decrease in their garbage disposal costs.The acquisition cost of the recycling machine is $100,000 and the present value of the net garbage disposal cost savings is calculated to be $25,000.The present value of the depreciation tax shield (CCA)is $35,000 and the machine is expected to have a zero salvage value.The firm can lease the machine instead of buying it - the present value of the before-tax lease payments is $60,000 and the present value of the tax savings from the lease payments is $20,000.Should the firm enter into the recycling project? Choose the most appropriate answer.
A) Yes, the NPV of the project is $25,000.
B) Yes, the NPV of the project is $50,000.
C) No, the NPV of the project is -$40,000.
D) No, the NPV of the project is -$15,000.
Q2) Frank owns a large dump truck.Charles offers to pay Frank $1,500 per month for 36 months' use of the truck.If Frank accepts the offer,then:
A) Frank is the lessee and Charles is the lessor
B) Frank is the lessor and Charles is the lessee
C) Frank and Charles are lessors
D) Frank and Charles are lessees
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Chapter 17: Investment Banking and Securities Law
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Q1) Which of the following is not true about a prospectus?
A) The investment dealer helps in the preparation of the document and is legally liable.
B) The CFO rather than CEO signs the document on behalf of the board of directors.
C) All parties involved in the process are supposed to do their best to ensure the consistency of the information provided.
D) It should be a detailed and honest disclosure of information about the firm.
Q2) If you are handed a formal summary of a security that describes the costs,investment objectives,and risks involved,what are you reading?
A) Annual report
B) Prospectus
C) Auditor report
D) Proxy statement
Q3) Which of the following is part of a prospectus?
A) Description of the proposed business activity
B) Description of the potential market
C) Description of the risk factors
D) All of the above
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Chapter 18: Debt Instruments
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Q1) Investment-grade debt rating refers to which of the following?
A) The issuer is less likely to meet debt payment opbligations.
B) The issuer is more likely to increase dividend payments.
C) The issuer is likely to meet debt payment obligations.
D) None of the above.
Q2) Which of the following has the characteristics of a fixed contractual commitment?
A) Long-term debt
B) Common stock dividends
C) Preferred stock
D) Retained earnings
Q3) Which of the following securities is secured by assets?
A) ABCP
B) A fixed interest rate loan
C) A debenture
D) All of the above
Q4) Explain the implication of the failure of Lehman Brothers on short-term debt yields,and how it was remedied.
Q5) Indicate important sources of finance available to corporations in the money market.
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Chapter 19: Equity and Hybrid Instruments
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Q1) Explain an important implication of viewing a company's common shares as a call option.
Q2) Which of the following statements about dividends is true?
A) Dividends are paid before interest is paid.
B) Dividends received by Canadian households are taxed at the marginal personal tax rate.
C) Dividends are tax deductible.
D) Dividends received by one Canadian corporation from another Canadian corporation are not taxed.
Q3) A LYON is a note that:
A) is convertible.
B) has a zero coupon.
C) both of the above.
Q4) Evaluate the following statement:
The cost of preferred stock is the rate of return shareholders require on the firm's preferred stock.
A) False.
B) True.
Q5) Explain how the value of convertible debt varies as a function of the common share price.
21
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Chapter 20: Cost of Capital
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Q1) An analyst has obtained the following information about Maudite Brewers Co.: Book value of assets $25,000; book value of common equity $10,000; book value of preferred shares $5,000.The company has 4,000 common shares outstanding which are currently trading at $5 per share.The company has 3,000 preferred shares outstanding which are currently trading at $2 per share.The yield on the debt equals the coupon rate.The weights used to determine the weighted average cost of capital are:
Common Equity: Preferred Equity: Debt:
A) 55.56% 16.67% 27.77%
B) 40% 20% 40%
C) 80% 10% 10%
D) Cannot be determined because we need the market value of debt.
Q2) Use the following statements to answer this question:
A) I and II are correct.
B) I and II are incorrect.
C) I is correct and II is incorrect.
