Principles of Finance Review
Questions
Course Introduction
Principles of Finance introduces students to the fundamental concepts and tools used in financial decision-making within organizations. The course covers topics such as the time value of money, financial statement analysis, risk and return, valuation of stocks and bonds, capital budgeting, and the role of financial markets and institutions. Emphasis is placed on understanding how financial managers analyze information to make investment and financing decisions that maximize firm value. By the end of the course, students will have developed foundational skills to interpret financial data and apply financial principles in both personal and professional contexts.
Recommended Textbook Fundamentals of Corporate Finance 3rd Australian Edition by Berk DeMarzo
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Page 2
Chapter 1: Corporate Finance and the Financial Manager
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Sample Questions
Q1) A typical 'public' company has many types of shareholders, from individuals holding a few shares, to large institutions that hold very large numbers of shares. How does a financial manager ensure that the priorities and concerns of such disparate shareholders are met?
A)The decisions taken by the financial manager should be solely influenced by the benefit to the company since, by maximising its fitness, he or she will also maximise the benefits of that company to the shareholders.
B)The financial manager should seek to make investments that do not harm the interests of the shareholders.
C)In general, all shareholders will agree that they are better off if the financial manager works to maximise the value of their investment.
D)The financial manager should consider the interests and concerns of large shareholders a priority, so the needs of those who hold a controlling interest in the company are met.
Answer: C
Q2) What is the term for the applicable price that the seller gets when he/she sells a share on an exchange?
Answer: The seller gets the bid price when he sells a share on an exchange.
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Page 3
Chapter 2: Introduction to Financial Statement Analysis
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Sample Questions
Q1) Financial statements are accounting reports issued periodically by a firm which present information on the past performance of the firm, a summary of the firm's assets and the financing of those assets, and a prediction of the firm's future performance.
A)True
B)False
Answer: False
Q2) The third party who checks annual financial statements to ensure that they are prepared according to Generally Accepted Accounting Principles (GAAP)and verifies that the information reported is reliable is the A)Australian Securities and Investments Commission (ASIC).
B)auditor.
C)Australian Securities Exchange.
D)Australian Accounting Standards Board.
Answer: B
Q3) Refer to the balance sheet above. If on 30 June 2017 Luther has 8 million shares outstanding trading at $15 per share, then what is Luther's market-to-book ratio?
Answer: market-to-book = market value of equity/book value of equity market-to-book = 8 million × $15/$63.6 = 1.89
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Chapter 3: Time Value of Money: an Introduction
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Sample Questions
Q1) Jeff has the opportunity to receive lump-sum payments either now or in the future. Which of the following opportunities is the best, given that the interest rate is 7% per year?
A)One that pays $1 500 in five years
B)One that pays $1 200 in two years
C)One that pays $1 800 in ten years
D)One that pays $1 000 now
Answer: A
Q2) What is the future value (FV)of $60 000 in five years, assuming the interest rate is 5% per year?
A)$75 000.00
B)$76 576.89
C)$62 500.00
D)$72 674.86
Answer: B
Q3) Dollar amounts received at different points in time cannot be compared in absolute terms.
A)True
B)False
Answer: True
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Chapter 4: Time Value of Money: Valuing Cash Flow
Streams
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Sample Questions
Q1) $12 500 is invested in a certain business at the start of a year, in return the investor will receive $3 000 at the end of each of the next five years. What is the net present value of this business opportunity if the interest rate is 5% per year?
A)$137.09
B)$443.88
C)$385.10
D)$488.43
Q2) Ally wishes to leave a provision in her will that $2 000 will be paid annually in perpetuity to a local charity. How much must she provide in her will for this perpetuity if the interest rate is 6%?
A)$3 201.21
B)$42 000.00
C)$21 200.00
D)$33 333.33
Q3) Trial and error is the only way to compute the internal rate of return (IRR)when interest is calculated over five or more periods.
A)True
B)False
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Chapter 5: Interest Rates
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Q1) The opportunity cost of capital will generally be higher than the interest rate offered by Australian government securities with the same term, for a risk-free investment. A)True B)False
Q2) Can the nominal interest rate ever be negative? Can the real interest rate ever be negative? Explain.
Q3) Why, in general, do investment opportunities offer a rate greater than that offered by Australian government securities for the same horizon?
