Investment and Financing Decisions
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Course Introduction
This course explores the fundamental principles and practical approaches to making investment and financing decisions in business. Students will analyze the criteria used for evaluating investment projects, including risk assessment, cost of capital, and capital budgeting techniques such as net present value and internal rate of return. The course also delves into financing options available to firms, covering equity, debt, hybrid instruments, and their implications for the firms value and capital structure. Through real-world case studies and financial modeling, students will develop an understanding of how managers make decisions that maximize shareholder wealth while accounting for risk, market conditions, and strategic objectives.
Recommended Textbook Fundamentals of Corporate Finance 2nd Edition by Jonathan Berk
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Chapter 1: Corporate Finance and the Financial Manager
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Q1) Which of the following is not a role of financial institutions?
A)Moving funds from savers to borrowers.
B)Spreading out risk-bearing.
C)Printing money for borrowers.
D)Moving funds though time.
Answer: C
Q2) What are the terms for the two types of prices quoted for a stock on an exchange?
Answer: The two quotes associated with a stock quoted on the exchange are bid price and ask price.
Q3) Raising new capital by issuing bonds is an example of a commercial banking activity.
A)True
B)False Answer: False
Q4) If broker will buy a share of stock from you at $3.85 and sell it to you at $3.87,the ask price would be $3.85.
A)True
B)False Answer: False
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Chapter 2: Introduction to Financial Statement Analysis
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Q1) Price-earnings ratios tend to be high for fast-growing firms.
A)True
B)False
Answer: True
Q2) Which ratio would you use to measure the financial health of a firm by assessing that firm's leverage?
A)debt-equity or equity multiplier ratio
B)market-to-book ratio
C)market debt-equity ratio
D)current or quick ratio
Answer: A
Q3) Refer to the income statement above.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
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Chapter 3: Time Value of Money: An Introduction
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Q1) Which of the following statements regarding the valuing of costs and benefits is NOT correct?
A)The first step in evaluating a project is to identify its costs and benefits.
B)In the absence of competitive markets,we can use one-sided prices to determine exact cash values.
C)Competitive market prices allow us to calculate the value of a decision without worrying about the tastes or opinions of the decision maker.
D)Because competitive markets exist for most commodities and financial assets,we can use them to determine cash values and evaluate decisions in most situations.
Answer: B
Q2) In general,if an action increases a firm's value by providing benefits with a value greater than any costs involved,then that action is good for the firm's investors.
A)True
B)False
Answer: True
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Chapter 4: Time Value of Money: Valuing Cash Flow
Streams
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Q1) Clarissa wants to fund a growing perpetuity that will pay $5000 per year to a local museum,starting next year.She wants the annual amount paid to the museum to grow by 5% per year.Given that the interest rate is 8%,how much does she need to fund this perpetuity?
A)$62,500.00
B)$102,112.33
C)$143,445.65
D)$166,666.67
Q2) A bank is negotiating a loan.The loan can either be paid off as a lump sum of $100,000 at the end of five years,or as equal annual payments at the end of each of the next five years.If the interest rate on the loan is 10%,what annual payments should be made so that both forms of payment are equivalent?
A)$12,000
B)$16,380
C)$19,588
D)$20,000
Q3) How do the growth perpetuity results differ with negative and positive growths of similar magnitude assuming everything else remains unchanged?
Q4) Can we apply the growth perpetuity equation for negative growth as well?
Page 6
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Chapter 5: Interest Rates
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Q1) A homeowner has $200,000 home with a 20-year mortgage,paid monthly at 7.25%
APR.After five years he receives $50,000 as an inheritance.If he pays this $50,000 toward his mortgage along with his regular payment,by approximately how many years will it reduce the amount of time it takes him to pay off his mortgage?
A)6 years
B)5 years
C)4 years
D)3 years
Q2) Can the nominal interest rate ever be negative? Can the real interest rate ever be negative? Explain.
Q3) What,typically,is used to calculate the opportunity cost of capital on a risk-free investment?
A)the best available expected return offered in any investment available in the market
B)the interest rate on U.S.Treasury securities with the same term
C)the interest rate of any investments alternatives that are available
D)the best rate of return offered by U.S.Treasury securities
Q4) How are interest and return of principal handled in an amortizing loan payment?