D) I is incorrect and II is correct.
I.The cost of debt of the firm is always constant.
II.The estimation of the cost of debt using the yield to maturity requires the price of the bonds now.
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Chapter 21: Capital Structure Decisions
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Q1) The board of directors of a Canadian firm must:
A) act in the best interests of the company.
B) always act in the best interests of the shareholders.
C) always act in the best interests of all stakeholders including creditors.
D) act in the best interests of the managers of the firm.
Q2) James Bay Water Park Company operates in a world with zero taxes and no financial distress.The firm has a debt/equity ratio of 1.The cost of equity is 12 percent and the cost of debt is 5 percent.The only difference between Lanudiere Resort Company and James Bay Water Park is that Lanudiere Resort has a debt/equity ratio of 0.What is the cost of equity for Lanudiere Resort?
A) 5.0%
B) 8.5%
C) 12.0%
D) 17.0%
Q3) The M&M proof of capital structure irrelevance relies on:
A) arbitrage arguments
B) personal and corporate leverage are perfect substitutes
C) both of the above
D) neither of the above
Q4) Briefly explain the trade-off theory of capital structure.
Page 23
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Chapter 22: Dividend Policy
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Q1) Montreal Trust Corp.is facing reduced earnings.Its entire industry has been facing declining demand due to a severe recession; however its stock price has suffered more than the stock price of its competitors.The market believes that it is fundamentally weaker than its competitors.Montreal Trust's CEO has decided to prop up the stock price by increasing its dividend.He believes that,according to the dividend discount model (DDM),if Montreal Trust increases its dividend,then its stock price will rise.Why won't this work?
Q2) Saguenay Resort Inc.and Gaspésie Spa Inc.both have 100,000 shares outstanding and both stocks trade for $10 per share.Saguenay Resort Inc.pays a dividend of $1 per share while Gaspésie Spa Inc.pays a 10% stock dividend.After the dividends are paid,the number of shares outstanding for Saguenay Resort Inc.and Gaspésie Spa Inc.,respectively,are:
A) 100,000; 100,000
B) 90,000; 100,000
C) 100,000; 110,000
D) 110,000; 90,000
Q3) Evaluate the following statement: "If a firm has a number of positive NPV projects,it can cut its dividend so that it is not passing up good opportunities."
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Chapter 23: Working Capital Management: General Issues
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Q1) Firms can grow faster and decrease their cash conversion cycle by doing all of the following except:
A) Delay paying bills
B) Increase its inventory turnover
C) Reduce collection time
D) Reduce production costs
Q2) The two components of the operating cycle are:
A) Average days of revenues + average collected payment
B) Average days of revenues in inventory + payables turnover
C) Average days of revenues + average collection period
D) Average days of revenues in inventory + average collection period
Q3) The cash conversion cycle allows firms to calculate
A) The amount of cash they need to operate
B) How long a firm must keep any borrowed funds
C) How long a firm needs to borrow money for
D) The amount of cash a firm needs to be profitable
Q4) Explain what the break-even sales growth rate means and what impact it has on the development of a firm's operations and credit granting (financial)policy.
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Chapter 24: Working Capital Management: Current Assets and
Current Liabilities
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Q1) When a cheque is written by the firm,it is said to generate:
A) a float.
B) an account receivable.
C) an account payable.
D) none of the above.
Q2) What determines the optimum amount of cash a firm should hold?
A) The motives for the use of the cash
B) The firm's borrowing capacity
C) a and b
D) None of the above determines the optimum amount of cash a firm should hold
Q3) Which firms can maintain a higher portion of their liquidity in marketable securities and less in cash?
A) Firms that have well-developed cash management systems and more predictable cash flows.
B) Firms that have more cash than they need.
C) Firms that have expertise in securities trading.
D) Firms that have volatile cash flows.
Q4) Explain how revolving loans work and how they are beneficial to firms who are trying to minimize their cost of borrowing and manage their short-term financing so that they do not become illiquid.
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