A)Australian government securities are generally considered to be the best alternative to most investments.
B)The opportunity cost of capital for a given horizon is generally based on Australian government securities with that same horizon.
C)The return from Australian government securities generally attracts less tax than the returns from other investments.
D)Most investment opportunities offer far greater risk than those offered by Australian government securities.
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Chapter 6: Bond Valuation
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Sample Questions
Q1) A bond will trade at a discount if its coupon rate is less than its yield to maturity.
A)True
B)False
Q2) Consider a zero-coupon bond with a $1 000 face value and 10 years left until maturity. If the YTM of this bond is 10.4%, then the price of this bond is closest to:
A)$1 040
B)$1 000
C)$372
D)$602
Q3) A bond is currently trading below par. Which of the following must be true about that bond?
A)The bond's yield to maturity is less than its coupon rate.
B)The bond is a zero-coupon bond.
C)The bond's yield to maturity is greater than its coupon rate.
D)B and C above
Q4) Under what situation can a zero-coupon bond be selling at a premium?
Q5) How are the cash flows of a coupon bond different from an amortising loan?
Q6) Under what situation can a zero-coupon bond be selling at par to its face value?
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Chapter 7: Share Valuation: the Dividend-Discount Model
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Sample Questions
Q1) A company can increase its dividend payments by issuing more shares.
A)True
B)False
Q2) Sultan Services has 1.2 million shares outstanding. It expects earnings at the end of the year of $5.6 million. Sultan pays out 60% of its earnings in total-40% paid out as dividends and 20% used to repurchase shares. If Sultan's earnings are expected to grow by 7% per year, these payout rates do not change, and Sultan's equity cost of capital is 9%, what is Sultan's share price?
A)$56.00
B)$93.33
C)$140.00
D)$22.40
Q3) NoGrowth Industries presently pays an annual dividend of $1.70 per share and it is expected that these dividend payments will continue indefinitely. If NoGrowth's equity cost of capital is 14%, then the value of a share of NoGrowth is closest to:
A)$12.00
B)$11.33
C)$11.55
D)$11.00
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Page 9
Chapter 8: Investment Decision Rules
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Sample Questions
Q1) If your new shopping centre will have 160 square metres of retail space available to be leased, to which businesses should you lease and why?
Q2) The present value (PV)of an investment is the difference between the cost of the investment and the benefit of the investment in dollars today.
A)True
B)False
Q3) Personal preferences for cash flow should not affect the decision-making process. A manager should decide based on always maximising the net present value (NPV).
A)True
B)False
Q4) Which of the following decision rules might best be used as a supplement to net present value (NPV)by a firm that favours liquidity?
A)payback period
B)equivalent annual annuity
C)MIRR
D)profitability index
Q5) What is a safe method to use when confronted with mutually exclusive projects?
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Chapter 9: Fundamentals of Capital Budgeting
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Sample Questions
Q1) A maker of computer games expects to sell 500 000 games at a price of $49 per game. These units cost $12 to produce. Selling, general, and administrative expenses are $1.2 million and depreciation is $280 000. What is the EBIT break-even point for the number of games sold in this case?
A)$40 000
B)$24 865
C)$30 192
D)$30 204
Q2) Which of the following statements is FALSE?
A)When evaluating a capital budgeting project, financial managers should make the decision that maximises net present value (NPV).
B)Sensitivity analysis reveals which aspects of the project are most critical when we are actually managing the project.
C)The break-even level of an input is the level for which the investment has an internal rate of return (IRR)of zero.
D)The most difficult part of capital budgeting is deciding how to estimate the cash flows and the cost of capital.
Q3) What are the most difficult parts of 'capital budgeting'?
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11
Chapter 10: Share Valuation: a Second Look
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Sample Questions
Q1) An advantage of the 'valuation multiple method' as compared to the 'discounted cash flow method' is that it takes into account important differences between different firms.
A)True
B)False
Q2) If you want to value a firm but do not want to explicitly forecast its dividends, what is the simplest model for you to use?
A)the dividend-discount model
B)the enterprise value model
C)the discounted free cash flow model
D)None of the above models can be used if you do not want to forecast dividends or use of debt.
Q3) Individual investors trade conservatively, given the difficulty of finding over- and under-valued stocks.
A)True
B)False
Q4) What additional adjustments are required to find the share price, in case we are using the discounted cash flow model?
