Managerial Finance
Exam Answer Key
Course Introduction
Managerial Finance explores the principles and practices essential for effective financial decision-making within organizations. The course covers key topics such as financial analysis and planning, working capital management, capital budgeting, risk and return assessment, and the cost of capital. Emphasis is placed on the application of financial theory to real-world managerial problems, including ethical considerations and the impact of global financial markets. By integrating analytical tools with practical case studies, students develop the skills necessary to evaluate financial performance, allocate resources efficiently, and contribute to strategic objectives in a managerial capacity.
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) 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
Q3) What strategies are available to shareholders to help ensure that managers are motivated to act in the interest of the shareholders rather than their own interest?
Answer: 1.The threat of a hostile takeover
2.Shareholder initiatives
3.Performance-based compensation
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Page 3
Chapter 3: Arbitrage and Financial Decision Making
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Q1) Assume that the risk-free interest rate is 10%.Rank each of the four projects from most desirable to least desirable based upon NPV.Which project would you invest in first? Are there any projects that you wouldn't invest in?
Answer: Ranking
1.NPV beta = 15 - 12 / 1.1 = 4.09
2.NPV delta = -16 + 21 / 1.1 = 3.09
3.NPV alpha = -18 + 23 / 1.1 = 2.91
Would never invest in gamma.NPV gamma = 15 - 20 / 1.1 = -3.18
Q2) The first step in evaluating a project is to identify its ________.
A) amortization value and depreciation value
B) principal value and maturity value
C) present value and future value
D) costs and benefits
Answer: D
Q3) A competitive market in which there are no arbitrage opportunities is called
A) a normal market.
B) a fair market.
C) an arbitrage market.
D) a free market.
Answer: A
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Chapter 4: The Time Value of Money
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Q1) Draw a timeline detailing the cash flows from investment "B."
Q2) You are thinking about investing in a mine that will produce $10,000 worth of ore in the first year.As the ore closest to the surface is removed it will become more difficult to extract the ore.Therefore,the value of the ore that you mine will decline at a rate of 8% per year forever.If the appropriate interest rate is 6%,then the value of this mining operation is closest to:
A) $71,429
B) $500,000
C) $166,667
D) This problem cannot be solved.
Q3) You have been offered the following investment opportunity: if you pay $2,500 today,you will receive $1,000 at the end of each of the next three years.Draw a timeline detailing this investment opportunity.
Q4) When a value or a cash flow is compounded or discounted,the value or cash flow will have
A) linear growth.
B) exponential growth.
C) constant growth.
D) percentage growth.
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Chapter 5: Interest Rates
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Q1) 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.
Q2) The effective annual rate (EAR)for a savings account with a stated APR of 4% compounded daily is closest to:
A) 4.00%
B) 4.10%
C) 4.08%
D) 4.06%
Q3) Should you purchase the delivery truck or lease it? Why?
Q4) Assuming that you have made all of the first 24 payments on time,how much interest have you paid over the first two years of your loan?
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Chapter 6: Valuing Bonds
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Q1) Which of the following statements is false?
A) Bond ratings encourage widespread investor participation and relatively liquid markets.
B) Bonds in the top four categories are often referred to as investment grade bonds.
C) A bond's rating depends on the risk of bankruptcy as well as the bondholder's ability to lay claim to the firm's assets in the event of a bankruptcy.
D) Debt issues with a low-priority claim in bankruptcy will have a better rating than issues from the same company that have a higher priority in bankruptcy.
Q2) The price today of a 4-year default-free security with a face value of $1,000 and an annual coupon rate of 5.25% is closest to:
A) $1,000
B) $1,003
C) $1,008
D) $987
Q3) Explain why the expected return of a corporate bond does not equal its yield to maturity?
Q4) 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) Two firms in the same industry selling the same types of products, while similar in many respects, are likely to be of different size or scale.
B) In the method of comparables we estimate the value of the firm based on the value of other, comparable firms or investments that we expect will generate very similar cash flows in the future.
C) Consider the case of a new firm that is identical to an existing publicly traded company. If these firms will generate identical cash flows, the Law of One Price implies that we can use the value of the existing company to determine the value of the new firm.
D) A valuation multiple is a ratio of some measure of the firm's scale to the value of the firm.
