Principles of Finance
Question Bank
Course Introduction
Principles of Finance introduces students to the fundamental concepts and tools essential for understanding the financial decision-making process within organizations. The course covers key topics such as time value of money, risk and return, financial statement analysis, valuation of assets (stocks and bonds), capital budgeting, cost of capital, and the functioning of financial markets. Through practical examples and case studies, students develop analytical skills needed to assess financial health, make investment decisions, and understand how firms raise and allocate financial resources for long-term growth and sustainability.
Recommended Textbook
Fundamentals of Corporate Finance 2nd Canadian Edition by Jonathan Berk
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Page 2
Chapter 1: Corporate Finance and the Financial Manager
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Sample Questions
Q1) Whose interests should a financial manager consider paramount when making a decision?
A) the stockholders who have risked their money to become owners of the company
B) the employees and associated stakeholders who are employed by the company
C) the public who consume the company's goods and services
D) the senior management and associated colleagues at the executive level within the company
E) the financial manager's own interests
Answer: A
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) What are the main differences between a limited partnership and limited liability partnership?
Answer: A limited partnership is required to have at least one general partner.A limited liability partnership can only be used in the legal and accounting professions.The limitation on a partner's liability is only in cases related to actions of negligence of other partners or those supervised by other partners.
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3
Chapter 2: Introduction to Financial Statement Analysis
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Sample Questions
Q1) 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
E) price-to-book ratio
Answer: A
Q2) If the above statement of financial position is for a retail company,how has the company's leverage changed between 2014 and 2015?
A) The company has experienced a very significant decrease in its leverage.
B) The company has experienced a significant decrease in its leverage.
C) The company has experienced no significant change in its leverage.
D) The company has experienced a significant increase in its leverage.
E) The company has experienced a slight decrease in its leverage.
Answer: D
Q3) What role do external auditors play in the firm's financial reporting process?
Answer: As the name implies,external auditors act as third party monitors to the firms' financial reporting process.
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Page 4
Chapter 3: The Valuation Principle: the Foundation of Financial Decision Making
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Sample Questions
Q1) What is a competitive market?
A) a market in which goods can be bought at the ask price and sold at bid price
B) a market in which a good can be bought and sold at the same price
C) a market in which a good is sold at a lower price than that for which it can be bought
D) a market in which a good is bought for a lower price than that for which it can be sold
E) a market in which buyers do not have to shop around for the cheapest price
Answer: B
Q2) In order to distinguish between inflows and outflows,different colours are assigned to each of these cash flows when constructing a timeline.
A)True
B)False Answer: False
Q3) The one-year discount factor is the discount at which we can purchase money in the future.
A)True
B)False
Answer: True
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Page 5
Chapter 4: The Time Value of Money
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Sample Questions
Q1) Which of the following investments has the highest net present value (NPV),given that the interest rate is 5.5%?
A) one that pays $250 at the end of each of the next four years
B) one that pays $500 at the end of next year and $500 in four years' time
C) one that pays $250 at the end of next year and $750 in four years' time
D) one that pays $200 at the end of next year, $200 at the end of the second year, and $300 at the end of the third and fourth years
E) one that pays $250 at the beginning of each year for the next four years.
Q2) Dan buys a property for $250,000.He is offered a 20-year loan by the bank,at an interest rate of 6% per year.What is the annual loan payment Dan must make?
A) $21,796.14
B) $24,864.98
C) $32,684.66
D) $64,486.34
E) $13,250.00
Q3) If a few intermediate cash flows in valuing a stream of cash flows are zero,can we delete those points on the timeline and squeeze the timeline to show only nonzero cash flows?
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6
Chapter 5: Interest Rates
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Sample Questions
Q1) A 12% APR with bi-monthly compounding is equivalent to an EAR of:
A) 11.98%
B) 12.50%
C) 12.00%
D) 12.62%
E) 12.14%
Q2) You decide to take out a 30-year mortgage for $445,000 at 6% APR.What are your monthly payments?