Q5) Everything else remaining same,under what situation will APR and EAR be equal?
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Chapter 6: Bonds
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Q1) The current zero-coupon yield curve for risk-free bonds is shown above.What is the risk-free interest rate on a 3-year maturity?
A)3.00%
B)3.15%
C)3.25%
D)6.34%
Q2) Which of the following bonds will be least sensitive to a change in interest rates?
A)a ten-year bond with a $2000 face value whose yield to maturity is 5.8% and coupon rate is 5.8% APR paid semiannually
B)a 15-year bond with a $5000 face value whose yield to maturity is 7.4% and coupon rate is 6.2% APR paid annually
C)a 20-year bond with a $3000 face value whose yield to maturity is 6.0% and coupon rate is 5.4% APR paid semiannually
D)a 30-year bond with a $1000 face value whose yield to maturity is 5.5% and coupon rate is 6.4% APR paid annually
Q3) Assuming that this bond trades for $1035.44,then the YTM for this bond is equal to:
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Chapter 7: Stock Valuation
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Q1) Jumbuck Exploration has a current stock price of $2.00 and is expected to sell for $2.10 in one year's time,immediately after it pays a dividend of $0.26.Which of the following is closest to Jumbuck Exploration's equity cost of capital?
A)9%
B)12%
C)18%
D)22%
Q2) Which of the following statements is FALSE?
A)As firms mature,their earnings exceed their investment needs and they begin to pay dividends.
B)Total return equals earnings multiplied by the dividend payout rate.
C)Cutting the firm's dividend to increase investment will raise the stock price if,and only if,the new investments have a positive net present value (NPV).
D)We cannot use the constant dividend growth model to value the stock of a firm with rapid or changing growth.
Q3) What role do dividends play in stock investing?
Q4) Can the dividend-discount model handle negative growth rates?
Q5) What is a major assumption about growth rate in the dividend-discount model?
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Chapter 8: Investment Decision Rules
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Q1) The net present value (NPV)for project alpha is closest to:
A)$20.96
B)$16.92
C)$24.01
D)$14.41
Q2) The net present value (NPV)of project A is closest to:
A)12.0
B)12.6
C)15.0
D)42.9
Q3) Assuming that your capital is constrained,which project should you invest in first?
A)Project C
B)Project G
C)Project B
D)Project F
Q4) The payback rule is based on the idea that an opportunity that pays back its initial investment quickly is a worthwhile opportunity.
A)True
B)False
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Chapter 9: Fundamentals of Capital Budgeting
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Q1) The required net working capital in the second year for the Sisyphean Corporation's project is closest to:
A)$3960
B)$4360
C)$3190
D)$5940
Q2) A firm is considering a new project that will generate cash revenue of $1,000,000 and cash expenses of $700,000 per year for five years.The equipment necessary for the project will cost $200,000 and will be depreciated straight line over four years.What is the expected free cash flow in the second year of the project if the firm's marginal tax rate is 35%?
A)$195,000
B)$162,500
C)$212,500
D)$245,000
Q3) Capital budgeting decisions use the Net Present Value rule so that those decisions maximize net present value (NPV).
A)True
B)False
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Chapter 10: Stock Valuation: A Second Look
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Q1) Aerelon Airways,a commercial airline,suffers a major crash.As a result,passengers are considered to be less likely to choose Aerelon as their carrier,and it is expected free cash flows will fall by $20 million per year for five years.If Aerelon has 65 million shares outstanding,an equity cost of capital of 12%,and no debt,by how much would Aerelon's shares be expected to fall in price as a result of this accident?
A)$0.98
B)$1.11
C)$1.28
D)$1.45
Q2) Praetorian Industries will pay a dividend of $2.50 per share this year and has an an equity cost of capital of 8%.Praetorian's stock is currently trading at $84 per share.By comparing Praetorian with similar firms,an investor expects that its dividends will grow by up to 5% per year.What is the best next step that the investor should take regarding Praetorian's stock?
A)Sell any Praetorian stock that she owns.
B)Short Praetorian's stock.
C)Revise Praetorian's equity cost of capital.