Q5) 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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Sample Questions
Q1) Greg purchased stock in Cockatoo Limited at a price of $89 per share one year ago. The company was acquired by Wombat Investments at a price of $10 per share. What is Greg's return on his investment?
A)-96.25%
B)-79.00%
C)-88.76%
D)-85.45%
Q2) A portfolio of shares can achieve diversification benefits if the shares that comprise the portfolio are
A)susceptible to common risks only.
B)not perfectly correlated.
C)perfectly correlated.
D)both B and C
Q3) Investments with high returns are expected to have high variability.
A)True
B)False
Q4) Common risk is also called 'correlated risk'.
A)True
B)False
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Chapter 12: Systematic Risk and the Equity Risk Premium
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Sample Questions
Q1) Diversification reduces the risk of a portfolio because share prices do not move identically and some of the risks are averaged out of the portfolio.
A)True
B)False
Q2) 'Correlation' is the degree to which the returns share common risks.
A)True
B)False
Q3) A share market comprises 5 000 shares of company A and 2 000 shares of company B. Assume the share prices for companies A and B are $20 and $35, respectively. What is the capitalisation of the market portfolio?
A)$165 000
B)$170 000
C)$150 000
D)$185 000
Q4) For large portfolios, investors should expect a higher return for higher volatility, but this does not hold true for individual shares.
A)True
B)False
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Chapter 13: The Cost of Capital
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Sample Questions
Q1) The relative proportion of debt, equity and other securities that a firm has outstanding constitute its:
A)current ratio.
B)capital structure.
C)asset ratio.
D)None of the above.
Q2) The WACC depends on the risk of a company's line of business.
A)True
B)False
Q3) Massive Inc shares have a market capitalisation of $55 billion. The company just paid a dividend of $0.35 per share and each share trades for $35. The growth rate in dividends is expected to be 6.5% per year. Also, Massive has $20 billion of debt that trades with a yield to maturity of 7%. If the firm's tax rate is 30%, compute the WACC.
A)7.93%
B)7.45%
C)6.81%
D)6.85%
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Chapter 14: Raising Capital
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Sample Questions
Q1) The cost of issuing an IPO in Australia is higher than most other security issuance fees. A typical spread is
A)4%.
B)5%.
C)6%.
D)7%.
Q2) Suppose you sold the 1.25 million shares to the angel investor for $500 000. What was your percentage ownership in the company immediately following the angel investor's investment?
A)70%
B)73.3%
C)100%
D)75.0%
Q3) What are some of the advantages of going public?
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Page 16
Chapter 15: Debt Financing
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Sample Questions
Q1) Which of the following statements is FALSE?
A)If the call provision offers a cheaper way to retire the bonds, the issuer will forgo the option of purchasing the bonds in the open market and call the bonds instead.
B)To understand how call provisions affect the price of a bond, we first need to consider when an issuer will exercise its right to call the bond.
C)When bond yields have increased, by exercising the call on the callable bond and then immediately refinancing, the issuer can lower its borrowing costs.
D)An issuer can always retire one of its bonds early by repurchasing the bond in the open market.
Q2) Which of the following would be most likely to have the lowest price?
A)A convertible senior bond
B)A straight subordinated bond
C)A callable subordinated bond
D)A straight senior bond
Q3) Private debt can be in the form of bonds.
A)True
B)False
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Page 17
Chapter 16: Capital Structure
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Sample Questions
Q1) Managers should make use of the interest tax shield if the firm has volatility in taxable income.
A)True
B)False
Q2) Market frictions such as corporate taxes affect the firm's value to its investors and hence play a critical role in the firm's choice of capital structure.
A)True
B)False
Q3) MM Proposition I states that in a perfect capital market, the total value of a firm is equal to the market value of the ________ generated by its assets.
A)cash flows after taxes
B)earnings after interest
C)free cash flows
D)earnings after taxes
Q4) The presence of financial distress costs is not sufficient to explain why firms choose debt levels that are too low to exploit the interest tax shield.
A)True
B)False
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Chapter 17: Payout Policy
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Q1) With perfect capital markets, an open market repurchase increases the share price as the number of outstanding shares is decreased.
A)True B)False
Q2) One of the primary difficulties in estimating firm-specific gamma in a dividend imputation system is that the rate of distribution of franking credits is difficult to determine.