A) $2,622.69
B) $2,646.96
C) $2,694.06
D) $2,688.32
E) $2,667.99
Q3) The amount of your original loan is closest to:
A) $37,000
B) $32,000
C) $20,300
D) $31,250
E) $29,000
Q4) What is a mortgage?
Page 7
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Chapter 6: Bonds
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Q1) What is the yield to maturity of a ten-year,$1000 bond with a 5.2% coupon rate and semi-annual coupons if this bond is currently trading for a price of $884?
A) 5.02%
B) 6.23%
C) 6.82%
D) 12.46%
E) 5.20%
Q2) How are the cash flows of a coupon bond different from an amortizing loan?
Q3) The above table shows the yields to maturity on a number of one-year,zero-coupon securities.What is the credit spread on a one-year,zero-coupon corporate bond with a B rating?
A) 0.7%
B) 1.7%
C) 1.8%
D) 6.9%
E) 0.6%
Q4) Why do bond prices fall as interest rates rise?
Q5) Under what situation can a zero-coupon bond be selling at a premium?
Q6) Assuming that this bond trades for $1035.44,then what is the YTM for this bond?
Page 8
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Chapter 7: Valuing Stocks
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Sample Questions
Q1) Credenza Industries is expected to pay a dividend of $1.20 at the end of the coming year.It is expected to sell for $62.00 at the end of the year.If its equity cost of capital is 8%,what is the expected capital gain from the sale of this stock at the end of the coming year?
A) $3.48
B) $4.86
C) $14.28
D) $58.52
E) $62.00
Q2) If you want to value a firm that has consistent earnings growth,but varies how it pays out these earnings to shareholders between dividends and repurchases,the simplest model for you to use is the
A) enterprise value model.
B) dividend-discount model.
C) total payout model.
D) discounted free cash flow model.
E) net present value model.
Q3) How can the dividend-discount model handle changing growth rates?
Q4) What are the major limitations of valuation using multiples?
Q5) Can the dividend-discount model handle negative growth rates?
Page 9
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Chapter 8: Investment Decision Rules
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Sample Questions
Q1) Most corporations measure the value of a project in terms of which of the following?
A) discount value
B) discount factor
C) future value (FV)
D) present value (PV)
E) market value
Q2) The net present value (NPV)of project B is closest to: A) 12.6
Q3) What is the IRR for this project?
A) 4.59%
B) 8.63%
C) 15.91%
D) 21.86%
E) 44.63%
Q4) What is the general shape of the net present value (NPV)profile?
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Chapter 9: Fundamentals of Capital Budgeting
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Q1) How does the capital budgeting process begin?
A) by analyzing alternate projects
B) by evaluating the net present value (NPV) of each project's cash flows
C) by compiling a list of potential projects
D) by forecasting the future consequences for the firm of each potential project
E) by calculating the incremental earnings of a project
Q2) The CCA tax shield for Shepard Industries project in year 1 is closest to:
A) $84
B) $168
C) $96
D) $72
E) $100
Q3) A consumer good company is developing a new brand of organic toothpaste.Above is the sensitivity analysis for this product.The assumptions regarding which parameter should be scrutinized most carefully in the estimation process?
A) units sold
B) sales price
C) cost of goods
D) cost of capital
E) net working capital
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Chapter 10: Risk and Return in Capital Markets
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Sample Questions
Q1) Treasury bill returns are 5%,4%,3%,and 6% over four years.The standard deviation of returns of Treasury bills is:
A) 1.51%
B) 1.11%
C) 1.00%
D) 1.29%
E) 1.43%
Q2) Your investment over one year had a realized return of 7% and a dividend of $1.25.If the sale price was $36 per share,what was the cost of the investment?