D)Revise her estimate of Praetorian's dividend growth.
Q3) Which is the best valuation technique when using comparables?
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Chapter 11: Risk and Return in Capital Markets
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Q1) A stock whose return does not depend on overall economic conditions has a low systematic risk.
A)True
B)False
Q2) 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 total return rate (yield)for this period is closest to:
A)0.70%
B)-8.13%
C)-8.80%
D)0.75%
Q3) The Ishares Bond Index fund (TLT)has a mean and annual standard deviation of returns of 7% and 10%,respectively.What is the 66% confidence interval for the returns on TLT?
A)-5%,10%
B)7%,10%
C)-3%,17%
D)-10%,10%
Q4) What are the two components of realized return from a stock investment?
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Chapter 12: Systematic Risk and the Equity Risk Premium
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Q1) The market or equity risk premium can be estimated by computing the historical average excess return of the market portfolio.
A)True
B)False
Q2) Which of the following statements is FALSE?
A)If two stocks move in opposite directions,one will tend to be above average when to other is below average,and the covariance will be negative.
B)The correlation between two stocks has the same sign as their covariance,so it has a similar interpretation.
C)The covariance of a stock with itself is simply its variance.
D)The covariance allows us to gauge the strength of the relationship between stocks.
Q3) Which of the following combinations of two stocks would give you the biggest reduction in risk?
A)Duke Energy and Wal-Mart
B)Wal-Mart and Microsoft
C)Microsoft and Duke Energy
D)No combination will reduce risk.
Q4) Is it possible for a stock to have high total risk but low systematic risk?
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Chapter 13: The Cost of Capital
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Q1) When a firm is evaluating the purchase of a business that is unrelated to its current business,it is appropriate to use the current WACC of the firm that is purchasing the business.
A)True
B)False
Q2) What is the difference between the effective cost of debt and the cost of debt?
Q3) The costs of external financing must be deducted from the net present value (NPV)of a project to evaluate if it is worth undertaking.
A)True
B)False
Q4) Your estimate of the market risk premium is 6%.The risk-free rate of return is 5% and General Motors has a beta of 1.2.What is General Motors' cost of equity capital?
A)12.2%
B)11.8%
C)12.9%
D)11.4%
Q5) Which of the three costs - debt,preferred stock and common equity - is most difficult to estimate?
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Chapter 14: Raising Equity Capital
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Q1) Which of the following statements is FALSE?
A)After deciding to go public,managers of the company work with an underwriter,an investment banking firm that manages the offering and designs its structure.
B)The shares that are sold in the IPO may either be new shares that raise new capital,known as a secondary offering,or existing shares that are sold by current shareholders (as part of their exit strategy),known as a primary offering.
C)Many IPOs,especially the larger offerings,are managed by a group of underwriters.
D)At an IPO,a firm offers a large block of shares for sale to the public for the first time.
Q2) What is the major reason that underwriters tend to offer stocks in an IPO at a price that is below that which the market will pay?
A)to gain from the rise in value of any stocks they hold after the IPO
B)to reduce their exposure to losses from unsold stock
C)to benefit from greenshoe provisions
D)to increase their spread
Q3) How does IPO pricing puzzle financial economists?
Q4) What are venture capital firms?
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Chapter 15: Debt Financing
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Q1) When a callable bond sells at a premium,the likelihood of a call is ________ and the yield to worst is the yield to ________.
A)high,call
B)low,call
C)low,maturity
D)high,maturity.
Q2) Which of the following is usually a form of public debt?
A)a private placement
B)a bank loan
C)a bond issue
D)a revolving line of credit
Q3) What kind of corporate debt has a maturity of less than ten years?
A)asset-backed bonds
B)debentures
C)notes
D)mortgage bonds
Q4) What are secured debt?
Q5) What are callable bonds?
Q6) What is an original issue discount bond?
Q7) What are notes?
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Chapter 16: Capital Structure
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Q1) A firm requires an investment of $20,000 and borrows $10,000 at 8%.If the return on equity is 20%,what is the firm's pre tax WACC?
A)14%
B)15%
C)16%
D)17%
Q2) Suppose a project financed via an issue of debt requires five annual interest payments of $20 million each year.If the tax rate is 30% and the cost of debt is 5%,what is the value of the interest rate tax shield?