Q2) If CCM has $150 million of debt and 12 million shares of stock outstanding,then the share price for CCM is closest to:
A) $49.50
B) $11.25
C) $20.50
D) $22.75
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Page 9
Chapter 8: Investment Decision Rules
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Q1) The payback period for project A is closest to:
A) 2.0 years
B) 2.4 years
C) 2.5 years
D) 2.2 years
Q2) The payback period for project Beta is closest to:
A) 2.9 years
B) 3.1 years
C) 2.6 years
D) 3.2 years
Q3) Which of the following statements is false?
A) The profitability index measures the value created in terms of NPV per unit of resource consumed.
B) The profitability index is the ratio of value created to resources consumed.
C) The profitability index can be easily adapted for determining the correct investment decisions when multiple resource constraints exist.
D) The profitability index measures the "bang for your buck."
Q4) Explain why the NPV decision rule might provide Larry with a different decision outcome than the IRR rule when evaluating Larry's three movie deal offer.
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Chapter 9: Fundamentals of Capital Budgeting
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Q1) The NPV for Epiphany's Project is closest to:
A) $4,825
B) $39,000
C) $11,946
D) $20,400
Q2) Which of the following statements is false?
A) The ultimate goal in capital budgeting is to determine the effect of the decision to take a particular project on the firm's cash flows.
B) To the extent that overhead costs are fixed and will be incurred in any case, they are incremental to the project and should be included in the capital budgeting analysis.
C) Unlevered Net Income = (Revenue - Costs - Depreciation) × (1 - <sub>c</sub>).
D) Earnings are not cash flows.
Q3) Construct a simple income statement showing the incremental EBIT and the incremental unlevered net income for all three years of the Sisyphean Corporation's project.
Q4) What is the NPV of Epiphany's project?
Q5) How does scenario analysis differ from sensitivity analysis?
Q6) What is sensitivity analysis?
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Chapter 10: Capital Markets and the Pricing of Risk
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Q1) What is the standard deviation of Big Cure's average net income for their new blockbuster drug?
A) $0
B) $1 billion
C) $100 million
D) $500 million
Q2) Which of the following statements is false?
A) Because investors are risk averse, they will demand a risk premium to hold unsystematic risk.
B) Over any given period, the risk of holding a stock is that the dividends plus the final stock price will be higher or lower than expected, which makes the realized return risky.
C) The risk premium for diversifiable risk is zero, so investors are not compensated for holding firm-specific risk.
D) Because investors can eliminate firm-specific risk "for free" by diversifying their portfolios, they will not require a reward or risk premium for holding it.
Q3) Which pharmaceutical company faces less risk?
Q4) What is the difference between common risk and independent risk?
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Chapter 11: Optimal Portfolio Choice and the Capital Asset
Pricing Model
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Q1) the CAPM allows us to identify the efficient portfolio of risky assets without having any knowledge of the ________ of each security.
A) systematic risk
B) common risk
C) diversifiable risk
D) expected return
Q2) The amount of risk that will remain in a portfolio depends on the degree to which the stocks are exposed to
A) independent risks.
B) diversifiable risks.
C) common risks.
D) idiosyncratic risks.
Q3) The required return is ________ that is necessary to compensate for the risk investment i will contribute to the portfolio.
A) the realized return
B) the highest return
C) the lowest return
D) the expected return
Q4) Calculate the correlation between Home Depot's and IBM's returns.
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) In the real world, specific projects should differ only slightly from the average investment made by the firm.
B) We can estimate r<sub>U</sub> for a new project by looking at single-division firms that have similar business risks.
C) The project's equity cost of capital depends on its unlevered cost of capital, r<sub>U</sub>, and the debt-equity ratio of the incremental financing that will be put in place to support the project.
D) Projects may vary in the amount of leverage they will support - for example, acquisitions of real estate or capital equipment are often highly levered, whereas investments in intellectual property are not.
Q2) The cost of capital of any investment opportunity equals ________ of available investments with the same beta.
A) the realized return
B) the expected return
C) the level of systematic risk
D) the volatility of return
Q3) 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) Investors appear to put too ________ weight on ________ rather than considering ________.