A) $32.15
B) $32.78
C) $33.64
D) $34.81
E) $34.90
Q3) Investors should earn a risk premium for bearing unsystematic risk. A)True B)False
Q4) How does diversification affect systematic and unsystematic risk?
Q5) Why must riskier investments offer higher expected returns?
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Chapter 11: Systematic Risk and the Equity Risk Premium
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Sample Questions
Q1) The expected return on your of your investment is closest to:
A) 18%
B) 20%
C) 12%
D) 24%
E) 32%
Q2) The volatility of a portfolio that is equally invested in Wal-Mart and Duke Energy is closest to:
A) 5.0%
B) 0.6%
C) 7.6%
D) 22.4%
E) 10.1%
Q3) Since total risk is greater than systematic risk,should standard deviation be always greater than beta?
Q4) What role does the standard deviations of two assets play in computation of the expected return of the two asset portfolio?
Q5) How does the S&P/TSX Composite index rank in terms of number and market capitalization of Canadian public firms?
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Chapter 12: Determining the Cost of Capital
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Sample Questions
Q1) Ford Motor Company is discussing new ways to recapitalize the firm and raise additional capital.Its current capital structure has a 10% weight in equity,20% in preferred stock,and 70% in debt.The cost of equity capital is 15%,the cost of preferred stock is 10%,and the pretax cost of debt is 8%.What is the weighted average cost of capital for Ford if its marginal tax rate is 30%?
A) 7.01%
B) 7.42%
C) 7.98%
D) 8.01%
E) 8.73%
Q2) A firm has $1 million market value and it sells preferred stock with a par value of $100.If the coupon rate on the preferred stock is 7% and the preferred stock trades at $95,what is the cost of preferred stock financing?
A) 6.75%
B) 7.15%
C) 7.21%
D) 7.37%
E) 8.12%
Q3) Is it incorrect to use the coupon rate of debt toward cost of debt?
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Page 14
Chapter 13: Risk and the Pricing of Options
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Sample Questions
Q1) How many of the January 2009 call options are out-of-the-money?
A) 0
B) 1
C) 2
D) 3
E) 4
Q2) What are European options?
Q3) The binomial option pricing model calculates the option price by creating a replicating portfolio out of a risk-free bond and the underlying stock.
A)True
B)False
Q4) Assume you want to sell 20 call option contracts with an exercise price closest to being at-the-money and that expires January 2011.The current price that you would receive for such a contract is:
A) $4500
B) $2600
C) $3900
D) $4000
E) $3500
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Chapter 14: Raising Equity Capital
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Sample Questions
Q1) What is the post-money valuation for the series D funding round?
A) $1.89 million
B) $1.96 million
C) $2.14 million
D) $2.24 million
E) $2.43 million
Q2) Suppose you had sold the 1 million shares to the angel investor for $500,000.What would have been the post-money valuation of your shares immediately following the angel investor's investment?
A) $500,000
B) $700,000
C) $1.0 million
D) $2.0 million
E) $2.5 million
Q3) What advantages do venture capital firms offer limited partners compared to investing directly in start-ups themselves as angel investors?
Q4) What is the difference between preferred stocks issued by a private company and a mature company?
Q5) How many types of seasoned equity offerings are there?
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Chapter 15: Debt Financing
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Sample Questions
Q1) Why do corporations choose to have a Canada call provision rather than leaving the bonds as non-callable?
Q2) The purchase by a group of private investors of all the equity of a public corporation,primarily through debt financing,is known as a(n)
A) IPO.
B) SEO.
C) LBO.
D) debt buyout.
E) equity buyout.
Q3) Kruller A.G.issues a bond that is offered for sale simultaneously in Europe,the United States,and Japan.Which of the following best describes this bond?
A) a domestic bond
B) a foreign bond
C) a Eurobond
D) a global bond
E) a corporate bond
Q4) Private debt cannot be in the form of bonds.