A)$32.35 million
B)$22.25 million
C)$25.98 million
D)$22.67 million
Q3) With perfect capital markets,what is the market value of Luther's equity after the share repurchase?
A)$15 billion
B)$10 billion
C)$25 billion
D)$20 billion
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Chapter 17: Payout Policy
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Q1) Long-term investors can defer capital gains tax until they sell,and therefore,there is a tax advantage for share repurchases over dividends.
A)True
B)False
Q2) According to the ________ theory of payout policy,managers pay out cash only when pressured to do so by investors.
A)agency
B)supply
C)price pressure
D)managerial entrenchment
Q3) What are the characteristics of special dividend?
Q4) The fact that firms continue to issue dividends despite their tax disadvantage is often referred to as the
A)issuance puzzle.
B)dividend puzzle.
C)payback puzzle.
D)policy puzzle.
Q5) What are the ways in which a firm can retain its free cash flow?
Q6) What is the effect on the stock price when a firm repurchases its shares?
Page 19
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Chapter 18: Financial Modeling and Pro Forma Analysis
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Q1) Calgary Doughnuts had sales of $200 million in 2007.Its cost of sales were $160 million.If sales are expected to grow at 10% in 2008,compute the forecasted costs using the percent of sales method.
A)$160 million
B)$170 million
C)$173 million
D)$176 million
Q2) What is net new financing?
Q3) What are a firm's options when it generates more cash than planned?
Q4) Based upon the average EV/Sales ratio of the comparable firms,Ideko's target economic value is closest to:
A)$191 million
B)$155 million
C)$165 million
D)$157 million
E)$193 million
Q5) Is total net working capital or incremental net working capital more relevant for calculation of free cash flow?
Q6) What is common starting point for forecasting?
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Chapter 19: Working Capital Management
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Q1) What is the meaning of the term 2/10 net 30?
A)If the invoice is paid within 10 days a 2% discount can be taken.If the invoice is paid between 11 and 29 days a 1% discount can be taken.After 30 days the full invoice is due.
B)If the invoice is paid within 2 days a 10% discount can be taken,otherwise the full invoice is due in 30 days.
C)If the invoice is paid within 2 days a 10% discount can be taken,otherwise a 2% discount can be taken if the invoice is paid in 30 days.
D)If the invoice is paid within 10 days a 2% discount can be taken,otherwise the full invoice is due in 30 days.
Q2) Franklin Industries has a current net working capital of $2.5 million.It expects that this will grow at a rate of 3.5% annually forever.If it could slow that growth to 3% per year,how would that affect the the value of the firm,given that it has a cost of capital of 11%?
A)a decrease of $2.22 million
B)an increase of $12,500
C)an increase of $0.78 million
D)an increase of $2.08 million
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Chapter 20: Short-Term Financial Planning
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Q1) A company that makes decorations for Christmas trees has high sales in its fourth quarter but very low sales during the rest of the year.It manufactures decorations steadily throughout the year,however.Which of the following is NOT a likely consequence of this scenario?
A)The firm will need sources of short-term cash to fund inventory in the second and third quarters.
B)The firm will see negative net cash flows in the second and third quarter.
C)The firm will have a large short-term surplus in the fourth quarter.
D)Cash payables will rise from the first to fourth quarter.
Q2) Cash flow forecasts are conducted in order to determine whether a firm has a cash flow surplus or deficit and whether such a surplus or deficit is temporary or permanent.
A)True
B)False
Q3) What is temporary working capital?
Q4) What do we understand by positive cash flow shocks?
Q5) What is the average and maximum maturity of commercial paper?
Q6) What are commitment fees and what effect does it have on the loan?
Q7) What do we understand by seasonality?
Q8) What is permanent working capital?
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Chapter 21: Option Applications and Corporate Finance
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Q1) The open interest for a January 2009 put option that is closest to being at-the-money is:
A)7174
B)982
C)319
D)8422
Q2) Option are also called derivative assets because they derive their value solely from the price of another asset.
A)True
B)False
Q3) Suppose that a stock sells at a price of $40 on the expiration date.Compute the payoff to the seller of a call option if the option strike price is $20.