A) little; their own experience; all the historical evidence
B) much; their own experience; all the historical evidence
C) little; historical evidence; their own experience
D) much; historical evidence; their own experience
Q2) Which of the following statements is false?
A) Portfolios with high market capitalizations will have positive alphas if the market portfolio is not efficient.
B) The size effect is the observation that firms with high book-to-market ratios have positive alphas.
C) If the market portfolio is not efficient, then a portfolio of high book-to-market stocks will likely have positive alphas.
D) Portfolios with low book-to-market ratios will have negative alphas if the market portfolio is not efficient.
Q3) Why is the high trading volume observed in markets inconsistent with the CAPM equilibrium?
Q4) What does the existence of a positive alpha investment strategy imply?
Q5) Explain why the market portfolio proxy may not be efficient.
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Chapter 14: Financial Options
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Q1) Which of the following statements is false?
A) The option price is more sensitive to changes in volatility for at-the-money options than it is for in-the-money options.
B) A share of stock can be thought of as a put option on the assets of the firm with a strike price equal to the value of debt outstanding.
C) In the context of corporate finance, equity is at-the-money when a firm is close to bankruptcy.
D) Because the price of equity is increasing with the volatility of the firm's assets, equity holders benefit from a zero-NPV project that increases the volatility of the firm's assets.
Q2) Which of the following statements is false?
A) The intrinsic value of an option is the value it would have if it expired immediately.
B) A European option cannot be worth less than its American counterpart.
C) Put options increase in value as the stock price falls.
D) A put option cannot be worth more than its strike 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) 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.
Q2) Using risk-neutral probabilities,calculate the price of a two-year call option on Kinston stock with a strike price of $9.
Q3) Using the binomial pricing model,the calculated price of a one-year put option on KD stock with a strike price of $20 is closest to:
A) -7.7
B) 2.4
C) 4.6
D) -1.8
Q4) ________ have the highest expected returns and ________ have the lowest expected returns.
A) Out-of-the-money calls; out-of-the-money puts
B) In-the-money puts; out-of-the-money puts
C) Out-of-the-money puts; out-of-the-money calls
D) In-the-money calls; out-of-the-money puts
Q5) Using the binomial pricing model,calculate the price of a two-year call option on Kinston stock with a strike price of $9.
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Chapter 16: Real Options
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Q1) Even if an investment opportunity currently has ________ NPV,it does not imply that the opportunity is ________.
A) negative; worthless
B) positive; worthless
C) negative; worth more
D) positive; worth more
Q2) ________ need not be exercised immediately.
A) Out-of-the money real options
B) At-the-money real options
C) Real options
D) In-the-money real options
Q3) Assume that you are not able to sell the plant,but you are able to shut down the plant at no cost at any time.The value of the option to abandon production will be closest to:
A) $1.0 million
B) $0.5 million
C) -$1.0 million
D) $3.0 million
Q4) Assuming you are able to sell the plant,draw a decision tree detailing this problem.
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Chapter 17: Capital Structure in a Perfect Market
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Q1) Suppose that you borrow only $45,000 in financing the project.According to MM proposition II,calculate the firm's equity cost of capital.
Q2) Consider the following equation: E + D = U = A
The A in this equation represents
A) the value of the firm's debt.
B) the market value of the firm's assets.
C) the value of the firm's equity.
D) the value of the firm's unlevered equity.
Q3) When corporations raise funds from outside investors,they must choose which type of security to issue.The most common choices are financing through A) equity alone.
B) debt alone.
C) a combination of debt and equity.
D) Both A and C
Q4) The market value of Luther's non-cash assets is closest to:
A) $20 billion
B) $19 billion
C) $25 billion
D) $24 billion
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Chapter 18: Debt and Taxes
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Q1) If Flagstaff currently maintains a .5 debt to equity ratio,then the value of Flagstaff as an all equity firm would be closest to:
A) $80 million
B) $100 million
C) $73 million
D) $115 million
Q2) The value of a firm is the total amount it can raise from ________.
A) all investors
B) creditors
C) shareholders
D) stakeholders
Q3) LCMS' annual interest tax shield is closest to:
A) $2.8 million
B) $2.0 million
C) $3.6 million
D) $5.6 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 19: Financial Distress, managerial Incentives, and Information
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Q1) What is the expected payoff to equity holders with the speculative oil lease deal?