A)True
B)False
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Chapter 16: Capital Structure
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Q1) Assume that in addition to 1.25 billion common shares outstanding,Luther has stock options given to employees valued at $2 billion.After the repurchase,how many shares will Luther have outstanding?
A) 1.0 billion
B) 1.2 billion
C) 0.75 billion
D) 1.1 billion
E) 1.25 billion
Q2) Suppose a firm has $50 million of permanent debt.If the tax rate is 25% and the cost of debt is 7%,what is the value of the interest tax shield each year?
A) $3.5 million
B) $50 million
C) $0.875 million
D) $178.6 million
E) $12.5 million
Q3) The presence of leverage can influence the behaviour of the managers of a firm. A)True B)False
Q4) How do capital structure choices differ across industries?
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Chapter 17: Payout Policy
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Q1) Share repurchases have a tax advantage over dividends because A) dividend payments are tax deductible.
B) share repurchases increase the value of debt.
C) capital gains can be deferred by long-term investors.
D) repurchases are associated with increased customer loyalty.
E) dividends are not taxed.
Q2) When a firm retains cash,it pays corporate tax on the interest it earns and the investor will owe capital gains tax on the increased firm value-in essence the interest on retained cash is taxed
A) once.
B) at a rate of zero.
C) twice.
D) only at the corporate level.
E) only at the investor level.
Q3) The optimal dividend policy when dividend tax rates exceed capital gains tax rates is to pay dividends only.
A)True
B)False
Q4) What is the difference between an open market share repurchase and a targeted repurchase?
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Chapter 18: Financial Modelling and Pro Forma Analysis
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Sample Questions
Q1) How do we know if expansion is a good idea for the firm?
Q2) Based upon Ideko's sales and operating cost assumptions,what production capacity will Ideko require in 2018?
A) 1505 units
B) 1115 units
C) 1323 units
D) 1702 units
E) 1914 units
Q3) Assuming that Ideko has a EBITDA multiple of 8.5,then the continuation unlevered price-earnings ratio of Ideko in 2015 is closest to:
A) 17.6
B) 16.4
C) 14.5
D) 19.0
E) 13.7
Q4) What is the major shortcoming of the percent of sales method for firms experiencing rapid growth?
Q5) What are a firm's options when it generates more cash than planned?
Q6) Why is EBITDA multiple used for valuation rather than sales or earnings?
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Chapter 19: Working Capital Management
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Q1) Which of the following best describes the collection float?
A) how long it takes the firm to receive the cheque after the customer has mailed it
B) how long it takes the firm to process the cheque and deposit it in the bank
C) how long it takes before the bank gives the firm credit for the funds
D) how long it takes for a firm to be able to use funds after a customer has paid for its goods
E) how long it takes before payments to suppliers actually result in cash outflow for the firm
Q2) Which of the following firms would be expected to need the most cash to conduct its daily operations?
A) a retail grocery store that sells on a cash only basis
B) an electronics manufacturer that only assemble its goods once they have been paid for
C) an airline that has many of its fares pre-paid by cash or credit card
D) an aircraft manufacturer with large inventory and long development and sales cycles
E) a clothing retailer that accepts both cash and credit payments
Q3) What is a firm's cash cycle?
Q4) What is the credit period?
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Chapter 20: Short Term Financial Planning
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Q1) Ahab's Army Surplus has a commited line of credit with a maximum of $1.2 million and interest rate of 3.5% (EAR).The loan has a commitment fee of 0.45% (EAR).If the firm borrows $900,000 at the start of the year and repays it at the end of the year,what is the total cost of the loan?
A) $42,000
B) $35,550
C) $43,350
D) $32,850
E) $31,500
Q2) Which of the following companies is most likely to have the greatest need for short-term financial planning?
A) a company that mines sand for use in glass-making
B) a company that manufactures condiments such as ketchup
C) a company that produces advertisements for roadside billboards
D) a company that provides catering services for weddings
E) a utility company that provides electricity
Q3) What is the difference between a pledging of accounts receivable and a factoring of accounts receivable?