A)True B)False
Q3) What is the attitude that most valuation practitioners have to the value of franking credits?
Q4) Repurchases and special dividends are useful for making large and frequent distributions to shareholders.
A)True B)False
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Chapter 18: Financial Modelling and Pro-Forma Analysis
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Sample Questions
Q1) The amount of the decrease in net working capital for Ideko in 2014 was closest to:
A)$4 090
B)$5 230
C)$3 410
D)$4 685
Q2) Is 'total net working capital' or 'incremental net working capital' more relevant for calculation of free cash flow?
Q3) The 'per cent of sales method' relies on the idea that capacity increases are ________, even though in practice such increases are ________.
A)incremental, incremental
B)lumpy, lumpy
C)lumpy, incremental
D)incremental, lumpy
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Chapter 19: Working Capital Management
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Sample Questions
Q1) A 'collection float' is the amount of time it takes for a firm to be able to use funds after a customer has paid for its goods.
A)True
B)False
Q2) A firm has an average accounts payable balance of $180 000. Its average daily cost of goods sold is $12 000. What is the average number of days that the firm takes to pay its debt?
A)2 days
B)15 days
C)8 days
D)21 days
Q3) The amount of cash a firm needs to be able to pay its bills is sometimes referred to as a 'transactions balance'.
A)True
B)False
Q4) Trade credit should always be used when it is offered.
A)True
B)False
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Chapter 20: Option Applications and Corporate Finance
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Sample Questions
Q1) A 'put option' gives the owner the right to ________ an asset at a fixed price at some future date.
A)hold
B)buy
C)sell
D)None of the above.
Q2) Which of the following statements is FALSE?
A)Because an option is a contract between two parties, for every owner of a financial option, there is also an option writer, the person who takes the other side of the contract.
B)There are two kinds of options. European options allow their holders to exercise the option on any date up to and including a final date called the expiration date.
C)When a holder of an option enforces the agreement and buys or sells a share at the agreed-upon price, he is 'exercising the option'.
D)The price at which the holder buys or sells the share when the option is exercised is called the 'exercise price'.
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Chapter 21: Mergers and Acquisitions
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Q1) Which of the following statements is FALSE?
A)The method of payment (cash or shares)affects how the value of the target's assets is recorded for tax purposes and it affects the combined firm's financial statements for financial reporting.
B)Any goodwill created in a merger deal can be amortised for tax purposes over 15 years.
C)The combined firm must mark-up the value assigned to the target's assets on the financial statements by allocating the purchase price to target assets according to their fair market value.
D)Many transactions are carried out as acquisitive reorganisations under the tax law. These structures allow the target shareholders to defer their tax liability on the part of the payment made in acquirer shares but they do not allow the acquirer to step up the book value of the target assets.
Q2) What is a 'white knight'?
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23
Chapter 22: International Corporate Finance
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Q1) Which of the following statements is FALSE?
A)Using a currency swap, a firm can borrow in the market where it has the best access to capital, and then 'swap' the coupon and principal payments to whichever currency it would prefer to make payments in.
B)Currency swaps generally also have final face value payments, also in different currencies.
C)With differential access to national markets, to maximise shareholder value, the firm should raise capital in the foreign market; the method of valuing the foreign project as if it were a domestic project would then provide the correct net present value (NPV).
D)Differential access to national capital markets is common enough that it provides the best explanation for the existence of currency swaps, which are like interest rate swap contracts, but with the holder receiving coupons in one currency and paying coupons denominated in a different currency.
Q2) Australian tax policy allows companies to apply the part of the tax credit that is not used to offset domestic taxes owed, so this extra tax credit is not wasted.
A)True
B)False
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Page 24
Chapter 23: Insurance and Risk Management
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Q1) An operator of an oil rig has a 0.5% chance of experiencing a catastrophic failure. This failure will cost the operator $500 million. If the risk-free rate is 2%, the expected return on the market is 8%, and the beta of the risk is 0, what is the actuarially fair insurance premium?
A)$2 314 815
B)$2 550 000
C)$2 450 980
D)$2 500 000
Q2) Which of the following is an agreement to trade an asset on some future date, at a price that is fixed today?
A)notional contract
B)margin
C)interest rate swap
D)futures contract
Q3) A floating interest rate adjusts to current market conditions.
A)True
B)False
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Page 25