A) $10 million
B) $160 million
C) $275 million
D) $135 million
Q2) Which of the following is NOT a direct cost of bankruptcy?
A) Costs to Creditors
B) Investment Banking Costs
C) Costs of accounting experts
D) Legal Costs and Fees
Q3) Which of the following firms is likely to maintain low levels of debt?
A) An electric utility
B) A tobacco company
C) An Internet firm
D) A mature restaurant chain
Q4) 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.
Q5) List five general categories of indirect costs associated with bankruptcy.
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Chapter 20: Payout Policy
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Q1) Anyone who purchases the stock on or after the ________ date will not receive the dividend.
A) distribution
B) record
C) ex-dividend
D) declaration
Q2) The effective dividend tax rate for a buy and hold individual investor in 2006 is closest to:
A) 0%
B) 35%
C) 15%
D) 20%
Q3) Calculate the effective tax disadvantage for retaining cash in 1999,2001,and 2005.
Q4) The firm mails dividend checks to the registered shareholders on the
A) ex-dividend date.
B) declaration date.
C) distribution date.
D) record date.
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Page 22
Chapter 21: Capital Budgeting and Valuation With Leverage
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Q1) A project's cost of capital depends on its ________.
A) risk
B) future cash flows
C) discounted cash flows
D) average free cash flows
Q2) Calculate the NPV for Iota's new project.
Q3) The debt capacity for Omicron's new project in year 2 is closest to:
A) $55.25
B) $38.75
C) $22.00
D) $33.00
Q4) The ________ for a project will depend on the characteristics of both the project and the firm.
A) maximal leverage
B) minimal leverage
C) nominal leverage
D) optimal leverage
Q5) Describe three simplifying assumptions that we make in valuing a project.
Q6) Describe the key steps in the flow-to-equity method for valuing a levered investment.
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Chapter 22: Valuation and Financial Modelling: a Case Study
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Q1) What is the purpose of the sensitivity analysis?
Q2) We can use a one-year Canadian Treasury Bill rate as ________ interest rate when we convert an unlevered beta to a cost of capital for an acquired firm.
A) a risk-free B) a nominal C) a real
D) an effective
Q3) 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%
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 P/E multiples for the comparable firms?
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Chapter 23: The Mechanics of Raising Equity Capital
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Q1) Which of the following statements is false?
A) Once the issue price (or offer price) is set, underwriters may invoke another mechanism to protect themselves against a loss - the over-allotment allocation.
B) Before the offer price is set, the underwriters work closely with the company to come up with a price range that they believe provides a reasonable valuation for the firm.
C) Before an IPO, the company prepares the final registration statement and final prospectus containing all the details of the IPO, including the number of shares offered and the offer price.
D) A "road trip" is where senior management and the lead underwriters travel around the country (and sometimes around the world) promoting the company and explaining their rationale for the offer price to the underwriters' largest customers - mainly institutional investors such as mutual funds and pension funds.
Q2) What will the proceeds from the IPO be if Luther is selling 1.1 million shares ?
Q3) How much money did Luther raise?
Q4) Based upon the price/revenue ratio,what would be a reasonable value for KD?
Q5) When referring to IPOs,what is book building?
Q6) Describe the four characteristics of IPOs that puzzle financial economists.
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Chapter 24: Debt Financing
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Q1) Which of the following statements is false?
A) In the case of a Treasury note or Treasury bond offering, the stop-out yield determines the coupon of the bond and then all bidders pay the discounted value for the bond or note.
B) All competitive bidders submit sealed bids in terms of yields and the amount of bonds they are willing to purchase.
C) In the past, the Treasury has issued bonds with maturities of 30 years (often called long bonds) and 20 years.
D) Noncompetitive bidders (usually individuals) just submit the amount of bonds they wish to purchase and are guaranteed to have their orders filled at the auction.
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 is the Yield to Call (YTC)on this bond?
Q4) What is the Yield to Maturity (YTM)on this bond?
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Chapter 25: Leasing
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Q1) Which of the following statements is false?
A) The Canada Revenue Agency (CRA) had its own classification rules under Interpretation Bulletin IT-233R that effectively ruled on June 14, 2001, that the legal form of the contract would be central to determining if the transaction was a sale or lease.