Q4) How does seasonality lead to short-term financing needs?
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Chapter 21: Risk Management
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Q1) Adverse selection is a market friction that raises the cost of insurance.
A)True
B)False
Q2) What is the percentage change in a 7-year zero-coupon bond with a duration of 7 years,when interest rates increase from 6% to 7%?
A) -1%
B) -6.8%
C) -6.4%
D) -7%
E) -6.7%
Q3) Because insurance provides cash to the firm to offset losses,it can reduce the firm's need for external capital and thus reduce ________ costs.
A) labour
B) external
C) input
D) issuance
E) startup
Q4) How does insurance allow firms to increase their use of debt financing?
Q5) How does insurance allow firms to reduce issuance costs?
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Chapter 22: International Corporate Finance
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Q1) What is the importer-exporter dilemma?
Q2) You own a Canadian firm that invests in a U.S.project with the cash flows shown in the table above.Given a corporate tax rate of 40% and a WACC of 8.9%,what is the NPV of the investment.?
A) $9.3 million CAD
B) $0.1 million CAD
C) -$0.1 million CAD
D) $7.5 million CAD
E) $7.2 million CAD
Q3) What are internationally integrated capital markets?
Q4) Canadian tax policy requires Canadian corporations to pay taxes on their foreign income at the same rate as profits earned in Canada.
A)True
B)False
Q5) The amount of taxes paid by a foreign subsidiary does not depend on the amount repatriated back to the home country.
A)True
B)False
Q6) Why do firms prefer forward contracts rather than the cash-can-carry strategy?
Page 24
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Chapter 23: Leasing
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Q1) Calculate the monthly lease payments for a four-year $1.00 out lease of the bulldozer.
Q2) If your firm's borrowing cost is 3% and the tax rate is 45%,what is the NPV of buying and leasing?
A) $20,479
B) $15,069
C) -$20,479
D) -$15,069
E) -$14,145
Q3) Suppose that the bulldozer can be leased with a $1.00-out lease.The lease payments will be closest to:
A) $2,114
B) $1,825
C) $2,030
D) $2,103
E) $1,945
Q4) Most leases involve a large upfront payment.
A)True
B)False
Q5) Explain the reduced resale costs argument for leasing.
Page 25
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Chapter 24: Mergers and Acquisitions
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Q1) This period is known as the conglomerate wave because firms typically acquired firms in unrelated businesses:
A) 1960s
B) 1970s
C) 1980s
D) 1990s
E) 2000s
Q2) Consider two firms,Left Company and Right Enterprises,both with earnings of $2.50 per share and 15 million shares outstanding.Left is a mature company with few growth opportunities and a stock price of $7 per share.Right is a new firm with much higher growth opportunities and a stock price of $16 per share.Assume Right acquires Left using its own stock and the takeover adds no value.What is the change in Right's price-earnings ratio as a result of the acquisition?
A) 0
B) 3.0
C) -3.2
D) -3.6
E) -1.8
Q3) What is the major drawback of adopting a poison pill?
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26
Chapter 25: Corporate Governance
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Q1) Explain what it means for a firm to have dual class shares.
Q2) Examples of cross-holdings include: I.Japanese keiretsu
II)German Gruppe
III)Australian foundations
IV)Korean chaebol
A) I, II, and IV
B) I, II, and III
C) I and IV
D) I, II, III, and IV
E) II and III
Q3) What is the cost of aligning managers' interests with those of shareholders?
Q4) What is the drawback of having more independent directors on the board?
Q5) ________ is a person making a trade based on privileged information.
A) Rogue trading
B) Illegal trading
C) Standard trading
D) Insider trading
E) Exchange trading
Q6) Describe the "stakeholder" model of corporate governance.
Q7) What is the role of takeovers in corporate governance?
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