A)-$20
B)-$30
C)-$40
D)-$50
Q4) What is the long position of an options contract?
Q5) When is an option in-the-money?
Q6) When is an option at-the-money?
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Chapter 22: Mergers and Acquisitions
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Q1) This period is known for known for "strategic" or "global" deals that were more likely to be friendly and to involve companies in related businesses;these mergers often were designed to create strong firms on a scale that would allow them to compete globally:
A)1960s
B)1970s
C)1980s
D)1990s
Q2) Which of the following statements regarding monopoly mergers is false?
A)It is often argued that merging with or acquiring a major rival enables a firm to substantially reduce competition within the industry and thereby increase profits.
B)Financial researchers have found that the share prices of other firms in the same industry did not significantly increase following the announcement of a merger within the industry.
C)While only the merging company benefits when competition is reduced,all companies in an industry pay the associated costs.
D)Society as a whole bears the cost of monopoly strategies,so most countries have antitrust laws that limit such activity.
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Chapter 23: International Corporate Finance
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Q1) Which of the following statements is FALSE?
A)Many countries regulate or limit capital inflows or outflows,and many do not allow their currencies to be freely converted into dollars,thereby creating capital market segmentation.
B)The existence of internationally integrated capital markets makes many decisions in international corporate finance more complicated but potentially more lucrative for a firm that is well positioned to exploit the market segmentation.
C)Political,legal,social,and cultural characteristics that differ across countries may require compensation in the form of a country risk premium.
D)Swaps allow firms to mitigate their exchange rate risk exposure between assets and liabilities,while still making investments and raising funds in the most attractive locales.
Q2) Under U.S.tax law,a multinational corporation may use any excess tax credits generated in high-tax foreign countries to offset its net U.S.tax liabilities on earnings in low-tax foreign countries.
A)True
B)False
Q3) What is cash-and-carry?
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Chapter 24: Leasing
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Q1) Which of the following statements is false?
A)A lease is a contract between two parties: the lessee and the lessor.
B)Most leases involve little or no upfront payment.
C)The lessee is the owner of the asset,who is entitled to the lease payments in exchange for lending the asset.
D)At the end of the contract term,the lease specifies who will retain ownership of the asset and at what terms.
Q2) Which of the following statements is false?
A)If the lease is deemed to be a true lease,the firm is assumed to have effective ownership of the asset and the asset is protected against seizure.
B)Although the legal ownership of the asset resides with the lessor,in a non-tax lease the lessee receives the depreciation deductions.
C)The treatment of leased property in bankruptcy will depend on whether the lease is classified as a security interest or a true lease by the bankruptcy judge.
D)In a non-tax lease,the interest portion of the lease payment is interest income for the lessor.
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Chapter 25: Insurance and Risk Management
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Q1) 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.
Q2) An interest rate that adjusts to current market conditions is called a ________.
A)floating rate.
B)fixed rate.
C)notional rate.
D)arbitrage rate.
Q3) What is the duration of a five-year zero-coupon bond?
A)2.5 Years
B)1 Year
C)5 Years
D)0 Years
Q4) Assuming that your firm will purchase insurance,what is the minimum-size deductible that would leave your firm with an incentive to implement the new safety policies?
Q5) What is the actuarially fair cost of full insurance?
Page 27
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Chapter 26: Corporate Governance
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Q1) The Sarbanes-Oxley Act requires all of the following except?
A)That audit partners rotate every five years to limit the likelihood that auditing relationships become too cozy over long periods of time.
B)Strict limits on the amount of non-audit fees (consulting or otherwise)that an accounting firm can earn from the same firm that it audits.
C)That senior management and the boards of public companies to be comfortable enough with the process through which funds are allocated and controlled,and outcomes monitored throughout the firm,to be willing to attest to their effectiveness and validity.
D)The Auditor must personally attest to the accuracy of the financial statements presented to shareholders and to sign a statement to that effect.
Q2) Directors who are not employees,former employees,or family members of employees and who do not have existing or potential business relationships with the firm are called
A)Monitoring Directors.
B)Independent Directors.
C)Gray Directors.
D)Inside Directors.
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