B) A lease contract would be treated as a lease and a sale contract would be treated as a sale.
C) If the contract were designed strictly to avoid tax, the General Anti-Avoidance Rule (GAAR) could be used to reassess the case.
D) The categories used to report leases in the financial statements affect the values of assets on the balance sheet, but they have no direct effect on the cash flows that result from a leasing transaction.
Q2) If a firm purchases a piece of equipment,the expense is ________.Therefore,the purchase price can ________ over time,generating a CCA tax shield.
A) an operating expenditure; be an operating expense
B) an operating expenditure; be amortized
C) a capital expenditure; be depreciated
D) a capital expenditure; be an operating expense
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Chapter 26: Working Capital Management
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Q1) Your firm purchases goods from its supplier on terms of 1/10,net 30.The effective annual cost to your firm if it chooses not to take advantage of the trade discount offered and stretches the accounts payable to 45 days is closest to:
A) 13.0%
B) 11.1%
C) 15.9%
D) 20.1%
Q2) Which of the following money market investments is essentially a loan arrangement wherein a securities dealer is the "borrower" and the investor is the "lender?" The investor buys securities from the securities dealer,with an agreement to sell the securities back to the dealer at a later date for a specified higher price.
A) Certificates of Deposit (CD)
B) Commercial Paper
C) Banker's Acceptance
D) Repurchase Agreement
E) Treasury Bill
Q3) Calculate the number of days in Luther's Operating Cycle.
Q4) What is a compensating balance?
Q5) Describe "just-in-time" inventory management.
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Chapter 27: Short-Term Financial Planning
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Q1) When a company analyzes its short-term financing needs,it typically examines cash flows at
A) monthly intervals.
B) yearly intervals.
C) quarterly intervals.
D) weekly intervals.
Q2) The major current assets that are used for short-term secured financing are ________.
A) accounts receivable and inventory
B) accounts receivable and short-term investments
C) inventory and short-term investments
D) prepaid expenses and taxes recoverable
Q3) Luther Industries wants to borrow $1 million for two months.Using its inventory as collateral,it can obtain a 10% (APR)loan (compounded monthly).The lender requires that a warehouse arrangement be used.The warehouse fee is $10,000,payable at the end of the two months.Calculate the effective annual rate of this loan for Luther Industries.
Q4) 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) The 1990s were known for "strategic" deals that were more likely to be ________ in related businesses; these mergers often were designed to create strong firms on a scale that would allow them to compete ________.
A) friendly and to involve companies; globally
B) hostile but to involve companies; globally
C) friendly but not to involve companies; globally
D) friendly and to involve companies; domestically
Q2) Which of the following statements regarding mergers and taxes is false?
A) Carryback and carryforward provisions essentially deliver the benefits of conglomeration to a small firm with volatile earnings.
B) It might appear that a conglomerate has a tax advantage over a single-product firm simply because losses in one division can offset profits in another division.
C) Companies with current-year losses can also use them to offset earnings (carryback) for the twenty prior years.
D) The IRS will disallow a tax break if it can show that the principal reason for a takeover is tax avoidance, so it is unlikely that the tax advantage could, by itself, be a valid reason to acquire another firm.
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Page 30
Chapter 29: 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 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) that the auditor must personally attest to the accuracy of the financial statements presented to shareholders and must 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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Chapter 30: Risk Management
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Q1) 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
Q2) If your firm is uninsured,the NPV of implementing the new safety policies is closest to:
A) $2.25 million
B) -$.25 million
C) $2.5 million
D) $2.15 million
Q3) Hedging involves contracts or transactions that provide the firm with ________ that offset its losses from price changes.
A) profits
B) incomes
C) cash flows
D) net earnings
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) The present value of the £5 million cash inflow computed by first discounting the £s and then converting into dollars is closest to:
A) $8,961,420
B) $8,950,495
C) $8,954,615
D) $8,943,695
Q2) 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
Q3) What conditions cause the cash flows of a foreign project to be affected by exchange rate risk?
Q4) What is the pound present value of the project?
Q5) Calculate the pound denominated cost of capital for Luther's project.
Q6) How do we make adjustments when a project has inputs and outputs in different currencies?
Q7) What is the dollar present value of the project?
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